**UNITED STATESSECURITIES AND 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 periodended March 31, 2006**

** **

**OR**

** **
| o | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|---|------------|---------------------------------------------------------------------------------------------------------|

 

**For the transition periodfrom           to**

** **

**Commission file number:333-133278**

** **

**KIMBALLHILL, INC.**

(Exact name of Registrantas specified in its charter)

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

 

**(847) 364-7300**

*(Registrant’s telephone number, including areacode)*

 

**Not Applicable**

*(Former name, former address and former fiscalyear, if changed since last report)*

 

Indicate by check mark whether the Registrant(1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the Registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days. Yes oNo x

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

oLarge acceleratedfiler                          o Acceleratedfiler                         x Non-accelerated filer

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).oYes x No

 

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**KIMBALL HILL, INC. AND SUBSIDIARIES****FORM 10-Q**

**TABLE OF CONTENTS**
|               |                                                                                                                        |   | PAGE   |
|---------------|-----------------------------------------------------------------------------------------------------------------------------|--------|--------|
|          | PART I—FINANCIAL  INFORMATION                                                                                     |   |   |
| Item 1.       | Financial Statements.                                                                                                       |   |   |
|          |                                                                                                                        |   |   |
|          | Unaudited  Condensed Consolidated Balance Sheets as of March 31, 2006 and  September 30, 2005                     |   | 3      |
|          |                                                                                                                        |   |   |
|          | Unaudited  Condensed Consolidated Statements of Operations for the Three and Six Months  Ended March 31, 2006 and 2005 |   | 4      |
|          |                                                                                                                        |   |   |
|          | Unaudited Condensed Consolidated Statements of Cash  Flows for the Six Months Ended March 31, 2006 and 2005            |   | 5      |
|          |                                                                                                                        |   |   |
|          | Notes to  Unaudited Condensed Consolidated Financial Statements                                                             |   | 6      |
|          |                                                                                                                        |   |   |
| Item 2.       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations.                                |   | 21     |
|          |                                                                                                                        |   |   |
| Item 3.       | Quantitative  and Qualitative Disclosures About Market Risk.                                                                |   | 35     |
|          |                                                                                                                        |   |   |
| Item 4.       | Controls and  Procedures.                                                                                                   |   | 35     |
|          |                                                                                                                        |   |   |
|          | PART II—OTHER  INFORMATION                                                                                        |   |   |
|          |                                                                                                                        |   |   |
| Item 1.       | Legal Proceedings.                                                                                                          |   | 36     |
|          |                                                                                                                        |   |   |
| Item  1A.     | Risk  Factors.                                                                                                              |   | 36     |
|          |                                                                                                                        |   |   |
| Item  6.      | Exhibits.                                                                                                                   |   | 36     |
|          |                                                                                                                        |   |   |
| SIGNATURES    |                                                                                                                        | 37     |
|          |                                                                                                                        |   |   |
| EXHIBIT INDEX |                                                                                                                        | 38     |

 

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**PART I—FINANCIALINFORMATION**Item 1. Financial Statements.Kimball Hill, Inc. andSubsidiariesUnauditedCondensed Consolidated Balance Sheets
| **(in thousands, except shares)**                                                                                                          | ** ** | **March 31,  2006** | ** ** | **September 30,  2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|------------------------------|------------|
| **Assets**                                                                                                                                                | ** ** | ** **               | ** ** | ** **                   | ** ** |
| HOMEBUILDING:                                                                                                                                             |       |                     |       |                         |       |
| Cash and cash equivalents                                                                                                                                 |       | $                        | 18,511     |                         | $          | 16,763 |   |
| Receivables from title companies                                                                                                                          |       | 20,455                   |       | 22,879                       |       |
| Inventory                                                                                                                                                 |       | 947,860                  |       | 808,778                      |       |
| Inventory not owned                                                                                                                                       |       | 37,821                   |       | 46,721                       |       |
| Deferred expenses and other assets                                                                                                                        |       | 20,794                   |       | 11,207                       |       |
| Investments in and advances to unconsolidated  entities                                                                                                   |       | 39,356                   |       | 37,033                       |       |
| Deferred taxes                                                                                                                                            |       | 11,726                   |       | 13,541                       |       |
| Property and equipment, net of accumulated  depreciation                                                                                                  |       | 10,729                   |       | 5,185                        |       |
|                                                                                                                                                      |       | 1,107,252                |       | 962,107                      |       |
| MORTGAGE BANKING:                                                                                                                                         |       |                     |       |                         |       |
| Cash and cash equivalents                                                                                                                                 |       | 2,791                    |       | 4,697                        |       |
| Trade accounts receivable                                                                                                                                 |       | 1,352                    |       | 1,586                        |       |
| Mortgage loans held for sale                                                                                                                              |       | 3,687                    |       | 1,785                        |       |
| Property and equipment, net of accumulated  depreciation                                                                                                  |       | 290                      |       | 320                          |       |
|                                                                                                                                                      |       | 8,120                    |       | 8,388                        |       |
| TOTAL ASSETS                                                                                                                                              |       | $                        | 1,115,372  |                         | $          | 970,495 |   |
| **Liabilities and equity**                                                                                                                                | ** ** | ** **               | ** ** | ** **                   | ** ** |
| HOMEBUILDING:                                                                                                                                             |       |                     |       |                         |       |
| Accounts payable and accrued expenses                                                                                                                     |       | $                        | 88,626     |                         | $          | 94,370 |   |
| Deposits on sales of residential units                                                                                                                    |       | 13,927                   |       | 14,008                       |       |
| Liabilities related to inventory not owned                                                                                                                |       | 5,015                    |       | 10,402                       |       |
| Income tax payable                                                                                                                                        |       | 5,080                    |       | 15,368                       |       |
| Notes payable                                                                                                                                             |       | 614,059                  |       | 473,225                      |       |
|                                                                                                                                                      |       | 726,707                  |       | 607,373                      |       |
| MORTGAGE BANKING:                                                                                                                                         |       |                     |       |                         |       |
| Accounts payable and accrued expenses                                                                                                                     |       | 753                      |       | 914                          |       |
| Other liabilities                                                                                                                                         |       | 106                      |       | 234                          |       |
| Notes payable for mortgage loans                                                                                                                          |       |                     |       | 186                          |       |
|                                                                                                                                                      |       | 859                      |       | 1,334                        |       |
| Total liabilities                                                                                                                                         |       | 727,566                  |       | 608,707                      |       |
| MINORITY  INTEREST IN CONSOLIDATED PARTNERSHIPS                                                                                                           |       | 43,790                   |       | 45,495                       |       |
| MINORITY  INTEREST IN INVENTORY NOT OWNED                                                                                                                 |       | 31,721                   |       | 31,721                       |       |
| REEDEEMABLE  EQUITY:                                                                                                                                      |       |                     |       |                         |       |
| Redeemable common stock, no par value; shares  outstanding: 393,414 at March 31, 2006 and 298,000 at September 30,  2005                        |       | 45,439                   |       | 33,763                       |       |
| SHAREHOLDERS’  EQUITY:                                                                                                                               |       |                     |       |                         |       |
| Common stock, no par value; 10,000,000 shares  authorized; shares outstanding: 3,515,405 at March 31, 2006 and  3,578,486 at September 30, 2005 |       | 19,921                   |       | 20,216                       |       |
| Retained earnings                                                                                                                                         |       | 246,935                  |       | 230,593                      |       |
| Total shareholders’ equity                                                                                                                           |       | 266,856                  |       | 250,809                      |       |
| TOTAL LIABILITIES AND EQUITY                                                                                                                              |       | $                        | 1,115,372  |                         | $          | 970,495 |   |
|                                                                                                                                                      |       |                     |       |                         |       |

* *

*See notes to unaudited condensedconsolidated financial statements.*

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**KimballHill, Inc. and SubsidiariesUnaudited Condensed Consolidated Statements of Operations**
| ** **                                                                      | ** ** | **Three Months Ended  March 31,** | ** ** | **Six Months Ended  March 31,** | ** ** |
|---------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|------------------------------------------------|------------|
| **(in thousands)**                                                         | ** ** | **2006**                                         | ** ** | **2005**                                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| HOMEBUILDING:                                                                   |       |                                             |       |                                           |       |   |   |   |   |
| Revenues:                                                                       |       |                                             |       |                                           |       |   |   |   |   |
| Sales of residential units and land                                             |       | $                                                | 231,692    |                                           | $          | 214,391 |   | $ | 452,720 |   | $ | 403,595 |   |
| Rental and other income                                                         |       | 123                                              |       | 551                                            |       | 1,641 |   | 1,166 |   |
| Total homebuilding revenues                                                     |       | 231,815                                          |       | 214,942                                        |       | 454,361 |   | 404,761 |   |
| Expenses:                                                                       |       |                                             |       |                                           |       |   |   |   |   |
| Cost of sales of residential units and land                                     |       | 182,181                                          |       | 164,259                                        |       | 349,480 |   | 313,965 |   |
| General and administrative                                                      |       | 20,962                                           |       | 19,280                                         |       | 41,456 |   | 37,428 |   |
| Sales and marketing                                                             |       | 12,661                                           |       | 10,605                                         |       | 22,844 |   | 20,824 |   |
| Depreciation                                                                    |       | 172                                              |       | 204                                            |       | 350 |   | 396 |   |
| Total homebuilding expenses                                                     |       | 215,976                                          |       | 194,348                                        |       | 414,130 |   | 372,613 |   |
| Equity in income of unconsolidated joint ventures                               |       | 373                                              |       | 268                                            |       | 530 |   | 2,895 |   |
| Minority interests in net losses (earnings) of  consolidated partnerships  |       | 557                                              |       | (1,135)                                        |       | 198 |   | (1,924 | ) |
| Homebuilding earnings before income taxes                                       |       | 16,769                                           |       | 19,727                                         |       | 40,959 |   | 33,119 |   |
| MORTGAGE  BANKING:                                                              |       |                                             |       |                                           |       |   |   |   |   |
| Revenues:                                                                       |       |                                             |       |                                           |       |   |   |   |   |
| Gain on sales of mortgage loans                                                 |       | 1,620                                            |       | 977                                            |       | 2,989 |   | 1,930 |   |
| Interest income                                                                 |       | 4                                                |       | 17                                             |       | 9 |   | 50 |   |
| Total mortgage banking revenues                                                 |       | 1,624                                            |       | 994                                            |       | 2,998 |   | 1,980 |   |
| Expenses:                                                                       |       |                                             |       |                                           |       |   |   |   |   |
| General and administrative                                                      |       | 1,101                                            |       | 1,114                                          |       | 2,228 |   | 2,354 |   |
| Interest expense                                                                |       | 2                                                |       | 12                                             |       | 6 |   | 34 |   |
| Depreciation                                                                    |       | 21                                               |       | 41                                             |       | 49 |   | 68 |   |
| Total mortgage banking expenses                                                 |       | 1,124                                            |       | 1,167                                          |       | 2,283 |   | 2,456 |   |
| Mortgage banking earnings (losses) before income  taxes                         |       | 500                                              |       | (173)                                          |       | 715 |   | (476 | ) |
| EARNINGS BEFORE INCOME TAXES                                                    |       | 17,269                                           |       | 19,554                                         |       | 41,674 |   | 32,643 |   |
| PROVISION FOR INCOME TAXES                                                      |       | 6,271                                            |       | 7,215                                          |       | 15,129 |   | 12,045 |   |
| NET EARNINGS                                                                    |       | $                                                | 10,998     |                                           | $          | 12,339 |   | $ | 26,545 |   | $ | 20,598 |   |
|                                                                            |       |                                             |       |                                           |       |   |   |   |   |

 

