**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

**Form 10-Q**

**(Mark One)**
| x                                                  | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|----------------------------------------------------|-----------------------------------------------------------------------------------------------|
|                                               | ** **                                                                                    |
| **For the  quarterly period ended March 31, 2007** |
| ** **                                         |
| **OR**                                             |
|                                               |                                                                                          |
| o                                                  | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**Forthe transition period from          to           **

**Commissionfile number: 333-133278**

**KIMBALLHILL, INC.**

(Exact name of Registrant as specified in its charter)

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

 

**(847) 364-7300**

(Registrant’s telephone number, including area code)

**NotApplicable**

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

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

xYes o No

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

oLarge acceleratedfiler                          o Acceleratedfiler                         x Non-accelerated filer

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

oYes x No

As of May 11, 2007, therewere 4,438,309 shares of common stock outstanding.

 

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**KIMBALL HILL, INC. AND SUBSIDIARIES**

**FORM 10-Q**

**TABLE OFCONTENTS**
|                | ** ** |                                                                                                                         | ** ** | **PAGE** | ** ** |
|----------------|------------|-------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
|           |       | PART I—FINANCIAL  INFORMATION                                                                                      |       |     |       |
|           |       |                                                                                                                    |       |     |       |
| Item 1.        |       | Financial Statements.                                                                                                   |       |     |       |
|           |       |                                                                                                                    |       |     |       |
|           |       | Unaudited Condensed  Consolidated Balance Sheets   as of March 31, 2007 and September 30, 2006                          |       | 3        |       |
|           |       |                                                                                                                    |       |     |       |
|           |       | Unaudited  Condensed Consolidated Statements of Operations   for the Three and Six Months Ended March 31, 2007 and 2006 |       | 4        |       |
|           |       |                                                                                                                    |       |     |       |
|           |       | Unaudited  Condensed Consolidated Statements of Cash Flows   for the Six Months Ended March 31, 2007 and 2006           |       | 5        |       |
|           |       |                                                                                                                    |       |     |       |
|           |       | Notes to  Unaudited Condensed Consolidated Financial Statements                                                         |       | 6        |       |
|           |       |                                                                                                                    |       |     |       |
| Item 2.        |       | Management’s  Discussion and Analysis of Financial Condition and   Results of Operations.                          |       | 25       |       |
|           |       |                                                                                                                    |       |     |       |
| Item 3.        |       | Quantitative  and Qualitative Disclosures About Market Risk.                                                            |       | 43       |       |
|           |       |                                                                                                                    |       |     |       |
| Item 4.        |       | Controls and  Procedures.                                                                                               |       | 44       |       |
|           |       |                                                                                                                    |       |     |       |
|           |       | PART II—OTHER INFORMATION                                                                                          |       |     |       |
|           |       |                                                                                                                    |       |     |       |
| Item 1.        |       | Legal Proceedings.                                                                                                      |       | 45       |       |
|           |       |                                                                                                                    |       |     |       |
| Item  1A.      |       | Risk  Factors.                                                                                                          |       | 45       |       |
|           |       |                                                                                                                    |       |     |       |
| Item  6.       |       | Exhibits.                                                                                                               |       | 45       |       |
|           |       |                                                                                                                    |       |     |       |
| SIGNATURES     |       | 46                                                                                                                      |       |
|           |       |                                                                                                                    |       |     |       |
| EXHIBIT  INDEX |       | 47                                                                                                                      |       |

 

2

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**PART I—FINANCIAL INFORMATION**

