**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

**Form 10-Q**

**(Mark One)**
| x                                                      | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|--------------------------------------------------------|-----------------------------------------------------------------------------------------------|
|                                                   | ** **                                                                                    |
| **For the  quarterly period ended June 30, 2007** |
| ** **                                             |
| **OR**                                                 |
|                                                   |                                                                                          |
| o                                                      | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**Forthe transition period from          to           **

**Commissionfile number: 333-133278**

**KIMBALLHILL, INC.**

(Exact name of Registrant as specified in its charter)

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

 

**(847) 364-7300**

(Registrant’s telephone number, including area code)

**NotApplicable**

(Former name, former address and former fiscal year, if changed sincelast report)

Indicate by check mark whether the Registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorterperiod that the Registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.

xYes o No

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act.(Check one):

oLarge acceleratedfiler                          o Acceleratedfiler                         x Non-accelerated filer

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act).

oYes x No

As of August 3, 2007,there were 4,432,645 shares of common stock outstanding.

 

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**KIMBALL HILL, INC. AND SUBSIDIARIES**

**FORM 10-Q**

**TABLE OFCONTENTS**
|               | ** ** |                                                                                                                              | ** ** | **PAGE** | ** ** |
|---------------|------------|------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
|          |       | PART I—FINANCIAL  INFORMATION                                                                                           |       |     |       |
|          |       |                                                                                                                         |       |     |       |
| Item  1.      |       | Financial  Statements.                                                                                                       |       |     |       |
|          |       |                                                                                                                         |       |     |       |
|          |       | Unaudited  Condensed Consolidated Balance Sheets   as of June 30, 2007 and September 30, 2006                                |       | 3        |       |
|          |       |                                                                                                                         |       |     |       |
|          |       | Unaudited Condensed Consolidated Statements of  Operations   for the Three and Nine Months Ended June 30, 2007 and 2006 |       | 4        |       |
|          |       |                                                                                                                         |       |     |       |
|          |       | Unaudited Condensed Consolidated Statements of Cash  Flows   for the Nine Months Ended June 30, 2007 and 2006           |       | 5        |       |
|          |       |                                                                                                                         |       |     |       |
|          |       | Notes to Unaudited Condensed Consolidated Financial  Statements                                                              |       | 6        |       |
|          |       |                                                                                                                         |       |     |       |
| Item 2.       |       | Management’s Discussion and Analysis of Financial  Condition and   Results of Operations.                               |       | 25       |       |
|          |       |                                                                                                                         |       |     |       |
| Item 3.       |       | Quantitative and Qualitative Disclosures About Market  Risk                                                                  |       | 44       |       |
|          |       |                                                                                                                         |       |     |       |
| Item 4.       |       | Controls and Procedures                                                                                                      |       | 44       |       |
|          |       |                                                                                                                         |       |     |       |
|          |       | PART  II—OTHER INFORMATION                                                                                              |       |     |       |
|          |       |                                                                                                                         |       |     |       |
| Item  1.      |       | Legal  Proceedings                                                                                                           |       | 45       |       |
|          |       |                                                                                                                         |       |     |       |
| Item  1A.     |       | Risk  Factors                                                                                                                |       | 45       |       |
|          |       |                                                                                                                         |       |     |       |
| Item 3.       |       | Defaults Upon Senior Securities                                                                                              |       | 46       |       |
|          |       |                                                                                                                         |       |     |       |
| Item  5.      |       | Other  Information                                                                                                           |       | 46       |       |
|          |       |                                                                                                                         |       |     |       |
| Item 6.       |       | Exhibits                                                                                                                     |       | 49       |       |
|          |       |                                                                                                                         |       |     |       |
| SIGNATURES    |       | 50                                                                                                                           |       |
|          |       |                                                                                                                         |       |     |       |
| EXHIBIT INDEX |       | 51                                                                                                                           |       |

 

 

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**PART I—FINANCIALINFORMATION**

**Item 1.  Financial Statements.**

**KimballHill, Inc. and Subsidiaries**Unaudited Condensed Consolidated Balance Sheets
| ** **                                                                                                                                     | ** ** | **June 30,** | ** ** | **September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|------------------------|------------|
| **(in thousands, except shares)**                                                                                               | ** ** | **2007**          | ** ** | **2006**               | ** ** |
| **Assets**                                                                                                                                     | ** ** | ** **        | ** ** | ** **             | ** ** |
| HOMEBUILDING:                                                                                                                                  |       |              |       |                   |       |
| Cash and cash  equivalents                                                                                                                     |       | $                 | 14,278     |                   | $          | 16,042 |   |
| Receivables                                                                                                                                    |       | 26,792            |       | 35,323                 |       |
| Income taxes  receivable                                                                                                                       |       | 9,356             |       |                   |       |
| Inventory                                                                                                                                      |       | 819,154           |       | 899,297                |       |
| Inventory not  owned                                                                                                                           |       | 38,416            |       | 37,821                 |       |
| Deferred  expenses and other assets                                                                                                            |       | 21,214            |       | 19,229                 |       |
| Investments in  and advances to unconsolidated entities                                                                                        |       | 46,201            |       | 48,238                 |       |
| Deferred income  taxes                                                                                                                         |       | 56,324            |       | 14,133                 |       |
| Property and  equipment, net of accumulated depreciation                                                                                       |       | 10,874            |       | 10,635                 |       |
|                                                                                                                                           |       | 1,042,609         |       | 1,080,718              |       |
| MORTGAGE BANKING:                                                                                                                              |       |              |       |                   |       |
| Cash and cash  equivalents                                                                                                                     |       | 1,555             |       | 2,623                  |       |
| Trade accounts  receivable                                                                                                                     |       | 2,147             |       | 2,319                  |       |
| Mortgage loans  held for sale                                                                                                                  |       | 1,999             |       | 5,663                  |       |
| Property and  equipment, net of accumulated depreciation                                                                                       |       | 229               |       | 254                    |       |
|                                                                                                                                           |       | 5,930             |       | 10,859                 |       |
| TOTAL ASSETS                                                                                                                                   |       | $                 | 1,048,539  |                   | $          | 1,091,577 |   |
|                                                                                                                                           |       |              |       |                   |       |
| **Liabilities and equity**                                                                                                                     | ** ** | ** **        | ** ** | ** **             | ** ** |
| HOMEBUILDING:                                                                                                                                  |       |              |       |                   |       |
| Accounts payable  and accrued expenses                                                                                                         |       | $                 | 76,237     |                   | $          | 106,779 |   |
| Deposits on  sales of residential units                                                                                                        |       | 6,337             |       | 6,333                  |       |
| Liabilities  related to inventory not owned                                                                                                    |       | 5,038             |       | 5,015                  |       |
| Income taxes  payable                                                                                                                          |       |              |       | 3,702                  |       |
| Notes payable                                                                                                                                  |       | 607,059           |       | 500,208                |       |
|                                                                                                                                           |       | 694,671           |       | 622,037                |       |
| MORTGAGE BANKING:                                                                                                                              |       |              |       |                   |       |
| Accounts payable  and accrued expenses                                                                                                         |       | 546               |       | 927                    |       |
| Other  liabilities                                                                                                                             |       | 376               |       | 196                    |       |
|                                                                                                                                           |       | 922               |       | 1,123                  |       |
| Total  liabilities                                                                                                                             |       | 695,593           |       | 623,160                |       |
|                                                                                                                                           |       |              |       |                   |       |
| MINORITY INTEREST IN  CONSOLIDATED PARTNERSHIPS                                                                                                |       | 12,884            |       | 43,244                 |       |
| MINORITY INTEREST IN  INVENTORY NOT OWNED                                                                                                      |       | 31,721            |       | 31,721                 |       |
|                                                                                                                                           |       |              |       |                   |       |
| REDEEMABLE EQUITY:                                                                                                                             |       |              |       |                   |       |
| Redeemable  common stock, no par value; shares outstanding:  155,704 at June 30, 2007 and 228,002 at September 30, 2006                        |       | 9,755             |       | 26,334                 |       |
|                                                                                                                                           |       |              |       |                   |       |
| SHAREHOLDERS’ EQUITY:                                                                                                                     |       |              |       |                   |       |
| Common stock, no  par value; 10,000,000 shares authorized; shares outstanding:  4,276,962 at June 30, 2007 and 4,316,878 at September 30, 2006 |       | 108,386           |       | 111,305                |       |
| Retained  earnings                                                                                                                             |       | 190,200           |       | 255,813                |       |
| Total  shareholders’ equity                                                                                                               |       | 298,586           |       | 367,118                |       |
| TOTAL LIABILITIES AND  EQUITY                                                                                                                  |       | $                 | 1,048,539  |                   | $          | 1,091,577 |   |
|                                                                                                                                           |       |              |       |                   |       |

 

***Seenotes to unaudited condensed consolidated financial statements.***

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**KimballHill, Inc. and SubsidiariesUnaudited Condensed Consolidated Statements of Operations**
| ** **                                                     | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                     | ** ** | **June 30,**                | ** ** | **June 30,**               | ** ** |
| **(in thousands)**                                        | ** ** | **2007**                         | ** ** | **2006**                        | ** ** | **2007** | ** ** | **2006** | ** ** |
| HOMEBUILDING:                                                  |       |                             |       |                            |       |   |   |   |   |
| Revenues:                                                      |       |                             |       |                            |       |   |   |   |   |
| Sales of residential units and land                            |       | $                                | 207,563    |                            | $          | 309,753 |   | $ | 636,345 |   | $ | 762,473 |   |
| Rental and other income                                        |       | 426                              |       | 799                             |       | 1,183 |   | 2,440 |   |
| Total homebuilding revenues                                    |       | 207,989                          |       | 310,552                         |       | 637,528 |   | 764,913 |   |
| Expenses:                                                      |       |                             |       |                            |       |   |   |   |   |
| Cost of sales of residential units and land                    |       | 261,500                          |       | 257,639                         |       | 691,930 |   | 607,119 |   |
| General and administrative                                     |       | 13,691                           |       | 19,620                          |       | 44,441 |   | 61,076 |   |
| Sales and marketing                                            |       | 13,360                           |       | 15,829                          |       | 39,994 |   | 38,673 |   |
| Depreciation                                                   |       | 317                              |       | 208                             |       | 902 |   | 558 |   |
| Total homebuilding expenses                                    |       | 288,868                          |       | 293,296                         |       | 777,267 |   | 707,426 |   |
| Equity in income of unconsolidated joint ventures              |       | 590                              |       | 369                             |       | 1,688 |   | 899 |   |
| Minority interests in net losses of consolidated  partnerships |       | 15,415                           |       | 18                              |       | 15,268 |   | 216 |   |
| Homebuilding (loss) earnings before income taxes               |       | (64,874                          | )          | 17,643                          |       | (122,783 | ) | 58,602 |   |
|                                                           |       |                             |       |                            |       |   |   |   |   |
| MORTGAGE  BANKING:                                             |       |                             |       |                            |       |   |   |   |   |
| Revenues:                                                      |       |                             |       |                            |       |   |   |   |   |
| Gain on sales of mortgage loans                                |       | 1,011                            |       | 2,299                           |       | 4,247 |   | 5,288 |   |
| Interest income                                                |       |                             |       | 1                               |       |   |   | 10 |   |
| Total mortgage banking revenues                                |       | 1,011                            |       | 2,300                           |       | 4,247 |   | 5,298 |   |
| Expenses:                                                      |       |                             |       |                            |       |   |   |   |   |
| General and administrative                                     |       | 1,129                            |       | 1,143                           |       | 3,685 |   | 3,371 |   |
| Interest expense                                               |       |                             |       | 1                               |       |   |   | 7 |   |
| Depreciation                                                   |       | 18                               |       | 21                              |       | 54 |   | 70 |   |
| Total mortgage banking expenses                                |       | 1,147                            |       | 1,165                           |       | 3,739 |   | 3,448 |   |
| Mortgage banking (loss) earnings before income taxes           |       | (136                             | )          | 1,135                           |       | 508 |   | 1,850 |   |
| (LOSS) EARNINGS  BEFORE INCOME TAXES                           |       | (65,010                          | )          | 18,778                          |       | (122,275 | ) | 60,452 |   |
| (BENEFIT)  PROVISION FOR INCOME TAXES                          |       | (24,117                          | )          | 6,813                           |       | (47,171 | ) | 21,942 |   |
| NET (LOSS)  EARNINGS                                           |       | $                                | (40,893    | )                               | $          | 11,965 |   | $ | (75,104 | ) | $ | 38,510 |   |
| ** **                                                     | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |

 

*See notes to unaudited condensedconsolidated financial statements.*

 

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**KimballHill, Inc. and SubsidiariesUnaudited Condensed Consolidated Statements of Cash Flows**
| **For the nine months ended June 30, 2007 and 2006 (in thousands)** | ** ** | **2007** | ** ** | **2006**  | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|-----------|------------|
| **Cash flows from operating  activities:**                                                                                 |       |     |       |      |       |
| Net (loss)  earnings                                                                                                       |       | $        | (75,104    | )         | $          | 38,510 |   |
| Adjustments to  reconcile net (loss) earnings to cash flows from operating activities:                                     |       |     |       |      |       |
| Depreciation                                                                                                               |       | 956      |       | 628       |       |
| Inventory  valuation adjustments                                                                                           |       | 133,721  |       | 3,200     |       |
| Write-off of  land option costs                                                                                            |       | 7,764    |       |      |       |
| Amortization of  deferred expenses                                                                                         |       | 4,921    |       | 3,920     |       |
| Unrealized loss  on derivatives                                                                                            |       | 94       |       |      |       |
| Equity-based  compensation                                                                                                 |       | 616      |       | 616       |       |
| Distributions of  income from investments in unconsolidated entities                                                       |       | 676      |       | 489       |       |
| Net earnings  from investments in unconsolidated entities                                                                  |       | (1,688   | )          | (899      | )          |
| Minority  interest in consolidated losses                                                                                  |       | (15,268  | )          | (216      | )          |
| Deferred income  taxes                                                                                                     |       | (42,191  | )          | 1,671     |       |
| Changes in  operating assets and liabilities:                                                                              |       |     |       |      |       |
| Receivables                                                                                                                |       | 8,703    |       | (1,805    | )          |
| Mortgage loans  held for sale                                                                                              |       | 3,664    |       | (2,434    | )          |
| Inventory                                                                                                                  |       | (53,662  | )          | (167,287  | )          |
| Deferred expenses  and other assets                                                                                        |       | (7,565   | )          | (5,098    | )          |
| Accounts payable  and accrued expenses                                                                                     |       | (30,923  | )          | (579      | )          |
| Deposits and  other liabilities                                                                                            |       | 184      |       | (1,966    | )          |
| Income taxes,  net                                                                                                         |       | (12,898  | )          | (14,666   | )          |
| Net cash used in  operating activities                                                                                     |       | (78,000  | )          | (145,916  | )          |
|                                                                                                                       |       |     |       |      |       |
| **Cash flows from investing  activities:**                                                                                 |       |     |       |      |       |
| Purchases of  property and equipment                                                                                       |       | (1,170   | )          | (6,995    | )          |
| Disposals of  property and equipment                                                                                       |       |     |       | 858       |       |
| Distributions of  contributed capital from investments in unconsolidated entities                                          |       | 3,241    |       | 698       |       |
| Contributions and  advances to investments in unconsolidated entities                                                      |       | (6,830   | )          | (8,460    | )          |
| Net cash used in  investing activities                                                                                     |       | (4,759   | )          | (13,899   | )          |
|                                                                                                                       |       |     |       |      |       |
| **Cash flows from financing  activities:**                                                                                 |       |     |       |      |       |
| Proceeds from  issuance of notes and mortgage loans payable                                                                |       | 269,125  |       | 1,175,356 |       |
| Repayments of  notes and mortgage loans payable                                                                            |       | (162,473 | )          | (996,155  | )          |
| Debt issuance  costs                                                                                                       |       | (850     | )          | (6,598    | )          |
| Net proceeds  from issuance of common stock                                                                                |       | 39       |       | 712       |       |
| Repurchases of  common stock                                                                                               |       | (10,822  | )          | (3,174    | )          |
| Contributions  from minority interests                                                                                     |       | 3,000    |       |      |       |
| Distributions to  minority interests                                                                                       |       | (18,092  | )          | (2,541    | )          |
| Net cash  provided by financing activities                                                                                 |       | 79,927   |       | 167,600   |       |
| **Net (decrease) increase in cash  and cash equivalents**                                                                  |       | (2,832   | )          | 7,785     |       |
| Cash and cash  equivalents—Beginning of period                                                                        |       | 18,665   |       | 21,460    |       |
| Cash and cash  equivalents—End of period                                                                              |       | $        | 15,833     |      | $          | 29,245 |   |
|                                                                                                                       |       |     |       |      |       |
| **Reconciliation to cash and cash  equivalents reported on the condensed  consolidated balance sheets:**                   |       |     |       |      |       |
| Homebuilding                                                                                                               |       | $        | 14,278     |      |       |   |
| Mortgage banking                                                                                                           |       | 1,555    |       |      |       |
| Total                                                                                                                      |       | $        | 15,833     |      |       |   |
|                                                                                                                       |       |     |       |      |       |
| **Supplemental disclosure of cash  flow information:**                                                                     |       |     |       |      |       |
| Cash paid for  interest                                                                                                    |       | $        | 42,259     |      | $          | 34,999 |   |
| Cash paid for  income taxes                                                                                                |       | $        | 7,918      |      | $          | 34,937 |   |
| **Supplemental disclosure of  noncash investing and financing activities:**                                                |       |     |       |      |       |
| Increase in  liabilities related to inventory not owned                                                                    |       | $        | 23         |      | $          | 23,222 |   |
| Increase in inventory  related to lots distributed by unconsolidated entities                                              |       | $        | 6,638      |      |       |   |
| ** **                                                                                                                 |       |     |       |      |       |

 

*See notesto unaudited condensed consolidated financial statements.*

5

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**KimballHill, Inc. and SubsidiariesNotes to Unaudited Condensed Consolidated Financial Statements**

**1.  Basis of Presentation andSignificant Accounting Policies**

The accompanying unaudited condensed consolidatedfinancial statements include the accounts of Kimball Hill, Inc. and all of itswholly-owned, majority-owned and controlled subsidiaries (the “Company”), aswell as certain variable interest entities from which the Company is purchasingland or lots under option agreements and purchase contracts. All significantintercompany accounts, transactions and balances have been eliminated inconsolidation. The unaudited condensed consolidated financial statements havebeen prepared in accordance with accounting principles generally accepted inthe United States of America (“GAAP”) for interim financial information and inaccordance with the instructions to Form 10-Q and Article 10 of Regulation S-X.Such financial statements do not include all of the information and disclosuresrequired by GAAP for complete financial statements. As a result, thesefinancial statements should be read in conjunction with the auditedconsolidated financial statements and accompanying notes for the fiscal yearended September 30, 2006 in the Company’s Annual Report on Form 10-K. In theopinion of management, all adjustments (consisting of normal, recurringaccruals) necessary for fair presentation have been included in theaccompanying financial statements.

***Seasonal Variability andHomebuilding Industry Downturn—***Historically, thehomebuilding industry has experienced seasonal fluctuations; therefore, theoperating results for the three month and nine month periods endedJune 30, 2007 are not necessarily indicative of the results that may beexpected for the fiscal year ending September 30, 2007. Inventory impairmentcharges, described further in note 2, have also impacted the Company’soperating results for the three and nine months ended June 30, 2007. Dueto the deterioration in market conditions for new home sales and the resultingdecline in the Company’s operating performance, the Company has amended certaincovenants in its senior credit facility in December 2006 and most recentlyin August 2007. See notes 5 and 11 for a description of the amendmentsto the senior credit facility.

***Stock Plans******—******Effective October 1, 2006, theCompany adopted SFAS 123R,******Share-BasedPayment******, which requires that the costresulting from all share-based payment transactions be recognized in thefinancial statements and establishes fair value as the measurement objective inaccounting for share-based payment arrangements. SFAS 123R applies to allawards granted, modified, repurchased or cancelled by the Company after theeffective date of adoption. The Company has not granted, modified, repurchasedor cancelled any awards since the effective date. Since the Company previouslyused the minimum value method under SFAS***123, *Accounting for Stock-Based Compensation*, the Company willcontinue to account for any portion of awards outstanding at October 1, 2006using the accounting principles originally applied to those awards.