*See notes to unaudited condensedconsolidated financial statements.*

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**KimballHill, Inc. and SubsidiariesUnaudited Condensed Consolidated Statements of Cash Flows**
| ** **                                                                                                                       | ** ** | ** **                                         | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                                                                       | ** ** | **Six Months Ended March 31,** | ** ** |
| **(in thousands)**                                                                                                          | ** ** | **2006**                                           | ** ** | **2005** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                                                                           |       |                                               |       |   |   |
| Net earnings                                                                                                                     |       | $                                                  | 26,545     |   | $ | 20,598 |   |
| Adjustments to  reconcile net earnings to net cash used in operating activities:                                                 |       |                                               |       |   |   |
| Depreciation                                                                                                                     |       | 399                                                |       | 464 |   |
| Write-down of  inventory                                                                                                         |       | 3,000                                              |       |   |   |
| Amortization of  deferred expenses                                                                                               |       | 2,834                                              |       | 2,825 |   |
| Equity-based  compensation                                                                                                       |       | 410                                                |       | 3,967 |   |
| ESOP  compensation expense                                                                                                       |       |                                               |       | 696 |   |
| Distributions of  income from investments in unconsolidated entities                                                             |       | 290                                                |       | 2,839 |   |
| Net earnings  from investments in unconsolidated entities                                                                        |       | (530                                               | )          | (2,895 | ) |
| Minority  interest in consolidated (losses) earnings                                                                             |       | (198                                               | )          | 1,924 |   |
| Deferred income  taxes                                                                                                           |       | 1,815                                              |       | (387 | ) |
| Changes in  operating assets and liabilities:                                                                                    |       |                                               |       |   |   |
| Receivables                                                                                                                      |       | 2,658                                              |       | 10,230 |   |
| Mortgage loans  held for sale                                                                                                    |       | (1,902                                             | )          | 3,929 |   |
| Inventory                                                                                                                        |       | (138,569                                           | )          | (107,030 | ) |
| Deferred  expenses and other assets                                                                                              |       | (12,421                                            | )          | (4,465 | ) |
| Accounts payable  and accrued expenses                                                                                           |       | (5,905                                             | )          | (828 | ) |
| Deposits and  other liabilities                                                                                                  |       | (209                                               | )          | (521 | ) |
| Income taxes  payable                                                                                                            |       | (9,828                                             | )          | (3,311 | ) |
| Net cash used in  operating activities                                                                                           |       | (131,611                                           | )          | (71,965 | ) |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                                                                           |       |                                               |       |   |   |
| Purchases of  property and equipment                                                                                             |       | (6,771                                             | )          | (322 | ) |
| Disposals of  property and equipment                                                                                             |       | 858                                                |       |   |   |
| Distributions of  contributed capital from investments in unconsolidated entities                                                |       | 235                                                |       | 824 |   |
| Contributions  and advances to investments in unconsolidated entities                                                            |       | (2,318                                             | )          | (16,505 | ) |
| Net cash used in  investing activities                                                                                           |       | (7,996                                             | )          | (16,003 | ) |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                                                                           |       |                                               |       |   |   |
| Proceeds from  issuance of notes and mortgage loans payable                                                                      |       | 1,037,440                                          |       | 495,975 |   |
| Repayments of  notes and mortgage loans payable                                                                                  |       | (896,792                                           | )          | (384,035 | ) |
| Proceeds from  issuance of common stock                                                                                          |       | 702                                                |       | 4,012 |   |
| Repurchases of  common stock                                                                                                     |       | (394                                               | )          | (154 | ) |
| Distributions to  minority interests                                                                                             |       | (1,507                                             | )          | (10,799 | ) |
| Net cash  provided by financing activities                                                                                       |       | 139,449                                            |       | 104,999 |   |
| NET (DECREASE) INCREASE  IN CASH AND CASH EQUIVALENTS                                                                            |       | (158                                               | )          | 17,031 |   |
| CASH AND CASH  EQUIVALENTS—Beginning of period                                                                              |       | 21,460                                             |       | 7,656 |   |
| CASH AND CASH  EQUIVALENTS—End of period                                                                                    |       | $                                                  | 21,302     |   | $ | 24,687 |   |
| RECONCILIATION TO CASH  AND CASH EQUIVALENTS REPORTED ON THE CONDENSED CONSOLIDATED BALANCE SHEETS:                              |       |                                               |       |   |   |
| Homebuilding                                                                                                                     |       | $                                                  | 18,511     |   | $ | 19,960 |   |
| Mortgage banking                                                                                                                 |       | 2,791                                              |       | 4,727 |   |
| TOTAL                                                                                                                            |       | $                                                  | 21,302     |   | $ | 24,687 |   |
| SUPPLEMENTAL DISCLOSURE  OF CASH FLOW INFORMATION:                                                                               |       |                                               |       |   |   |
| Cash paid for  interest                                                                                                          |       | $                                                  | 18,585     |   | $ | 16,555 |   |
| Cash paid for  income taxes                                                                                                      |       | $                                                  | 23,142     |   | $ | 15,743 |   |
| SUPPLEMENTAL DISCLOSURE  OF NONCASH INVESTING AND FINANCING ACTIVITIES:                                                          |       |                                               |       |   |   |
| Inventory not owned  includes $5,015 of liabilities related to inventory not owned for the six  months ended March 31, 2006 |       |                                               |       |   |   |
|                                                                                                                             |       |                                               |       |   |   |

 

See notes to unaudited condensed consolidatedfinancial statements.

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

**1. Basis ofPresentation and Significant Accounting Policies**

The accompanying unaudited condensed consolidatedfinancial statements include the accounts of Kimball Hill, Inc. and all ofits wholly-owned, majority-owned and controlled subsidiaries (the “Company”),as well as certain variable interest entities from which the Company ispurchasing land 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 for interim financial information and inaccordance with the instructions to Form 10-Q and Article 10 ofRegulation S-X. Such financial statements do not include all of the informationand disclosures required by accounting principles generally accepted in theUnited States of America 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, 2005, appearing in the Company’s prospectus dated May 4,2006, which is a part of the Company’s registration statement on Form S-4,as amended. In the opinion of management, all adjustments (consisting ofnormal, recurring accruals) necessary for fair presentation have been includedin the accompanying financial statements.

Historically, the homebuilding industry hasexperienced seasonal fluctuations; therefore, the operating results for thethree and six month periods ended March 31, 2006 are not necessarilyindicative of the results that may be expected for the fiscal year ending September 30,2006.

***SegmentInformation and Concentrations******—In***accordancewith Statement of Financial Accounting Standards No. 131, *Disclosures about Segments of an Enterprise and Related Information*,the Company has identified two reportable segments: homebuilding and mortgagebanking. The Company’s chief decision maker is its chief executive officer. TheCompany’s homebuilding segment consists primarily of homebuilding operations,which is engaged in the acquisition and development of land and construction ofresidential homes. Since the Company’s geographic homebuilding regions havesimilar economic characteristics, housing products and class of prospectivebuyers, the geographic homebuilding regions have been aggregated into a singlehomebuilding segment. The Company’s mortgage banking segment originatesmortgages which are sold to third parties. Corporate expenses are allocated tothe segment that directly benefits from the expense. General corporate expensesthat benefit both segments are nominal and are allocated to the homebuildingsegment. During both the three and six month periods ended March 31, 2006and 2005, two of the Company’s five regions contributed 45% and 38%, respectively,of the Company’s total homebuilding revenues. During the three month periodsended March 31, 2006 and 2005, these two regions contributed 67% and 63%of the total homebuilding gross profit. During the six month periods ended March 31,2006 and 2005, these two regions contributed 68% and 63% of the totalhomebuilding gross profit.

Information about the Company’s reportable segments ispresented in its condensed consolidated statements of operations and condensedconsolidated balance sheets. The Company’s reporting segments follow the sameaccounting policies used for the Company’s consolidated financial statements asdescribed in the summary of significant accounting policies in the September 30,2005 audited consolidated financial statements. Corporate assets shared by thesegments are nominal and are included within the homebuilding segment.Management evaluates a segment’s performance based upon a number of factorsincluding earnings before income taxes.

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

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The Company has recognized employee compensation costfor certain of its stock options granted that were considered to be variableawards. If the Company had elected to recognize compensation cost based on thefair value of the options granted at the grant date, which corresponds to theirvesting date, as prescribed by SFAS 123, earnings before income taxeswould have increased by approximately $2.4 million and $4.0 million for thethree and six months ended March 31, 2005, respectively. There would havebeen no effect on earnings for the three and six months ended March 31,2006.

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. Each year, the Company will recognizecompensation cost, for the relative service period covered, equal to the marketvalue of the underlying common shares of the Company on the date of grant.During the three and six months ended March 31, 2006, compensation cost of$205,000 and $410,000 related to deferred stock units is included in theCompany’s condensed consolidated statement of operations. There was no effecton earnings for the three and six months ended March 31, 2005.

**2. Inventory**

Inventory consists of the following(in thousands):
| ** **                                             | ** ** | **March 31,** | ** ** | **September 30,** | ** ** |
|--------------------------------------------------------|------------|--------------------|------------|------------------------|------------|
| ** **                                             | ** ** | **2006**           | ** ** | **2005**               | ** ** |
| Residential  lots—developed and under development |       | $                  | 560,574    |                   | $          | 541,169 |   |
| Finished homes  and construction in progress           |       | 356,506            |       | 248,878                |       |
| Deposits on land  purchases                            |       | 16,886             |       | 15,612                 |       |
| Land held for  future development or sale              |       | 13,894             |       | 3,119                  |       |
| Total                                                  |       | $                  | 947,860    |                   | $          | 808,778 |   |
|                                                   |       |               |       |                   |       |

 

In March 2006, the Company decided to exit theCleveland market and recorded a $3 million charge to reduce the carrying valueof inventory located in the Cleveland market to its estimated realizable valueunder our exit plans. The Company’s decision to exit the Cleveland marketreflects the Company’s perception regarding local market conditions currentlyand in the foreseeable future.

The Company capitalizes interestduring development and construction. Capitalized interest is charged to cost ofsales as residential units are closed. Interest costs are (in thousands):
| ** **                                     | ** ** | **Three Months Ended  March 31,** | ** **               | **Six Months Ended  March 31,** | ** ** |
|------------------------------------------------|------------|--------------------------------------------------|--------------------------|------------------------------------------------|------------|
| ** **                                     | ** ** | **2006**                                         | ** **               | **2005**                                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Capitalized  interest—beginning of period |       | $                                                |    46,213 |                                           | $          |    31,582 |   | $ |    40,076 |   | $ |    29,551 |   |
| Interest  incurred                             |       | 10,098                                           |                     | 9,914                                          |       | 21,281 |   | 16,520 |   |
| Interest  included in cost of sales            |       | (6,097                                           | )                        | (5,310)                                        |       | (11,143 | ) | (9,885 | ) |
| Capitalized  interest—end of period       |       | $                                                |    50,214 |                                           | $          |    36,186 |   | $ |    50,214 |   | $ |    36,186 |   |
|                                           |       |                                             |                     |                                           |       |   |   |   |   |

 

**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 

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not sufficient to permit the entity to finance itsactivities without additional subordinated financial support from other partiesor (ii) equity holders either (a) lack a direct or indirect abilityto make decisions about the entity, (b) are not obligated to absorbexpected losses of the entity or (c) do not have the right to receiveexpected residual returns of the entity, if they occur. FIN 46R requires theconsolidation of VIEs in which an enterprise absorbs a majority of the entity’sexpected losses, receives a majority of the entity’s expected residual returns,or both, as a result of ownership, contractual or other financial interests inthe entity.

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

At March 31, 2006, the Company has consolidatedoptioned land with an initial fair value of approximately $37.8 millionfor which it paid cash option deposits of $1.1 million. The Company hasspecific performance obligations to purchase approximately $31.7 millionof the consolidated inventory not owned. The Company has estimated the initialfair value 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 initial fair value of the land under contract and anynon-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 Inand Advances to Unconsolidated Entities**

Investments in and advances to unconsolidated entitiesrepresent the Company’s ownership interest in entities accounted for under theequity method when the Company holds less than a controlling interest in theentity or it is not the primary beneficiary in a VIE as defined by FIN 46R. Ininstances where the Company expects to purchase land from the unconsolidatedentity, the Company’s share of the unconsolidated entity’s earnings is deferreduntil homes related to the lots purchased are delivered and title passes to ahomebuyer. The Company’s partners generally are unrelated homebuilders, landsellers or other real estate entities.

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, with the Company’s interest in these entitiesranging from 6% to 45%. The Company accounts for its interest in these jointventures under the equity method, and the Company’s condensed consolidatedbalance sheets include investments in joint ventures totaling $39.4 million and$37.0 million at March 31, 2006 and September 30, 2005, respectively.These joint ventures typically obtain secured acquisition, development andconstruction financing. At March 31, 2006 and September 30, 2005, theCompany’s unconsolidated joint ventures had outstanding third-party borrowingsof $836 million and $803 million, respectively. From time to time the Companyhas issued repayment guarantees and/or loan-to-value maintenance guarantees inrespect of this indebtedness. These guarantees require the Company to repaydebt of the joint venture in the event of a payment default, in the case of therepayment guarantees, or in the event that the debt of the joint ventureexceeds the value of the property securing the debt, in the case of theloan-to-value maintenance guarantees. At March 31, 2006 and September 30,2005, the Company had guarantees of $72.6 million and $67.6 million,respectively, related to the indebtedness of these joint ventures.

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**5. Financing**

***Homebuilding***

The Company’s notes payable, at their principalamounts, consist of the following (in thousands):
| ** **                                               | ** ** | **March 31,** | ** ** | **September 30,** | ** ** |
|----------------------------------------------------------|------------|--------------------|------------|------------------------|------------|
| ** **                                               | ** ** | **2006**           | ** ** | **2005**               | ** ** |
| Senior unsecured  credit facility                        |       | $                  | 367,632    |                   |       |   |
| Senior  subordinated notes (net of unamortized discount) |       | 200,625            |       |                   |       |
| Other senior  secured credit facilities                  |       | 45,802             |       | $                      | 115,178    |   |
| Other senior  debt                                       |       |               |       | 6,921                  |       |
| Senior secured  revolving credit facilities              |       |               |       | 306,126                |       |
| Working capital  loans                                   |       |               |       | 45,000                 |       |
| Total                                                    |       | $                  | 614,059    |                   | $          | 473,225 |   |
|                                                     |       |               |       |                   |       |

 

In December 2005, the Company issued $203 millionaggregate principal amount of senior subordinated notes due December 2012in a private placement pursuant to Rule 144A promulgated under theSecurities Act of 1933, as amended. The senior subordinated notes were sold at98.796% of par and accrue interest at a coupon rate of 10.5% per annum.Interest is paid semi-annually beginning June 2006. The net proceeds wereused to repay amounts outstanding under working capital loans and certainsenior secured revolving credit facilities. The Company may redeem the notes,in whole or part, at any time on or after December 15, 2009, at aredemption price equal to 100% of the principal amount, plus a 5.25% premiumdeclining ratably to par on December 15, 2011, plus accrued and unpaidinterest. In addition, at any time prior to December 15, 2008, the Companymay redeem up to 35% of the aggregate principal amount of the notes with theproceeds of qualified equity offerings at a redemption price equal to 110.5% ofthe principal amount, plus accrued and unpaid interest. The notes are unsecuredsenior subordinated obligations and subordinated in right of payment to all ofthe Company’s existing and future senior debt, including borrowings under theCompany’s senior unsecured credit facility. All of the Company’s wholly ownedsubsidiaries, other than the Company’s mortgage subsidiary, have fully andunconditionally guaranteed the notes on a joint and several, unsecured seniorsubordinated, basis. The guarantees are general unsecured obligations of theguarantors and will be subordinated in right of payment to all existing andfuture senior debt of the guarantors, which includes their guarantees of theCompany’s senior unsecured credit facility. The indenture governing the seniorsubordinated notes contains a number of significant covenants that couldrestrict the Company’s ability and that of its restricted subsidiaries to,among other things: incur additional indebtedness, make certain distributions,investments and other restricted payments, create certain liens, enter intotransactions with affiliates, and merge, consolidate or sell substantially allof our assets.

On April 13, 2006, the Company filed aregistration statement with the U.S. Securities and Exchange Commission (the “Commission”)relating to an offer to exchange the notes for an issue of registered noteswith terms substantially identical to the notes. On May 4, 2006, theCommission declared the Company’s amended registration statement effective, andthe Company will offer the exchange notes in return for the notes during theexchange offer period.