**Item 1.  Financial Statements.**

**Kimball Hill, Inc. and Subsidiaries**

**Unaudited CondensedConsolidated Balance Sheets**
| ** **                                                                                                                                       | ** ** | **March 31,** | ** ** | **September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|------------------------|------------|
| **(in thousands, except shares)**                                                                                                 | ** ** | **2007**           | ** ** | **2006**               | ** ** |
| **Assets**                                                                                                                                       | ** ** | ** **         | ** ** | ** **             | ** ** |
| HOMEBUILDING:                                                                                                                                    |       |               |       |                   |       |
| Cash and cash  equivalents                                                                                                                       |       | $                  | 7,540      |                   | $          | 16,042 |   |
| Receivables                                                                                                                                      |       | 20,085             |       | 35,323                 |       |
| Income taxes  receivable                                                                                                                         |       | 7,256              |       |                   |       |
| Inventory                                                                                                                                        |       | 833,262            |       | 899,297                |       |
| Inventory not  owned                                                                                                                             |       | 49,999             |       | 37,821                 |       |
| Deferred  expenses and other assets                                                                                                              |       | 20,911             |       | 19,229                 |       |
| Investments in  and advances to unconsolidated entities                                                                                          |       | 51,546             |       | 48,238                 |       |
| Deferred income  taxes                                                                                                                           |       | 34,095             |       | 14,133                 |       |
| Property and  equipment, net of accumulated depreciation                                                                                         |       | 10,918             |       | 10,635                 |       |
|                                                                                                                                             |       | 1,035,612          |       | 1,080,718              |       |
| MORTGAGE BANKING:                                                                                                                                |       |               |       |                   |       |
| Cash and cash  equivalents                                                                                                                       |       | 4,704              |       | 2,623                  |       |
| Trade accounts  receivable                                                                                                                       |       | 1,736              |       | 2,319                  |       |
| Mortgage loans  held for sale                                                                                                                    |       | 2,133              |       | 5,663                  |       |
| Property and  equipment, net of accumulated depreciation                                                                                         |       | 244                |       | 254                    |       |
|                                                                                                                                             |       | 8,817              |       | 10,859                 |       |
| TOTAL ASSETS                                                                                                                                     |       | $                  | 1,044,429  |                   | $          | 1,091,577 |   |
|                                                                                                                                             |       |               |       |                   |       |
| **Liabilities and equity**                                                                                                                       | ** ** | ** **         | ** ** | ** **             | ** ** |
| HOMEBUILDING:                                                                                                                                    |       |               |       |                   |       |
| Accounts payable  and accrued expenses                                                                                                           |       | $                  | 81,319     |                   | $          | 106,779 |   |
| Deposits on  sales of residential units                                                                                                          |       | 6,635              |       | 6,333                  |       |
| Liabilities  related to inventory not owned                                                                                                      |       | 13,939             |       | 5,015                  |       |
| Income taxes  payable                                                                                                                            |       |               |       | 3,702                  |       |
| Notes payable                                                                                                                                    |       | 529,842            |       | 500,208                |       |
|                                                                                                                                             |       | 631,735            |       | 622,037                |       |
| MORTGAGE BANKING:                                                                                                                                |       |               |       |                   |       |
| Accounts payable  and accrued expenses                                                                                                           |       | 528                |       | 927                    |       |
| Other  liabilities                                                                                                                               |       | 108                |       | 196                    |       |
|                                                                                                                                             |       | 636                |       | 1,123                  |       |
| Total  liabilities                                                                                                                               |       | 632,371            |       | 623,160                |       |
|                                                                                                                                             |       |               |       |                   |       |
| MINORITY INTEREST IN  CONSOLIDATED PARTNERSHIPS                                                                                                  |       | 28,299             |       | 43,244                 |       |
| MINORITY INTEREST IN  INVENTORY NOT OWNED                                                                                                        |       | 31,721             |       | 31,721                 |       |
|                                                                                                                                             |       |               |       |                   |       |
| REDEEMABLE EQUITY:                                                                                                                               |       |               |       |                   |       |
| Redeemable  common stock, no par value; shares outstanding:   155,704 at March 31, 2007 and 228,002 at September 30, 2006                        |       | 11,857             |       | 26,334                 |       |
| SHAREHOLDERS’ EQUITY:                                                                                                                       |       |               |       |                   |       |
| Common stock, no  par value; 10,000,000 shares authorized; shares outstanding:   4,309,605 at March 31, 2007 and 4,316,878 at September 30, 2006 |       | 111,190            |       | 111,305                |       |
| Retained  earnings                                                                                                                               |       | 228,991            |       | 255,813                |       |
| Total  shareholders’ equity                                                                                                                 |       | 340,181            |       | 367,118                |       |
| TOTAL LIABILITIES AND  EQUITY                                                                                                                    |       | $                  | 1,044,429  |                   | $          | 1,091,577 |   |
|                                                                                                                                             |       |               |       |                   |       |

 

*See notes to unaudited condensedconsolidated financial statements.*

3

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**Kimball Hill, Inc. and Subsidiaries**