During fiscal 2005, the Company granted 37,500deferred stock units, representing a right to receive 37,500 shares of theCompany’s common stock at a future date. Under the terms of the agreement,one-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 earlierof: a) the fifth anniversary of the date of grant, b) the executive’sseparation of service, c) the executive’s death or disability, or d) a changein control. Each period, the Company recognizes compensation cost, for therelative service period covered, equal to the market value of the underlyingcommon shares of the Company on the date of grant. During the three months andnine months ended June 30, 2007 and 2006, compensation cost of $0.2 million and$0.6 million related to deferred stock units is included in the Company’scondensed consolidated statements of operations.

***Redeemable Common Stock******—***Under the terms ofthe Company’s amended stock option plans, the Company has contractualobligations to purchase shares of its outstanding common stock at fair valuefrom certain of its directors, executive officers and other key employees inthe event of termination of board membership or employment, as applicable, byreason of specified circumstances, including death, disability, involuntarytermination or retirement.

At the time outstanding shares qualify for thisredemption right, the redemption amount is transferred from shareholders’equity to redeemable common stock. Subsequent changes to the redemption amountare transferred from shareholders’ equity to redeemable common stock in thecase of an increasing redemption amount, or, from redeemable common stock toshareholders’ equity in the case of a decreasing redemption amount. Certainoutstanding options would qualify for this redemption right after exercise ofthe options.

6

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Based upon the most recent independent valuation of theCompany as of June 30, 2007, the fair value of redeemable common stock wasvalued at $62.65 per share.

***Derivative Financial Instruments******—***The Company uses best-efforts and mandatory salescommitments to hedge 100% of its mortgage loans held for sale from anunexpected charge due to a decline in value and uses interest rate capagreements to protect a portion of its homebuilding borrowings from sharpincreases in short-term interest rates. The derivatives are carried at fairvalue with the changes in fair value recorded to current earnings.

In November 2006, the Companyentered into a two year interest rate cap agreement to protect $100 million ofits borrowings. Under the terms of the agreement the LIBOR rate is capped at5.5% per annum.

**2.  Inventory**

Inventory consists of the following:
| ** **                                             | ** ** | **June 30,** | ** ** | **September 30,** | ** ** |
|--------------------------------------------------------|------------|-------------------|------------|------------------------|------------|
| **(in thousands)**                                | ** ** | **2007**          | ** ** | **2006**               | ** ** |
| Residential  lots—developed and under development |       | $                 | 452,607    |                   | $          | 581,701 |   |
| Finished homes  and construction in progress           |       | 285,058           |       | 262,392                |       |
| Deposits on land  purchases                            |       | 8,951             |       | 15,499                 |       |
| Land held for  future development or sale              |       | 72,538            |       | 39,705                 |       |
| Total                                                  |       | $                 | 819,154    |                   | $          | 899,297 |   |
|                                                   |       |              |       |                   |       |

 

***In accordance with Statement of Financial AccountingStandards No. 144,******Accountingfor the Impairment or Disposal of Long-Lived Assets******(“SFAS 144”), the***Company assesses housing projects, land held for development and sale, andproperty and equipment for recoverability whenever events or changes incircumstances indicate that the carrying amount of an asset may not berecoverable. Due to the continued deterioration in market conditions, thenational homebuilding climate and the Company’s expectations regarding therecoverability of certain assets, the Company reviewed all of its inventory forimpairment in connection with the preparation of the accompanying unauditedcondensed consolidated financial statements and recorded inventory impairmentcharges of $81.3 million and $133.7 million during the three and ninemonths ended June 30, 2007. The Company recorded $0.2 million and $3.2 millionof inventory impairment charges during the three and nine months ended June 30,2006 related to the Company’s decision to exit the Cleveland market. Thesecharges are included in cost of sales in the accompanying condensedconsolidated statements of operations.

For purposes of measuring impairment, SFAS 144distinguishes between long-lived assets held for sale and long-lived assets tobe held and used. Long-lived assets held for sale should be reported at thelower 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 berecoverable from future undiscounted cash flows should be reported at the lowerof the carrying amount or fair value.

The Company’s current operating strategy includesselling certain land inventory to: increase its liquidity and pay down debt,adjust the balance of its land holdings by region and reduce its overallinvestment in land. ***TheCompany has identified certain land parcels it intends to sell and is activelymarketing the properties for delivery within the next 12 months.******As of June 30, 2007,the Company has $71.6 million of land inventory that is held for sale. Forpurposes of these impairment calculations, the Company determined the fairvalue of each asset held for sale by using internal project modeling softwareto determine the present value of the estimated future cash flows on acommunity-by-community basis using discount rates which are commensurate withthe risk of the community and by comparing to recent comparable land sales andrecent discussions with land brokers and potential buyers. The Company recordedan impairment charge of $9.9 million and $35.3 million on land held for saleduring the three and nine months ended June 30, 2007.***

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***For purposes of impairment calculations on assets to be heldand used, the Company determined the fair value of each asset to be held andused by using internal project modeling software to determine the present valueof the estimated future cash flows on a community-by-community basis usingdiscount rates which are commensurate with the risk of the community and bycomparing to recent comparable land sales. The Company recorded an impairmentcharge on housing projects where the Company intends to construct and sellhomes************of $71.4 million and $98.4 millionduring the three and nine months ended June 30, 2007.***

***The largest homebuilding project reviewed is in the Midwestregion where the Company is developing land and currently intends to constructand sell approximately 1,200 homes over the next 6 years. Due to the project’soverall size, timeline and complexity and the project’s limited experience todate, its estimates of future recoverability are sensitive to management’sjudgments and expectations of future market conditions. The Company’s currentprojection of cash flows from this project was updated as of June 30, 2007based on recent results of this project and current market conditions and itwas determined that the related inventory was not recoverable and as such theCompany recorded an impairment charge of $38.1 million during the three andnine months ended June 30, 2007 on the project. This project is a consolidatedmajority-owned and controlled subsidiary. A loss of approximately $15 millionhas been allocated to the project’s minority interest partner and is includedwithin the Company’s condensed consolidated statements of operations for thethree and nine months ended June 30, 2007. The project’s total inventorybalance reduced to approximately $42.5 million at June 30, 2007.***

***In addition, the Company is obligated to purchase additionalland in this project,************for approximately $42 million atvarious dates beginning in June 2009, on which it intends to construct and sellan additional 1,500 homes. The future purchase of land has been consolidated inaccordance with FIN 46R at its initial fair value of $31.7 million. The Company’scurrent projections of cash flows from this future purchase of land showpositive undiscounted cash flows and as such no impairment charges have beenrecorded on the future purchase of land in this project.***

***These evaluations for impairment are significantly impactedby estimates of revenues, costs and expenses and other factors. The Companywill continue to monitor the homebuilding climate in each of its markets andcould change its intentions about whether to continue homebuilding activitiesrelated to any assets in the future. Changes in the Company’s intentions or itsexpectations of market performance could have a material impact on the carryingvalue of its assets as certain of the assets determined to be recoverable on anundiscounted cash flow basis may have carrying values greater than fair value.***

Given the continued deterioration in market conditionsand uncertainty about the timing and pace of any recovery, the Company hastightened its land acquisition criteria and is working with land sellers torenegotiate land purchase and option contracts to extend purchase dates andreduce purchase prices. If the Company is unable to obtain satisfactory terms,the Company will not exercise its land option agreements and will abandon itsearnest money if contractually obligated to do so. During the three and ninemonths ended June 30, 2007, the Company wrote-off $0.3 million and $7.8 millionof costs related to the abandonment of land option contracts.

The Company capitalizes interestduring development and construction. Capitalized interest is charged to cost ofsales as residential units are closed. Interest costs for the three and ninemonths ended June 30, 2007 and 2006 are as follows:
| ** **                                     | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                     | ** ** | **June  30**,                    | ** ** | **June  30,**                   | ** ** |
| **(in thousands)**                        | ** ** | **2007**                         | ** ** | **2006**                        | ** ** | **2007** | ** ** | **2006** | ** ** |
| Capitalized  interest—beginning of period |       | $                                | 66,126     |                            | $          | 50,214 |   | $ | 59,409 |   | $ | 40,076 |   |
| Interest  incurred                             |       | 12,646                           |       | 14,877                          |       | 35,844 |   | 36,158 |   |
| Interest  included in cost of sales            |       | (8,957                           | )          | (9,445                          | )          | (25,438 | ) | (20,588 | ) |
| Capitalized  interest—end of period       |       | $                                | 69,815     |                            | $          | 55,646 |   | $ | 69,815 |   | $ | 55,646 |   |
|                                           |       |                             |       |                            |       |   |   |   |   |

 

** **

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** **

**3*.* **Inventory Not Owned

In December 2003, the Financial AccountingStandards Board (“FASB”) issued FIN 46R, *Consolidation of VariableInterest Entities*. Under FIN 46R, a variable interest entity (“VIE”)is created when (i) the equity investment at risk is not sufficient topermit the entity to finance its activities without additional subordinatedfinancial 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 theentity, if they occur. FIN 46R requires the consolidation of VIEs in which anenterprise absorbs a majority of the entity’s expected losses, receives amajority of the entity’s expected residual returns, or both, as a result ofownership, contractual or other financial interests in the entity.

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

At June 30, 2007, the Company has consolidatedoptioned land with an initial fair value of $38.4 million for which it paidcash option deposits of $1.7 million. The Company estimated the initial fairvalue of the consolidated optioned land based upon the Company’s optioncontract price. In many cases, the Company was unable to obtain the relevantfinancial information from the selling entities, therefore, the Company hasused the information available to make an assumption as to whether the sellingentity has additional assets or has debt obligations outstanding. Thedifference between the fair value of the land under contract and the Company’snon-refundable deposit is recorded in liabilities related to inventory notowned unless it is determined by the Company that the selling entity does notcarry debt in which case the difference is recorded as minority interest ininventory not owned.

**4.  Investments In and Advancesto Unconsolidated Entities**

Investments in and advances to unconsolidated entitiesrepresent the Company’s ownership interest in entities accounted for under theequity method when it has a significant influence over the entity but holdsless than a controlling interest in the entity or it is not the primarybeneficiary in a VIE as defined by FIN 46R. The Company’s business partnersgenerally are unrelated homebuilders, land sellers or other real estateentities.

In the ordinary course of business, the Companyperiodically enters into arrangements with land developers or otherhomebuilders to acquire land and develop lots. These arrangements include thecreation of joint ventures, in which the Company’s current interests range from6% to 49%. The Company accounts for its interest in these joint ventures underthe equity method, and the Company’s condensed consolidated balance sheetsinclude investments in joint ventures totaling $46.2 million and $48.2 millionat June 30, 2007 and September 30, 2006, respectively. These joint venturestypically obtain secured acquisition, development and construction financing.At June 30, 2007 and September 30, 2006, the Company’s unconsolidated jointventures had outstanding third party borrowings of $908 million and $865million, respectively. From time to time the Company has issued repaymentguarantees and/or loan-to-value maintenance guarantees in respect of thisindebtedness. These guarantees require the Company to repay debt of the jointventure in the event of a payment default or in the event that the debt of thejoint venture exceeds the value of the property securing the debt. At June 30,2007 and September 30, 2006, the Company had guarantees of $98.8 million and$74.3 million, respectively, related to the outstanding indebtedness of thesejoint ventures.

** **

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** **

**5.  Financing**

***Homebuilding***

The Company’s notes payable consist of the following:
| ** **                                               | ** ** | **June 30,** | ** ** | **September 30,** | ** ** |
|----------------------------------------------------------|------------|-------------------|------------|------------------------|------------|
| **(in thousands)**                                  | ** ** | **2007**          | ** ** | **2006**               | ** ** |
| Senior  subordinated notes (net of unamortized discount) |       | $                 | 200,949    |                   | $          | 200,750 |   |
| Senior credit  facility                                  |       | 357,759           |       | 244,947                |       |
| Other senior  secured credit facilities                  |       | 48,351            |       | 54,511                 |       |
| Total                                                    |       | $                 | 607,059    |                   | $          | 500,208 |   |
|                                                     |       |              |       |                   |       |

 

In December 2005, the Company issued $203 millionaggregate principal amount of senior subordinated notes due December 2012 in aprivate placement pursuant to Rule 144A promulgated under the Securities Act of1933. In May 2006, the Company exchanged all of the senior subordinated notesissued in the private placement for an issue of notes registered with the SECwith terms substantially identical to the notes issued in the privateplacement. The senior subordinated notes were sold at 98.796% of par and accrueinterest at a coupon rate of 10.5% per annum. Interest is paid semi-annually inJune and December. The net proceeds were used to repay amounts outstandingunder working capital loans and certain senior secured revolving creditfacilities. The Company may redeem the notes, in whole or part, at any time onor after December 15, 2009, at a redemption price equal to 100% of theprincipal 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 thenotes with the proceeds of qualified equity offerings at a redemption priceequal to 110.5% of the principal amount, plus accrued and unpaid interest. Inaddition, if the Company experiences specific kinds of changes of control, theCompany is required to make an offer to purchase all of the notes at a purchaseprice of 101% of the principal amount thereof, plus accrued and unpaidinterest. The notes are unsecured senior subordinated obligations andsubordinated in right of payment to all of the Company’s existing and futuresenior debt, including borrowings under the Company’s senior credit facilitydescribed below and in note 11. All of the Company’s wholly owned subsidiaries,other than the Company’s mortgage subsidiary, have fully and unconditionallyguaranteed the notes on a joint and several, unsecured senior subordinated,basis. The guarantees are general unsecured obligations of the guarantors andwill be subordinated in right of payment to all existing and future senior debtof the guarantors, which includes their guarantees of the Company’s seniorcredit facility. The indenture governing the senior subordinated notes containsa number of significant covenants that could restrict the Company’s ability andthat of its restricted subsidiaries to, among other things: incur additionalindebtedness, make certain distributions, investments and other restrictedpayments, create certain liens, enter into transactions with affiliates, andmerge, consolidate or sell substantially all of the Company’s assets. As ofJune 30, 2007, the Company was restricted from incurring additionalindebtedness (excluding available borrowings under the senior credit facility),except under certain limited circumstances.

In December 2005, the Company entered into a newsenior credit facility to finance its business operations. Proceeds of the newsenior credit facility were used to retire its existing senior securedrevolving credit facilities and substantially all of its other senior securedcredit facilities. The senior credit facility has a maximum availability of$500 million, subject to a borrowing base as well as sublimits of $100 millionfor the issuance of letters of credit and $10 million for swing line loans. TheCompany has the right, without the consent of its lenders (other than thoseparticipating in the increase), to increase the commitment by an amount of upto $200 million, provided that no such increase shall cause the senior creditfacility to exceed $700 million. The applicable borrowing base will bedetermined regularly throughout the life of the senior credit facility. Thecomposition of the borrowing base will be limited to parameters set forth inthe senior credit facility agreement and certain types of real estate (such as 

 

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unimproved entitled land and lots under development)will be removed from the borrowing base if held beyond specified maturitydates. Borrowings under the senior credit facility will generally bear interestbased on an applicable margin plus LIBOR or an alternate base rate. Theapplicable margin for interest ranges from 1.5% to 2.25%, depending upon theCompany’s senior leverage ratio, which is defined as the ratio of totalliabilities to consolidated net worth. Fees for letters of credit are based onLIBOR plus a margin of 1.5%. An unused commitment fee equal to 0.2% to 0.3% peryear accrues on the undrawn portion of the senior credit facility and ispayable quarterly in arrears.

In December 2006, the Company amended certaincovenants in the senior credit facility. The amended covenants require theCompany to: maintain a minimum tangible net worth of at least $300 million plus50% of positive net income earned subsequent to September 30, 2006; maintain aratio of total liabilities to adjusted tangible net worth not to exceed 2.0x(decreasing to 1.75x as of June 30, 2007 and increasing to 2.5x as of December31, 2008); maintain a ratio of total debt to adjusted tangible net worth not toexceed 1.5x; maintain a ratio of total land (including undeveloped land, landunder development and finished lots on which home construction has yet tobegin) to adjusted tangible net worth not to exceed 1.5x; and maintain aninterest coverage ratio of no less than 1.75x through December 31, 2006(decreasing to 1.5x through March 31, 2007, decreasing to 1.4x through June 30,2007, decreasing to 1.35x through September 30, 2007, increasing to 1.5xthrough December 31, 2007, increasing to 1.75x through March 31, 2008 and thenincreasing to 2.25x through the remaining term of the senior credit facility).For purposes of these tests, adjusted tangible net worth is benefited byadjustments of 50% of the Company’s outstanding senior subordinated debt (up toa maximum $100 million adjustment) and 100% of minority interests inconsolidated entities (up to a maximum $50 million adjustment). As of June 30,2007, the Company had $358 million of borrowings under the senior creditfacility at an effective rate of 7.09% and, after giving effect to theborrowing base limitation, had additional availability of $110 million. TheCompany’s obligations under the senior credit facility are guaranteed by all ofits wholly-owned subsidiaries, other than the Company’s mortgage subsidiary,and are subject to a number of customary financial and operating covenants.

As of and during the three and nine months ended June30, 2007, the Company was in compliance with the covenants of this seniorcredit facility with the exception that the Company’s speculative housing unitsin its Nevada region were in excess of the amount allowed under the seniorcredit facility. In August 2007, the Company amended and restated this seniorcredit facility. The amendment and restatement provides a waiver to thelimitation on speculative housing units allowed from June 30, 2007 untilSeptember 1, 2007. See note 11 for additional information related to theCompany’s amended and restated senior credit facility.

**6.  Commitments and Contingencies**

In the normal course of business, the Company acquiresrights under option agreements to purchase land for future development and/ordeveloped lots. The agreements generally are contingent upon municipalityapprovals. As of June 30, 2007, the Company has rights, under such agreements,to purchase approximately 7,500 lots, within 33 separate developments,with an aggregate contract price of $315 million. Approximately 1,600 ofthe lots contain specific performance requirements, with an aggregate purchaseprice of $44 million, of which the Company is obligated to pay $2 millionwithin the next twelve months and the remaining $42 million at various datesbeginning in June 2009. Approximately 1,800 of the lots, with an aggregatepurchase price of $145 million, are to be purchased from joint ventures inwhich the Company has an investment balance of $34 million as of June 30, 2007.This investment is recorded in investments in and advances to unconsolidatedentities on the condensed consolidated balance sheets.

At June 30, 2007, excluding inventory not owned (seenote 3), the Company was contingently liable to banks and financialinstitutions for approximately $49 million for outstanding letters of creditand performance bonds securing performance of certain contractual obligationsand land option contracts.

 

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Under the terms of theCompany’s amended stock option plans, the Company has contractual obligationsto purchase shares of its common stock, including shares issuable underoutstanding options, from certain of its directors, executive officers andother key employees in the event of termination of board membership oremployment, as applicable, by reason of specified circumstances, includingdeath, disability, involuntary termination or retirement. As of June 30, 2007,the Company’s aggregate repurchase obligation, net of proceeds to be receivedfrom any stock option exercises, would have been approximately $17.4 million inthe event that all of these obligations were triggered. The Company’s abilityto satisfy its repurchase obligations is subject to certain limitations setforth in the Trust Indenture governing the senior subordinated notes issued bythe Company.

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

The Company provides product warranties to itscustomers covering workmanship, materials, and certain mechanical systems fortwo years, and structural systems for ten years. The Company estimates andrecords warranty liabilities based on historical experience and known risks atthe time a home closes, and in the case of unexpected claims, upon identificationand quantification of the obligations. The Company’s warranty accrual isincluded in accounts payable and accrued expenses in its condensed consolidatedbalance sheets. Changes in the Company’s warranty liability for the three andnine months ended June 30, 2007 and 2006 are as follows:
| ** **                         | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                         | ** ** | **June 30,**                | ** ** | **June 30,**               | ** ** |
| **(in thousands)**            | ** ** | **2007**                         | ** ** | **2006**                        | ** ** | **2007** | ** ** | **2006** | ** ** |
| Balance at  beginning of period    |       | $                                | 5,194      |                            | $          | 6,338 |   | $ | 5,798 |   | $ | 5,844 |   |
| Warranties  issued                 |       | 739                              |       | 1,793                           |       | 2,535 |   | 4,628 |   |
| Settlements and  other adjustments |       | (1,240                           | )          | (1,466                          | )          | (3,640 | ) | (3,807 | ) |
| Balance at end  of period          |       | $                                | 4,693      |                            | $          | 6,665 |   | $ | 4,693 |   | $ | 6,665 |   |
|                               |       |                             |       |                            |       |   |   |   |   |

 

At June 30, 2007, the Company was committed to fundapproximately $30.4 million in mortgage loans to homebuyers at agreed-uponrates. The Company has entered into best-efforts and mandatory salecommitments to sell these mortgages to third parties.