In December 2005, the Company entered into a newsenior unsecured credit facility to finance its business operations. Proceedsof the new credit facility were used to retire its existing senior securedrevolving credit facilities and substantially all of its other senior securedcredit facilities. The credit facility has a maximum availability of $500million, subject to a borrowing base as well as sublimits of $100 million forthe 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 

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increase shall cause the senior unsecured creditfacility to exceed $700 million. The applicable borrowing base will bedetermined regularly throughout the life of the facility. The composition ofthe borrowing base will be limited to parameters set forth in the creditfacility agreement and certain types of real estate (such as unimprovedentitled land and lots under development) will be removed from the borrowingbase if held beyond specified maturity dates. Borrowings under the credit facilitywill generally bear interest based on an applicable margin plus LIBOR or analternate base rate. The applicable margin for interest ranges from 1.5% to2.25%, depending upon the Company’s senior leverage ratio, which is defined asthe ratio of total liabilities to consolidated net worth. Fees for letters ofcredit are based on LIBOR plus a margin of 1.5%. An unused commitment fee equalto 0.2% to 0.3% per year accrues on the undrawn portion of the facility and ispayable quarterly in arrears. As of March 31, 2006, the Company had $368million of borrowings under the credit facility at an effective rate of 6.71%and, after giving effect to the borrowing base limitation, had additionalavailability of $131 million. The Company’s obligations under the seniorunsecured credit facility are guaranteed by all of its wholly-ownedsubsidiaries, other than the Company’s mortgage subsidiary, and are subject toa number of customary financial and operating covenants, including covenantsrequiring the Company to: maintain a minimum tangible net worth of at least$225 million plus 50% of positive net income as earned subsequent to September 30,2005; maintain a ratio of total liabilities to adjusted tangible net worth notto exceed 2.50x; maintain a ratio of total debt to adjusted tangible net worthnot in excess of 2.0x (decreasing to 1.75x as of March 31, 2007); maintainan interest coverage ratio of no less than 2.25x; and limit the number ofspeculative housing units owned by the Company, excluding foundations, as ofthe end of any fiscal quarter to a maximum of 30% of the Company’s housing unitclosings during the previous 12-month period; and limit the number ofspeculative housing units in any building region, excluding foundations, as ofthe end of any fiscal quarter to a maximum of 35% of the Company’s housing unitclosings in such region during the previous 12-month period. In additionto these covenants, the credit facility includes restrictions upon debt andinvestments which permit: subordinated debt up to $300 million; other unsecureddebt up to $25 million; secured debt up to 25% of tangible net worth;guarantees of minority-owned joint venture debt up to 35% of adjusted tangiblenet worth; and investments in minority-owned joint ventures up to 30% of tangiblenet worth. For purposes of these tests, adjusted tangible net worth isbenefited by adjustments of 50% of the Company’s outstanding seniorsubordinated debt (up to a maximum $100 million adjustment) and 100% ofminority interests in consolidated entities (up to a maximum $50 millionadjustment). As of and during the three and six months ended March 31,2006, the Company was in compliance with the covenants of this facility.

**6. Commitments andContingencies**

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 March 31, 2006, the Company has rights, under suchagreements, to purchase approximately 15,100 lots, within 79 separatedevelopments, with an aggregate contract price of approximately$690 million, including inventory not owned which was consolidated underthe accounting guidance of FIN 46R. Approximately 1,700 of the lots, with an aggregatepurchase price of approximately $48 million, contain specific performancerequirements. Approximately 1,800 of the lots, with an aggregate purchase priceof approximately $175 million, are to be purchased from joint ventures in whichthe Company has an investment balance of approximately $30 million as of March 31,2006. This investment is recorded in investments in and advances tounconsolidated entities on the condensed consolidated balance sheets.

At March 31, 2006, excluding inventory not owned(see note 3), the Company was contingently liable to banks and financialinstitutions for approximately $55 million for outstanding letters of creditand performance bonds securing performance of certain contractual obligationsand land option contracts.

Under the terms of the Company’s amended stock optionplans, the Company has contractual obligations to purchase shares of theCompany’s common stock, including shares issuable under outstanding options,from the Company’s 

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directors and certain of the Company’s executiveofficers and other key employees in the event of termination of boardmembership or employment, as applicable, by reason of specified circumstances,including death, disability, termination, retirement or resignation. The termsof the original stock option agreements required the repurchase obligation atan amount other than fair market value. During the Company’s quarter ended December 31,2005, the stock option agreements were amended so that the repurchaseobligation of stock is at fair market value. Based upon the most recentindependent valuation of the Company as of December 31, 2005, and theshares and options outstanding as of March 31, 2006, the aggregaterepurchase obligation, net of proceeds to be received from any stock option exercises,would have been approximately $58 million in the event that all of theseobligations were triggered.

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, uponidentification and quantification of the obligations. The Company’s warrantyaccrual is included in accounts payable and accrued expenses in its condensedconsolidated balance sheets. Changes in the Company’s warranty liability forthe three and six months ended March 31, 2006 and 2005 are as follows (inthousands):
| ** **                         | ** ** | **Three Months Ended  March 31,** | ** ** | **Six Months Ended  March 31,** | ** ** |
|------------------------------------|------------|--------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                         | ** ** | **2006**                                         | ** ** | **2005**                                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Balance at  beginning of period    |       | $                                                | 6,094      |                                           | $          | 3,785 |   | $ | 5,844 |   | $ | 3,324 |   |
| Warranties  issued                 |       | 1,251                                            |       | 1,267                                          |       | 2,835 |   | 2,401 |   |
| Settlements and  other adjustments |       | (1,007                                           | )          | (774                                           | )          | (2,341 | ) | (1,447 | ) |
| Balance at end  of period          |       | $                                                | 6,338      |                                           | $          | 4,278 |   | $ | 6,338 |   | $ | 4,278 |   |
|                               |       |                                             |       |                                           |       |   |   |   |   |

 

At March 31, 2006 the Company was committed tofund $28 million in mortgage loans to homebuyers. The Company has entered intobest-efforts and mandatory sale commitments to sell these mortgages tothird parties.

The Company is party to a $100 million flexible earlypurchase facility agreement which allows the Company to sell qualifyingmortgage loans to the holder of the flexible early purchase facility after suchloans have been originated subject to the Company’s obligation to sell the loanto an investor in the secondary market. At March 31, 2006, approximately$33 million of the facility was in use by the Company.

**7. RecentAccounting Pronouncements**

In December 2004, the FASB issued Statement ofFinancial Accounting Standards No. 123 (revised 2004), *Share-Based Payment*, (“SFAS 123R”). SFAS 123R is a revisionof SFAS 123 and supersedes APB No. 25. SFAS 123R requires that 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 is effective as ofthe beginning of the first annual reporting period that begins after December 15,2005. SFAS 123R applies to all awards granted, modified, repurchased orcancelled after the effective date, and all outstanding portions of awardsgranted prior to the effective date which are unvested as of the effective dateof the pronouncement.

Entities may adopt the provisions of SFAS 123R usingeither the modified prospective or modified retrospective methods. Under themodified prospective method, compensation cost is recognized on or after therequired effective date for the portion of outstanding awards for which therequisite service has not yet been rendered, based on the grant-date fair valueof those awards calculated under SFAS 123 for either recognition or pro formadisclosure. For 

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periods before the required effective date, themodified retrospective application may be applied to either (a) all prior years for which SFAS 123 was effective or(b) only to prior interim periods in the year of initial adoption, on abasis consistent with the pro forma disclosures required for those periods bySFAS 123. SFAS 123R becomes effective for the Company on October 1, 2006.The Company is currently evaluating the requirements of SFAS 123R.

In May 2005, the FASB issued SFAS No. 154, *Accounting Changes and Error Corrections — a replacement for APBOpinion No. 20 and FASB Statement No. 3* (“SFAS 154”). SFAS154 requires prior period financial statements to be restated for changes inaccounting principles. SFAS 154 also redefines restatement as the revision ofpreviously issued financial statements to reflect the correction of an error.SFAS 154 is effective for accounting changes and corrections of errors made infiscal years beginning after December 15, 2005. SFAS 154 is not expectedto have a material impact on the Company’s results of operations or financialposition.

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

**8.**Summarized FinancialInformation

The Company’s senior subordinated notes and seniorunsecured credit facility are fully and unconditionally guaranteed, on a jointand several basis, by all of the Company’s wholly owned subsidiaries (“GuarantorSubsidiaries”), other than the Company’s mortgage subsidiary. The Company’smortgage subsidiary and majority owned and controlled subsidiaries arenon-guarantors (“Non-Guarantor Subsidiaries”) of the senior subordinated notesand the senior unsecured credit facility. In lieu of providing separate auditedfinancial statements for the Guarantor Subsidiaries, consolidated condensedfinancial statements are presented below. Separate financial statements andother disclosures concerning the Guarantor Subsidiaries are not presentedbecause management has determined that they are not material to investors.

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| **As of March 31, 2006  (in thousands)** | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                                        | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** | ** **       | ** ** |
| HOMEBUILDING:                                                     |       |       |       |                        |       |                            |       |             |       |             |       |
| Cash and cash equivalents                                         |       | $          | 4,955      |                        | $          | 13,516                          |       | $                | 40         |             | $          | — |   | $ | 18,511 |   |
| Receivables from title companies                                  |       |       |       | 20,443                      |       | 12                              |       |             |       | 20,455           |       |
| Inventory                                                         |       |       |       | 795,997                     |       | 151,863                         |       |             |       | 947,860          |       |
| Inventory not owned                                               |       |       |       | 37,821                      |       |                            |       |             |       | 37,821           |       |
| Deferred expenses and other assets                                |       | 12,036     |       | 8,713                       |       | 45                              |       |             |       | 20,794           |       |
| Investments in and advances to unconsolidated  entities           |       |       |       | 39,356                      |       |                            |       |             |       | 39,356           |       |
| Deferred taxes                                                    |       | 11,726     |       |                        |       |                            |       |             |       | 11,726           |       |
| Property and equipment, net of accumulated  depreciation          |       | 2,541      |       | 8,188                       |       |                            |       |             |       | 10,729           |       |
| Investments in subsidiaries                                       |       | 294,564    |       | 12,625                      |       |                            |       | (307,189         | )          |             |       |
|                                                              |       | 325,822    |       | 936,659                     |       | 151,960                         |       | (307,189         | )          | 1,107,252        |       |
| MORTGAGE BANKING                                                  |       |       |       |                        |       | 8,120                           |       |             |       | 8,120            |       |
| TOTAL ASSETS                                                      |       | $          | 325,822    |                        | $          | 936,659                         |       | $                | 160,080    |             | $          | (307,189 | ) | $ | 1,115,372 |   |
| **Liabilities and equity**                                        | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** | ** **       | ** ** |
| HOMEBUILDING:                                                     |       |       |       |                        |       |                            |       |             |       |             |       |
| Accounts payable and accrued expenses                        |       | $          | 30         |                        | $          | 88,433                          |       | $                | 163        |             | $          | — |   | $ | 88,626 |   |
| Deposits on sales of residential units                            |       |       |       | 13,686                      |       | 241                             |       |             |       | 13,927           |       |
| Liabilities related to inventory not owned                   |       |       |       | 5,015                       |       |                            |       |             |       | 5,015            |       |
| Income tax payable                                                |       | 5,080      |       |                        |       |                            |       |             |       | 5,080            |       |
| Notes payable                                                     |       | 577,923    |       | 9,800                       |       | 26,336                          |       |             |       | 614,059          |       |
| Intercompany                                                      |       | (569,506   | )          | 497,643                     |       | 71,863                          |       |             |       |             |       |
|                                                              |       | 13,527     |       | 614,577                     |       | 98,603                          |       |             |       | 726,707          |       |
| MORTGAGE BANKING                                                  |       |       |       |                        |       | 859                             |       |             |       | 859              |       |
| Total liabilities                                                 |       | 13,527     |       | 614,577                     |       | 99,462                          |       |             |       | 727,566          |       |
| MINORITY  INTEREST IN CONSOLIDATED PARTNERSHIPS                   |       |       |       |                        |       | 44,373                          |       | (583             | )          | 43,790           |       |
| MINORITY  INTEREST IN INVENTORY NOT OWNED                         |       |       |       | 31,721                      |       |                            |       |             |       | 31,721           |       |
| REEDEMABLE  EQUITY                                                |       | 45,439     |       |                        |       |                            |       |             |       | 45,439           |       |
| SHAREHOLDERS’  EQUITY                                        |       | 266,856    |       | 290,361                     |       | 16,245                          |       | (306,606         | )          | 266,856          |       |
| TOTAL  LIABILITIES AND EQUITY                                     |       | $          | 325,822    |                        | $          | 936,659                         |       | $                | 160,080    |             | $          | (307,189 | ) | $ | 1,115,372 |   |
|                                                              |       |       |       |                        |       |                            |       |             |       |             |       |

 

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

 