## **Unaudited CondensedConsolidated Statements of Operations**

| ** **                                                                | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                | ** ** | **March 31,**               | ** ** | **March 31,**             | ** ** |
| **(in thousands)**                                                   | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| HOMEBUILDING:                                                             |       |                             |       |                           |       |   |   |   |   |
| Revenues:                                                                 |       |                             |       |                           |       |   |   |   |   |
| Sales of residential units and land                                       |       | $                                | 190,370    |                           | $          | 231,692 |   | $ | 428,782 |   | $ | 452,720 |   |
| Rental and other income                                                   |       | 340                              |       | 123                            |       | 757 |   | 1,641 |   |
| Total homebuilding revenues                                               |       | 190,710                          |       | 231,815                        |       | 429,539 |   | 454,361 |   |
| Expenses:                                                                 |       |                             |       |                           |       |   |   |   |   |
| Cost of sales of residential units and land                               |       | 187,279                          |       | 182,181                        |       | 430,430 |   | 349,480 |   |
| General and administrative                                                |       | 14,124                           |       | 20,962                         |       | 30,750 |   | 41,456 |   |
| Sales and marketing                                                       |       | 12,800                           |       | 12,661                         |       | 26,634 |   | 22,844 |   |
| Depreciation                                                              |       | 331                              |       | 172                            |       | 585 |   | 350 |   |
| Total homebuilding expenses                                               |       | 214,534                          |       | 215,976                        |       | 488,399 |   | 414,130 |   |
| Equity in income of unconsolidated joint ventures                         |       | 598                              |       | 373                            |       | 1,098 |   | 530 |   |
| Minority interests in net (earnings) losses of  consolidated partnerships |       | (71                              | )          | 557                            |       | (147 | ) | 198 |   |
| Homebuilding (loss) earnings before income taxes                          |       | (23,297                          | )          | 16,769                         |       | (57,909 | ) | 40,959 |   |
|                                                                      |       |                             |       |                           |       |   |   |   |   |
| MORTGAGE  BANKING:                                                        |       |                             |       |                           |       |   |   |   |   |
| Revenues:                                                                 |       |                             |       |                           |       |   |   |   |   |
| Gain on sales of mortgage loans                                           |       | 1,494                            |       | 1,620                          |       | 3,236 |   | 2,989 |   |
| Interest income                                                           |       |                             |       | 4                              |       |   |   | 9 |   |
| Total mortgage banking revenues                                           |       | 1,494                            |       | 1,624                          |       | 3,236 |   | 2,998 |   |
| Expenses:                                                                 |       |                             |       |                           |       |   |   |   |   |
| General and administrative                                                |       | 1,352                            |       | 1,101                          |       | 2,556 |   | 2,228 |   |
| Interest expense                                                          |       |                             |       | 2                              |       |   |   | 6 |   |
| Depreciation                                                              |       | 14                               |       | 21                             |       | 36 |   | 49 |   |
| Total mortgage banking expenses                                           |       | 1,366                            |       | 1,124                          |       | 2,592 |   | 2,283 |   |
| Mortgage banking earnings before income taxes                             |       | 128                              |       | 500                            |       | 644 |   | 715 |   |
| (LOSS) EARNINGS  BEFORE INCOME TAXES                                      |       | (23,169                          | )          | 17,269                         |       | (57,265 | ) | 41,674 |   |
| (BENEFIT)  PROVISION FOR INCOME TAXES                                     |       | (9,927                           | )          | 6,271                          |       | (23,054 | ) | 15,129 |   |
| NET (LOSS)  EARNINGS                                                      |       | $                                | (13,242    | )                              | $          | 10,998 |   | $ | (34,211 | ) | $ | 26,545 |   |
|                                                                      |       |                             |       |                           |       |   |   |   |   |

*See notes to unaudited condensedconsolidated financial statements.*

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**Kimball Hill, Inc. and Subsidiaries**