**7.**   SegmentInformation and Concentrations

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

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

The Company’s corporate departments provide certainservices that are advantageous to perform in a centralized manner, givencertain cost efficiencies or required technical expertise. The Company’scorporate functions include: financial analysis, human resources, informationtechnology, legal, planning, risk management, sales training, 

 

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strategic marketing and treasury. Only corporate coststhat are deemed to directly benefit certain operating segments are allocated tothose operating segments.

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

Florida

Midwest: Illinois, Ohio and Wisconsin

Nevada

Pacific Coast: California, Oregon and Washington

Texas

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

The following tables illustrate the revenue, earningsbefore income taxes and assets of the Company’s reportable segments. Includedare reconciliations to the amounts reported in the condensed consolidatedfinancial statements.
|                                       | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                            | ** ** | **June 30,**                | ** ** | **June 30,**               | ** ** |
| **Revenues (in thousands)** | ** ** | **2007**                         | ** ** | **2006**                        | ** ** | **2007** | ** ** | **2006** | ** ** |
| Florida                               |       | $                                | 15,964     |                            | $          | 28,104 |   | $ | 61,619 |   | $ | 72,903 |   |
| Midwest                               |       | 33,936                           |       | 76,720                          |       | 113,264 |   | 159,611 |   |
| Nevada                                |       | 38,146                           |       | 44,671                          |       | 128,588 |   | 105,161 |   |
| Pacific Coast                         |       | 39,256                           |       | 71,523                          |       | 108,527 |   | 215,325 |   |
| Texas                                 |       | 76,583                           |       | 89,352                          |       | 212,626 |   | 210,498 |   |
| Mortgage banking                      |       | 1,011                            |       | 2,300                           |       | 4,247 |   | 5,298 |   |
| Segment revenue  subtotal             |       | 204,896                          |       | 312,670                         |       | 628,871 |   | 768,796 |   |
| Corporate and  unallocated (a)        |       | 463                              |       | 182                             |       | 696 |   | 1,415 |   |
| GAAP adjustment (b)                   |       | 3,641                            |       |                            |       | 12,208 |   |   |   |
| Consolidated  revenues                |       | $                                | 209,000    |                            | $          | 312,852 |   | $ | 641,775 |   | $ | 770,211 |   |
|                                  |       |                             |       |                            |       |   |   |   |   |

 

(a)       Corporate and unallocated includesrental and other income where the asset was held in the Company’s corporatedepartment rather than one of the Company’s operating segments.

(b)       The GAAP adjustment is for certainclosing costs and brokers commissions that are included as reductions torevenue in the Company’s internal measurement system that are reported asexpenses in accordance with GAAP.

 

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| ** **                                                                           | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                           | ** ** | **June 30,**                | ** ** | **June 30,**               | ** ** |
| **(Loss) Earnings Before Income Taxes (in thousands)** | ** ** | **2007**                         | ** ** | **2006**                        | ** ** | **2007** | ** ** | **2006** | ** ** |
| Florida                                                                              |       | $                                | (10,310    | )                               | $          | 6,703 |   | $ | (19,812 | ) | $ | 9,262 |   |
| Midwest                                                                              |       | (52,165                          | )          | 3,142                           |       | (70,876 | ) | 425 |   |
| Nevada                                                                               |       | 3,978                            |       | 10,041                          |       | 30,084 |   | 27,547 |   |
| Pacific Coast                                                                        |       | (13,585                          | )          | 17,953                          |       | (40,291 | ) | 62,924 |   |
| Texas                                                                                |       | (1,054                           | )          | 4,487                           |       | 3,969 |   | 9,781 |   |
| Mortgage banking                                                                     |       | (136                             | )          | 1,135                           |       | 508 |   | 1,850 |   |
| Segment (loss)  earnings before income taxes subtotal                                |       | (73,272                          | )          | 43,461                          |       | (96,418 | ) | 111,789 |   |
| Corporate and  unallocated                                                           |       | (4,397                           | )          | (9,011                          | )          | (18,108 | ) | (31,698 | ) |
|                                                                                 |       | (77,669                          | )          | 34,450                          |       | (114,526 | ) | 80,091 |   |
| Homebuilding  interest expense                                                       |       | (8,957                           | )          | (9,445                          | )          | (25,438 | ) | (20,588 | ) |
| GAAP adjustment(c)                                                                   |       | 21,616                           |       | (6,227                          | )          | 17,689 |   | 949 |   |
| Consolidated  (loss) earnings before income taxes                                    |       | $                                | (65,010    | )                               | $          | 18,778 |   | $ | (122,275 | ) | $ | 60,452 |   |
|                                                                                 |       |                             |       |                            |       |   |   |   |   |

 

(c)       Included in the GAAP adjustment are (i)timing differences for certaincapitalizable indirect construction costs that are expensed as incurred in theCompany’s internal measurement system and (ii)minority interest expense which is not included in the Company’s internalmeasurement system.
| ** **                          | ** ** | **June 30,** | ** ** | **September 30,** | ** ** |
|-------------------------------------|------------|-------------------|------------|------------------------|------------|
| **Assets (in thousands)** | ** ** | **2007**          | ** ** | **2006**               | ** ** |
| Florida                             |       | $                 | 78,004     |                   | $          | 91,226 |   |
| Midwest                             |       | 218,757           |       | 267,519                |       |
| Nevada                              |       | 245,230           |       | 224,331                |       |
| Pacific Coast                       |       | 142,081           |       | 181,289                |       |
| Texas                               |       | 176,007           |       | 197,604                |       |
| Mortgage banking                    |       | 5,930             |       | 10,859                 |       |
| Segment assets  subtotal            |       | 866,009           |       | 972,828                |       |
| Corporate and  unallocated          |       | 182,530           |       | 118,749                |       |
| Consolidated assets                 |       | $                 | 1,048,539  |                   | $          | 1,091,577 |   |
|                                |       |              |       |                   |       |

 

**8.  Recent AccountingPronouncements**

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

In September 2006, the FASB issued SFASNo. 157, *Fair Value Measurements*(“SFAS157”), which defines fair value, establishes a framework for measuring fairvalue in generally accepted accounting principles and expands disclosure aboutfair value measurements. SFAS 157 is effective for financial statements issuedfor fiscal years beginning after November 15, 2007, and interim periods withinthose fiscal years. The Company is in the process of determining the effect, ifany, the adoption of SFAS 157 will have on its financial statements.

In September 2006, the SEC issued StaffAccounting Bulletin No. 108, *Considering the Effects ofPrior Year Misstatements when Quantifying Misstatements in Current YearFinancial Statements*(“SAB 108”), which provides guidance as to howthe effects on prior year uncorrected misstatements should be considered whenquantifying misstatements in the current financial statements. SAB 108 wasissued in order to eliminate the diversity of practice 

 

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surrounding how public companies quantify financialstatement misstatements. SAB 108 will require the Company to quantifymisstatements using both a balance sheet and income statement approach, withadjustment required if either method results in a material error. SAB 108 iseffective for financial statements issued for fiscal years beginning afterNovember 15, 2006. The Company is in the process of determining the effect, ifany, the adoption of SAB 108 will have on its financial statements.

In February 2007, the FASB issued SFASNo. 159, *The Fair Value Option for Financial Assetsand Financial Liabilities, including an amendment of FASB Statement No. 115*(“SFAS159”). SFAS 159 permits a company to measure certain financial instruments andother items at fair value. SFAS 159 is effective for financial statementsissued for fiscal years beginning after November 15, 2007. The Company is inthe process of determining the effect, if any, the adoption of SFAS 159 willhave on its financial statements.

**9.  Related Party Transactions**

In January 2007, the Company sold its ownershipinterest in a San Jose, California high-rise residential real estate project toan entity controlled by the Company’s Chairman and Chief Executive Officer for$2.9 million, which was equal to the Company’s total financial investment inthe project. This transaction was approved by the Company’s board of directors.

In two separate transactions during March 2007, theCompany purchased developed lots from two consolidated joint ventures at fairmarket value in accordance with the underlying joint venture agreements. Afterclosing the transaction, the consolidated joint ventures distributed $25.8million in accordance with the joint venture agreements to an entity thatindirectly owns approximately 21% of the Company’s issued and outstandingcommon stock as of June 30, 2007.

**10. **SummarizedFinancial Information

The Company’s senior subordinated notes and amendedand restated 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. TheCompany’s mortgage subsidiary and majority owned and controlled subsidiariesare non-guarantors (“Non-Guarantor Subsidiaries”) of the senior subordinatednotes and the senior credit facility. In lieu of providing separate financialstatements for the Guarantor Subsidiaries, consolidated condensed financialstatements are presented below. Separate financial statements and other disclosuresconcerning the Guarantor Subsidiaries are not presented because management hasdetermined that they are not material to investors.

 

15

----

** **
| **As of June  30, 2007**

**(in thousands)** | ** ** | **Parent** | ** ** | **Guarantor**

**Subsidiaries** | ** ** | **Non-Guarantor**

**Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------------------|------------|------------|------------|---------------------------------|------------|-------------------------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                                       | ** ** | ** ** | ** ** | ** **                      | ** ** | ** **                          | ** ** | ** **       | ** ** | ** **       | ** ** |
| HOMEBUILDING:                                                    |       |       |       |                            |       |                                |       |             |       |             |       |
| Cash and cash equivalents                                        |       | $          | 2,474      |                            | $          | 11,754                              |       | $                | 50         |             | $          | — |   | $ | 14,278 |   |
| Receivables                                                      |       |       |       | 26,792                          |       |                                |       |             |       | 26,792           |       |
| Income taxes receivable                                          |       | 9,356      |       |                            |       |                                |       |             |       | 9,356            |       |
| Inventory                                                        |       |       |       | 758,082                         |       | 61,072                              |       |             |       | 819,154          |       |
| Inventory not owned                                              |       |       |       | 38,416                          |       |                                |       |             |       | 38,416           |       |
| Deferred expenses and other assets                               |       | 8,958      |       | 12,219                          |       | 37                                  |       |             |       | 21,214           |       |
| Investments in and advances to unconsolidated  entities          |       |       |       | 46,201                          |       |                                |       |             |       | 46,201           |       |
| Deferred income taxes                                            |       | 56,324     |       |                            |       |                                |       |             |       | 56,324           |       |
| Property and equipment, net of accumulated  depreciation         |       | 8,341      |       | 2,533                           |       |                                |       |             |       | 10,874           |       |
| Investments in subsidiaries                                      |       | 229,003    |       | 1,704                           |       |                                |       | (230,707         | )          |             |       |
|                                                             |       | 314,456    |       | 897,701                         |       | 61,159                              |       | (230,707         | )          | 1,042,609        |       |
| MORTGAGE BANKING                                                 |       |       |       |                            |       | 5,930                               |       |             |       | 5,930            |       |
| TOTAL ASSETS                                                     |       | $          | 314,456    |                            | $          | 897,701                             |       | $                | 67,089     |             | $          | (230,707 | ) | $ | 1,048,539 |   |
| **Liabilities  and equity**                                      | ** ** | ** ** | ** ** | ** **                      | ** ** | ** **                          | ** ** | ** **       | ** ** | ** **       | ** ** |
| HOMEBUILDING:                                                    |       |       |       |                            |       |                                |       |             |       |             |       |
| Accounts payable and accrued expenses                            |       | $          | 179        |                            | $          | 76,034                              |       | $                | 24         |             | $          | — |   | $ | 76,237 |   |
| Deposits on sales of residential units                           |       |       |       | 6,192                           |       | 145                                 |       |             |       | 6,337            |       |
| Liabilities related to inventory not owned                       |       |       |       | 5,038                           |       |                                |       |             |       | 5,038            |       |
| Notes payable                                                    |       | 573,769    |       |                            |       | 33,290                              |       |             |       | 607,059          |       |
| Intercompany                                                     |       | (567,833   | )          | 550,364                         |       | 17,469                              |       |             |       |             |       |
|                                                             |       | 6,115      |       | 637,628                         |       | 50,928                              |       |             |       | 694,671          |       |
| MORTGAGE BANKING                                                 |       |       |       |                            |       | 922                                 |       |             |       | 922              |       |
| Total liabilities                                                |       | 6,115      |       | 637,628                         |       | 51,850                              |       |             |       | 695,593          |       |
|                                                             |       |       |       |                            |       |                                |       |             |       |             |       |
| MINORITY  INTEREST IN CONSOLIDATED PARTNERSHIPS                  |       |       |       |                            |       | 13,467                              |       | (583             | )          | 12,884           |       |
| MINORITY  INTEREST IN INVENTORY NOT OWNED                        |       |       |       | 31,721                          |       |                                |       |             |       | 31,721           |       |
| REDEEMABLE  EQUITY                                               |       | 9,755      |       |                            |       |                                |       |             |       | 9,755            |       |
| SHAREHOLDERS’  EQUITY                                       |       | 298,586    |       | 228,352                         |       | 1,772                               |       | (230,124         | )          | 298,586          |       |
| TOTAL LIABILITIES AND  EQUITY                                    |       | $          | 314,456    |                            | $          | 897,701                             |       | $                | 67,089     |             | $          | (230,707 | ) | $ | 1,048,539 |   |
|                                                             |       |       |       |                            |       |                                |       |             |       |             |       |

** **

16

----

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

 

17

----

 
| **For the three months ended**

**June 30, 2007 (in thousands)** | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| ** **                                                                                               | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** | ** **       | ** ** |
| HOMEBUILDING:                                                                                            |       |       |       |                        |       |                            |       |             |       |             |       |
| Revenues:                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |
| Sales of residential units and land                                                                      |       | $          | —     |                        | $          | 205,098                         |       | $                | 2,465      |             | $          | — |   | $ | 207,563 |   |
| Rental and other income                                                                                  |       | 66         |       | 355                         |       | 5                               |       |             |       | 426              |       |
| Total homebuilding revenues                                                                              |       | 66         |       | 205,453                     |       | 2,470                           |       | —           |       | 207,989          |       |
| Expenses:                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |
| Cost of sales of residential units and land                                                              |       |       |       | 219,966                     |       | 41,534                          |       |             |       | 261,500          |       |
| General and administrative                                                                               |       | 4,592      |       | 9,081                       |       | 18                              |       |             |       | 13,691           |       |
| Sales and marketing                                                                                      |       |       |       | 13,067                      |       | 293                             |       |             |       | 13,360           |       |
| Depreciation                                                                                             |       | 107        |       | 210                         |       |                            |       |             |       | 317              |       |
| Total homebuilding expenses                                                                              |       | 4,699      |       | 242,324                     |       | 41,845                          |       | —           |       | 288,868          |       |
| Intercompany charge                                                                                      |       | 4,633      |       | (4,633                      | )          |                            |       |             |       |             |       |
| Equity in income of unconsolidated joint ventures                                                        |       |       |       | 590                         |       |                            |       |             |       | 590              |       |
| Minority interests in net earnings of consolidated  partnerships                                         |       |       |       |                        |       | 15,415                          |       |             |       | 15,415           |       |
| Homebuilding loss before income taxes                                                                    |       | —     |       | (40,914                     | )          | (23,960                         | )          | —           |       | (64,874          | )          |
| MORTGAGE  BANKING:                                                                                       |       |       |       |                        |       |                            |       |             |       |             |       |
| Revenues:                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |
| Gain on sales of mortgage loans                                                                          |       |       |       |                        |       | 1,011                           |       |             |       | 1,011            |       |
| Total mortgage banking revenues                                                                          |       |       |       |                        |       | 1,011                           |       |             |       | 1,011            |       |
| Expenses:                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |
| General and administrative                                                                               |       |       |       |                        |       | 1,129                           |       |             |       | 1,129            |       |
| Depreciation                                                                                             |       |       |       |                        |       | 18                              |       |             |       | 18               |       |
| Total mortgage banking expenses                                                                          |       |       |       |                        |       | 1,147                           |       |             |       | 1,147            |       |
| Mortgage banking loss before income taxes                                                                |       |       |       |                        |       | (136                            | )          |             |       | (136             | )          |
| EQUITY IN LOSS  OF CONSOLIDATED SUBSIDIARIES                                                             |       | (65,010    | )          | (23,960                     | )          |                            |       | 88,970           |       |             |       |
| LOSS BEFORE INCOME  TAXES                                                                                |       | (65,010    | )          | (64,874                     | )          | (24,096                         | )          | 88,970           |       | (65,010          | )          |
| BENEFIT FOR INCOME  TAXES                                                                                |       | (24,117    | )          | (24,068                     | )          | (8,939                          | )          | 33,007           |       | (24,117          | )          |
| NET LOSS                                                                                                 |       | $          | (40,893    | )                           | $          | (40,806                         | )          | $                | (15,157    | )                | $          | 55,963 |   | $ | (40,893 | ) |
|                                                                                                     |       |       |       |                        |       |                            |       |             |       |             |       |

 

 

18

----

| **For the three  months ended  June 30, 2006 (in thousands)**  | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| HOMEBUILDING:                                                  |       |       |       |                        |       |                            |       |             |       |             |       |
| Revenues:                                                      |       |       |       |                        |       |                            |       |             |       |             |       |
| Sales of residential  units and land                           |       | $          | —     |                        | $          | 304,409                         |       | $                | 5,344      |             | $          | — |   | $ | 309,753 |   |
| Rental and other  income                                       |       | 272        |       | 464                         |       | 63                              |       |             |       | 799              |       |
| Total homebuilding  revenues                                   |       | 272        |       | 304,873                     |       | 5,407                           |       | —           |       | 310,552          |       |
| Expenses:                                                      |       |       |       |                        |       |                            |       |             |       |             |       |
| Cost of sales of  residential units and land                   |       |       |       | 252,815                     |       | 4,824                           |       |             |       | 257,639          |       |
| General and administrative                                     |       | 8,901      |       | 10,711                      |       | 8                               |       |             |       | 19,620           |       |
| Sales and marketing                                            |       |       |       | 15,541                      |       | 288                             |       |             |       | 15,829           |       |
| Depreciation                                                   |       | 79         |       | 129                         |       |                            |       |             |       | 208              |       |
| Total homebuilding  expenses                                   |       | 8,980      |       | 279,196                     |       | 5,120                           |       | —           |       | 293,296          |       |
| Intercompany charge                                            |       | 8,708      |       | (8,708                      | )          |                            |       |             |       |             |       |
| Equity in income  of unconsolidated joint ventures             |       |       |       | 369                         |       |                            |       |             |       | 369              |       |
| Minority interests  in net losses of consolidated partnerships |       |       |       |                        |       | 18                              |       |             |       | 18               |       |
| Homebuilding earnings  before income taxes                     |       | —     |       | 17,338                      |       | 305                             |       | —           |       | 17,643           |       |
| MORTGAGE BANKING:                                              |       |       |       |                        |       |                            |       |             |       |             |       |
| Revenues:                                                      |       |       |       |                        |       |                            |       |             |       |             |       |
| Gain on sales of  mortgage loans                               |       |       |       |                        |       | 2,299                           |       |             |       | 2,299            |       |
| Interest income                                                |       |       |       |                        |       | 1                               |       |             |       | 1                |       |
| Total mortgage banking  revenues                               |       |       |       |                        |       | 2,300                           |       |             |       | 2,300            |       |
| Expenses:                                                      |       |       |       |                        |       |                            |       |             |       |             |       |
| General and administrative                                     |       |       |       |                        |       | 1,143                           |       |             |       | 1,143            |       |
| Interest expense                                               |       |       |       |                        |       | 1                               |       |             |       | 1                |       |
| Depreciation                                                   |       |       |       |                        |       | 21                              |       |             |       | 21               |       |
| Total mortgage banking  expenses                               |       |       |       |                        |       | 1,165                           |       |             |       | 1,165            |       |
| Mortgage banking  earnings before income taxes                 |       |       |       |                        |       | 1,135                           |       |             |       | 1,135            |       |
| EQUITY IN INCOME OF CONSOLIDATED  SUBSIDIARIES                 |       | 18,778     |       | 305                         |       |                            |       | (19,083          | )          |             |       |
| EARNINGS BEFORE INCOME TAXES                                   |       | 18,778     |       | 17,643                      |       | 1,440                           |       | (19,083          | )          | 18,778           |       |
| PROVISION FOR INCOME TAXES                                     |       | 6,813      |       | 6,404                       |       | 521                             |       | (6,925           | )          | 6,813            |       |
| NET EARNINGS                                                   |       | $          | 11,965     |                        | $          | 11,239                          |       | $                | 919        |             | $          | (12,158 | ) | $ | 11,965 |   |
|                                                           |       |       |       |                        |       |                            |       |             |       |             |       |