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| **For the three months ended  March 31, 2006 (in thousands)** | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| HOMEBUILDING:                                                                                         |       |       |       |                        |       |                            |       |             |       |             |       |
| Revenues:                                                                                             |       |       |       |                        |       |                            |       |             |       |             |       |
| Sales of residential units and land                                                                   |       | $          | —     |                        | $          | 230,309                         |       | $                | 12,946     |             | $          | (11,563 | ) | $ | 231,692 |   |
| Rental and other income                                                                               |       | 20         |       | 13                          |       | 90                              |       |             |       | 123              |       |
| Total homebuilding revenues                                                                           |       | 20         |       | 230,322                     |       | 13,036                          |       | (11,563          | )          | 231,815          |       |
| Expenses:                                                                                             |       |       |       |                        |       |                            |       |             |       |             |       |
| Cost of sales of residential units and land                                                           |       |       |       | 180,894                     |       | 12,073                          |       | (10,786          | )          | 182,181          |       |
| General and administrative                                                                            |       | 5,755      |       | 15,202                      |       | 5                               |       |             |       | 20,962           |       |
| Sales and marketing                                                                                   |       |       |       | 12,471                      |       | 190                             |       |             |       | 12,661           |       |
| Depreciation                                                                                          |       | 26         |       | 146                         |       |                            |       |             |       | 172              |       |
| Total homebuilding expenses                                                                           |       | 5,781      |       | 208,713                     |       | 12,268                          |       | (10,786          | )          | 215,976          |       |
| Intercompany charge                                                                                   |       | 5,761      |       | (5,761                      | )          |                            |       |             |       |             |       |
| Equity in income of unconsolidated joint ventures                                                     |       |       |       | 373                         |       |                            |       |             |       | 373              |       |
| Minority interests in net losses (earnings) of  consolidated partnerships                             |       |       |       | 574                         |       | (600                            | )          | 583              |       | 557              |       |
| Homebuilding earnings before income taxes                                                             |       |       |       | 16,795                      |       | 168                             |       | (194             | )          | 16,769           |       |
| MORTGAGE BANKING:                                                                                     |       |       |       |                        |       |                            |       |             |       |             |       |
| Revenues:                                                                                             |       |       |       |                        |       |                            |       |             |       |             |       |
| Gain on sales of mortgage loans                                                                       |       |       |       |                        |       | 1,620                           |       |             |       | 1,620            |       |
| Interest income                                                                                       |       |       |       |                        |       | 4                               |       |             |       | 4                |       |
| Total mortgage banking revenues                                                                       |       |       |       |                        |       | 1,624                           |       |             |       | 1,624            |       |
| Expenses:                                                                                             |       |       |       |                        |       |                            |       |             |       |             |       |
| General and administrative                                                                            |       |       |       |                        |       | 1,101                           |       |             |       | 1,101            |       |
| Interest expense                                                                                      |       |       |       |                        |       | 2                               |       |             |       | 2                |       |
| Depreciation                                                                                          |       |       |       |                        |       | 21                              |       |             |       | 21               |       |
| Total mortgage banking expenses                                                                       |       |       |       |                        |       | 1,124                           |       |             |       | 1,124            |       |
| Mortgage banking earnings before income taxes                                                         |       |       |       |                        |       | 500                             |       |             |       | 500              |       |
| EQUITY IN INCOME  OF CONSOLIDATED SUBSIDIARIES                                                        |       | 17,269     |       | (374                        | )          |                            |       | (16,895          | )          |             |       |
| EARNINGS BEFORE  INCOME TAXES                                                                         |       | 17,269     |       | 16,421                      |       | 668                             |       | (17,089          | )          | 17,269           |       |
| PROVISION FOR  INCOME TAXES                                                                           |       | 6,271      |       | 5,961                       |       | 243                             |       | (6,204           | )          | 6,271            |       |
| NET EARNINGS                                                                                          |       | $          | 10,998     |                        | $          | 10,460                          |       | $                | 425        |             | $          | (10,885 | ) | $ | 10,998 |   |
|                                                                                                  |       |       |       |                        |       |                            |       |             |       |             |       |

 

15

----

 
| **For the three months ended  March 31, 2005 (in thousands)** | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| HOMEBUILDING:                                                                                         |       |       |       |                        |       |                            |       |             |       |             |       |
| Revenues:                                                                                             |       |       |       |                        |       |                            |       |             |       |             |       |
| Sales of residential units and land                                                                   |       | $          | —     |                        | $          | 213,028                         |       | $                | 1,363      |             | $          | — |   | $ | 214,391 |   |
| Rental and other income                                                                               |       | 126        |       | 345                         |       | 80                              |       |             |       | 551              |       |
| Total homebuilding revenues                                                                           |       | 126        |       | 213,373                     |       | 1,443                           |       |             |       | 214,942          |       |
| Expenses:                                                                                             |       |       |       |                        |       |                            |       |             |       |             |       |
| Cost of sales of residential units and land                                                           |       |       |       | 163,379                     |       | 880                             |       |             |       | 164,259          |       |
| General and administrative                                                                            |       | 5,142      |       | 15,033                      |       | (895                            | )          |             |       | 19,280           |       |
| Sales and marketing                                                                                   |       |       |       | 10,451                      |       | 154                             |       |             |       | 10,605           |       |
| Depreciation                                                                                          |       | 26         |       | 169                         |       | 9                               |       |             |       | 204              |       |
| Total homebuilding expenses                                                                           |       | 5,168      |       | 189,032                     |       | 148                             |       |             |       | 194,348          |       |
| Intercompany charge                                                                                   |       | 5,042      |       | (5,042                      | )          |                            |       |             |       |             |       |
| Equity in income of unconsolidated joint ventures                                                     |       |       |       | 268                         |       |                            |       |             |       | 268              |       |
| Minority interests in net earnings of consolidated  partnerships                                      |       |       |       | (1,135                      | )          |                            |       |             |       | (1,135           | )          |
| Homebuilding earnings before income taxes                                                             |       |       |       | 18,432                      |       | 1,295                           |       |             |       | 19,727           |       |
| MORTGAGE BANKING:                                                                                     |       |       |       |                        |       |                            |       |             |       |             |       |
| Revenues:                                                                                             |       |       |       |                        |       |                            |       |             |       |             |       |
| Gain on sales of mortgage loans                                                                       |       |       |       |                        |       | 977                             |       |             |       | 977              |       |
| Interest income                                                                                       |       |       |       |                        |       | 17                              |       |             |       | 17               |       |
| Total mortgage banking revenues                                                                  |       |       |       |                        |       | 994                             |       |             |       | 994              |       |
| Expenses:                                                                                             |       |       |       |                        |       |                            |       |             |       |             |       |
| General and administrative                                                                            |       |       |       |                        |       | 1,114                           |       |             |       | 1,114            |       |
| Interest expense                                                                                      |       |       |       |                        |       | 12                              |       |             |       | 12               |       |
| Depreciation                                                                                          |       |       |       |                        |       | 41                              |       |             |       | 41               |       |
| Total mortgage banking expenses                                                                  |       |       |       |                        |       | 1,167                           |       |             |       | 1,167            |       |
| Mortgage banking losses before income taxes                                                           |       |       |       |                        |       | (173                            | )          |             |       | (173             | )          |
| EQUITY IN INCOME  OF CONSOLIDATED SUBSIDIARIES                                                        |       | 19,554     |       | 1,307                       |       |                            |       | (20,861          | )          |             |       |
| EARNINGS BEFORE  INCOME TAXES                                                                         |       | 19,554     |       | 19,739                      |       | 1,122                           |       | (20,861          | )          | 19,554           |       |
| PROVISION FOR  INCOME TAXES                                                                           |       | 7,215      |       | 7,284                       |       | 414                             |       | (7,698           | )          | 7,215            |       |
| NET EARNINGS                                                                                          |       | $          | 12,339     |                        | $          | 12,455                          |       | $                | 708        |             | $          | (13,163 | ) | $ | 12,339 |   |
|                                                                                                  |       |       |       |                        |       |                            |       |             |       |             |       |

 

 

16

----

| **For the six months ended  March 31, 2006 (in thousands)** | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| HOMEBUILDING:                                                                                       |       |       |       |                        |       |                            |       |             |       |             |       |
| Revenues:                                                                                           |       |       |       |                        |       |                            |       |             |       |             |       |
| Sales of residential units and land                                                                 |       | $          | —     |                        | $          | 448,821                         |       | $                | 15,462     |             | $          | (11,563 | ) | $ | 452,720 |   |
| Rental and other income                                                                             |       | 80         |       | 779                         |       | 782                             |       |             |       | 1,641            |       |
| Total homebuilding revenues                                                                         |       | 80         |       | 449,600                     |       | 16,244                          |       | (11,563          | )          | 454,361          |       |
| Expenses:                                                                                           |       |       |       |                        |       |                            |       |             |       |             |       |
| Cost of sales of residential units and land                                                         |       |       |       | 346,154                     |       | 14,112                          |       | (10,786          | )          | 349,480          |       |
| General and administrative                                                                          |       | 13,800     |       | 27,620                      |       | 36                              |       |             |       | 41,456           |       |
| Sales and marketing                                                                                 |       |       |       | 22,492                      |       | 352                             |       |             |       | 22,844           |       |
| Depreciation                                                                                        |       | 52         |       | 298                         |       |                            |       |             |       | 350              |       |
| Total homebuilding expenses                                                                         |       | 13,852     |       | 396,564                     |       | 14,500                          |       | (10,786          | )          | 414,130          |       |
| Intercompany charge                                                                                 |       | 13,772     |       | (13,772                     | )          |                            |       |             |       |             |       |
| Equity in income of unconsolidated joint ventures                                                   |       |       |       | 530                         |       |                            |       |             |       | 530              |       |
| Minority interests in net losses (earnings) of  consolidated partnerships                           |       |       |       | 574                         |       | (959                            | )          | 583              |       | 198              |       |
| Homebuilding earnings before income taxes                                                           |       |       |       | 40,368                      |       | 785                             |       | (194             | )          | 40,959           |       |
| MORTGAGE BANKING:                                                                                   |       |       |       |                        |       |                            |       |             |       |             |       |
| Revenues:                                                                                           |       |       |       |                        |       |                            |       |             |       |             |       |
| Gain on sales of mortgage loans                                                                     |       |       |       |                        |       | 2,989                           |       |             |       | 2,989            |       |
| Interest income                                                                                     |       |       |       |                        |       | 9                               |       |             |       | 9                |       |
| Total mortgage banking revenues                                                                     |       |       |       |                        |       | 2,998                           |       |             |       | 2,998            |       |
| Expenses:                                                                                           |       |       |       |                        |       |                            |       |             |       |             |       |
| General and administrative                                                                          |       |       |       |                        |       | 2,228                           |       |             |       | 2,228            |       |
| Interest expense                                                                                    |       |       |       |                        |       | 6                               |       |             |       | 6                |       |
| Depreciation                                                                                        |       |       |       |                        |       | 49                              |       |             |       | 49               |       |
| Total mortgage banking expenses                                                                     |       |       |       |                        |       | 2,283                           |       |             |       | 2,283            |       |
| Mortgage banking earnings before income taxes                                                       |       |       |       |                        |       | 715                             |       |             |       | 715              |       |
| EQUITY IN INCOME  OF CONSOLIDATED SUBSIDIARIES                                                      |       | 41,674     |       | 116                         |       |                            |       | (41,790          | )          |             |       |
| EARNINGS BEFORE  INCOME TAXES                                                                       |       | 41,674     |       | 40,484                      |       | 1,500                           |       | (41,984          | )          | 41,674           |       |
| PROVISION FOR  INCOME TAXES                                                                         |       | 15,129     |       | 14,696                      |       | 545                             |       | (15,241          | )          | 15,129           |       |
| NET EARNINGS                                                                                        |       | $          | 26,545     |                        | $          | 25,788                          |       | $                | 955        |             | $          | (26,743 | ) | $ | 26,545 |   |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |

 

17

----

 
| **For the six months ended  March 31, 2005 (in thousands)** | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| HOMEBUILDING:                                                                                       |       |       |       |                        |       |                            |       |             |       |             |       |
| Revenues:                                                                                           |       |       |       |                        |       |                            |       |             |       |             |       |
| Sales of residential units and land                                                                 |       | $          | —     |                        | $          | 402,232                         |       | $                | 1,363      |             | $          | — |   | $ | 403,595 |   |
| Rental and other income                                                                             |       | 167        |       | 850                         |       | 149                             |       |             |       | 1,166            |       |
| Total homebuilding revenues                                                                         |       | 167        |       | 403,082                     |       | 1,512                           |       |             |       | 404,761          |       |
| Expenses:                                                                                           |       |       |       |                        |       |                            |       |             |       |             |       |
| Cost of sales of residential units and land                                                         |       |       |       | 313,015                     |       | 950                             |       |             |       | 313,965          |       |
| General and administrative                                                                          |       | 10,684     |       | 26,609                      |       | 135                             |       |             |       | 37,428           |       |
| Sales and marketing                                                                                 |       |       |       | 20,568                      |       | 256                             |       |             |       | 20,824           |       |
| Depreciation                                                                                        |       | 52         |       | 327                         |       | 17                              |       |             |       | 396              |       |
| Total homebuilding expenses                                                                         |       | 10,736     |       | 360,519                     |       | 1,358                           |       |             |       | 372,613          |       |
| Intercompany charge                                                                                 |       | 10,569     |       | (10,569                     | )          |                            |       |             |       |             |       |
| Equity in income of unconsolidated joint ventures                                                   |       |       |       | 2,895                       |       |                            |       |             |       | 2,895            |       |
| Minority interests in net earnings of consolidated  partnerships                                    |       |       |       | (1,924                      | )          |                            |       |             |       | (1,924           | )          |
| Homebuilding earnings before income taxes                                                           |       |       |       | 32,965                      |       | 154                             |       |             |       | 33,119           |       |
| MORTGAGE BANKING:                                                                                   |       |       |       |                        |       |                            |       |             |       |             |       |
| Revenues:                                                                                           |       |       |       |                        |       |                            |       |             |       |             |       |
| Gain on sales of mortgage loans                                                                     |       |       |       |                        |       | 1,930                           |       |             |       | 1,930            |       |
| Interest income                                                                                     |       |       |       |                        |       | 50                              |       |             |       | 50               |       |
| Total mortgage banking revenues                                                                |       |       |       |                        |       | 1,980                           |       |             |       | 1,980            |       |
| Expenses:                                                                                           |       |       |       |                        |       |                            |       |             |       |             |       |
| General and administrative                                                                          |       |       |       |                        |       | 2,354                           |       |             |       | 2,354            |       |
| Interest expense                                                                                    |       |       |       |                        |       | 34                              |       |             |       | 34               |       |
| Depreciation                                                                                        |       |       |       |                        |       | 68                              |       |             |       | 68               |       |
| Total mortgage banking expenses                                                                |       |       |       |                        |       | 2,456                           |       |             |       | 2,456            |       |
| Mortgage banking losses before income taxes                                                         |       |       |       |                        |       | (476                            | )          |             |       | (476             | )          |
| EQUITY IN INCOME  OF CONSOLIDATED SUBSIDIARIES                                                      |       | 32,643     |       | 179                         |       |                            |       | (32,822          | )          |             |       |
| EARNINGS BEFORE  INCOME TAXES                                                                       |       | 32,643     |       | 33,144                      |       | (322                            | )          | (32,822          | )          | 32,643           |       |
| PROVISION FOR  INCOME TAXES                                                                         |       | 12,045     |       | 12,230                      |       | (119                            | )          | (12,111          | )          | 12,045           |       |
| NET EARNINGS                                                                                        |       | $          | 20,598     |                        | $          | 20,914                          |       | $                | (203       | )                | $          | (20,711 | ) | $ | 20,598 |   |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |

#  

 

18

----

| **For the six months ended  March 31, 2006 (in thousands)** | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                                              |       |       |       |                        |       |                            |       |             |       |             |       |
| Net earnings                                                                                        |       | $          | 26,545     |                        | $          | 25,788                          |       | $                | 955        |             | $          | (26,743 | ) | $ | 26,545 |   |
| Adjustments to  reconcile net earnings to net cash flows used in operating activities               |       | (38,575    | )          | (129,657                    | )          | (14,623                         | )          | 24,699           |       | (158,156         | )          |
| Net cash used in  operating activities                                                              |       | (12,030    | )          | (103,869                    | )          | (13,668                         | )          | (2,044           | )          | (131,611         | )          |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                                              |       |       |       |                        |       |                            |       |             |       |             |       |
| Purchases of  property and equipment                                                                |       |       |       | (6,752                      | )          | (19                             | )          |             |       | (6,771           | )          |
| Disposals of  property and equipment                                                                |       |       |       |                        |       | 858                             |       |             |       | 858              |       |
| Distributions of  contributed capital from investments in unconsolidated entities                   |       |       |       | 235                         |       |                            |       |             |       | 235              |       |
| Contributions to  investments in unconsolidated entities                                            |       |       |       | (2,318                      | )          |                            |       |             |       | (2,318           | )          |
| Contributions to  investments in subsidiaries                                                       |       |       |       | (3,170                      | )          |                            |       | 3,170            |       |             |       |
| Net cash  provided by investing activities                                                          |       |       |       | (12,005                     | )          | 839                             |       | 3,170            |       | (7,996           | )          |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                                              |       |       |       |                        |       |                            |       |             |       |             |       |
| Proceeds from  issuance of notes and mortgage loans payable                                         |       | 698,411    |       | 323,188                     |       | 15,841                          |       |             |       | 1,037,440        |       |
| Repayments of  notes and mortgage loans payable                                                     |       | (124,614   | )          | (710,426                    | )          | (61,752                         | )          |             |       | (896,792         | )          |
| Proceeds from  issuance of common stock                                                             |       | 702        |       |                        |       |                            |       |             |       | 702              |       |
| Repurchases of  common stock                                                                        |       | (394       | )          |                        |       |                            |       |             |       | (394             | )          |
| Distributions to  minority interests                                                                |       |       |       | 128                         |       | (1,635                          | )          |             |       | (1,507           | )          |
| Contributions  from minority interests                                                              |       |       |       |                        |       | 2,463                           |       | (2,463           | )          |             |       |
| Distributions to  parent and guarantors                                                             |       |       |       |                        |       | (1,337                          | )          | 1,337            |       |             |       |
| Intercompany                                                                                        |       | (563,995   | )          | 506,714                     |       | 57,281                          |       |             |       |             |       |
| Net cash  provided by financing activities                                                          |       | 10,110     |       | 119,604                     |       | 10,861                          |       | (1,126           | )          | 139,449          |       |
| NET (DECREASE) INCREASE  IN CASH AND CASH EQUIVALENTS                                               |       | (1,920     | )          | 3,730                       |       | (1,968                          | )          |             |       | (158             | )          |
| CASH AND CASH  EQUIVALENTS—  Beginning of period                                               |       | 6,875      |       | 9,786                       |       | 4,799                           |       |             |       | 21,460           |       |
| CASH AND CASH  EQUIVALENTS—  End of period                                                     |       | $          | 4,955      |                        | $          | 13,516                          |       | $                | 2,831      |             | $          | — |   | $ | 21,302 |   |
| RECONCILIATION TO CASH  AND CASH EQUIVALENTS REPORTED ON THE CONSOLIDATED BALANCE SHEETS:           |       |       |       |                        |       |                            |       |             |       |             |       |
| Homebuilding                                                                                        |       | $          | 4,955      |                        | $          | 13,516                          |       | $                | 40         |             | $          | — |   | $ | 18,511 |   |
| Mortgage banking                                                                                    |       |       |       |                        |       | 2,791                           |       |             |       | 2,791            |       |
| TOTAL                                                                                               |       | $          | 4,955      |                        | $          | 13,516                          |       | $                | 2,831      |             | $          | — |   | $ | 21,302 |   |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |

#  

19

----

 

 
| **For the six months ended  March 31, 2005 (in thousands)** | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                                              |       |       |       |                        |       |                            |       |             |       |             |       |
| Net earnings                                                                                        |       | $          | 20,598     |                        | $          | 20,914                          |       | $                | (203       | )                | $          | (20,711 | ) | $ | 20,598 |   |
| Adjustments to reconcile net earnings to net cash  flows from operating activities                  |       | (20,061    | )          | (86,871                     | )          | (6,342                          | )          | 20,711           |       | (92,563          | )          |
| Net cash provided by (used in) operating activities                                                 |       | 537        |       | (65,957                     | )          | (6,545                          | )          |             |       | (71,965          | )          |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                                              |       |       |       |                        |       |                            |       |             |       |             |       |
| Purchases of property and equipment                                                                 |       |       |       | (246                        | )          | (76                             | )          |             |       | (322             | )          |
| Distributions of contributed capital from  investments in unconsolidated entities                   |       |       |       | 824                         |       |                            |       |             |       | 824              |       |
| Contributions to investments in unconsolidated  entities                                            |       |       |       | (16,505                     | )          |                            |       |             |       | (16,505          | )          |
| Net cash used in investing activities                                                               |       |       |       | (15,927                     | )          | (76                             | )          |             |       | (16,003          | )          |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                                              |       |       |       |                        |       |                            |       |             |       |             |       |
| Proceeds from issuance of notes and mortgage loans  payable                                         |       |       |       | 484,148                     |       | 11,827                          |       |             |       | 495,975          |       |
| Repayments of notes and mortgage loans payable                                                 |       | (59        | )          | (372,545                    | )          | (11,431                         | )          |             |       | (384,035         | )          |
| Proceeds from issuance of common stock                                                              |       | 4,012      |       |                        |       |                            |       |             |       | 4,012            |       |
| Repurchases of common stock                                                                         |       | (154       | )          |                        |       |                            |       |             |       | (154             | )          |
| Distributions to minority interests                                                                 |       |       |       | (10,799                     | )          |                            |       |             |       | (10,799          | )          |
| Intercompany                                                                                        |       | 3,480      |       | (12,850                     | )          | 9,370                           |       |             |       |             |       |
| Net cash provided by financing activities                                                           |       | 7,279      |       | 87,954                      |       | 9,766                           |       |             |       | 104,999          |       |
| NET INCREASE IN  CASH AND CASH EQUIVALENTS                                                          |       | 7,816      |       | 6,070                       |       | 3,145                           |       |             |       | 17,031           |       |
| CASH AND CASH  EQUIVALENTS—  Beginning of period                                               |       | 3,227      |       | 2,829                       |       | 1,600                           |       |             |       | 7,656            |       |
| CASH AND CASH  EQUIVALENTS—   End of period                                                    |       | $          | 11,043     |                        | $          | 8,899                           |       | $                | 4,745      |             | $          | — |   | $ | 24,687 |   |
| RECONCILIATION  TO CASH AND CASH EQUIVALENTS REPORTED ON THE CONSOLIDATED BALANCE SHEETS:           |       |       |       |                        |       |                            |       |             |       |             |       |
| Homebuilding                                                                                        |       | $          | 11,043     |                        | $          | 8,899                           |       | $                | 18         |             | $          | — |   | $ | 19,960 |   |
| Mortgage banking                                                                                    |       |       |       |                        |       | 4,727                           |       |             |       | 4,727            |       |
| TOTAL                                                                                               |       | $          | 11,043     |                        | $          | 8,899                           |       | $                | 4,745      |             | $          | — |   | $ | 24,687 |   |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |

#  

 

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# **Item 2. Management’sDiscussion 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 U.S., as measured by homedeliveries and revenues. We design, build and market high-quality single-familydetached, single-family attached and multi-family homes. Since we were foundedin 1969, we have delivered over 40,000 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 regions: Florida, theMidwest, Nevada, the Pacific Coast and Texas.
| **Florida** | ** ** | **Midwest**   | ** ** | **Nevada** | ** ** | **Pacific Coast** | ** ** | **Texas**   |
|-------------|------------|---------------|------------|------------|------------|-------------------|------------|-------------|
| Ft. Myers   |       | Chicago, IL   |       | Las Vegas  |       | Portland, OR      |       | Austin      |
| Naples      |       | Cleveland, OH |       |       |       | Sacramento, CA    |       | Dallas      |
| Sarasota    |       | Milwaukee, WI |       |       |       | Stockton, CA      |       | Ft. Worth   |
| Tampa       |       |          |       |       |       | Vancouver, WA     |       | Houston     |
|        |       |          |       |       |       |              |       | San Antonio |

 

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

**Recent Trends**

Over the last quarter, the national businessenvironment for the homebuilding industry has become more challenging than inrecent years, primarily due to increasing interest rates, concerns about homeaffordability, more rigorous underwriting standards for mortgage loans, andincreased levels of homes for sale on the market that are generally takinglonger to sell. Many view the current homebuilding environment and theanticipated changes as a return to a more normalized homebuilding marketplace.We anticipate that the changing marketplace will be amplified in the coastalmarkets and that some of the recently hot markets will give back a portion oftheir recent gains. Many of our competitors have reacted to these concerns withgreater utilization of a wide assortment of incentives. We have increased theuse of targeted incentives in several of our markets and have also remainedfocused on product development to meet an expectation of a shifting demand tosmaller more affordable homes and more attached product in several of ourmarkets. We continually review our land acquisition criteria and our landpurchase agreements and option contracts and will renegotiate with sellers whenadvantageous or necessary to do so. We believe that our company’s history andgeographic diversification will continue to benefit us as the homebuildingindustry transitions through a changing environment.

**Recent Events**

In December 2005, we issued $203 million aggregateprincipal amount of senior subordinated notes due December 2012 in aprivate placement pursuant to Rule 144A promulgated under the SecuritiesAct of 1933, as amended. On April 13, 2006, we filed a registrationstatement with the U.S. Securities and Exchange Commission (the 

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“Commission”) relating to an offer to exchange thesenior subordinated notes for an issue of registered notes with termssubstantially identical to the notes. On May 4, 2006, the Commissiondeclared our amended registration statement effective, and we will offer theexchange notes in return for the notes during the exchange offer period.

In March 2006, we decided to exit the Clevelandmarket and recorded a $3 million charge to reduce the carrying value ofinventory located in the Cleveland market to its estimated realizable valueunder our exit plan. Our decision to exit the Cleveland market reflects ourperception regarding local market conditions currently and in the foreseeablefuture. We intend to wind down operations over the next several months with theobjective of completing all construction and sales activities by December 31,2006. We believe our exit from the Cleveland market will not have a materialadverse impact on our financial condition or results of operations.

**Results ofOperations and Other Data**

The followingtable presents selected statement of operations and other data for the threeand six month periods ended March 31, 2006 and 2005:
| **(Dollars in thousands)**                                           | ** ** | **Three months ended  March 31,** | ** ** | **2006  vs.  2005** | ** ** | **Six months ended  March 31,** | ** ** | **2006  vs.  2005** | ** ** | ** ** |
|--------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|---------------------|------------|------------------------------------------------|------------|---------------------|------------|------------|
| ** **                                                                     | ** ** | **2006**                                         | ** ** | **2005**            | ** ** | ** **                                     | ** ** | **2006**            | ** ** | **2005**   | ** ** | ** ** | ** ** | ** ** |
| **Statement  of operations data:**                                             |       |                                             |       |                |       |                                           |       |                |       |       |   |   |   |   |
| Total  homebuilding revenues                                                   |       | $                                                | 231,815    |                | $          | 214,942                                        |       | 7.9                 | %          | $          | 454,361 |   | $ | 404,761 |   | 12.3 | % |   |
| Cost of sales of  residential units and land                                   |       | 182,181                                          |       | 164,259             |       | 10.9                                           | %          | 349,480             |       | 313,965    |   | 11.3 | % |   |
| Gross  homebuilding profit                                                     |       | 49,634                                           |       | 50,683              |       | (2.1                                           | )%         | 104,881             |       | 90,796     |   | 15.5 | % |   |
| Homebuilding  operating expenses                                               |       | 33,795                                           |       | 30,089              |       | 12.3                                           | %          | 64,650              |       | 58,648     |   | 10.2 | % |   |
| Equity in income  of unconsolidated entities                                   |       | 373                                              |       | 268                 |       | 39.2                                           | %          | 530                 |       | 2,895      |   | (81.7 | )% |   |
| Minority  interests in net losses (earnings) of consolidated partnerships |       | 557                                              |       | (1,135              | )          | —                                         |       | 198                 |       | (1,924     | ) | — |   |   |
| Homebuilding  earnings before income taxes                                     |       | 16,769                                           |       | 19,727              |       | (15.0                                          | )%         | 40,959              |       | 33,119     |   | 23.7 | % |   |
| Mortgage banking  earnings (losses) before income taxes                        |       | 500                                              |       | (173                | )          | —                                         |       | 715                 |       | (476       | ) | — |   |   |
| Earnings before  income taxes                                                  |       | 17,269                                           |       | 19,554              |       | (11.7                                          | )%         | 41,674              |       | 32,643     |   | 27.7 | % |   |
| Provision for  income taxes                                                    |       | 6,271                                            |       | 7,215               |       | (13.1                                          | )%         | 15,129              |       | 12,045     |   | 25.6 | % |   |
| Net earnings                                                                   |       | $                                                | 10,998     |                | $          | 12,339                                         |       | (10.9               | )%         | $          | 26,545 |   | $ | 20,598 |   | 28.9 | % |   |
| ** **                                                                     |       |                                             |       |                |       |                                           |       |                |       |       |   |   |   |   |
| **Other  financial data:**                                                     |       |                                             |       |                |       |                                           |       |                |       |       |   |   |   |   |
| Interest  incurred(1)                                                          |       | $                                                | 10,100     |                | $          | 9,926                                          |       | 1.8                 | %          | $          | 21,287 |   | $ | 16,554 |   | 28.6 | % |   |
| Depreciation                                                                   |       | 193                                              |       | 245                 |       | (21.2                                          | )%         | 399                 |       | 464        |   | (14.0 | )% |   |
| EBITDA(2)                                                                      |       | 23,561                                           |       | 25,121              |       | (6.2                                           | )%         | 53,222              |       | 43,026     |   | 23.7 | % |   |
| Gross  homebuilding profit margin(3)                                           |       | 21.4                                             | %          | 23.6                | %          | —                                         |       | 23.1                | %          | 22.4       | % | — |   |   |
| ** **                                                                     |       |                                             |       |                |       |                                           |       |                |       |       |   |   |   |   |
| **Other  data:**                                                               |       |                                             |       |                |       |                                           |       |                |       |       |   |   |   |   |
| Net new home  orders (units)(4)                                                |       | 1,146                                            |       | 1,158               |       | (1.0                                           | )%         | 1,784               |       | 1,851      |   | (3.6 | )% |   |
| Homes delivered  (units)                                                       |       | 807                                              |       | 760                 |       | 6.2                                            | %          | 1,570               |       | 1,470      |   | 6.8 | % |   |
| Average sales  price of homes delivered                                        |       | $                                                | 281        |                | $          | 275                                            |       | 2.2                 | %          | $          | 282 |   | $ | 271 |   | 4.1 | % |   |
| Backlog at end  of period (units)(5)                                           |       | 1,684                                            |       | 2,029               |       | (17.0                                          | )%         | 1,684               |       | 2,029      |   | (17.0 | )% |   |
| Backlog at end  of period (contract value)(5)                             |       | $                                                | 468,033    |                | $          | 592,767                                        |       | (21.0               | )%         | $          | 468,033 |   | $ | 592,767 |   | (21.0 | )% |   |
|                                                                           |       |                                             |       |                |       |                                           |       |                |       |       |   |   |   |   |

 

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(1)      Interest incurred is the amount of interestpaid and the net amount accrued (whether expensed or capitalized), excludingamortization of interest previously capitalized.