## **Unaudited CondensedConsolidated Statements of Cash Flows**

| **For the six months ended March 31, 2007 and 2006 (in thousands)** | ** ** | **2007**   | ** ** | **2006**   | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| **Cash  flows from operating activities:**                                                                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net (loss) earnings                                                                                                        |       | $          | (34,211    | )          | $          | 26,545 |   |
| Adjustments to reconcile net (loss) earnings to cash  flows from operating activities:                                     |       |       |       |       |       |
| Depreciation                                                                                                               |       | 621        |       | 399        |       |
| Inventory valuation adjustments                                                                                            |       | 52,376     |       | 3,000      |       |
| Write-off of land option costs                                                                                             |       | 7,440      |       |       |       |
| Amortization of deferred expenses                                                                                          |       | 3,062      |       | 2,834      |       |
| Unrealized loss on derivatives                                                                                             |       | 124        |       |       |       |
| Equity-based compensation                                                                                                  |       | 410        |       | 410        |       |
| Distributions of income from investments in  unconsolidated entities                                                       |       | 469        |       | 290        |       |
| Net earnings from investments in unconsolidated  entities                                                                  |       | (1,098     | )          | (530       | )          |
| Minority interest in consolidated earnings (losses)                                                                        |       | 147        |       | (198       | )          |
| Deferred income taxes                                                                                                      |       | (19,962    | )          | 1,815      |       |
| Changes in operating assets and liabilities:                                                                               |       |       |       |       |       |
| Receivables                                                                                                                |       | 15,821     |       | 2,658      |       |
| Mortgage loans held for sale                                                                                               |       | 3,530      |       | (1,902     | )          |
| Inventory                                                                                                                  |       | 4,029      |       | (138,569   | )          |
| Deferred expenses and other assets                                                                                         |       | (4,951     | )          | (12,421    | )          |
| Accounts payable and accrued expenses                                                                                      |       | (25,859    | )          | (5,905     | )          |
| Deposits and other liabilities                                                                                             |       | 214        |       | (209       | )          |
| Income taxes, net                                                                                                          |       | (10,798    | )          | (9,828     | )          |
| Net cash used in operating activities                                                                                      |       | (8,636     | )          | (131,611   | )          |
|                                                                                                                       |       |       |       |       |       |
| **Cash  flows from investing activities:**                                                                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Purchases of property and equipment                                                                                        |       | (894       | )          | (6,771     | )          |
| Disposals of property and equipment                                                                                        |       |       |       | 858        |       |
| Distributions of contributed capital from  investments in unconsolidated entities                                          |       | 3,241      |       | 235        |       |
| Contributions and advances to investments in  unconsolidated entities                                                      |       | (5,920     | )          | (2,318     | )          |
| Net cash used in investing activities                                                                                      |       | (3,573     | )          | (7,996     | )          |
|                                                                                                                       |       |       |       |       |       |
| **Cash  flows from financing activities:**                                                                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Proceeds from issuance of notes and mortgage loans  payable                                                                |       | 152,341    |       | 1,037,440  |       |
| Repayments of notes and mortgage loans payable                                                                             |       | (122,838   | )          | (896,792   | )          |
| Debt issuance costs                                                                                                        |       | (850       | )          |       |       |
| Net proceeds from issuance of common stock                                                                                 |       | 39         |       | 702        |       |
| Repurchases of common stock                                                                                                |       | (7,812     | )          | (394       | )          |
| Contributions from minority interests                                                                                      |       | 3,000      |       |       |       |
| Distributions to minority interests                                                                                        |       | (18,092    | )          | (1,507     | )          |
| Net cash provided by financing activities                                                                                  |       | 5,788      |       | 139,449    |       |
| **Net  decrease in cash and cash equivalents**                                                                             |       | (6,421     | )          | (158       | )          |
| Cash and cash  equivalents—Beginning of period                                                                        |       | 18,665     |       | 21,460     |       |
| Cash and cash  equivalents—End of period                                                                              |       | $          | 12,244     |       | $          | 21,302 |   |
|                                                                                                                       |       |       |       |       |       |
| **Reconciliation  to cash and cash equivalents reported on the  condensed consolidated balance sheets:**                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Homebuilding                                                                                                               |       | $          | 7,540      |       |       |   |
| Mortgage banking                                                                                                           |       | 4,704      |       |       |       |
| Total                                                                                                                      |       | $          | 12,244     |       |       |   |
|                                                                                                                       |       |       |       |       |       |
| **Supplemental  disclosure of cash flow information:**                                                                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash paid for interest                                                                                                     |       | $          | 23,139     |       | $          | 18,585 |   |
| Cash paid for income taxes                                                                                                 |       | $          | 7,706      |       | $          | 23,142 |   |
| **Supplemental  disclosure of noncash investing and financing activities:**                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Increase (decrease) in liabilities related to  inventory not owned                                                         |       | $          | 8,924      |       | $          | (5,387 | ) |
|                                                                                                                       |       |       |       |       |       |

*See notes to unaudited condensed consolidatedfinancial statements.*

5

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**Kimball Hill, Inc. and Subsidiaries**