 

19

----

** **
| **For the nine months ended   June 30, 2007 (in thousands)** | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| HOMEBUILDING:                                                                                             |       |       |       |                        |       |                            |       |             |       |             |       |
| Revenues:                                                                                                 |       |       |       |                        |       |                            |       |             |       |             |       |
| Sales of residential units and land                                                                       |       | $          | —     |                        | $          | 620,177                         |       | $                | 111,362    |             | $          | (95,194 | ) | $ | 636,345 |   |
| Rental and other income                                                                                   |       | 203        |       | 974                         |       | 6                               |       |             |       | 1,183            |       |
| Total homebuilding revenues                                                                               |       | 203        |       | 621,151                     |       | 111,368                         |       | (95,194          | )          | 637,528          |       |
| Expenses:                                                                                                 |       |       |       |                        |       |                            |       |             |       |             |       |
| Cost of sales of residential units and land                                                               |       |       |       | 633,409                     |       | 135,052                         |       | (76,531          | )          | 691,930          |       |
| General and administrative                                                                                |       | 15,268     |       | 29,087                      |       | 86                              |       |             |       | 44,441           |       |
| Sales and marketing                                                                                       |       |       |       | 38,709                      |       | 1,285                           |       |             |       | 39,994           |       |
| Depreciation                                                                                              |       | 288        |       | 614                         |       |                            |       |             |       | 902              |       |
| Total homebuilding expenses                                                                               |       | 15,556     |       | 701,819                     |       | 136,423                         |       | (76,531          | )          | 777,267          |       |
| Intercompany charge                                                                                       |       | 15,353     |       | (15,353                     | )          |                            |       |             |       |             |       |
| Equity in income of unconsolidated joint ventures                                                         |       |       |       | 1,688                       |       |                            |       |             |       | 1,688            |       |
| Minority interests in net earnings of consolidated  partnerships                                          |       |       |       |                        |       | 6,354                           |       | 8,914            |       | 15,268           |       |
| Homebuilding loss before income taxes                                                                     |       | —     |       | (94,333                     | )          | (18,701                         | )          | (9,749           | )          | (122,783         | )          |
| MORTGAGE  BANKING:                                                                                        |       |       |       |                        |       |                            |       |             |       |             |       |
| Revenues:                                                                                                 |       |       |       |                        |       |                            |       |             |       |             |       |
| Gain on sales of mortgage loans                                                                           |       |       |       |                        |       | 4,247                           |       |             |       | 4,247            |       |
| Total mortgage banking revenues                                                                           |       |       |       |                        |       | 4,247                           |       |             |       | 4,247            |       |
| Expenses:                                                                                                 |       |       |       |                        |       |                            |       |             |       |             |       |
| General and administrative                                                                                |       |       |       |                        |       | 3,685                           |       |             |       | 3,685            |       |
| Depreciation                                                                                              |       |       |       |                        |       | 54                              |       |             |       | 54               |       |
| Total mortgage banking expenses                                                                           |       |       |       |                        |       | 3,739                           |       |             |       | 3,739            |       |
| Mortgage banking earnings before income taxes                                                             |       |       |       |                        |       | 508                             |       |             |       | 508              |       |
| EQUITY IN LOSS  OF CONSOLIDATED SUBSIDIARIES                                                              |       | (122,275   | )          | (28,450                     | )          |                            |       | 150,725          |       |             |       |
| LOSS BEFORE  INCOME TAXES                                                                                 |       | (122,275   | )          | (122,783                    | )          | (18,193                         | )          | 140,976          |       | (122,275         | )          |
| BENEFIT FOR  INCOME TAXES                                                                                 |       | (47,171    | )          | (47,382                     | )          | (6,563                          | )          | 53,945           |       | (47,171          | )          |
| NET LOSS                                                                                                  |       | $          | (75,104    | )                           | $          | (75,401                         | )          | $                | (11,630    | )                | $          | 87,031 |   | $ | (75,104 | ) |
|                                                                                                      |       |       |       |                        |       |                            |       |             |       |             |       |

** **

20

----

** **
| **For the nine months ended  June 30, 2006 (in thousands)** | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| HOMEBUILDING:                                                                                       |       |       |       |                        |       |                            |       |             |       |             |       |
| Revenues:                                                                                           |       |       |       |                        |       |                            |       |             |       |             |       |
| Sales of residential units and land                                                                 |       | $          | —     |                        | $          | 753,230                         |       | $                | 20,806     |             | $          | (11,563 | ) | $ | 762,473 |   |
| Rental and other income                                                                             |       | 352        |       | 1,243                       |       | 845                             |       |             |       | 2,440            |       |
| Total homebuilding revenues                                                                         |       | 352        |       | 754,473                     |       | 21,651                          |       | (11,563          | )          | 764,913          |       |
| Expenses:                                                                                           |       |       |       |                        |       |                            |       |             |       |             |       |
| Cost of sales of residential units and land                                                         |       |       |       | 598,969                     |       | 18,936                          |       | (10,786          | )          | 607,119          |       |
| General and administrative                                                                          |       | 22,701     |       | 38,331                      |       | 44                              |       |             |       | 61,076           |       |
| Sales and marketing                                                                                 |       |       |       | 38,033                      |       | 640                             |       |             |       | 38,673           |       |
| Depreciation                                                                                        |       | 131        |       | 427                         |       |                            |       |             |       | 558              |       |
| Total homebuilding expenses                                                                         |       | 22,832     |       | 675,760                     |       | 19,620                          |       | (10,786          | )          | 707,426          |       |
| Intercompany charge                                                                                 |       | 22,480     |       | (22,480                     | )          |                            |       |             |       |             |       |
| Equity in income of unconsolidated joint ventures                                                   |       |       |       | 899                         |       |                            |       |             |       | 899              |       |
| Minority interests in net losses (earnings) of  consolidated partnerships                           |       |       |       | 574                         |       | (941                            | )          | 583              |       | 216              |       |
| Homebuilding earnings before income taxes                                                           |       | —     |       | 57,706                      |       | 1,090                           |       | (194             | )          | 58,602           |       |
| MORTGAGE  BANKING:                                                                                  |       |       |       |                        |       |                            |       |             |       |             |       |
| Revenues:                                                                                           |       |       |       |                        |       |                            |       |             |       |             |       |
| Gain on sales of mortgage loans                                                                     |       |       |       |                        |       | 5,288                           |       |             |       | 5,288            |       |
| Interest income                                                                                     |       |       |       |                        |       | 10                              |       |             |       | 10               |       |
| Total mortgage banking revenues                                                                     |       |       |       |                        |       | 5,298                           |       |             |       | 5,298            |       |
| Expenses:                                                                                           |       |       |       |                        |       |                            |       |             |       |             |       |
| General and administrative                                                                          |       |       |       |                        |       | 3,371                           |       |             |       | 3,371            |       |
| Interest expense                                                                                    |       |       |       |                        |       | 7                               |       |             |       | 7                |       |
| Depreciation                                                                                        |       |       |       |                        |       | 70                              |       |             |       | 70               |       |
| Total mortgage banking expenses                                                                     |       |       |       |                        |       | 3,448                           |       |             |       | 3,448            |       |
| Mortgage banking earnings before income taxes                                                       |       |       |       |                        |       | 1,850                           |       |             |       | 1,850            |       |
| EQUITY IN INCOME  OF CONSOLIDATED SUBSIDIARIES                                                      |       | 60,452     |       | 421                         |       |                            |       | (60,873          | )          |             |       |
| EARNINGS BEFORE  INCOME TAXES                                                                       |       | 60,452     |       | 58,127                      |       | 2,940                           |       | (61,067          | )          | 60,452           |       |
| PROVISION FOR  INCOME TAXES                                                                         |       | 21,942     |       | 21,100                      |       | 1,066                           |       | (22,166          | )          | 21,942           |       |
| NET EARNINGS                                                                                        |       | $          | 38,510     |                        | $          | 37,027                          |       | $                | 1,874      |             | $          | (38,901 | ) | $ | 38,510 |   |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |

 

21

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| **For the nine months ended  June 30, 2007 (in thousands)** | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| **Cash flows from operating  activities:**                                                          | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** | ** **       | ** ** |
| Net loss                                                                                            |       | $          | (75,104    | )                           | $          | (75,401                         | )          | $                | (11,630    | )                | $          | 87,031 |   | $ | (75,104 | ) |
| Adjustments to  reconcile net loss to net cash flows from operating activities                      |       | 27,789     |       | (35,469                     | )          | 116,557                         |       | (111,773         | )          | (2,896           | )          |
| Net cash (used  in) provided by operating activities                                                |       | (47,315    | )          | (110,870                    | )          | 104,927                         |       | (24,742          | )          | (78,000          | )          |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |
| **Cash flows from investing  activities:**                                                          | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** | ** **       | ** ** |
| Purchases of property  and equipment                                                                |       | (338       | )          | (802                        | )          | (30                             | )          |             |       | (1,170           | )          |
| Distributions of  contributed capital from investments in unconsolidated entities                   |       |       |       | 3,241                       |       |                            |       |             |       | 3,241            |       |
| Contributions and  advances to investments in unconsolidated entities                               |       |       |       | (6,830                      | )          |                            |       |             |       | (6,830           | )          |
| Contributions to  investments in subsidiaries                                                       |       |       |       | (4,213                      | )          |                            |       | 4,213            |       |             |       |
| Net cash used in  investing activities                                                              |       | (338       | )          | (8,604                      | )          | (30                             | )          | 4,213            |       | (4,759           | )          |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |
| **Cash flows from financing  activities:**                                                          | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** | ** **       | ** ** |
| Proceeds from issuance  of notes and mortgage loans payable                                         |       | 259,185    |       |                        |       | 9,940                           |       |             |       | 269,125          |       |
| Repayments of notes and  mortgage loans payable                                                     |       | (140,280   | )          | (9,801                      | )          | (12,392                         | )          |             |       | (162,473         | )          |
| Debt issuance costs                                                                                 |       | (850       | )          |                        |       |                            |       |             |       | (850             | )          |
| Net proceeds from issuance  of common stock                                                         |       | 39         |       |                        |       |                            |       |             |       | 39               |       |
| Repurchases of common  stock                                                                        |       | (10,822    | )          |                        |       |                            |       |             |       | (10,822          | )          |
| Contributions from  minority interests                                                              |       |       |       |                        |       | 3,000                           |       |             |       | 3,000            |       |
| Distributions to  minority interests                                                                |       |       |       |                        |       | (27,006                         | )          | 8,914            |       | (18,092          | )          |
| Contributions from  parent and guarantors                                                           |       |       |       |                        |       | 4,213                           |       | (4,213           | )          |             |       |
| Distributions to parent  and guarantors                                                             |       |       |       |                        |       | (15,828                         | )          | 15,828           |       |             |       |
| Intercompany                                                                                        |       | (58,663    | )          | 126,518                     |       | (67,855                         | )          |             |       |             |       |
| Net cash  provided by (used in) financing activities                                                |       | 48,609     |       | 116,717                     |       | (105,928                        | )          | 20,529           |       | 79,927           |       |
| **Net increase (decrease) in cash  and cash equivalents**                                           |       | 956        |       | (2,757                      | )          | (1,031                          | )          |             |       | (2,832           | )          |
| Cash and cash  equivalents—Beginning of period                                                 |       | 1,518      |       | 14,511                      |       | 2,636                           |       |             |       | 18,665           |       |
| Cash and cash  equivalents—End of period                                                       |       | $          | 2,474      |                        | $          | 11,754                          |       | $                | 1,605      |             |       |   | $ | 15,833 |   |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |
| **Reconciliation to cash and cash  equivalents reported on the consolidated balance sheets:**       | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** | ** **       | ** ** |
| Homebuilding                                                                                        |       | $          | 2,474      |                        | $          | 11,754                          |       | $                | 50         |             |       |   | $ | 14,278 |   |
| Mortgage banking                                                                                    |       |       |       |                        |       | 1,555                           |       |             |       | 1,555            |       |
| Total                                                                                               |       | $          | 2,474      |                        | $          | 11,754                          |       | $                | 1,605      |             |       |   | $ | 15,833 |   |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |
|                                                                                                     |            |            |            |                             |            |                                 |            |                  |            |                  |            |  |  |  |  |  |

 

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| **For the nine months ended  June 30, 2006 (in thousands)** | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| **Cash  flows from operating activities:**                                                          |       |       |       |                        |       |                            |       |             |       |             |       |
| Net earnings                                                                                        |       | $          | 38,510     |                        | $          | 37,027                          |       | $                | 1,874      |             | $          | (38,901 | ) | $ | 38,510 |   |
| Adjustments to reconcile net earnings to net cash  flows from operating activities                  |       | (44,813    | )          | (149,738                    | )          | (27,333                         | )          | 37,458           |       | (184,426         | )          |
| Net cash used in operating activities                                                               |       | (6,303     | )          | (112,711                    | )          | (25,459                         | )          | (1,443           | )          | (145,916         | )          |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |
| **Cash  flows from investing activities:**                                                          |       |       |       |                        |       |                            |       |             |       |             |       |
| Purchases of  property and equipment                                                                |       | (5,711     | )          | (1,262                      | )          | (22                             | )          |             |       | (6,995           | )          |
| Disposals of  property and equipment                                                                |       |       |       |                        |       | 858                             |       |             |       | 858              |       |
| Distributions of  contributed capital from investments in unconsolidated entities                   |       |       |       | 698                         |       |                            |       |             |       | 698              |       |
| Contributions  and advances to investments in unconsolidated entities                               |       |       |       | (8,460                      | )          |                            |       |             |       | (8,460           | )          |
| Contributions to  investments in subsidiaries                                                       |       |       |       | (2,463                      | )          |                            |       | 2,463            |       |             |       |
| Net cash (used in) provided by investing activities                                                 |       | (5,711     | )          | (11,487                     | )          | 836                             |       | 2,463            |       | (13,899          | )          |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |
| **Cash  flows from financing activities:**                                                          |       |       |       |                        |       |                            |       |             |       |             |       |
| Proceeds from  issuance of notes and mortgage loans payable                                         |       | 832,073    |       | 323,189                     |       | 20,094                          |       |             |       | 1,175,356        |       |
| Repayments of  notes and mortgage loans payable                                                     |       | (223,064   | )          | (710,427                    | )          | (62,664                         | )          |             |       | (996,155         | )          |
| Debt issuance  costs                                                                                |       | (6,598     | )          |                        |       |                            |       |             |       | (6,598           | )          |
| Net proceeds  from issuance of common stock                                                         |       | 712        |       |                        |       |                            |       |             |       | 712              |       |
| Repurchases of  common stock                                                                        |       | (3,174     | )          |                        |       |                            |       |             |       | (3,174           | )          |
| Distributions to  minority interests                                                                |       |       |       | 127                         |       | (2,668                          | )          |             |       | (2,541           | )          |
| Contributions  from parent and guarantors                                                           |       |       |       |                        |       | 2,463                           |       | (2,463           | )          |             |       |
| Distributions to  parent and guarantors                                                             |       |       |       |                        |       | (1,443                          | )          | 1,443            |       |             |       |
| Intercompany                                                                                        |       | (592,918   | )          | 525,778                     |       | 67,140                          |       |             |       |             |       |
| Net cash provided by financing activities                                                           |       | 7,031      |       | 138,667                     |       | 22,922                          |       | (1,020           | )          | 167,600          |       |
| **Net  (decrease) increase in cash and cash equivalents**                                           |       | (4,983     | )          | 14,469                      |       | (1,701                          | )          |             |       | 7,785            |       |
| Cash and cash equivalents—Beginning of period                                                  |       | 6,875      |       | 9,786                       |       | 4,799                           |       |             |       | 21,460           |       |
| Cash and cash equivalents—End of period                                                        |       | $          | 1,892      |                        | $          | 24,255                          |       | $                | 3,098      |             |       |   | $ | 29,245 |   |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |
|                                                                                                     |            |            |            |                             |            |                                 |            |                  |            |                  |            |  |  |  |  |  |

 

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**11.  Subsequent Events**

On August 10, 2007, the Company amended andrestated its existing senior credit facility. The terms of the amendment andrestatement (summarized below) reflect current market conditions and relateddeterioration of the Company’s profitability. Fees payable in connection withthe amendment and restatement totaled approximately $0.9 million.

The amendment and restatement permits the Company toignore, for purposes of financial covenant calculations (but not for interestmargin calculations), up to $40 million of tangible net worth reductions due toimpairment and abandonment charges. The amendment and restatement suspends theinterest coverage ratio covenant until March 31, 2009 and adds a minimumrequirement of adjusted earnings before interest, taxes, depreciation andamortization (as defined in the credit agreement) of $25 million on a trailingfour-quarter basis, and a minimum $50 million liquidity requirement (defined asunrestricted cash, available borrowings under the senior credit facility andother available lines of credit and receivables from home closings). Liquidityis tested monthly. The amendment and restatement reduces permitted unsecureddebt from $25 million to $15 million and permitted joint venture investmentsfrom 30% of tangible net worth to 25% of tangible net worth and, in the case ofour Nevada building region, eliminates until September 1, 2007 the pre-existingrequirement that the number of speculative housing units owned by the Company,as June 30, 2007, not exceed a maximum of 35% of its housing unit closings insuch region during the previous 12-month period. Prior to the amendment andrestatement, the Company was in default of the inventory restriction as of June30, 2007 due to its ownership of an excessive number of speculative housingunits in Nevada.

The amendment and restatement requires that the seniorcredit facility be secured by all properties to be included in the borrowingbase for the senior credit facility and related assets and prohibits theincurrence of any additional secured debt. In this regard, in contrast to theprevious calculation method for the borrowing base, the property of certain non-whollyowned subsidiaries cannot be included in the borrowing base calculation unlessand until such subsidiaries are able to guarantee the senior credit facility(on a secured basis) which will be subject to the consent of minority interestholders and there is no assurance that the Company would be able to obtain suchconsent. New properties that are proposed to be included as borrowing baseproperty would also be mortgaged and pledged to secure the senior creditfacility and also would need to satisfy specified parameters or otherwise beapproved by the majority lenders. As of June 30, 2007, the effect of theremoval of the property of such non-wholly owned subsidiaries from theborrowing base calculation upon the Company’s liquidity would have been toreduce its liquidity from $159 million to $155 million. As of June 30, 2007,the Company had $358 million of borrowings under the senior credit facility atan effective interest rate of 7.09% and, after calculating the borrowing baselimitation based on removal of the property of such non-wholly ownedsubsidiaries, would have had additional availability of approximately $106million. Finally, the amendment and restatement provides that the applicableinterest margins are subject to increase by 0.375% to 0.875% in the event thatliquidity (as defined above) is more than $50 million but less than or equal to$100 million.

On August 10, 2007, the Company entered into anemployment agreement with David K. Hill. Under the terms of David K.Hill’s employment agreement, if Mr. Hill’s employment is terminated byreason of his death or permanent disability, his family trust may request theCompany to purchase up to 500,000 shares of common stock of the Company,and upon receipt of such request the Company will reasonably determine in itssole discretion how many shares to purchase in light of the Company’s financialcondition and prospects and the limitations, restrictions and constraints inthe Company’s loan and financing arrangements at the time. The purchase pricepayable by the Company will be the fair market value at that time.