(2)      “EBITDA” represents net earnings beforeinterest expense, depreciation and amortization and provision for income taxes.EBITDA is included in this report because it is a means of assessing ouroperational performance. We believe it is therefore useful to securities analysts,investors and other interested parties in the evaluation of companies likeours. EBITDA is not a measure of our liquidity or financial performance underGAAP and should not be considered as an alternative to our net earnings or anyother performance measure derived in accordance with GAAP, or as an alternativeto cash flow 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,future requirements for capital expenditures or contractual commitments;

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

·      EBITDA does not reflect the significantinterest expense, or the cash requirements necessary to service interest orprincipal payments on our indebtedness;

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

·                  although depreciation and amortization arenon-cash charges, the assets being depreciated and amortized will often have tobe replaced in the future, and EBITDA does not reflect any cash requirementsfor such replacements; and

·                  other companies in our industry may calculateEBITDA differently than we do, limiting its usefulness as a comparativemeasure.

Because of these limitations, EBITDA should not beconsidered as a measure of discretionary cash available to us to invest in thegrowth of our business or to service our indebtedness. We compensate for theselimitations by relying primarily on our GAAP results and using EBITDA onlysupplementally. See the condensed consolidated statements of operations andcash flow presented in our condensed consolidated financial statements includedelsewhere in this report. The following is a reconciliation of EBITDA to netearnings, the most directly comparable GAAP measure:
| ** **                                       | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                       | ** ** | **March 31,**               | ** ** | **March 31,**             | ** ** |
| **(Dollars in thousands)**             | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net earnings                                     |       | $                                | 10,998     |                           | $          | 12,339 |   | $ | 26,545 |   | $ | 20,598 |   |
| Provision for  income taxes                      |       | 6,271                            |       | 7,215                          |       | 15,129 |   | 12,045 |   |
| Interest expense  in cost of sales               |       | 6,097                            |       | 5,310                          |       | 11,143 |   | 9,885 |   |
| Interest expense  in mortgage banking operations |       | 2                                |       | 12                             |       | 6 |   | 34 |   |
| Depreciation and  amortization(a)                |       | 193                              |       | 245                            |       | 399 |   | 464 |   |
| EBITDA                                           |       | $                                | 23,561     |                           | $          | 25,121 |   | $ | 53,222 |   | $ | 43,026 |   |
|                                             |       |                             |       |                           |       |   |   |   |   |

 

(a) Forthe periods shown, amortization was $0.

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

(4) Netnew home orders represents the number of new sales contracts executed withcustomers, net of sales contract cancellations.

(5) Backlogrepresents homes under sales contracts but not yet delivered at the end of theperiod.

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Thefollowing table presents information concerning our revenues from the sales ofresidential units and land, average sales price, homes delivered, net new homeorders, backlog units and backlog contract value by region:
| ** **                           | ** ** | **Sales of**  | ** ** | ** **           | ** ** | ** **    | ** ** | ** **       | ** ** | ** **             | ** ** | **Backlog**            | ** ** |
|--------------------------------------|------------|--------------------|------------|----------------------|------------|---------------|------------|------------------|------------|------------------------|------------|------------------------|------------|
| **Three Months Ended**     | ** ** | **residential**    | ** ** | ** **           | ** ** | ** **    | ** ** | **Net new** | ** ** | **Backlog**            | ** ** | **(contract**          | ** ** |
| **March 31,**                   | ** ** | **units and** | ** ** | **Average**          | ** ** | **Homes**     | ** ** | **home**         | ** ** | **(units) at**    | ** ** | **value) at**     | ** ** |
| **(Dollars in thousands)** | ** ** | **land**           | ** ** | **sales price** | ** ** | **delivered** | ** ** | **orders**(1)    | ** ** | **period end**(2) | ** ** | **period end**(2) | ** ** |
| 2006                                 |       |               |       |                 |       |          |       |             |       |                   |       |                   |       |
| Florida                              |       | $                  | 22,587     |                 | $          | 230.5         |       | 98               |       | 113                    |       | 198                    |       | $ | 56,682 |   |
| Midwest                              |       | 40,336             |       | 372.1                |       | 108           |       | 228              |       | 383                    |       | 138,416                |       |
| Nevada                               |       | 26,782             |       | 399.7                |       | 67            |       | 122              |       | 158                    |       | 62,661                 |       |
| Pacific Coast                        |       | 77,475             |       | 455.7                |       | 170           |       | 119              |       | 170                    |       | 81,136                 |       |
| Texas                                |       | 64,512             |       | 164.7                |       | 364           |       | 564              |       | 775                    |       | 129,138                |       |
| Total                                |       | $                  | 231,692    |                 | $          | 281.2         |       | 807              |       | 1,146                  |       | 1,684                  |       | $ | 468,033 |   |
| 2005                                 |       |               |       |                 |       |          |       |             |       |                   |       |                   |       |
| Florida                              |       | $                  | 26,661     |                 | $          | 246.9         |       | 108              |       | 149                    |       | 447                    |       | $ | 102,501 |   |
| Midwest                              |       | 57,162             |       | 391.5                |       | 146           |       | 119              |       | 344                    |       | 133,379                |       |
| Nevada                               |       | 31,223             |       | 314.8                |       | 86            |       | 102              |       | 146                    |       | 57,476                 |       |
| Pacific Coast                        |       | 49,411             |       | 411.8                |       | 120           |       | 348              |       | 493                    |       | 197,167                |       |
| Texas                                |       | 49,934             |       | 162.8                |       | 300           |       | 440              |       | 599                    |       | 102,244                |       |
| Total                                |       | $                  | 214,391    |                 | $          | 275.2         |       | 760              |       | 1,158                  |       | 2,029                  |       | $ | 592,767 |   |
|                                 |       |               |       |                 |       |          |       |             |       |                   |       |                   |       |

(1)      Net new home ordersrepresent the number of new sales contracts executed with customers, net ofsales contract cancellations.

(2)      Backlog represents homesunder sales contracts but not yet delivered at the end of the period. 
| ** **                           | ** ** | **Sales of**  | ** ** | ** **           | ** ** | ** **    | ** ** | ** **       | ** ** | ** **             | ** ** | **Backlog**            | ** ** |
|--------------------------------------|------------|--------------------|------------|----------------------|------------|---------------|------------|------------------|------------|------------------------|------------|------------------------|------------|
| **Six Months Ended**       | ** ** | **residential**    | ** ** | ** **           | ** ** | ** **    | ** ** | **Net new** | ** ** | **Backlog**            | ** ** | **(contract**          | ** ** |
| **March 31,**                   | ** ** | **units and** | ** ** | **Average**          | ** ** | **Homes**     | ** ** | **home**         | ** ** | **(units) at**    | ** ** | **value) at**     | ** ** |
| **(Dollars in thousands)** | ** ** | **land**           | ** ** | **sales price** | ** ** | **delivered** | ** ** | **orders**(1)    | ** ** | **period end**(2) | ** ** | **period end**(2) | ** ** |
| 2006                                 |       |               |       |                 |       |          |       |             |       |                   |       |                   |       |
| Florida                              |       | $                  | 44,784     |                 | $          | 232.0         |       | 193              |       | 127                    |       | 198                    |       | $ | 56,682 |   |
| Midwest                              |       | 82,769             |       | 378.5                |       | 212           |       | 340              |       | 383                    |       | 138,416                |       |
| Nevada                               |       | 60,390             |       | 389.6                |       | 155           |       | 201              |       | 158                    |       | 62,661                 |       |
| Pacific Coast                        |       | 143,714            |       | 456.2                |       | 315           |       | 201              |       | 170                    |       | 81,136                 |       |
| Texas                                |       | 121,063            |       | 162.7                |       | 695           |       | 915              |       | 775                    |       | 129,138                |       |
| Total                                |       | $                  | 452,720    |                 | $          | 281.7         |       | 1,570            |       | 1,784                  |       | 1,684                  |       | $ | 468,033 |   |
| 2005                                 |       |               |       |                 |       |          |       |             |       |                   |       |                   |       |
| Florida                              |       | $                  | 45,144     |                 | $          | 245.2         |       | 184              |       | 211                    |       | 447                    |       | $ | 102,501 |   |
| Midwest                              |       | 108,888            |       | 363.2                |       | 299           |       | 257              |       | 344                    |       | 133,379                |       |
| Nevada                               |       | 64,115             |       | 320.7                |       | 187           |       | 129              |       | 146                    |       | 57,476                 |       |
| Pacific Coast                        |       | 88,133             |       | 390.0                |       | 226           |       | 487              |       | 493                    |       | 197,167                |       |
| Texas                                |       | 97,315             |       | 167.6                |       | 574           |       | 767              |       | 599                    |       | 102,244                |       |
| Total                                |       | $                  | 403,595    |                 | $          | 270.8         |       | 1,470            |       | 1,851                  |       | 2,029                  |       | $ | 592,767 |   |
|                                 |       |               |       |                 |       |          |       |             |       |                   |       |                   |       |

(1)      Net new home ordersrepresent the number of new sales contracts executed with customers, net ofsales contract cancellations.

(2)      Backlog represents homesunder sales contracts but not yet delivered at the end of the period.

***Homebuilding revenues.******  ***Homebuilding revenues increased 7.9% to $231.8million for the three month period ended March 31, 2006 from $214.9million for the three month period ended March 31, 2005. The increase wasprimarily due to a 6.2% increase in the number of new home deliveries and a 2.2%increase in the average sales price of homes delivered during the three monthperiod ended March 31, 2006 as compared to the three month period ended March 31,2005. Land sales revenue was $4.7 million for the three month period ended March 31,2006 compared to $5.2 million for the three month period ended March 31,2005.

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Homebuilding revenues increased12.3% to $454.4 million for the six month period ended March 31, 2006 from$404.8 million for the six month period ended March 31, 2005. The increasewas primarily due to a 6.8% increase in the number of new home deliveries and a4.1% increase in the average sales price of homes delivered during the sixmonth period ended March 31, 2006 as compared to the six month periodended March 31, 2005. Land sales revenue for the six month period ended March 31,2006 increased to $10.5 million from $5.6 million for the six month periodended March 31, 2005.

Homebuilding revenues for both thethree and six month periods ended March 31, 2006 benefited from anincrease in the number of homes delivered in our Pacific Coast and Texasregions. Increased sales prices in our Nevada and Pacific Coast regions alsocontributed to the increased homebuiding revenues during the period, althoughthe increased average sales price in the Nevada region was offset by areduction in the number of homes delivered from the region. The increasedhomebuilding revenues in the Pacific Coast and Texas regions were partiallyoffset by a decrease in the number of homes delivered from our Midwest region.

***Home sales andbacklog.******  ***Net new home orders for the three month period ended March 31,2006 were 1,146, a 1.0% decrease from 1,158 net new home orders for the threemonth period ended March 31, 2005. Net new home orders for the six monthperiod ended March 31, 2006 were 1,784, a 3.6% decrease from 1,851 net newhome orders for the six month period ended March 31, 2005.

During the three and six monthperiods ended March 31, 2006, net new home orders in the Florida regiondecreased by 24.2% and 39.8%, respectively, due to fewer open selling locationsand a decrease in net new home orders per open selling location as certaincommunities were closing out. During the three and six month periods ended March 31,2006, net new home orders in the Pacific Coast region decreased by 65.8% and58.7%, respectively. The decrease in net new home orders in the Pacific Coastregion is the result of weakened market conditions. The deceases in net newhome orders in our Florida and Pacific Coast regions were substantially offsetby increased net new home orders in our Midwest, Nevada, and Texas regions.

At March 31, 2006, the contractvalue of our backlog was $468.0 million, as compared to $592.8 million at March 31,2005. At March 31, 2006, the average sales price per home in backlog was$278,000, down $14,000, or 4.8%, over the average sales price per home inbacklog of $292,000 at March 31, 2005. The reduction in backlog unitsreflects the delay in the opening of certain locations and current marketconditions.

***Gross homebuildingprofit margin.******  ***Gross homebuilding profit margin decreased to 21.4%for the three month period ended March 31, 2006, compared to 23.6% for thethree month period ended March 31, 2005. The gross profit decreasereflects a reduction in the homebuilding gross profit margin in our Midwest,Nevada, and Pacific Coast regions. Included within our gross profit is a $3million charge related to our decision to exit the Cleveland market. Althoughgross margins in the Nevada and Pacific Coast remain above our average grossprofit margin on a consolidated basis, the gross margin in these regions hasdecreased as a result of sales price pressure and increased construction costsand land prices. These decreases were partially offset by increased margins inour Florida and Texas regions. During the three month period ended March 31,2006, the Nevada and Pacific Coast regions contributed 45% of the totalhomebuilding revenues and 67% of the total homebuilding gross profit. Duringthe three months ended March 31, 2005, these two regions contributed 38%of the total homebuilding revenues and 63% of the total homebuilding grossprofit.

Gross homebuilding profit marginincreased to 23.1% for the six month period ended March 31, 2006, comparedto 22.4% for the six month period ended March 31, 2005. Our gross profitincrease reflects the increased percentage of homebuilding revenues contributedby our Pacific Coast region, where margins remain high relative to otherregions, and increased gross margins in our Florida and Texas regions. Theseincreases were partially offset by reductions in the homebuilding gross profitmargin in our Midwest, Nevada, and Pacific Coast regions. Included within ourgross profit is a $3 million charge related to our decision to exit theCleveland market. Although gross margins in the 

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Nevada and Pacific Coast remainabove our average gross profit margin on a consolidated basis, the gross marginin these regions has decreased as a result of sales price pressure andincreased construction costs and land prices. During the six month period endedMarch 31, 2006, the Nevada and Pacific Coast regions contributed 45% ofthe total homebuilding revenues and 68% of the total homebuilding gross profit.During the six months ended March 31, 2005, these two regions contributed38% of the total homebuilding revenues and 63% of the total homebuilding grossprofit.

***Homebuildingoperating expenses.******  ***Homebuilding operating expenses, which consist of allhomebuilding expenses other than cost of sales, increased 12.3% to $33.8million for the three month period ended March 31, 2006 from $30.1 millionfor the three month period ended March 31, 2005. Homebuilding operatingexpenses increased 10.2% to $64.6 million for the six month period ended March 31,2006 from $58.6 million for the six month period ended March 31, 2005.

During the three and six monthperiods ended March 31, 2005, we recorded $2.4 million and $4.0million of compensation expense related to certain stock options granted thatwere considered to be variable awards. We have since amended our equity-basedcompensation agreements to amend the terms that resulted in variable accountingtreatment. The increases for both the three month period and six month periodended March 31, 2006 are primarily due to increased personnel costs at boththe corporate and regional levels and the increased utilization of outside realestate brokers to sell our homes.

Homebuilding operating expenses were14.6% and 14.0% of total homebuilding revenue for the three month periods endedMarch 31, 2006 and 2005 and homebuilding operating expenses were 14.2% and14.5% of total homebuilding revenue for the six month periods ended March 31,2006 and 2005, respectively.

***Net mortgageoperations.******  ***Mortgage banking earnings before taxesincreased to $0.5 million for the three month period ended March 31, 2006,compared to a loss of $0.2 million for the three month period ended March 31,2005. Mortgage banking earnings before taxes increased to $0.7 million for thesix month period ended March 31, 2006, compared to a loss of $0.5 millionfor the six month period ended March 31, 2005. The increase in earningsfor the three and six month periods ended March 31, 2006 was due toincreased mortgage volume and reduced operating costs.

***Income taxes.******  ***We recorded income tax expense of $6.3million and $7.2 million for the three month periods ended March 31, 2006and 2005 and income tax expense of $15.1 million and $12.0 million for the sixmonth periods ended March 31, 2006 and 2005, respectively. Our consolidatedeffective tax rates were 36.3% and 36.9% for the three and six months ended March 31,2006 and 2005.

***Net earnings.******  ***As a result of the above factors, our netearnings decreased 10.9% to $11.0 million for the three month period ended March 31,2006 from $12.3 million for the three month period ended March 31, 2005.Our net earnings for the six month period ended March 31, 2006 increased28.9% to $26.5 million from $20.6 million for the six month period ended March 31,2005.

**Liquidity and Capital Resources**

Our principal uses of cash are landpurchases, lot development and home construction. As a result, our financingneeds depend principally on sales volume, land acquisition and inventorybalances. We fund our operations with cash flows from operating activities,borrowings under a senior unsecured credit facility, other bank debt, andminority interests in consolidated partnerships. We do not hold cash forinvestment purposes and we manage our cash and debt positions to minimizefinancing costs.

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***Operating cash flow activities***

In the six months ended March 31, 2006, cashflows used in operating activities totaled $131.6 million, compared to cashflows used in operating activities of $72.0 million in the same period lastyear. The decrease in operating cash flows consisted primarily of an increasein inventories, resulting from land purchases, lot development and homeconstruction, and the change in other operating assets and liabilities,including receivables, deferred expenses and other assets, and income taxespayable. These decreases were partially offset by increased net earnings.

***Investing cash flow activities***

Cash flows used in investing activities totaled $8.0million in the six months ended March 31, 2006, compared to cash flowsused in investing activities of $16.0 million in the same period last year. Theincrease in investing cash flows was primarily due to a reduction in the cashcontributed and advanced to unconsolidated entities, partially offset by thepurchase of a building to be used as our new principal executive office.

***Financing cash flowactivities***

Cash flows provided by financing activities totaled$139.4 million in the six months ended March 31, 2006, compared to $105.0million in the same period last year. Net borrowings of $140.6 million wereused to increase our investment in inventory, to purchase our new principalexecutive office and to fund our construction operations.

In December 2005, we issued $203 millionaggregate principal amount of senior subordinated notes due December 2012in a private placement pursuant to Rule 144A promulgated under theSecurities Act of 1933, as amended. The senior subordinated notes were sold at98.796% of par and accrue interest at a coupon rate of 10.5% per annum.Interest is paid semi-annually beginning June 2006. The net proceeds wereused to repay amounts outstanding under working capital loans and certainsenior secured revolving credit facilities. We may redeem the notes, in wholeor part, at any time on or after December 15, 2009, at a redemption priceequal to 100% of the principal amount, plus a 5.25% premium declining ratablyto par on December 15, 2011, plus accrued and unpaid interest. Inaddition, at any time prior to December 15, 2008, we may redeem up to 35%of the aggregate principal amount of the notes with the proceeds of qualifiedequity offerings at a redemption price equal to 110.5% of the principal amount,plus accrued and unpaid interest. The notes are unsecured senior subordinatedobligations and subordinated in right of payment to all of our existing andfuture senior debt, including borrowings under our senior unsecured creditfacility. All of the our wholly owned subsidiaries, other than our mortgagesubsidiary, have fully and unconditionally guaranteed the notes on a joint andseveral, unsecured senior subordinated, basis. The guarantees are generalunsecured obligations of the guarantors and will be subordinated in right ofpayment to all existing and future senior debt of the guarantors, whichincludes their guarantees of our senior unsecured credit facility. Theindenture governing the senior subordinated notes contains a number ofsignificant covenants that could restrict our ability and that of itsrestricted subsidiaries to, among other things: incur additional indebtedness,make certain distributions, investments and other restricted payments, createcertain liens, enter into transactions with affiliates, and merge, consolidateor sell substantially all of our assets.

On April 13, 2006, we filed a registrationstatement with the U.S. Securities and Exchange Commission (the “Commission”)relating to an offer to exchange the notes for an issue of registered noteswith terms substantially identical to the notes. On May 4, 2006, theCommission declared our amended registration statement effective, and we willoffer the exchange notes in return for the notes during the exchange offerperiod.

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

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credit facility to exceed $700 million. The applicableborrowing base will be determined regularly throughout the life of thefacility. The composition of the borrowing base will be limited to parametersset forth in the credit facility agreement and certain types of real estate(such as unimproved entitled land and lots under development) will be removedfrom the borrowing base if held beyond specified maturity dates. Borrowingsunder the credit facility will generally bear interest based on an applicablemargin plus LIBOR or an alternate base rate. The applicable margin for interestranges from 1.5% to 2.25%, depending upon our senior leverage ratio, which isdefined as the ratio of total liabilities to consolidated net worth. Fees forletters of credit are based on LIBOR plus a margin of 1.5%. An unusedcommitment fee equal to 0.2% to 0.3% per year accrues on the undrawn portion ofthe facility and is payable quarterly in arrears. As of March 31, 2006, wehad $368 million of borrowings under the credit facility at an effective rateof 6.71% and, after giving effect to the borrowing base limitation, had additionalavailability of $131 million. Our obligations under the senior unsecured creditfacility are guaranteed by all of our wholly-owned subsidiaries, other than ourmortgage subsidiary, and are subject to a number of customary financial andoperating covenants, including covenants requiring us to: maintain a minimumtangible net worth of at least $225 million plus 50% of positive net income asearned subsequent to September 30, 2005; maintain a ratio of totalliabilities to adjusted tangible net worth not to exceed 2.50x; maintain aratio of total debt to adjusted tangible net worth not in excess of 2.0x(decreasing to 1.75x as of March 31, 2007); maintain an interest coverageratio of no less than 2.25x; and limit the number of speculative housing unitsowned by us, excluding foundations, as of the end of any fiscal quarter to amaximum of 30% of our housing unit closings during the previous 12-monthperiod; and limit the number of speculative housing units in any buildingregion, excluding foundations, as of the end of any fiscal quarter to a maximumof 35% of our housing unit closings in such region during the previous 12-monthperiod. In addition to these covenants, the credit facility includesrestrictions upon debt and investments which permit: subordinated debt up to$300 million; other unsecured debt up to $25 million; secured debt up to 25% oftangible net worth; guarantees of minority-owned joint venture debt up to 35%of adjusted tangible net worth; and investments in minority-owned jointventures up to 30% of tangible net worth. For purposes of these tests, adjustedtangible net worth is benefited by adjustments of 50% of our outstanding seniorsubordinated debt (up to a maximum $100 million adjustment) and 100% ofminority interests in consolidated entities (up to a maximum $50 millionadjustment). As of and during the three and six months ended March 31,2006, we were in compliance with the covenants of this facility.

In addition to the senior unsecured credit facility,we are party to several senior secured project specific acquisition,development and construction loans with an aggregate amount outstanding as of March 31,2006 of $45.8 million. These loans bear interest at floating rates ranging fromthe prime rate to the prime rate plus 1%, with maturities generally tied to thesale of the underlying inventory.

We are party to several unsecured loan agreements thatfund our operations on an ongoing basis. In addition, KH Financial, L.P., ourwholly owned mortgage subsidiary, is party to a $5.0 million warehouse line ofcredit, used to fund its mortgage origination operations. This facility bearsinterest at a floating rate equal to LIBOR plus 1.75%, and as of March 31,2006, there were no amounts outstanding under the warehouse facility.

We are also party to a $100 million flexible earlypurchase facility agreement which allows us to sell qualifying mortgage loansto the holder of the flexible early purchase facility after such loans havebeen originated subject to our obligation to sell the loan to an investor inthe secondary market. At March 31, 2006, $33 million of the facility wasin use.

We believe that our cash, otherliquid assets and operating cash flow, together with available borrowings andpotential access to credit and capital markets, will be sufficient to meet ouroperating expenses and capital expenditures and service our debt requirementsas they become due. However, our ongoing ability to meet our substantial debtservice and other obligations, including compliance with financial covenants inour senior unsecured credit facility, will be dependent upon our futureperformance which will be subject to business, financial and other factors. Wewill not be able to control many of these factors, such as economic conditionsin the markets where we operate and pressure from 

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competitors. We cannot be certain thatour cash flow will be sufficient to allow us to pay principal and interest onour debt, including the senior subordinated notes, support our operations andmeet our other obligations. If we do not have enough money, we may be requiredto refinance all or part of our existing debt, sell assets or borrow moremoney. We cannot guarantee that we will be able to do so on terms acceptable tous, if at all. In addition, the terms of existing or future debt agreements,including our senior unsecured credit facility and the indenture for the seniorsubordinated notes, may restrict us from pursuing any of these alternatives.

**ContractualObligations**

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

The following summarizes ouraggregate contractual commitments at March 31, 2006:
| ** **                           | ** ** | **Payments due by period** | ** ** |
|--------------------------------------|------------|-------------------------------------------|------------|
| ** **                           | ** ** | ** **                                | ** ** | **Less than** | ** ** | ** ** | ** ** | ** ** | ** ** | **More than** | ** ** |
| **(Dollars in thousands)** | ** ** | **Total**                                 | ** ** | **1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **5 years** | ** ** |
| Notes payable(1)                     |       | $                                         | 855,380    |   | $ | 49,635 |   | $ | 139,984 |   | $ | 428,271 |   | $ | 237,490 |   |
| Operating leases                     |       | 8,779                                     |       | 2,140 |   | 4,145 |   | 2,424 |   | 70 |   |
| Purchase obligations(2)              |       | 48,337                                    |       | 6,482 |   | 41,855 |   |   |   |   |   |
| Total                                |       | $                                         | 912,496    |   | $ | 58,257 |   | $ | 185,984 |   | $ | 430,695 |   | $ | 237,560 |   |
|                                 |       |                                      |       |   |   |   |   |   |   |   |   |

(1)       Includes our seniorsubordinated notes due 2012, our senior unsecured credit facility, otherhomebuilding debt and mortgage loans relating to our mortgage bankingoperations, and related interest payments for the life of the debt. Interest onvariable rate obligations is based on rates effective as of March 31,2006.

(2)       Represents obligationsunder option agreements and purchase contracts with specific performanceprovisions, net of cash deposits.

Under the terms of our stock option agreements, we maybe required to purchase shares of our common stock at fair market value,including shares issuable under outstanding options or deferred stock units,from our directors and certain of our executive officers and other keyemployees, in the event of termination of board membership or employment, asapplicable, by reason of specified circumstances, including death, disability,termination, retirement or resignation. Based upon the most recent independentvaluation of the Company performed as of December 31, 2005 and the sharesissued or issuable in respect of options or deferred stock units outstanding asof March 31, 2006, our aggregate repurchase obligation, net of proceeds tobe received from any stock option exercises, is approximately $58 millionin the event that all of these obligations were triggered.

We are contingently liable to banks and financialinstitutions for approximately $55 million for outstanding letters of creditand performance bonds securing performance of certain contractual obligationsand land purchase contracts. Approximately $4 million of the outstandingletters of credit have been issued by a wholly owned subsidiary. We do notbelieve that any of these letters of credit or bonds are likely to be drawnupon. At March 31, 2006, we had committed to fund $28 million in mortgageloans to homebuyers. We have entered into best-efforts and mandatory salecommitments to sell these mortgages to third parties.