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**Item 2. Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.**

*The following discussion provides an assessment ofour results of operations, liquidity and capital resources and should be readin conjunction with the condensed consolidated financial statements and notesthereto included elsewhere in this report.*

**Overview**

We are one of the largest privately-owned homebuildersand one of the 30 largest homebuilders in the United States, as measured byhome deliveries and revenues. We design, build and market single-familydetached, single-family attached and multi-family homes. Since we were foundedin 1969, we have delivered over 44,000 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 operatewithin 17 markets across nine states located in five geographic regions: 
| **Florida** | ** ** | **Midwest**       | ** ** | **Nevada** | ** ** | **Pacific Coast** | ** ** | **Texas**   |
|-------------|------------|-------------------|------------|------------|------------|-------------------|------------|-------------|
| Ft. Myers   |       | Chicago, IL       |       | Las Vegas  |       | Portland, OR (b)  |       | Austin      |
| Naples      |       | Cleveland, OH (a) |       |       |       | Sacramento, CA    |       | Dallas      |
| Sarasota    |       | Milwaukee, WI (b) |       |       |       | Stockton, CA      |       | Ft. Worth   |
| Tampa       |       |              |       |       |       | Vancouver, WA (b) |       | Houston     |
|        |       |              |       |       |       |              |       | San Antonio |

 

(a)       In March 2006, we decided to exit theCleveland market based on our perception regarding local market conditionscurrently and in the foreseeable future. We completed all construction andsales activities during our second fiscal quarter of 2007.

(b)       In May 2007, we decided to exit theMilwaukee, Portland and Vancouver markets for the reasons set forth below under“Recent Events.” We are winding down operations with the objective ofcompleting all homebuilding activities during this fiscal year.

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 tothird parties as a means of managing inventory and obtaining the desired assetmix for our homebuilding operations. We also conduct mortgage origination andtitle services for the benefit of our homebuilding operations, althoughrevenues generated by these ancillary services have historically comprised lessthan 1% of our total revenues, and are not expected to be significant in thefuture.

**Recent Trends**

Market conditions for new home sales continued todeteriorate during our third fiscal quarter as inventory levels of both new andexisting homes remained high, and the aggressive use of sales incentivescontinues to put pressure on profit margins. In addition, home priceappreciation over the past few years, higher interest rates and tighteningcredit standards in the mortgage industry are all negatively affecting affordabilityand consumer sentiment for housing. We do not see conditions in thehomebuilding market improving significantly in the near term, which willsignificantly reduce our quarterly and full-year revenues and earnings whencompared to 2006 results.

The following describe some of the factors present inthe marketplace during our third fiscal quarter of 2007:

·       decreased levels of customer traffic,buyer sentiment and net sales;

·       increased frequency and level of customerincentive packages;

·       increased use and compensation of realestate brokers;

·       depressed market conditions for landsales; and

·       increased abandonment of earnest moneyrelated to land option agreements and purchase contracts.

25

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Given these significant market changes and uncertaintyabout the timing and pace of any recovery, we have adopted a strategy to manageour business through this current downturn. Our strategy focuses on:

·  tailoring our product offerings and option packages toaddress affordability constraints;

·       refining our pricing strategy to achievethe proper balance between velocity and profitability and to reduce the numberof completed but unsold homes;

·       renegotiating with vendors and subcontractorsto manage our construction costs;

·       sizing our operating structure to matchour perception regarding market conditions currently and into the foreseeablefuture;

·       tightening land acquisition criteria andworking with land sellers to renegotiate land purchase and option contracts toextend purchase dates and reduce purchase prices;

·       marketing and selling lots to generatecash and reduce our overall land holdings; and

·       reducing our debt and interest costs andmaximizing our liquidity.

We believe that our operating history and geographicdiversification will continue to benefit us as the homebuilding industrytransitions through a changing and challenging environment.

**Recent Events**

On August 9, 2007, our Board of Directors elected C.Kenneth Love to the position of President and Chief Executive Officer,effective as of October 1, 2007. Beginning on October 1, 2007, David K. Hillwill assume the new position of Executive Chairman, through which he willremain actively involved with us. See Part II, Item 5 of this report foradditional information.

In May 2007, we decided to exit the Portland, Oregonand Vancouver, Washington markets. As of June 30, 2007, we had $18.9 million ofassets deployed in these markets. A decision to continue in these markets wouldhave required near term investments to provide lots for the future to sustainour operations. We decided to redeploy our capital and narrow our managementfocus to our other existing markets. We believe that our exit from the Portlandand Vancouver markets will not have a material adverse impact on our financialcondition or results of operations.

In May 2007, we decided to exit the Milwaukee,Wisconsin market. As of June 30, 2007, we had $9.7 million of assets deployedin this market. Our decision to exit the Milwaukee market reflects ourperception regarding local market conditions currently and in the foreseeablefuture. We believe that our exit from the Milwaukee market will not have amaterial adverse impact on our financial condition or results of operations.

As part of our current operating strategy, we areselling certain land inventory to: increase our liquidity and reduce our debt,adjust the balance of our land holdings by region and reduce our overallinvestment in land. We have identified certain land parcels that we intend tosell and are actively marketing the properties for delivery within the next 12months. We believe that these properties are not critical to our homebuildingoperations. As of June 30, 2007, we have $71.6 million of land inventory thatis held for sale.

Due to the continued deterioration in marketconditions, the national homebuilding climate and our expectations regardingthe recoverability of certain assets, we reviewed all of our inventory forimpairment and recorded inventory impairment charges of $81.3 million and$133.7 million during the three and nine months ended June 30, 2007.Additionally, during the three and nine months ended June 30, 2007, the Companywrote-off $0.3 million and $7.8 million of costs related to the abandonment ofland option contracts. These charges are included in cost of sales in theaccompanying condensed consolidated statements of operations.

26

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**Financing Overview**

In August 2007, we amended and restated our existingsenior credit facility. The amendment and restatement requires that the seniorcredit facility be secured by all properties to be included in the seniorcredit facility’s borrowing base and prohibits the incurrence of any additionalsecured debt. Many of our debt covenants were modified under the amendment, themost significant of which were: for purposes of covenant calculations, we arepermitted to ignore up to $40 million of tangible net worth reductions relatedto impairment and abandonment charges; to suspend the interest coverage ratiocovenant until March 31, 2009; and to add a minimum $25 million trailingfour-quarter adjusted EBITDA requirement and a minimum $50 million liquidityrequirement. The amended and restated credit agreement is described in Part II,Item 5 of this report and is filed herewith as Exhibit 10.2.

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

In two separate transactions during March 2007, wepurchased developed lots from two consolidated joint ventures at fair marketvalue in accordance with the underlying joint venture agreements. After closingthe transaction, the consolidated joint ventures distributed $25.8 million inaccordance with the joint venture agreements to an entity that indirectly ownsapproximately 21% of our issued and outstanding common stock as of June 30,2007.

 

27

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**Results of Operations and Other Data**

The following table presents selected statements ofoperations and other data for the three and nine month periods ended June 30,2007 and 2006:
| ** **                                                     | ** ** | **Three months  ended  June 30,** | ** ** | **2007  vs.** | ** ** | **Nine months  ended  June 30,** | ** ** | **2007  vs.** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------------|------------|---------------|------------|----------------------------------|------------|---------------|------------|
| **(Dollars in  thousands)**                                    | ** ** | **2007**                          | ** ** | **2006**      | ** ** | **2006**                         | ** ** | **2007**      | ** ** | **2006** | ** ** | **2006** | ** ** |
| **Statement of operations data:**                              |       |                              |       |          |       |                             |       |          |       |   |   |   |   |
| Total homebuilding  revenues                                   |       | $                                 | 207,989    |          | $          | 310,552                          |       | (33.0         | )%         | $ | 637,528 |   | $ | 764,913 |   | (16.7 | )% |
| Cost of sales of  residential units and land (1)               |       | 261,500                           |       | 257,639       |       | 1.5                              | %          | 691,930       |       | 607,119 |   | 14.0 | % |
| Gross homebuilding  (loss) profit                              |       | (53,511                           | )          | 52,913        |       | (201.1                           | )%         | (54,402       | )          | 157,794 |   | (134.5 | )% |
| Homebuilding operating  expenses                               |       | 27,368                            |       | 35,657        |       | (23.2                            | )%         | 85,337        |       | 100,307 |   | (14.9 | )% |
| Equity in income of  unconsolidated entities                   |       | 590                               |       | 369           |       | 59.9                             | %          | 1,688         |       | 899 |   | 87.8 | % |
| Minority interests in  net losses of consolidated partnerships |       | 15,415                            |       | 18            |       | —                           |       | 15,268        |       | 216 |   | — |   |
| Homebuilding (loss)  earnings before income taxes              |       | (64,874                           | )          | 17,643        |       | (467.7                           | )%         | (122,783      | )          | 58,602 |   | (309.5 | )% |
| Mortgage banking (loss)  earnings before income taxes          |       | (136                              | )          | 1,135         |       | (112.0                           | )%         | 508           |       | 1,850 |   | (72.5 | )% |
| (Loss) earnings before  income taxes                           |       | (65,010                           | )          | 18,778        |       | (446.2                           | )%         | (122,275      | )          | 60,452 |   | (302.3 | )% |
| (Benefit) provision for  income taxes                          |       | (24,117                           | )          | 6,813         |       | (454.0                           | )%         | (47,171       | )          | 21,942 |   | (315.0 | )% |
| Net (loss) earnings                                            |       | $                                 | (40,893    | )             | $          | 11,965                           |       | (441.8        | )%         | $ | (75,104 | ) | $ | 38,510 |   | (295.0 | )% |
| ** **                                                     |       |                              |       |          |       |                             |       |          |       |   |   |   |   |
| **Other financial data:**                                      |       |                              |       |          |       |                             |       |          |       |   |   |   |   |
| Interest incurred (2)                                          |       | $                                 | 12,646     |          | $          | 14,878                           |       | (15.0         | )%         | $ | 35,844 |   | $ | 36,165 |   | (0.9 | )% |
| Depreciation                                                   |       | 335                               |       | 229           |       | 46.3                             | %          | 956           |       | 628 |   | 52.2 | % |
| EBITDA (3) (4)                                                 |       | (55,718                           | )          | 28,453        |       | (295.8                           | )%         | (95,881       | )          | 81,675 |   | (217.4 | )% |
| Gross homebuilding  profit margin (5)                          |       | (25.7                             | )%         | 17.0          | %          | —                           |       | (8.5          | )%         | 20.6 | % | — |   |
| ** **                                                     |       |                              |       |          |       |                             |       |          |       |   |   |   |   |
| **Other data:**                                                |       |                              |       |          |       |                             |       |          |       |   |   |   |   |
| Net new home orders  (units) (6)                               |       | 769                               |       | 942           |       | (18.4                            | )%         | 2,461         |       | 2,726 |   | (9.7 | )% |
| Homes delivered (units)                                        |       | 771                               |       | 1,109         |       | (30.5                            | )%         | 2,269         |       | 2,679 |   | (15.3 | )% |
| Average sales price of  homes delivered                        |       | $                                 | 251        |          | $          | 273                              |       | (8.1          | )%         | $ | 261 |   | $ | 278 |   | (6.1 | )% |
| Backlog at end of  period (units) (7)                          |       | 950                               |       | 1,517         |       | (37.4                            | )%         | 950           |       | 1,517 |   | (37.4 | )% |
| Backlog at end of period (contract value) (7)             |       | $                                 | 245,026    |          | $          | 413,749                          |       | (40.8         | )%         | $ | 245,026 |   | $ | 413,749 |   | (40.8 | )% |
|                                                           |       |                              |       |          |       |                             |       |          |       |   |   |   |   |

 

(1)      Inventory impairment and land optionabandonment charges of $81.7 million and $141.5 million are included in cost ofsales of residential units and land for the three and nine months ended June30, 2007. There were $0.2 million and $3.2 million of impairment and landoption abandonment charges recorded during the three and nine months ended June30, 2006.

(2)      Interest incurred is the amount ofinterest paid and the net amount accrued (whether expensed or capitalized), andthe amortization of debt issuance costs.

(3)      “EBITDA” represents net earnings beforeinterest expense, depreciation and amortization and provision for income taxes.EBITDA is included in this report because we use it to assess our operationalperformance. We believe it is therefore useful to securities analysts,investors and other interested parties in the evaluation of companies like oursbecause interest, taxes, depreciation and amortization can vary significantlybetween companies due in part to differences in structure, accounting policies,tax strategies, levels of indebtedness and interest rates. EBITDA is not ameasure of our liquidity or financial performance in accordance with accountingprinciples generally accepted in the United States of America (“GAAP”) andshould not be considered as an alternative to our net earnings or any otherperformance measure derived in accordance with GAAP, or as an alternative tocash flows from operating activities. EBITDA has limitations as an analyticaltool, and you should not consider it in isolation, or as a substitute for ananalysis of our results as reported under GAAP. Some limitations are:

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

28

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

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

·                   EBITDA does not reflect the significant expense or cashrequirements for federal and state income tax obligations;

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

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

Becauseof these limitations, EBITDA should not be considered as a measure ofdiscretionary cash available to us to invest in the growth of our business orto service our indebtedness. We compensate for these limitations by relyingprimarily on our GAAP results and using EBITDA only supplementally. See thecondensed consolidated statements of operations and cash flows presented in ourcondensed consolidated financial statements included elsewhere in this report.The following is a reconciliation of EBITDA to net earnings, the most directlycomparable GAAP measure:
| ** **                                       | ** ** | **Three Months  Ended  June 30,** | ** ** | **Nine Months  Ended  June 30,** | ** ** |
|--------------------------------------------------|------------|-----------------------------------|------------|----------------------------------|------------|
| **(Dollars in thousands)**             | ** ** | **2007**                          | ** ** | **2006**                         | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net (loss)  earnings                             |       | $                                 | (40,893    | )                                | $          | 11,965 |   | $ | (75,104 | ) | $ | 38,510 |   |
| (Benefit)  provision for income taxes            |       | (24,117                           | )          | 6,813                            |       | (47,171 | ) | 21,942 |   |
| Interest expense  in cost of sales               |       | 8,957                             |       | 9,445                            |       | 25,438 |   | 20,588 |   |
| Interest expense  in mortgage banking operations |       |                              |       | 1                                |       |   |   | 7 |   |
| Depreciation and  amortization                   |       | 335                               |       | 229                              |       | 956 |   | 628 |   |
| EBITDA                                           |       | $                                 | (55,718    | )                                | $          | 28,453 |   | $ | (95,881 | ) | $ | 81,675 |   |
|                                             |       |                              |       |                             |       |   |   |   |   |

 

(4)             In contrast to EBITDA, our amended and restated seniorcredit facility contains an adjusted EBITDA financial covenant. The mostsignificant difference between adjusted EBITDA and EBITDA is the add back ofinventory impairment and land option abandonment charges.

(5)             Represents gross homebuilding profit divided by totalhomebuilding revenues.

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

(7)             Backlog represents homes under sales contracts but notyet delivered at the end of the period.

***Homebuildingrevenues.******  ***Homebuilding revenues decreased 33% to $208 millionfor the three month period ended June 30, 2007 from $310.6 million for thethree month period ended June 30, 2006. New home deliveries decreased by 30.5%and the average sales price of homes delivered decreased by 8.1%. The decreasesin new home deliveries and average sales prices were partially offset byincreased land sales of $13.8 million for the three months ended June 30, 2007as compared to $6.6 million for the three months ended June 30, 2006.

Homebuilding revenues decreased 16.7%to $637.5 million for the nine month period ended June 30, 2007 from $764.9million for the nine month period ended June 30, 2006. New home deliveriesdecreased by 15.3% and the average sales price of homes delivered decreased by6.1%. The decreases in new home deliveries and average sales prices werepartially offset by increased land sales of $44.2 million for the nine monthsended June 30, 2007 as compared to $17.1 million for the nine months ended June30, 2006.

***Home sales andbacklog.******  ***Net new home orders for the three month period endedJune 30, 2007 were 769, an 18.4% decrease from 942 net new home orders for thethree month period ended June 30, 2006. Net new home orders for the nine monthperiod ended June 30, 2007 were 2,461, a 9.7% decrease from 2,726 net new homeorders for the nine month period ended June 30, 2006.

At June 30, 2007, the contract valueof our backlog was $245 million, as compared to $413.7 million at June 30,2006. At June 30, 2007, the average sales price per home in backlog was$258,000 down $15,000, or 5.5%, from the average sales price per home inbacklog of $273,000 at June 30, 2006.

 

29

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***Gross homebuilding profit margin.******  ***Duringthe three and nine month period ended June 30, 2007, we experienced marginpressures across all of our regions and there was a significant shift in homedeliveries from regions that historically had higher than average gross profitmargins to regions with lower than average gross profit margins.

Gross homebuilding profitmargin decreased to (25.7)% for the three month period ended June 30, 2007,compared to 17.0% for the three month period ended June 30, 2006. Included ingross profit for the three months ended June 30, 2007 are inventory valuationcharges of $81.3 million related to our expectations regarding therecoverability of certain assets from both active residential constructionprojects and land held for sale and $0.3 million of costs related to theabandonment of projects and write-off of deposits on cancelled land optioncontracts. Included in gross profit for the three months ended June 30, 2006are inventory valuation charges of $0.2 million. Included within the grossprofit for the three month period ended June 30, 2007 is $2.2 million from landsales.

Gross homebuilding profitmargin decreased to (8.5)% for the nine month period ended June 30, 2007,compared to 20.6% for the nine month period ended June 30, 2006. Included ingross profit for the nine months ended June 30, 2007 are inventory valuationcharges of $133.7 million related to our expectations regarding therecoverability of certain assets from both active residential constructionprojects and land held for sale and $7.8 million of costs related to theabandonment of projects and write-off of deposits on cancelled land optioncontracts. Included in gross profit for the nine months ended June 30, 2006 areinventory valuation charges of $3.2 million. Included within the gross profitfor the nine month period ended June 30, 2007 is $16.7 million from land sales,as compared with $2.1 million from land sales for the nine month period endedJune 30, 2006.

***Homebuildingoperating expenses.***   Homebuilding operatingexpenses, which consist of all homebuilding expenses other than cost of sales,decreased 23.2% to $27.4 million for the three months ended June 30, 2007 from$35.7 million for the three months ended June 30, 2006. Homebuilding operatingexpenses were 13.2% and 11.5% of homebuilding revenue for the three monthsended June 30, 2007 and 2006, respectively.

Homebuilding operatingexpenses decreased 14.9% to $85.3 million for the nine months ended June 30,2007 from $100.3 million for the nine months ended June 30, 2006. Homebuildingoperating expenses were 13.4% and 13.1% of homebuilding revenue for the ninemonths ended June 30, 2007 and 2006, respectively.

The decrease inhomebuilding operating expenses is attributed to lower compensation expense, dueto a reduction in headcount and incentive pay, partially offset by an increasein commissions paid to outside real estate brokers, as we increased ourutilization of their services to sell our homes.

***IncomeTaxes.***   We recorded income tax benefit of $24.1million and $47.2 million for the three and nine month periods ended June 30,2007. Included within the tax benefit for the nine month period ended June 30, 2007 is a $1.3million beneficial adjustment to reduce prior income tax estimates. We recordedincome tax expense of $6.8 million and $21.9 million for the three and ninemonth periods ended June 30, 2006.

**Segment analysis**

We aggregate ourhomebuilding operating segments into five reportable segments and our mortgagebanking operations into one reportable segment. We historically aggregated ourhomebuilding operating segments into one reportable segment and accordinglyhave revised that historical presentation for all periods to conform to thecurrent year presentation of five reportable homebuilding segments. Ourhomebuilding segments are engaged in the acquisition and development of land,and construction and sale of residential homes. Our mortgage banking segmentoriginates mortgages, which are sold to third parties.