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

At March 31, 2006, we owned andcontrolled 32,157 lots, approximately 47% of which were pursuant to optionagreements and purchase contracts. The following is a summary of our land/lotposition:

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| ** **                                                        | ** ** | **At March 31,** | ** ** |
|-------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                        | ** ** | **2006**                   | ** ** |
| Finished lots owned                                               |       | 5,818                      |       |
| Lots under development owned                                      |       | 11,288                     |       |
| Total lots owned                                                  |       | 17,106                     |       |
| Lots controlled under option agreements and purchase contracts(1) |       | 15,051                     |       |
| Total  land/lots controlled                                       |       | 32,157                     |       |
|                                                              |       |                       |       |

(1)       Includes 1,821 lots included in inventory not ownedwhich were consolidated under the accounting guidance of FIN 46R and 1,797 lotsthat we expect to purchase from unconsolidated entities in which we have aninvestment 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 toour homebuilding operations include land option agreements and purchase contractsand joint ventures.

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

In the ordinary course of business, we enter intooption agreements and purchase contracts to secure land for the construction ofhomes. These agreements generally require us to pay a deposit to the seller asconsideration for the right to acquire land during a specified period, usuallyat predetermined prices. Some of these option agreements and purchase contractscontain specific performance clauses, which require us to purchase the landupon satisfaction of certain requirements by both us and the sellers.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 of March 31,2006:
| ** **                                                                | ** ** | **Aggregate**           | ** ** |
|---------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                | ** ** | **exercise price** | ** ** |
| **(Dollars in thousands)**                                      | ** ** | **of options**(1)  | ** ** |
| Option agreements and purchase contracts with specific performance        |       | $                       | 6,482      |   |
| Options agreements and purchase contracts without specific performance(2) |       | 635,548                 |       |
| Total  option agreements and purchase contracts                           |       | $                       | 642,030    |   |
|                                                                      |       |                    |       |

(1)       Excludes $48.0 million related to inventory not ownedincluded on our condensed consolidated balance sheet at an initial fair valueof $37.8 million.

(2)       Includes $175 million related to purchases from jointventures in which we have an investment balance of approximately $30 million asof March 31, 2006. These investments are recorded in investments in andadvances to unconsolidated entities on our condensed consolidated balancesheets.

We expect to exercise all of our option agreements andpurchase contracts with specific performance obligations and, subject to marketconditions, substantially all of our option agreements and purchase contractswithout specific performance obligations.

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

Investments in and advances to unconsolidated entitiesrepresent our ownership interest in entities accounted for under the equitymethod when we hold less than a controlling interest in the entity or we arenot the primary beneficiary in a Variable Interest Entity (VIE) as defined byFIN 46R. In instances where we expect to purchase land from the unconsolidatedentity, our share of the unconsolidated entity’s earnings is deferred untilhomes related to the lots purchased are delivered and title passes to ahomebuyer. Our partners generally are unrelated homebuilders, land sellers orother real estate entities.

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In the ordinary course ofbusiness, we periodically enter into arrangements with land developers or otherhomebuilders to acquire land and develop lots. These arrangements include thecreation of joint ventures, with our interest in these entities ranging from 6%to 45%. We account for our interest in these joint ventures under the equitymethod, and our condensed consolidated balance sheets include investments injoint ventures totaling $39.4 million and $37.0 million at March 31, 2006and September 30, 2005, respectively. These joint ventures typicallyobtain secured acquisition, development and construction financing. At March 31,2006 and September 30, 2005, our unconsolidated joint ventures hadoutstanding third-party borrowings of $836 million and $803 million,respectively. From time to time we issue repayment guarantees and/orloan-to-value maintenance guarantees in respect of this indebtedness. Theseguarantees require us to repay debt of the joint venture in the event of apayment default, in the case of the repayment guarantees, or in the event thatthe debt of the joint venture exceeds the value of the property securing thedebt, in the case of the loan-to-value maintenance guarantees. At March 31,2006 and September 30, 2005, we had guarantees of $72.6 million and $67.6million, respectively, related to the indebtedness of these joint ventures.

**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 respective market practices and may besubject to certain contingencies such as the buyer’s ability to qualify forfinancing. Homes covered by such sales contracts but not yet delivered areconsidered “backlog.” We do not recognize revenue upon the sale of a home untilit is delivered to the homebuyer and other criteria for sale and profitrecognition are met. We sometimes build homes before obtaining a salescontract; however, these homes are excluded from backlog until a sales contractis signed. At March 31, 2006, 8% of the number of homes in inventoryconsisted of completed homes without sales contracts. At September 30,2005, 7% of the number of homes in inventory consisted of completed homeswithout sales contracts. Our cancellation rates for the three months ended March 31,2006 and 2005 were 23% and 21%, respectively. Our cancellation rates for thesix months ended March 31, 2006 and 2005 were 27% and 23%, 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.

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. To date, inflation has not had amaterial adverse effect on our results of operations. However, there is noassurance that inflation will not have a material adverse impact on our futureresults of operations.

**CriticalAccounting 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 accounting principles generally accepted in the United Statesof America. The preparation of these financial statements requires us to makeestimates 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

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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;

·   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 the prospectus dated May 4, 2006, whichis a part of our amended registration statement on Form S-4.

**Recent AccountingPronouncements**

In December 2004,the FASB issued Statement of Financial Accounting Standards No. 123(revised 2004), *Share-Based Payment*, (“SFAS 123R”).SFAS 123R is a revision of SFAS 123 and supersedes APB No. 25. SFAS 123Rrequires that the cost resulting from all share-based payment transactions berecognized in the financial statements and establishes fair value as themeasurement objective in accounting for share-based payment arrangements. SFAS123R is effective as of the beginning of the first annual reporting period thatbegins after December 15, 2005. SFAS 123R applies to all awards granted,modified, repurchased or cancelled after the effective date, and alloutstanding portions of awards granted prior to the effective date which areunvested as of the effective date of the pronouncement.

Entities may adopt theprovisions of SFAS 123R using either the modified prospective or modifiedretrospective methods. Under the modified prospective method, compensation costis recognized on or after the required effective date for the portion ofoutstanding awards for which the requisite service has not yet been rendered,based on the grant-date fair value of those awards calculated under SFAS 123for either recognition or pro forma disclosure. For periods before the requiredeffective date, the modified retrospective application may be applied to either (a) all prior years for whichSFAS 123 was effective or (b) only to prior interim periods in the year ofinitial adoption, on a basis consistent with the pro forma disclosures requiredfor those periods by SFAS 123. SFAS 123R becomes effective for us on October 1,2006. We are currently evaluating the requirements of SFAS 123R.

In May 2005, theFASB issued SFAS No. 154, *Accounting Changes andError Corrections — a replacement for APB Opinion No. 20 and FASBStatement No. 3* (“SFAS 154”). SFAS 154 requires prior periodfinancial statements to be restated for changes in accounting principles. SFAS154 also redefines restatement as the revision of previously issued financialstatements to reflect the correction of an error. SFAS 154 is effective for accountingchanges and

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corrections of errors made in fiscal years beginningafter December 15, 2005. SFAS 154 is not expected to have a materialimpact on our results of operations or financial position.

In June 2005, theEmerging Issues Task Force (“EITF”) released Issue No. 04-5, *Determining Whether a General Partner, or the General Partners as aGroup, Controls a Limited Partnership or Similar Entity When the LimitedPartners Have Certain Rights* (“EITF 04-5”). EITF 04-5creates a framework for evaluating whether a general partner or a group ofgeneral partners controls a limited partnership and therefore shouldconsolidate the partnership. EITF 04-5 states that the presumption ofgeneral partner control would be overcome only when the limited partners havecertain specific rights as outlined in EITF 04-5. EITF 04-5 iseffective immediately for all newly formed limited partnerships and forexisting limited partnership agreements that are modified. For general partnersin all other limited partnerships, EITF 04-5 is effective no later thanthe beginning of the first reporting period in fiscal years beginning after December 15,2005. Implementation of EITF 04-5 is not expected to have a materialimpact on our results of operations or financial position.

**Cautionary FactorsThat May Affect Future Results**

Our disclosure and analysis in this report containforward-looking statements about our financial results and estimates andbusiness prospects that involve substantial risks and uncertainties. From timeto time, we also may provide oral or written forward-looking statements inother materials we release to analysts, debt holders and the public.Forward-looking statements give our current expectations or forecasts of futureevents. You can identify these statements by the fact that they do not relatestrictly 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 ofthe forward-looking statements included in this report and in any other of ourreports or public statements may not approximate actual experience, and theexpectations derived from them may not be realized, due to known or unknownrisks and uncertainties. As a result, actual results may differ materially fromthe results discussed in and anticipated by the forward-looking statements. Thefollowing risks and uncertainties relevant to our business include factors webelieve could adversely affect us. Other factors beyond those listed belowcould also adversely affect us.

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·       high interest rates, changes in tax laws and inflation;

·       changes in macroeconomic conditions in our markets and regions;

·       the availability of sufficient capital;

·       fluctuations in inventory values and carrying costs;

·       our ability to acquire desirable lots or land for residential buildout;

·       our ability to compete effectively against homebuilders in our markets andwith sales or rentals of existing homes in our markets;

·       adverse weather conditions and natural disasters in our markets;

·       the availability and quality of subcontractors and raw materials;

·       utility shortages and price increases;

·       the growth or expansion of our operations;

·       our ability to develop our communities successfully;

·       our ability to retain certain members of our senior management and otherkey employees;

·       the future availability of insurance at reasonable cost;

·       fluctuations in real estate values;

·       poor relations with residents of our communities;

·       expenses related to construction defect, soil subsidence and home warrantyclaims;

·       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 outstanding shares of our commonstock; and

·       geopolitical risks and market disruption.

Given theseuncertainties, you are cautioned not to place undue reliance on theseforward-looking statements. These forward-looking statements are made as of thedate of this report. We undertake no obligation to update or revise anyforward-looking statements, whether as a result of new information, futureevents or otherwise. However, any further disclosures made on related subjectsin subsequent reports or communications should be considered. Additionalinformation about factors that could lead to material changes in performance iscontained in the prospectus dated May 4, 2006, which is a part of ouramended registration statement on Form S-4. You should understandthat it is not possible to predict or identify all such factors. Consequently,you should not consider any such list to be a complete set of all potentialrisks or uncertainties.

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**Item 3.    Quantitative and Qualitative DisclosuresAbout Market Risk.**

We are exposed to anumber of market risks in the ordinary course of business. Our primary marketrisk exposure for financial instruments relates to fluctuations in interestrates. We do not enter into or hold derivatives for trading or speculativepurposes. As of March 31, 2006, we had a total of $405 million of floatingrate debt outstanding, including our senior unsecured credit facility and otherfacilities. Borrowings under these facilities generally bear interest based onapplicable margin plus LIBOR or an alternate base rate. As of March 31,2006, we were not a party to any interest rate swap agreements. Holding ourvariable rate debt balances constant as of March 31, 2006, each onepercentage point increase in interest rates would result in an increase ininterest incurred for the next twelve month period of approximately $4.0million. A one percentage point increase in interest rates on our averagevariable rate debt outstanding during the twelve month period ended March 31,2006 would have resulted in an increase in interest incurred of approximately$4.8 million.

**Item 4.    Controls andProcedures.**

***Disclosurecontrols and procedures.***We maintain disclosure controlsand procedures (as defined in Rule 13a-15(e) of the SecuritiesExchange Act of 1934, as amended (the “Act”)) that are designed to providereasonable assurance that information required to be disclosed by us, includingour consolidated entities, in the reports that we file or submit under the Act,is recorded, processed, summarized and reported, within the time periodsspecified in the Securities and Exchange Commission’s rules and forms andthat such information is accumulated and communicated to management, includingthe Chairman and Chief Executive Officer (the “Principal Executive Officer”)and Chief Financial Officer (the “Principal Financial Officer”), asappropriate, to allow timely decisions regarding required disclosure. Prior tothe filing of this report, we completed an evaluation under the supervision andwith the participation of senior management, including our Principal ExecutiveOfficer and our Principal Financial Officer, of the effectiveness of the designand operation of our disclosure controls and procedures as of March 31,2006. Based on this evaluation, our Principal Executive Officer and ourPrincipal Financial Officer concluded that our disclosure controls andprocedures were effective at the reasonable assurance level as of March 31,2006.

***Changesin internal control over financial reporting.***There wereno changes in our internal control over financial reporting that occurredduring the second fiscal quarter of 2006 that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.

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**PART II—OTHERINFORMATION**

**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 our prospectusdated May 4, 2006 under the heading entitled “Risk factors.” The riskfactors disclosed in our prospectus, in addition to the other information setforth in this report, could materially affect our business, financial conditionor results. Additional risks and uncertainties not currently known to us orthat are deemed to be immaterial also may materially adversely affect ourbusiness, financial condition or results.

**Item 6.     Exhibits.**
|  Exhibits                            | ** ** | ** **                                                                                                                       |
|-------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|
|        31.1 |       | Rule 13a-14(a) / 15d-14(a) Certification  of David K. Hill, Chairman and Chief Executive Officer.                 |
|                                      |       |                                                                                                                             |
|        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 and Chief Executive Officer.                                         |
|                                      |       |                                                                                                                             |
|        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 May 15, 2006 | /s/ DAVID K. HILL                                 |
|                    | David K. Hill                                     |
|                    | Chairman and Chief Executive Officer              |
|                    | (Principal Executive Officer)                     |
|                    |                                              |
| Dated May 15, 2006 | /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**                                                                                                              | ** ** | ** ** |
|-----------------|------------|------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| 31.1            |       | Rule 13a-14(a) /  15d-14(a) Certification of David K. Hill, Chairman and Chief Executive  Officer.                 |
|            |       |                                                                                                                         |
| 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 and Chief Executive Officer.                                     |
|            |       |                                                                                                                         |
| 32.2            |       | Section 1350 Certification of Eugene K. Rowehl,  Senior Vice President and Chief Financial Officer.                     |

 

 

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