Thefive reportable homebuilding segments include operations in the followinggeographic regions:

Florida

Midwest:Illinois, Ohio and Wisconsin

30

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Nevada

PacificCoast: California, Oregon and Washington

Texas

Thefollowing table presents financial and operational information for our fivereportable homebuilding segments:
| **Three Months Ended  June 30,  (Dollars in thousands)** | ** ** | **Average  sales price  of homes** | ** ** | **Homes  delivered** | ** ** | **Net new  home  orders**(1) | ** ** | **Backlog  (units) at  period end**(2) | ** ** | **Backlog  (contract  value) at  period end**(2) | ** ** |
|-----------------------------------------------------------------------------------|------------|----------------------------------------------|------------|----------------------|------------|-----------------------------------|------------|--------------------------------------------------|------------|------------------------------------------------------------|------------|
| 2007                                                                              |       |                                         |       |                 |       |                              |       |                                             |       |                                                       |       |
| Florida                                                                           |       | $                                            | 239        |                 | 69         |                              | 101        |                                             | 128        |                                                       | $          | 26,870 |   |
| Midwest                                                                           |       | 337                                          |       | 100                  |       | 92                                |       | 187                                              |       | 65,892                                                     |       |
| Nevada                                                                            |       | 366                                          |       | 87                   |       | 95                                |       | 89                                               |       | 33,411                                                     |       |
| Pacific Coast                                                                     |       | 371                                          |       | 109                  |       | 64                                |       | 98                                               |       | 36,725                                                     |       |
| Texas                                                                             |       | 175                                          |       | 406                  |       | 417                               |       | 448                                              |       | 82,128                                                     |       |
| Total                                                                             |       | $                                            | 251        |                 | 771        |                              | 769        |                                             | 950        |                                                       | $          | 245,026 |   |
| 2006                                                                              |       |                                         |       |                 |       |                              |       |                                             |       |                                                       |       |
| Florida                                                                           |       | $                                            | 251        |                 | 112        |                              | 69         |                                             | 155        |                                                       | $          | 46,540 |   |
| Midwest                                                                           |       | 349                                          |       | 215                  |       | 146                               |       | 314                                              |       | 111,898                                                    |       |
| Nevada                                                                            |       | 405                                          |       | 110                  |       | 111                               |       | 159                                              |       | 63,245                                                     |       |
| Pacific Coast                                                                     |       | 453                                          |       | 157                  |       | 127                               |       | 140                                              |       | 62,265                                                     |       |
| Texas                                                                             |       | 164                                          |       | 515                  |       | 489                               |       | 749                                              |       | 129,801                                                    |       |
| Total                                                                             |       | $                                            | 273        |                 | 1,109      |                              | 942        |                                             | 1,517      |                                                       | $          | 413,749 |   |

 
| **Nine Months Ended  June 30,  (Dollars in thousands)** | ** ** | **Average  sales price  of homes** | ** ** | **Homes  delivered** | ** ** | **Net new  home  orders**(1) | ** ** | **Backlog  (units) at  period end**(2) | ** ** | **Backlog  (contract  value) at  period end**(2) | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------------------------------|------------|----------------------|------------|-----------------------------------|------------|--------------------------------------------------|------------|------------------------------------------------------------|------------|
| 2007                                                                             |       |                                         |       |                 |       |                              |       |                                             |       |                                                       |       |
| Florida                                                                          |       | $                                            | 277        |                 | 230        |                              | 285        |                                             | 128        |                                                       | $          | 26,870 |   |
| Midwest                                                                          |       | 335                                          |       | 333                  |       | 361                               |       | 187                                              |       | 65,892                                                     |       |
| Nevada                                                                           |       | 378                                          |       | 269                  |       | 313                               |       | 89                                               |       | 33,411                                                     |       |
| Pacific Coast                                                                    |       | 398                                          |       | 281                  |       | 299                               |       | 98                                               |       | 36,725                                                     |       |
| Texas                                                                            |       | 176                                          |       | 1,156                |       | 1,203                             |       | 448                                              |       | 82,128                                                     |       |
| Total                                                                            |       | $                                            | 261        |                 | 2,269      |                              | 2,461      |                                             | 950        |                                                       | $          | 245,026 |   |
| 2006                                                                             |       |                                         |       |                 |       |                              |       |                                             |       |                                                       |       |
| Florida                                                                          |       | $                                            | 239        |                 | 305        |                              | 196        |                                             | 155        |                                                       | $          | 46,540 |   |
| Midwest                                                                          |       | 364                                          |       | 427                  |       | 486                               |       | 314                                              |       | 111,898                                                    |       |
| Nevada                                                                           |       | 396                                          |       | 265                  |       | 312                               |       | 159                                              |       | 63,245                                                     |       |
| Pacific Coast                                                                    |       | 455                                          |       | 472                  |       | 328                               |       | 140                                              |       | 62,265                                                     |       |
| Texas                                                                            |       | 163                                          |       | 1,210                |       | 1,404                             |       | 749                                              |       | 129,801                                                    |       |
| Total                                                                            |       | $                                            | 278        |                 | 2,679      |                              | 2,726      |                                             | 1,517      |                                                       | $          | 413,749 |   |

 

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

(2)      Backlog represents homes under sales contracts but notyet delivered at the end of the period.

Our internal measurementsystem is intended to establish accountabilities to continually improvebusiness focus, motivate behavior and drive performance. The following tablepresents financial information based on our internal measurement system, whichis not in accordance with accounting principles generally accepted in theUnited States of America (“GAAP”).

31

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| **For the three months ended June 30:  (Dollars in thousands)** | ** ** | **Revenues** | ** ** | **(Loss) earnings before  income taxes** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|--------------|------------|---------------------------------------------------------|------------|
| **2007**                                                                                                | ** ** | ** **   | ** ** | ** **                                              | ** ** |
| Florida                                                                                                 |       | $            | 15,964     |                                                    | $          | (10,310 | ) |
| Midwest                                                                                                 |       | 33,936       |       | (52,165                                                 | )          |
| Nevada                                                                                                  |       | 38,146       |       | 3,978                                                   |       |
| Pacific Coast                                                                                           |       | 39,256       |       | (13,585                                                 | )          |
| Texas                                                                                                   |       | 76,583       |       | (1,054                                                  | )          |
| Mortgage banking                                                                                        |       | 1,011        |       | (136                                                    | )          |
| Segment subtotal                                                                                        |       | 204,896      |       | (73,272                                                 | )          |
| Corporate and unallocated                                                                               |       | 463          |       | (4,397                                                  | )          |
|                                                                                                    |       | 205,359      |       | (77,669                                                 | )          |
| Homebuilding interest expense(1)                                                                        |       |         |       | (8,957                                                  | )          |
| GAAP adjustment(2)                                                                                      |       | 3,641        |       | 21,616                                                  |       |
| Consolidated total                                                                                      |       | $            | 209,000    |                                                    | $          | (65,010 | ) |
| **2006**                                                                                                | ** ** | ** **   | ** ** | ** **                                              | ** ** |
| Florida                                                                                                 |       | $            | 28,104     |                                                    | $          | 6,703 |   |
| Midwest                                                                                                 |       | 76,720       |       | 3,142                                                   |       |
| Nevada                                                                                                  |       | 44,671       |       | 10,041                                                  |       |
| Pacific Coast                                                                                           |       | 71,523       |       | 17,953                                                  |       |
| Texas                                                                                                   |       | 89,352       |       | 4,487                                                   |       |
| Mortgage banking                                                                                        |       | 2,300        |       | 1,135                                                   |       |
| Segment subtotal                                                                                        |       | 312,670      |       | 43,461                                                  |       |
| Corporate and unallocated                                                                               |       | 182          |       | (9,011                                                  | )          |
|                                                                                                    |       | 312,852      |       | 34,450                                                  |       |
| Homebuilding interest expense(1)                                                                        |       |         |       | (9,445                                                  | )          |
| GAAP adjustment(2)                                                                                      |       |         |       | (6,227                                                  | )          |
| Consolidated total                                                                                      |       | $            | 312,852    |                                                    | $          | 18,778 |   |

 

32

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| **For the nine months ended June 30:  (Dollars in thousands)** | ** ** | **Revenues** | ** ** | **(Loss) earnings before  income taxes** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|--------------|------------|---------------------------------------------------------|------------|
| **2007**                                                                                               | ** ** | ** **   | ** ** | ** **                                              | ** ** |
| Florida                                                                                                |       | $            | 61,619     |                                                    | $          | (19,812 | ) |
| Midwest                                                                                                |       | 113,264      |       | (70,876                                                 | )          |
| Nevada                                                                                                 |       | 128,588      |       | 30,084                                                  |       |
| Pacific Coast                                                                                          |       | 108,527      |       | (40,291                                                 | )          |
| Texas                                                                                                  |       | 212,626      |       | 3,969                                                   |       |
| Mortgage banking                                                                                       |       | 4,247        |       | 508                                                     |       |
| Segment subtotal                                                                                       |       | 628,871      |       | (96,418                                                 | )          |
| Corporate and unallocated                                                                              |       | 696          |       | (18,108                                                 | )          |
|                                                                                                   |       | 629,567      |       | (114,526                                                | )          |
| Homebuilding interest expense(1)                                                                       |       |         |       | (25,438                                                 | )          |
| GAAP adjustment(2)                                                                                     |       | 12,208       |       | 17,689                                                  |       |
| Consolidated total                                                                                     |       | $            | 641,775    |                                                    | $          | (122,275 | ) |
| **2006**                                                                                               | ** ** | ** **   | ** ** | ** **                                              | ** ** |
| Florida                                                                                                |       | $            | 72,903     |                                                    | $          | 9,262 |   |
| Midwest                                                                                                |       | 159,611      |       | 425                                                     |       |
| Nevada                                                                                                 |       | 105,161      |       | 27,547                                                  |       |
| Pacific Coast                                                                                          |       | 215,325      |       | 62,924                                                  |       |
| Texas                                                                                                  |       | 210,498      |       | 9,781                                                   |       |
| Mortgage banking                                                                                       |       | 5,298        |       | 1,850                                                   |       |
| Segment subtotal                                                                                       |       | 768,796      |       | 111,789                                                 |       |
| Corporate and unallocated                                                                              |       | 1,415        |       | (31,698                                                 | )          |
|                                                                                                   |       | 770,211      |       | 80,091                                                  |       |
| Homebuilding interest expense(1)                                                                       |       |         |       | (20,588                                                 | )          |
| GAAP adjustment(2)                                                                                     |       |         |       | 949                                                     |       |
| Consolidated  total                                                                                    |       | $            | 770,211    |                                                    | $          | 60,452 |   |

 

(1)      For internal measurement purposes, we measure ourhomebuilding operating results exclusive of any interest expense or otherfinancing costs.

(2)      The GAAP adjustment to revenues is for certain closing costs and brokers commissions that are included asreductions to revenue in our internal measurement system that are reported asexpenses in accordance with GAAP. The GAAP adjustment to (loss) earningsbefore income taxes relates to: (a) timing differences of certaincapitalizable indirect construction costs that are expensed as incurred in ourinternal measurement system, and (b) minority interest expense which isnot included in our internal measurement system.

***Florida.  ***Homebuilding revenues decreased in thequarter ended June 30, 2007, compared to the quarter ended June 30, 2006,primarily due to a 38.4% decrease in the number of homes delivered and a $12thousand decrease in the average sales price of homes delivered. Homebuildinggross profit margins were (47.1)% in the third fiscal quarter of 2007, comparedto 17.8% in the third fiscal quarter of 2006. Gross profit for the three monthperiod ended June 30, 2007 was negatively impacted by $9.8 million of inventoryvaluation charges.

Homebuilding revenues decreased in the nine monthperiod ended June 30, 2007, compared to the nine month period ended June 30,2006, primarily due to a 24.6% decrease in the number of homes delivered,offset partially by a $38 thousand increase in the average sales price of homesdelivered. Homebuilding gross profit margins were (20.5)% in the nine monthsended June 30, 2007, compared to 21.3% in the nine months ended June 30, 2006.Gross profit for the nine month period ended June 30, 2007 was negativelyimpacted by $19.1 million of inventory valuation charges and $0.2 million ofcosts related to the abandonment of projects and write-off of deposits oncancelled land option contracts.

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***Midwest.  ***Homebuildingrevenues decreased in the quarter ended June 30, 2007, compared to the quarterended June 30, 2006, primarily due to a 53.5% decrease in the number of homesdelivered and a $12 thousand decrease in the average sales price of homes delivered.Homebuilding gross profit margins were (140.1)% in the third fiscal quarter of2007, compared to 8.6% in the third fiscal quarter of 2006. Gross profit forthe three month period ended June 30, 2007 was negatively impacted by $50.1million of inventory valuation charges. Gross profit for the three month period ended June 30, 2006 was negativelyimpacted by $0.2 million of inventory valuation charges.

Homebuilding revenues decreased in the nine monthperiod ended June 30, 2007, compared to the nine month period ended June 30,2006, primarily due to a 22% decrease in the number of homes delivered and a$29 thousand decrease in the average sales price of homes delivered.Homebuilding gross profit margins were (53.0)% in the nine months ended June 30,2007, compared to 7.4% in the nine months ended June 30, 2006. Gross profit forthe nine month period ended June 30, 2007 was negatively impacted by $63.7million of inventory valuation charges and $3.1 million of costs related to theabandonment of projects and write-off of deposits on cancelled land optioncontracts. Gross profit for the nine monthperiod ended June 30, 2006 was negatively impacted by $3.2 million of inventoryvaluation charges.

***Nevada.  ***Homebuildingrevenues decreased in the quarter ended June 30, 2007, compared to the quarterended June 30, 2006, primarily due to a 20.9% decrease in the number of homesdelivered and a $39 thousand decrease in the average sales price of homes,offset partially by a $7.4 million increase in land sales. Homebuilding grossprofit margins were 18.5% in the third fiscal quarter of 2007, compared to28.1% in the third fiscal quarter of 2006. Included within gross profit for thequarter ended June 30, 2007 is $1.8 million from land sales.

Homebuilding revenues increasedin the nine month period ended June 30, 2007, compared to the nine month periodended June 30, 2006, primarily due to a $30.6 million increase in land sales.Homebuilding gross profit margins were 26.5% in the nine months ended June 30,2007, compared to 32.4% in the nine months ended June 30, 2006. Included withingross profit for the nine months ended June 30, 2007 is $15.8 million from landsales.

***Pacific Coast.  ***Homebuilding revenues decreased in thequarter ended June 30, 2007, compared to the quarter ended June 30, 2006,primarily due to a 30.6% decrease in the number of homes delivered and a $82thousand decrease in the average sales price of homes delivered. Homebuildinggross profit margins were (26.2)% in the third fiscal quarter of 2007, comparedto 26.7% in the third fiscal quarter of 2006. Gross profit for the three monthperiod ended June 30, 2007 was negatively impacted by $15.7 million ofinventory valuation charges and $0.1 million of costs related to theabandonment of projects and write-off of deposits on cancelled land optioncontracts.

Homebuilding revenues decreased in the nine monthperiod ended June 30, 2007, compared to the nine month period ended June 30,2006, primarily due to a 40.5% decrease in the number of homes delivered and a$57 thousand decrease in the average sales price of homes delivered.Homebuilding gross profit margins were (29.9)% in the nine months ended June30, 2007, compared to 32.0% in the nine months ended June 30, 2006. Grossprofit for the nine month period ended June 30, 2007 was negatively impacted by$41.7 million of inventory valuation charges  and $3.9 million of costs related to theabandonment of projects and write-off of deposits on cancelled land optioncontracts.

***Texas.  ***Homebuildingrevenues decreased in the quarter ended June 30, 2007, compared to the quarterended June 30, 2006, primarily due to a 21.2% decrease in the number of homesdelivered, offset partially by a $11 thousand increase in the average salesprice of homes delivered. Homebuilding gross profit margins were 7.6% in thethird fiscal quarter of 2007, compared to 11.2% in the third fiscal quarter of2006. Gross profit for the threemonth period ended June 30, 2007 was negatively impacted by $5.7 million ofinventory valuation charges and $0.2 million of costs related to theabandonment of projects and write-off of deposits on cancelled land optioncontracts.

Homebuilding revenues increased in the nine monthperiod ended June 30, 2007, compared to the nine month period ended June 30,2006, primarily due to a $13 thousand increase in the average sales price ofhomes delivered, offset partially by a 4.5% decrease in the number of homesdelivered. Homebuilding gross profit margins were 8.4% in the 

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nine months ended June 30, 2007, compared to 13.2% inthe nine months ended June 30, 2006. Gross profit for the nine month periodended June 30, 2007 was negatively impacted by $9.2 million of inventoryvaluation charges and $0.6 million of costs related to the abandonment ofprojects and write-off of deposits on cancelled land option contracts.

***Mortgage banking.  ***Mortgagebanking earnings before taxes decreased to a net loss of $0.1 million in thethird fiscal quarter of 2007, compared to net earnings of $1.1 million in thethird fiscal quarter of 2006. Mortgage banking earnings before taxes decreasedto $0.5 million during the nine months ended June 30, 2007, compared to $1.9million during the nine month period ended June 30, 2006. The decrease inearnings before taxes was primarily due to a decrease in home closings, adecrease in the average mortgage loan size and a reduced mortgage capture rate.

***Corporate and unallocated.  ***Corporateand unallocated costs totaled $4.4 million in the third fiscal quarter of 2007and $9.0 million in the third fiscal quarter of 2006. Corporate and unallocatedcosts as a percentage of total consolidated revenues were 2.1% for the threemonths ended June 30, 2007 and 2.9% for the three months ended June 30, 2006.

Corporate and unallocatedcosts totaled $18.1 million in the nine months ended June 30, 2007 and $31.7million in the nine months ended June 30, 2006. Corporate and unallocated costsas a percentage of total consolidated revenues were 2.8% for the nine monthsended June 30, 2007 and 4.1% for the nine months ended June 30, 2006.

The reduction incorporate and unallocated costs is primarily related to a decrease in incentivecompensation due to lower overall corporate earnings.

**Liquidity and Capital Resources**

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

***Operating cashflows activities***

Cash usedin operating activities totaled $78 million during the nine months ended June30, 2007, compared to $145.9 million of cash used in operating activitiesduring the nine months ended June 30, 2006. The increase in operating cashflows is primarily due to a significant reduction in the net investment ininventory related to land purchases, lot development and home construction,partially offset by lower sales volume and margins during the nine months endedJune 30, 2007.

***Investing cashflows activities***

Cash used in investingactivities totaled $4.8 million during the ninemonths ended June 30, 2007, compared to $13.9 million cash used in investingactivities during the nine months ended June 30, 2006. The increase ininvesting cash flows was primarily due to a decrease in fixed asset purchasesand a decrease in net contributions to investments in unconsolidatedsubsidiaries.

***Financing cashflows activities***

Cashprovided by financing activities totaled $79.9 million during the nine monthsended June 30, 2007, compared to $167.6 million cash provided by financingactivities during the nine months ended June 30, 2006. During the nine monthsended June 30, 2007, we increased our outstanding borrowings by $106.7 millionprimarily to fund inventory purchases and other operating cash requirements.During the nine months ended June 30, 2007, we distributed $18.1 million ofcash to joint venture partners and repurchased $10.8 million of our commonstock.

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InDecember 2005, we issued $203 million aggregate principal amount of seniorsubordinated notes due December 2012 in a private placement pursuant toRule 144A promulgated under the Securities Act of 1933. In May 2006,we exchanged all of the senior subordinated notes issued in December 2005for an issue of notes registered with the SEC with terms substantiallyidentical to the notes issued in the private placement. The senior subordinatednotes 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 netproceeds were used to repay amounts outstanding under working capital loans andcertain senior secured revolving credit facilities. We may redeem the notes, inwhole or part, at any time on or after December 15, 2009, at a redemptionprice equal to 100% of the principal amount, plus a 5.25% premium decliningratably to par on December 15, 2011, plus accrued and unpaid interest. Atany time prior to December 15, 2008, we may also redeem up to 35% of theaggregate principal amount of the notes with the proceeds of qualified equityofferings at a redemption price equal to 110.5% of the principal amount, plusaccrued and unpaid interest. In addition, if we experience specific kinds ofchanges of control, we are required to make an offer to purchase all of thenotes at a purchase price of 101% of the principal amount thereof, plus accruedand unpaid interest. The notes are unsecured senior subordinated obligationsand 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 ownedsubsidiaries, other than our mortgage subsidiary, have fully andunconditionally guaranteed the notes on a joint and several, unsecured seniorsubordinated, basis. The guarantees are general unsecured obligations of theguarantors and will be subordinated in right of payment to all existing andfuture senior debt of the guarantors, which includes their guarantees of oursenior credit facility. The indenture governing the senior subordinated notescontains a number of significant covenants that restricts our ability and thatof our restricted subsidiaries to, among other things: incur additionalindebtedness, make certain distributions, investments and other restrictedpayments, create certain liens, enter into transactions with affiliates, andmerge, consolidate or sell substantially all of our assets. As of June 30,2007, we were restricted from incurring additional indebtedness (excludingavailable borrowings under the senior credit facility), except under certainlimited circumstances.

InDecember 2005, we entered into a new senior credit facility to finance ourbusiness operations. Proceeds of the new senior credit facility were used toretire our existing senior secured revolving credit facilities andsubstantially all of our other senior secured credit facilities. The seniorcredit facility has a maximum availability of $500 million, subject to aborrowing base as well as sublimits of $100 million for the issuance of lettersof credit and $10 million for swing line loans. We have the right, without theconsent of our lenders (other than those participating in the increase), toincrease the commitment by an amount of up to $200 million, provided that nosuch increase shall cause the senior credit facility to exceed $700 million.The applicable borrowing base is determined regularly throughout the life ofthe senior credit facility. The composition of the borrowing base is limited toparameters set forth in the senior credit facility agreement and certain typesof real estate (such as unimproved entitled land and lots under development) isremoved from the borrowing base if held beyond specified maturity dates.Borrowings under the senior credit facility generally bear interest based on anapplicable margin plus LIBOR or an alternate base rate. The applicable marginfor interest ranges from 1.5% to 2.25%, depending upon our senior leverageratio, which is defined as the ratio of total liabilities to consolidated networth. Fees for letters of credit are based on LIBOR plus a margin of 1.5%. Anunused commitment fee equal to 0.2% to 0.3% per year accrues on the undrawnportion of the senior credit facility and is payable quarterly in arrears. Ourobligations under the senior credit facility are subject to a number ofcustomary financial and operating covenants.

InDecember 2006, we amended certain covenants in our senior credit facility. Thecovenants as amended, require us to: maintain a minimum tangible net worth ofat least $300 million plus 50% of positive net income earned subsequent toSeptember 30, 2006; maintain a ratio of total liabilities to adjusted tangiblenet worth not to exceed 2.0x (decreasing to 1.75x as of June 30, 2007 andincreasing to 2.5x as of December 31, 2008); maintain a ratio of total debt toadjusted tangible net worth not to exceed 1.5x; maintain a ratio of total land(including undeveloped land, land under development and finished lots on whichhome construction has yet to begin) to adjusted tangible net worth not toexceed 1.5x; and maintain an interest coverage ratio of no less than 1.75xthrough December 31, 2006 (decreasing 

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to 1.5xthrough March 31, 2007, decreasing to 1.4x through June 30, 2007, decreasing to1.35x 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 throughthe remaining term of the senior credit facility). For purposes of these tests,adjusted tangible net worth is benefited by adjustments of 50% of ouroutstanding senior subordinated debt (up to a maximum $100 million adjustment)and 100% of minority interests in consolidated entities (up to a maximum $50million adjustment).

OnAugust 10, 2007, we amended and restated our existing senior credit facility.The terms of the amendment and restatement (summarized below) reflect currentmarket conditions and related deterioration of our profitability. Fees payablein connection with the amendment and restatement totaled approximately $0.9 million.

Theamendment and restatement permits us to ignore, for purposes of financialcovenant calculations (but not for interest margin calculations), up to $40million of tangible net worth reductions due to impairment and abandonmentcharges. The amendment and restatement suspends the interest coverage ratiocovenant until March 31, 2009 and adds a minimum $25 million trailingfour-quarter adjusted EBITDA requirement (as defined in the credit agreement) anda minimum $50 million liquidity requirement (defined as unrestricted cash,available borrowings under the senior credit facility and other available linesof credit and receivables from home closings). Liquidity is tested monthly. Theamendment and restatement reduces permitted unsecured debt from $25 million to$15 million and permitted joint venture investments from 30% of tangible networth to 25% of tangible net worth and, in the case of our Nevada buildingregion, eliminates until September 1, 2007 the pre-existing requirement thatthe number of speculative housing units owned by us, as June 30, 2007, notexceed a maximum of 35% of our housing unit closings in such region during theprevious 12-month period. Prior to the amendment and restatement, wewere in default of the inventory restriction as of June 30, 2007 due to ourownership of an excessive number of speculative housing units in Nevada.

Theamendment and restatement requires that the senior credit facility be securedby all properties to be included in the borrowing base for the senior creditfacility and related assets and prohibits the incurrence of any additionalsecured debt. In this regard, in contrast to the previous calculation methodfor the borrowing base, the property of certain non-wholly owned subsidiariescannot be included in the borrowing base calculation unless and until suchsubsidiaries are able to guarantee the senior credit facility (on a securedbasis) which will be subject to the consent of minority interest holders andthere is no assurance that we would be able to obtain such consent. Newproperties that are proposed to be included as borrowing base property wouldalso be mortgaged and pledged to secure the senior credit facility and alsowould need to satisfy specified parameters or otherwise be approved by themajority lenders. As of June 30, 2007, the effect of the removal of theproperty of such non-wholly owned subsidiaries from the borrowing basecalculation upon our liquidity would have been to reduce our liquidityfrom $159 million to $155 million. As of June30, 2007, we had $358 million of borrowings under the senior credit facility atan effective interest rate of 7.09% and, after calculating the borrowing baselimitation based on removal of the property of such non-wholly ownedsubsidiaries, would have had additional availability of approximately $106million. Finally, the amendment and restatement provides that the applicableinterest margins are subject to increase by 0.375% to 0.875% in the event thatliquidity (as defined above) is more than $50 million but less than or equal to$100 million.

As ofand during the three and nine months ended June 30, 2007, we were in compliancewith the covenants of our senior credit facility as amended and restated.

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InNovember 2006, we entered into a two year interest rate cap agreement toprotect $100 million of our borrowings from sharp increases in the prevailingshort-term interest rates. Under the terms of the agreement, the LIBOR rate iscapped at 5.5% per annum.

We areparty to senior secured project-specific acquisition, development andconstruction loans. These loans bear interest at a floating rate ranging fromLIBOR to LIBOR plus 2.25% with maturities generally tied to the sale of theunderlying inventory. As of June 30, 2007, we had $33 million outstandingrelated to these project-specific acquisition, development and constructionloans.

We areparty to several unsecured loan agreements that fund our operations on anongoing basis. In addition, KH Financial, L.P., our wholly owned mortgagesubsidiary, is party to a $5 million warehouse line of credit, used tofund its mortgage origination operations. This facility bears interest at afloating rate equal to LIBOR plus 2.25%, and as of June 30, 2007 there were noamounts outstanding under the warehouse facility.

We arealso party to a $100 million flexible early purchase facility agreementwhich allows us to sell qualifying mortgage loans to the holder of the flexibleearly purchase facility after such loans have been originated subject to ourobligation to sell the loan to an investor in the secondary market. At June 30,2007, the facility held $35.5 million of loans sold by KH Financial, L.P.

Webelieve that our cash, other liquid assets and operating cash flow, togetherwith available borrowings under our senior credit facility, will be sufficientto meet our operating expenses and capital expenditures and service our debtrequirements over the next twelve months. However, our ongoing ability to meetour substantial debt service and other obligations, including compliance withfinancial covenants in our senior credit facility and senior subordinatednotes, will be dependent upon our future performance which will be subject tobusiness, financial and other factors. We will not be able to control many ofthese factors, such as the continued deterioration in the homebuildingindustry, economic conditions in the markets where we operate and pressure fromcompetitors. Our current levels of cash flow have not been sufficient to allowus to pay principal and interest on our debt, including our senior creditfacility and senior subordinated notes, support our operations and meet ourother obligations without continued reliance upon additional borrowings underour senior credit facility. If we do not have enough money, or access toadditional borrowings, or are unable to maintain compliance with financialcovenants in our senior credit facility and senior subordinated notes, we maybe required to seek to refinance all or part of our existing debt, sell assetsor borrow more money. We cannot guarantee that we will be able to do so onterms acceptable to us, if at all. In addition, the terms of existing or futuredebt agreements, including our senior credit facility and the indenture for oursenior subordinated notes, may restrict us from pursuing any of thesealternatives.

**Contractual Obligations**

Our primary contractual cash obligations for ouroperations are payments under our debt agreements and purchase obligations withspecific performance requirements under land option agreements and purchasecontracts. These land option agreements and purchase contracts may require usto purchase land contingent upon us and the seller meeting certain obligations.We expect to fund our contractual obligations in the ordinary course ofbusiness through our operating cash flows and our credit facilities.

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Thefollowing summarizes our aggregate contractual commitments at June 30, 2007:
| ** **                           | ** ** | **Payments due  by period** | ** ** |
|--------------------------------------|------------|---------------------------------------|------------|
| **(Dollars in thousands)** | ** ** | **Total**                             | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than 5  years** | ** ** |
| Notes payable (1)                    |       | $                                     | 788,604    |   | $ | 59,734 |   | $ | 476,010 |   | $ | 42,199 |   | $ | 210,661 |   |
| Operating leases                     |       | 9,452                                 |       | 2,627 |   | 4,662 |   | 1,674 |   | 489 |   |
| Purchase  obligations (2)            |       | 43,632                                |       | 1,777 |   | 41,855 |   |   |   |   |   |
| Total                                |       | $                                     | 841,688    |   | $ | 64,138 |   | $ | 522,527 |   | $ | 43,873 |   | $ | 211,150 |   |
|                                 |       |                                  |       |   |   |   |   |   |   |   |   |

 

(1)             Includes our senior subordinated notes,senior credit facility, other homebuilding debt, and related interest paymentsfor the life of the debt. Interest on variable rate obligations is based onrates effective as of June 30, 2007.

(2)             Represents obligations under land option agreements andpurchase contracts with specific performance provisions, net of cash deposits.

Under the terms of our stock option plans, we may berequired to purchase shares of our common stock at fair market value, includingshares issuable under outstanding options or deferred stock units, from certainof our directors, executive officers and other key employees, in the event oftermination of board membership or employment, as applicable, by reason ofspecified circumstances, including death, disability, involuntary terminationor retirement. As of June 30, 2007, the aggregate repurchase obligation, net ofproceeds to be received from any stock option exercises, would have been$17.4 million in the event that all of these obligations were triggered.Our ability to satisfy our repurchase obligations is subject to certainlimitations set forth in the Trust Indenture governing the senior subordinatednotes. In addition, under the terms of David K. Hill’s employment agreement, ifMr. Hill’s employment is terminated by reason of his death or permanentdisability, his family trust may request us to purchase up to 500,000 shares ofcommon stock of the Company, and upon receipt of such request we will reasonablydetermine in our sole discretion how many shares to purchase in light of ourfinancial condition and prospects and the limitations, restrictions andconstraints in our loan and financing arrangements at the time. The purchaseprice payable by us will be the fair market value at that time.

We are contingently liable to banks and financialinstitutions for approximately $49 million for outstanding letters of creditand performance bonds securing performance of certain contractual obligationsand land purchase contracts. Approximately $2.7 million of the outstandingletters of credit have been issued by a wholly owned subsidiary. At June 30,2007, we had committed to fund approximately $30.4 million in mortgage loans tohomebuyers at agreed-upon rates. We have entered into best-efforts andmandatory sale commitments to sell these mortgages to third parties.

**Land and Lot Position and Homes in Inventory**

At June 30, 2007, we owned andcontrolled 21,240 lots, approximately 35% of which were pursuant to optionagreements and purchase contracts. The following is a summary of our land/lotposition as of June 30, 2007:
| **Number of lots**                                        | ** ** |
|---------------------------------------------------------------------|------------|
| Finished lots  owned                                                |       | 4,974 |   |
| Lots under  development owned                                       |       | 8,777 |   |
| Total lots owned  (1)                                               |       | 13,751 |   |
| Lots controlled  under option agreements and purchase contracts (2) |       | 7,489 |   |
| Total land/lots  controlled                                         |       | 21,240 |   |
|                                                                |       |   |   |

 

(1)             Includes 2,068 lots that have beenidentified as held for sale, which we intend to sell and are actively marketingfor delivery within the next 12 months.

(2)             Includes 1,895 lotsincluded in inventory not owned which were consolidated under the accountingguidance of FIN 46R and 1,832 lots that we expect to purchase fromunconsolidated entities in which we have an investment as an equity member.

**Off-Balance Sheet Arrangements**

Our primary use of off-balance sheet arrangements isto secure desirable lots on which to build homes in a manner that we believereduces the overall risk to us. Our off-balance sheet arrangements relating to ourhomebuilding operations include land option agreements and purchase contractsand joint ventures.

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

In the ordinary course ofbusiness, we enter into option agreements and purchase contracts to secure landfor the construction of homes. These agreements generally require us to pay adeposit to the seller as consideration for the right to acquire land during aspecified period, usually at predetermined prices. Some of these optionagreements and purchase contracts contain specific performance clauses, whichrequire us to purchase the land upon satisfaction of certain requirements.Otherwise, our liabilities under option agreements and purchase contracts aregenerally limited to forfeiture of the nonrefundable deposits, letters ofcredit and other nonrefundable amounts incurred. Below is a summary of theaggregate exercise price of all option agreements and purchase contracts as ofJune 30, 2007:
| **(Dollars in thousands)**                                        | ** ** | **Aggregate  exercise  price of land  options **(1) | ** ** |
|-----------------------------------------------------------------------------|------------|------------------------------------------------------------------------------|------------|
| Option  agreements and purchase contracts with specific performance         |       | $                                                                            | 1,777      |   |
| Options  agreements and purchase contracts without specific performance (2) |       | 264,599                                                                      |       |
| Total option  agreements and purchase contracts                             |       | $                                                                            | 266,376    |   |
|                                                                        |       |                                                                         |       |

 

(1)             Excludes $49 million of purchaseobligations related to inventory not owned included on our condensedconsolidated balance sheets at an initial fair value of $38 million, of which$42 million of the purchase obligations contains specific performanceobligations.

(2)             Includes $145 million related to purchases from jointventures in which we have an investment balance of $34 million as ofJune 30, 2007. These investments are recorded in investments in andadvances to unconsolidated entities on our condensed consolidated balancesheets.

Given the continueddeterioration in market conditions and uncertainty about the timing and pace ofany recovery, we have tightened our land acquisition criteria and are workingwith land sellers to renegotiate land purchase and option contracts to extendpurchase dates and reduce purchase prices. If we are unable to obtainsatisfactory terms, we will not exercise our land option agreements and willabandon our earnest money if contractually obligated to do so. During the threeand nine months ended June 30, 2007, we wrote-off $0.3 million and $7.8 millionof costs related to the abandonment of land option contracts. We expect toexercise all of our land option agreements and purchase contracts with specificperformance obligations.

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

Investmentsin and advances to unconsolidated entities represent our ownership interests inentities accounted for under the equity method when we have a significantinfluence over the entity but hold less than a controlling interest in theentity or we are not the primary beneficiary in a variable interest entity asdefined by the Financial Accounting Standards Board (“FASB”) RevisedInterpretation No. 46 (“FIN 46R”). Our business partners generally areunaffiliated homebuilders, land sellers or other real estate entities.

In theordinary course of business, we periodically enter into arrangements with landdevelopers or other homebuilders to acquire land and develop lots. Thesearrangements include the creation of joint ventures, in which our currentinterests range from 6% to 49%. We account for our interest in these jointventures under the equity method, and our condensed consolidated balance sheetsinclude investments in and advances to joint ventures totaling $46.2 millionand $48.2 million at June 30, 2007 and September 30, 2006, respectively. Thesejoint ventures typically obtain secured acquisition, development andconstruction financing. At June 30, 2007 and September 30, 2006, ourunconsolidated joint ventures had outstanding third party borrowings of $908million and $865 million, respectively. From time to time we have issuedrepayment guarantees and/or loan-to-value maintenance guarantees in respect ofthis indebtedness. These guarantees require us to repay debt of the jointventure in the event of a payment default or in the event that the debt of thejoint venture exceeds the value of the property securing the debt. At June 30,2007 and September 30, 2006, we had guarantees of $98.8 million and $74.3 million,respectively, related to the outstanding indebtedness of these joint ventures.

 

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**Seasonality and Variability in Quarterly Results**

Our homebuildingoperating cycle generally reflects increased new order activity in our secondand third fiscal quarters and increased deliveries in our third and fourthfiscal quarters. We believe that this seasonality reflects the tendency ofhomebuyers to shop for a new home in the spring with the goal of closing in thefall, as well as the scheduling of paving and construction to accommodateseasonal weather conditions. We also experience seasonality in our mortgagebanking operations as loan originations correspond with the closing of homes.

**Backlog**

Our sales contractsrequire cash deposits in line with local market practices and may be subject tocertain 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 tothe homebuyer and other criteria for sale and profit recognition are met. Wesometimes build homes before obtaining a sales contract; however, these homesare excluded from backlog until a sales contract is signed. At June 30, 2007,we had 257 completed homes in inventory without sales contracts whichrepresented 17% of our total home inventory. Our cancellation rates for thethree months ended June 30, 2007 and 2006 were 29% and 30%, respectively.Our cancellation rates for the nine months ended June 30, 2007 and 2006were 26% and 28%, respectively.

**Interest Rates and Inflation**

Our business issignificantly affected by the level of interest rates. Higher interest ratesmay decrease demand for our homes by making it more difficult for homebuyers toqualify for mortgages or to obtain mortgages at interest rates that areacceptable to them. Higher interest rates would also increase our borrowingcosts because a portion of our bank loans fluctuate with LIBOR and primelending rates. In November 2006, we entered into a two year interest rate capagreement to protect $100 million of our borrowings from sharp increases in theLIBOR lending rate.

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

**Critical Accounting Estimates and Policies**

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

Management believes thatthe following critical accounting policies affect its more significantjudgments and estimates used in preparation of its condensed consolidatedfinancial statements:

·         Revenuerecognition;

·         Homebuildinginventory and costs of sales;

·         Variable interest entities;

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·         Investments in and advances to unconsolidatedentities;

·         Warranty costs;

·         Litigation reserves;

·         Insurance claims costs;

·         Valuation of deferred tax assets; and

·         Stock-based compensation.

Therehave been no significant changes in the above critical accounting policies, ascompared to those we disclosed in our Annual Report on Form 10-K for thefiscal year ended September 30, 2006.

**Recent Accounting Pronouncements**

In July 2006, theFASB issued FASB Interpretation No. 48, *Accountingfor Uncertainty in Income Taxes*(“FIN 48”), which prescribes arecognition threshold and measurement process for recording in the financialstatements uncertain tax positions taken or expected to be taken in a taxreturn. Additionally, FIN 48 provides guidance on the derecognition, classification,accounting in interim periods and disclosure requirements for uncertain taxpositions. The accounting provisions of FIN 48 will be effective for usbeginning October 1, 2007. We are in the process of determining theeffect, if any, the adoption of FIN 48 will have on our financial statements.

In September 2006,the FASB issued SFAS No. 157, *FairValue Measurements*(“SFAS 157”), which defines fair value,establishes a framework for measuring fair value in generally acceptedaccounting principles and expands disclosure about fair value measurements.SFAS 157 is effective for financial statements issued for fiscal yearsbeginning after November 15, 2007, and interim periods within those fiscalyears. We are in the process of determining the effect, if any, the adoption ofSFAS 157 will have on our financial statements.

In September 2006,the SEC issued Staff Accounting Bulletin No. 108, *Considering the Effects of Prior Year Misstatementswhen Quantifying Misstatements in Current Year Financial Statements*(“SAB108”), which provides guidance as to how the effects on prior year uncorrectedmisstatements should be considered when quantifying misstatements in thecurrent financial statements. SAB 108 was issued in order to eliminate thediversity of practice surrounding how public companies quantify financialstatement misstatements. SAB 108 will require us to quantify misstatementsusing both a balance sheet and income statement approach, with adjustmentrequired if either method results in a material error. SAB 108 is effective forfinancial statements issued for fiscal years beginning after November 15,2006. We are in the process of determining the effect, if any, the adoption ofSAB 108 will have on our financial statements.

In February 2007,the FASB issued SFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities, including an amendment of FASBStatement No. 115*(“SFAS 159”). SFAS 159 permits a company tomeasure certain financial instruments and other items at fair value. SFAS 159is effective for financial statements issued for fiscal years beginning afterNovember 15, 2007. We are in the process of determining the effect, if any, theadoption of SFAS 159 will have on our financial statements.

**Cautionary Factors That May Affect Future Results**

Our disclosure andanalysis in this report contain forward-looking statements about our financialresults and estimates and business prospects that involve substantial risks anduncertainties. From time to time, we also may provide oral or writtenforward-looking statements in other materials we release to analysts, debtholders and the public. Forward-looking statements give our currentexpectations or forecasts of future events. You can identify these statementsby 

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the fact that they do notrelate 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 anyother of our reports or public statements may not approximate actualexperience, and the expectations derived from them may not be realized, due toknown or unknown risks and uncertainties. As a result, actual results maydiffer materially from the results discussed in and anticipated by theforward-looking statements. The following risks and uncertainties relevant toour business include factors we believe could adversely affect us:

·                          continued deterioration in homebuildingindustry;

·                          availability and affordability of mortgagefinancing;

·                          high interest rates, changes in tax laws andinflation;

·                          changes in macroeconomic conditions in our marketsand regions;

·                          the availability of sufficient capital;

·                          fluctuations in inventory values and carrying costs;

·                          our ability to acquire desirable lots or land forresidential buildout;

·                          our ability to compete effectively againsthomebuilders in our markets and with sales or rentals of existing homes in ourmarkets;

·                          adverse weather conditions and natural disasters inour markets;

·                          the availability and quality of subcontractors andraw materials;

·                          utility shortages and price increases;

·                          our ability to develop our communities successfully;

·                          our ability to retain certain members of our seniormanagement and other key employees;

·                          the future availability of insurance at reasonablecost;

·                          fluctuations in real estate values;

·                          poor relations with residents of our communities;

·                          expenses related to construction defect, soilsubsidence and home warranty claims;

·                          changes in our legal and regulatory environment;

·                          changes in environmental laws and regulations;

·                          restrictions on our financial services companies;

·                          our obligation to repurchase issued and outstandingshares of our common stock;

·                          geopolitical risks and market disruption; 

·                          our substantial level of indebtedness;

·                          the indenture for our senior subordinated notes andother debt agreements impose significant operating and financial restrictions; 

·                          the growth or expansion of our operations; and

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·                          our controlling stockholder’s interests may conflictwith the interests of other stakeholders.

Other factors beyondthose listed above could also adversely affect us. Given these uncertainties,you are cautioned not to place undue reliance on these forward-lookingstatements. These forward-looking statements are made as of the date of thisreport. We undertake no obligation to update or revise any forward-lookingstatements, whether as a result of new information, future events or otherwise.However, any further disclosures made on related subjects in subsequent reportsor communications should be considered. Additional information about factorsthat could lead to material changes in performance is contained in our Annual Report on Form 10-K for the fiscalyear ended September 30, 2006. You should understand that it is not possible topredict or identify all such factors. Consequently, you should not consider anysuch list to be a complete set of all potential risks or uncertainties.

**Item 3.     Quantitative andQualitative Disclosures About Market Risk.**

We areexposed to a number of market risks in the ordinary course of business. Ourprimary market risk exposure for financial instruments relates to fluctuationsin interest rates. We do not believe our exposure in this area is material tocash flows or earnings. As of June 30, 2007, we had a total of $397 million offloating rate debt outstanding, including our senior credit facility and other facilities.Borrowings under these facilities generally bear interest based on applicablemargins plus LIBOR or an alternate base rate. Holding our variable rate debtbalances constant as of June 30, 2007, each one percentage point increase ininterest rates would result in an increase in interest incurred for the nexttwelve month period of approximately $4.0 million. A one percentage pointincrease in interest rates on our average variable rate debt outstanding duringthe twelve month period ended June 30, 2007 would have resulted in an increasein interest incurred of approximately $3.3 million.

Currently,we hedge exposure on $100 million of our variable rate debt from interest ratefluctuations through the use of an interest rate cap. Under the terms of theagreement, the LIBOR rate is capped at 5.5% per annum. We do not enter into orhold derivatives for trading or speculative purposes.

**Item 4.     Controls andProcedures.**

***Disclosurecontrols and procedures.*** We maintain disclosure controls and procedures (as defined in Rule13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Act”)) thatare designed to provide reasonable assurance that information required to bedisclosed by us, including our consolidated entities, in the reports that we fileor submit under the Act, is recorded, processed, summarized and reported,within the time periods specified in the Securities and Exchange Commission’srules and forms and that such information is accumulated and communicated tomanagement, including the Chairman and Chief Executive Officer (the “PrincipalExecutive Officer”) and Chief Financial Officer (the “Principal FinancialOfficer”), as appropriate, to allow timely decisions regarding requireddisclosure. Prior to the filing of this report, we completed an evaluationunder 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 andprocedures as of June 30, 2007. Based on this evaluation, our PrincipalExecutive Officer and our Principal Financial Officer concluded that ourdisclosure controls and procedures were effective at the reasonable assurancelevel as of June 30, 2007.

***Changesin internal control over financial reporting.***  There were no changes in our internal controlover financial reporting that occurred during the third fiscal quarter of 2007that have materially affected, or are reasonably likely to materially affect,our internal control over financial reporting.

 

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**PARTII—OTHER INFORMATION**

**Item 1.     Legal Proceedings.**

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

**Item 1A.   Risk Factors.**

There have been nomaterial changes in our risk factors from those disclosed in Part I, Item 1A ofour Annual Report on Form 10-K for the fiscal year ended September 30, 2006other than the inclusion of the risk factors listed below. The risk factorsdisclosed in our Annual Report on Form 10-K as amended by this report, inaddition to the other information set forth in this report, could materiallyaffect our business, financial condition or results. Additional risks anduncertainties not currently known to us or that are deemed to be immaterialalso may materially adversely affect our business, financial condition orresults.

**The homebuilding industry continues to experiencedeteriorating conditions that may continue for an indefinite period and mayfurther adversely affect our business and results of operations compared toprior periods.**

The U.S. homebuildingindustry as a whole continues to experience a significant and sustained decreasein demand for new homes and an oversupply of new and existing homes availablefor sale. The rapid increase in new and existing home prices in our marketsover the past several years reduced housing affordability and tempered buyerdemand. In particular, investors and speculators reduced their purchasingactivity and instead stepped up their efforts to sell the residential propertythey had earlier acquired. These trends resulted in overall fewer home sales,greater cancellations of home purchase agreements by buyers, higher inventoriesof unsold homes and the increased use by homebuilders, speculators, investorsand others of discounts, incentives, advertising expenses, broker commissionsand price concessions to close home sales compared to the past several yearsall of which negatively impacted margins. 

Reflecting these demandand supply trends, we, like many other homebuilders, experienced a large dropin net new sales orders, a reduction in our margins, slower price appreciationfor new homes sold, higher incentives and in many cases price declines. Thehomebuilding market may not improve in the near future, and it may weakenfurther. Continued weakness in the homebuilding market would have an adverseeffect on our business and our results of operations as compared to those ofearlier periods.

**The availability and affordability of residentialmortgage financing could adversely affect our business, revenues andprofitability.**

The majority of our customers finance their purchases through mortgagefinancing obtained from us or other sources. Increases in interest rates ordecreases in the availability of mortgage funds could cause a decline in themarket for new homes as potential homebuyers may not be able to obtainaffordable financing. In particular, because the availability of mortgagefinancing is an important factor in marketing many of our homes, anylimitations or restrictions on the availability of financing could reduce ourhome sales and the lending volume at our mortgage subsidiary. Increasedinterest rates can also limit our ability to realize our backlog because oursales contracts typically provide our customers with a financing contingency.Financing contingencies allow customers to cancel their home purchase contractsin the event they cannot arrange for financing. Even if our potential customersdo not need financing, changes in interest rates and mortgage availabilitycould make it harder for them to sell their existing homes to potential buyerswho need financing. Interest rates currently are at one of their lowest levelsin decades, and any future increases in interest rates could adversely affectour revenues and profitability. 

 

During the first half of 2007, the mortgage market began to receivenegative attention, resulting in tighter lending standards throughout themortgage industry. This volatility in the mortgage market may have a negativeimpact on our business by making it more difficult for certain of ourhomebuyers to obtain financing or resell their existing home.

 

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**Item 3.   DefaultsUpon Senior Securities.**

As of June 30, 2007, we were in default of the inventory restriction ofour senior credit facility due to our ownership of an excessive number ofspeculative housing units in Nevada. In August 2007, we amended and restatedthis senior credit facility as discussed in Part II, Item 5 of this report. Theamendment and restatement provides a waiver to the limitation on speculativehousing units allowed from June 30, 2007 until September 1, 2007. 

 

**Item 5.   Other Information.**

***(a)***

***Management Changes***

On August 9, 2007, ourBoard of Directors elected C. Kenneth Love to the position of President andChief Executive Officer, effective as of October 1, 2007. Beginning on October1, 2007, David K. Hill will assume the new position of Executive Chairman,through which he will remain actively involved with us. Biographical and otherimportant information with respect to Mr. Love required by Item 5.02(c) of Form8-K is contained in our Annual Report on Form 10-K for the fiscal year endedSeptember 30, 2006, and such information is incorporated by reference herein. Inaccordance with Mr. Love’s previously disclosed employment agreement, his basesalary will be increased October 1, 2007 to an amount commensurate with hisposition of President and Chief Executive Officer and his equity-basedcompensation will be reviewed.

Mr. Hill is the founderof our Company, has been its Chief Executive Officer since its foundation andhas had primary responsibility for our growth, profitability and success.Although Mr. Hill has expressed his desire to reduce his involvement in ourday-to-day operations, it is in the best interests of the Company to ensurethat Mr. Hill continues to play an active role in our management and business.As such, on August 10, 2007, we entered into an employment agreement with Mr.Hill. The agreement provides that, effective October 1, 2007, Mr. Hill willserve as Executive Chairman, Chairman of the Executive Committee of the Boardof Directors and a director. The initial term of the agreement is from October1, 2006 until October 1, 2011, and thereafter the agreement will renew automaticallyfor one-year terms unless terminated by either party upon ninety days priorwritten notice. The agreement provides for a minimum base salary of $1,500,000effective October 1, 2006 (which may be increased by us not less frequentlythan annually) and an annual bonus ranging from 120-160% of base salary subjectto achievement of performance goals. In addition, the board has discretion toaward an additional bonus based on factors that the board deems appropriate. IfMr. Hill’s employment is terminated by us without cause, by Mr. Hill for goodreason, or by reason of Mr. Hill’s death or permanent disability, he isentitled to receive: (a) a lump sum payment equal to his base salary and targetbonus earned but unpaid through the date of termination; (b)  periodic payments, for a period of threeyears, equal to the sum of (i) his then current base salary, and (ii) histarget bonus in an amount equal to 120% of base salary; (c) continued coverageunder our employee benefit and welfare plans for three years; and (d) ifapplicable, specified excise and other tax reimbursement payments. In addition,if Mr. Hill’s employment is terminated by reason of his death or permanentdisability, his family trust may request us to purchase up to 500,000 shares ofcommon stock of the Company, and upon receipt of such request we will reasonablydetermine in our sole discretion how many shares to purchase in light of ourfinancial condition and prospects and the limitations, restrictions andconstraints in our loan and financing arrangements at the time. The purchaseprice payable by us will be the fair market value at that time. The employmentagreement also contains non-competition and non-solicitation provisions thatcontinue for a period of three years after termination of Mr. Hill’s employmentwith us.

The above description ofMr. Hill’s employment agreement is qualified in its entirety by reference tothe copy of the employment agreement filed herewith as Exhibit 10.1 and isincorporated herein by reference.

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***Amendments to By-Laws***

Primarily to reflect themanagement changes discussed above, we amended our By-Laws on August 10, 2007.A copy of our amended and restated By-Laws is filed herewith as Exhibit 3.2.

***Amended and Restated Senior CreditFacility***

In December 2005, weentered into a new senior credit facility to finance our business operations.Proceeds of the new senior credit facility were used to retire our existingsenior secured revolving credit facilities and substantially all of our othersenior secured credit facilities. The senior credit facility has a maximumavailability of $500 million, subject to a borrowing base as well as sublimitsof $100 million for the issuance of letters of credit and $10 million for swingline loans. We have the right, without the consent of our lenders (other thanthose participating in the increase), to increase the commitment by an amountof up to $200 million, provided that no such increase shall cause the seniorcredit facility to exceed $700 million. The applicable borrowing base isdetermined regularly throughout the life of the senior credit facility. Thecomposition of the borrowing base is limited to parameters set forth in thesenior credit facility agreement and certain types of real estate (such asunimproved entitled land and lots under development) is removed from theborrowing base if held beyond specified maturity dates. Borrowings under thesenior credit facility generally bear interest based on an applicable marginplus LIBOR or an alternate base rate. The applicable margin for interest rangesfrom 1.5% to 2.25%, depending upon our senior leverage ratio, which is definedas the ratio of total liabilities to consolidated net worth. Fees for lettersof credit are based on LIBOR plus a margin of 1.5%. An unused commitment feeequal to 0.2% to 0.3% per year accrues on the undrawn portion of the seniorcredit facility and is payable quarterly in arrears. Our obligations under thesenior credit facility are subject to a number of customary financial andoperating covenants.

In December 2006, weamended certain covenants in our senior credit facility. The covenants asamended, require us to: maintain a minimum tangible net worth of at least $300million plus 50% of positive net income earned subsequent to September 30,2006; maintain a ratio of total liabilities to adjusted tangible net worth notto exceed 2.0x (decreasing to 1.75x as of June 30, 2007 and increasing to 2.5xas of December 31, 2008); maintain a ratio of total debt to adjusted tangiblenet worth not to exceed 1.5x; maintain a ratio of total land (includingundeveloped land, land under development and finished lots on which homeconstruction has yet to begin) to adjusted tangible net worth not to exceed1.5x; and maintain an interest coverage ratio of no less than 1.75x throughDecember 31, 2006 (decreasing to 1.5x through March 31, 2007, decreasing to1.4x 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 March31, 2008 and then increasing to 2.25x through the remaining term of the seniorcredit facility). For purposes of these tests, adjusted tangible net worth is benefitedby adjustments of 50% of our outstanding senior subordinated debt (up to amaximum $100 million adjustment) and 100% of minority interests in consolidatedentities (up to a maximum $50 million adjustment).

On August 10, 2007, weamended and restated our existing senior credit facility. The terms of theamendment and restatement (summarized below) reflect current market conditionsand related deterioration of our profitability. Fees payable in connection withthe amendment and restatement totaled approximately $0.9 million.

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The amendment andrestatement permits us to ignore, for purposes of financial covenantcalculations (but not for interest margin calculations), up to $40 million oftangible net worth reductions due to impairment and abandonment charges. Theamendment and restatement suspends the interest coverage ratio covenant untilMarch 31, 2009 and adds a minimum $25 million trailing four-quarter adjustedEBITDA requirement (as defined in the credit agreement) and a minimum $50million liquidity requirement (defined as unrestricted cash, availableborrowings under the senior credit facility and other available lines of creditand receivables from home closings). Liquidity is tested monthly. The amendmentand restatement reduces permitted unsecured debt from $25 million to $15million and permitted joint venture investments from 30% of tangible net worthto 25% of tangible net worth and, in the case of our Nevada building region,provides for a waiver until September 1, 2007 of the existing requirement thatthe number of speculative housing units owned by us, as June 30, 2007, notexceed a maximum of 35% of our housing unit closings in such region during theprevious 12-month period.

The amendment andrestatement requires that the senior credit facility be secured by allproperties to be included in the borrowing base for the senior credit facilityand related assets and prohibits the incurrence of any additional secured debt.In this regard, in contrast to the previous calculation method for theborrowing base, the property of certain non-wholly owned subsidiaries cannot beincluded in the borrowing base calculation unless and until such subsidiariesare able to guarantee the senior credit facility (on a secured basis) whichwill be subject to the consent of minority interest holders and there is noassurance that we would be able to obtain such consent. New properties that areproposed to be included as borrowing base property would also be mortgaged andpledged to secure the senior credit facility and also would need to satisfyspecified parameters or otherwise be approved by the majority lenders. As ofJune 30, 2007, the effect of the removal of the property of such non-whollyowned subsidiaries from the borrowing base calculation upon our liquidity wouldhave been to reduce our liquidity from $159 million to $155 million. As of June30, 2007, we had $358 million of borrowings under the senior credit facility atan effective interest rate of 7.09% and, after calculating the borrowing baselimitation based on removal of the property of such non-wholly ownedsubsidiaries, would have had additional availability of approximately $106million. Finally, the amendment and restatement provides that the applicableinterest margins are subject to increase by 0.375% to 0.875% in the event thatliquidity (as defined above) is more than $50 million but less than or equal to$100 million.

The above description ofthe amended and restated credit facility is qualified in its entirety byreference to the copy of the Credit Agreement filed herewith as Exhibit 10.2and is incorporated herein by reference.

**(b)**  Notapplicable.

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**Item 6.      Exhibits.**
| Exhibits | ** ** | ** **                                                                                                                                                                                                                                                                                                                                | ** ** | ** ** |
|----------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
|     |       |                                                                                                                                                                                                                                                                                                                                      |       |       |
| 3.2      |       | By-Laws of Kimball Hill, Inc. (Amended and Restated  as of August 10, 2007).                                                                                                                                                                                                                                                              |
|     |       |                                                                                                                                                                                                                                                                                                                                      |
| 10.1     |       | Employment Agreement, dated August 10, 2007, by and  between Kimball Hill, Inc. and David K. Hill.                                                                                                                                                                                                                                        |
|     |       |                                                                                                                                                                                                                                                                                                                                      |
| 10.2     |       | 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. |
|     |       |                                                                                                                                                                                                                                                                                                                                      |
| 31.1     |       | Rule 13a-14(a) / 15d-14(a) Certification of David K.  Hill, Chairman, Chief Executive Officer and Director.                                                                                                                                                                                                                               |
|     |       |                                                                                                                                                                                                                                                                                                                                      |
| 31.2     |       | Rule 13a-14(a) / 15d-14(a) Certification of Eugene  K. Rowehl, Senior Vice President and Chief Financial Officer.                                                                                                                                                                                                                         |
|     |       |                                                                                                                                                                                                                                                                                                                                      |
| 32.1     |       | Section 1350 Certification of David K. Hill,  Chairman, Chief Executive Officer and Director.                                                                                                                                                                                                                                             |
|     |       |                                                                                                                                                                                                                                                                                                                                      |
| 32.2     |       | Section 1350 Certification of Eugene K. Rowehl,  Senior Vice President and Chief Financial Officer.                                                                                                                                                                                                                                       |

 

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**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|                        |   | KIMBALL HILL, INC.                                |
|------------------------|--------|---------------------------------------------------|
|                   |   | Registrant                                        |
|                   |   |                                              |
| Dated August 14,  2007 |   | /s/ DAVID K. HILL                                 |
|                   |   | David K. Hill                                     |
|                   |   | Chairman, Chief Executive Officer and Director    |
|                   |   | (Principal Executive Officer)                     |
|                   |   |                                              |
| Dated August 14,  2007 |   | /s/ EUGENE K. ROWEHL                              |
|                   |   | Eugene K. Rowehl                                  |
|                   |   | Senior Vice President and Chief Financial Officer |
|                   |   | (Principal Financial Officer)                     |

 

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# **EXHIBIT INDEX**

| Exhibit  Number | ** ** | **Description**                                                                                                                                                                                                                                                                                                                           |
|-----------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |       |                                                                                                                                                                                                                                                                                                                                      |
| 3.2             |       | By-Laws of Kimball Hill, Inc. (Amended and Restated  as of August 10, 2007).                                                                                                                                                                                                                                                              |
|            |       |                                                                                                                                                                                                                                                                                                                                      |
| 10.1            |       | Employment Agreement, dated August 10, 2007, by and  between Kimball Hill, Inc. and David K. Hill.                                                                                                                                                                                                                                        |
|            |       |                                                                                                                                                                                                                                                                                                                                      |
| 10.2            |       | 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. |
|            |       |                                                                                                                                                                                                                                                                                                                                      |
| 31.1            |       | Rule 13a-14(a) / 15d-14(a) Certification of David K.  Hill, Chairman, Chief Executive Officer and Director.                                                                                                                                                                                                                               |
|            |       |                                                                                                                                                                                                                                                                                                                                      |
| 31.2            |       | Rule 13a-14(a) / 15d-14(a) Certification of Eugene  K. Rowehl, Senior Vice President and Chief Financial Officer.                                                                                                                                                                                                                         |
|            |       |                                                                                                                                                                                                                                                                                                                                      |
| 32.1            |       | Section 1350 Certification of David K. Hill,  Chairman, Chief Executive Officer and Director.                                                                                                                                                                                                                                             |
|            |       |                                                                                                                                                                                                                                                                                                                                      |
| 32.2            |       | Section 1350 Certification of Eugene K. Rowehl,  Senior Vice President and Chief Financial Officer.                                                                                                                                                                                                                                       |

 

 

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