## **Notes to UnauditedCondensed Consolidated Financial Statements**

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

The accompanyingunaudited condensed consolidated financial statements include the accounts ofKimball Hill, Inc. and all of its wholly-owned, majority-owned and controlledsubsidiaries (the “Company”), as well as certain variable interest entitiesfrom which the Company is purchasing land or lots under option agreements andpurchase contracts. All significant intercompany accounts, transactions andbalances have been eliminated in consolidation. The unaudited condensedconsolidated financial statements have been prepared in accordance withaccounting principles generally accepted in the United States of America (“GAAP”)for interim financial information and in accordance with the instructions toForm 10-Q and Article 10 of Regulation S-X. Such financial statements do notinclude all of the information and disclosures required by GAAP for completefinancial statements. As a result, these financial statements should be read inconjunction with the audited consolidated financial statements and accompanyingnotes for the fiscal year ended September 30, 2006 in the Company’s AnnualReport on Form 10-K. In the opinion of management, all adjustments (consistingof normal, recurring accruals) necessary for fair presentation have beenincluded in the accompanying financial statements.

Historically, thehomebuilding industry has experienced seasonal fluctuations; therefore, theoperating results for the three month and six month periods ended March 31,2007 are not necessarily indicative of the results that may be expected for thefiscal year ending September 30, 2007.

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

During fiscal 2005, theCompany granted 37,500 deferred stock units, representing a right to receive37,500 shares of the Company’s common stock at a future date. Under the termsof the agreement, one-third of the deferred stock units fully vest on each ofOctober 1, 2005, 2006, and 2007, respectively, with the shares beingissued on the earlier of: a) the fifth anniversary of the date of grant, b) theexecutive’s separation of service, c) the executive’s death or disability, ord) a change in control. Each period, the Company recognizes compensation cost,for the relative service period covered, equal to the market value of theunderlying common shares of the Company on the date of grant. During both thethree months and six months ended March 31, 2007 and 2006, compensation cost of$0.2 million and $0.4 million related to deferred stock units is included inthe Company’s condensed consolidated statements of operations.

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

At the time outstandingshares qualify for this redemption right, the redemption amount is transferredfrom shareholders’ equity to redeemable common stock. Subsequent changes to theredemption amount are transferred from shareholders’ equity to redeemablecommon stock in the case of an increasing redemption amount, or, fromredeemable common stock to shareholders’ equity in the case of a decreasingredemption amount. Certain outstanding options would qualify for thisredemption right after exercise of the options.

6

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Based upon the mostrecent independent valuation of the Company as of March 31, 2007, the fairvalue of redeemable common stock was valued at $76.15 per share.

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

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

**2.  Inventory**

Inventoryconsists of the following:
| ** **                                             | ** ** | **March 31,** | ** ** | **September 30,** | ** ** |
|--------------------------------------------------------|------------|--------------------|------------|------------------------|------------|
| **(in thousands)**                                | ** ** | **2007**           | ** ** | **2006**               | ** ** |
| Residential lots—developed  and under development |       | $                  | 516,042    |                   | $          | 581,701 |   |
| Finished homes  and construction in progress           |       | 253,537            |       | 262,392                |       |
| Deposits on land  purchases                            |       | 9,440              |       | 15,499                 |       |
| Land held for  future development or sale              |       | 54,243             |       | 39,705                 |       |
| Total                                                  |       | $                  | 833,262    |                   | $          | 899,297 |   |
|                                                   |       |               |       |                   |       |

 

***In accordance with Statement of Financial AccountingStandards No. 144,******Accountingfor the Impairment or Disposal of Long-Lived Assets******(“SFAS 144”), the***Company assesses housing projects, land held for development and sale, andproperty and equipment for recoverability whenever events or changes incircumstances indicate that the carrying amount of an asset may not berecoverable. Due to the continued deterioration in market conditions, thenational homebuilding climate and the Company’s expectations regarding therecoverability of certain assets, the Company reviewed all of its inventory forimpairment in connection with the preparation of the accompanying unauditedcondensed consolidated financial statements and recorded inventory impairmentcharges of $12.4 million and $52.4 million during the three and six monthsended March 31, 2007. The Company recorded $3 million of inventory impairmentcharges during both the three and six months ended March 31, 2006 related tothe Company’s decision to exit the Cleveland market. These charges are includedin cost of sales in the accompanying condensed consolidated statements ofoperations.

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

The Company’s currentoperating strategy includes selling certain land inventory to: increase itsliquidity and pay down debt, adjust the balance of its land holdings by regionand reduce its overall investment in land. ***The Company has identified certainland parcels it intends to sell and is actively marketing the properties fordelivery within the next 12 months.******As of March 31, 2007, the Companyhas $54.2 million of land inventory that is held for sale. For purposes ofthese impairment calculations, the Company determined the fair value of eachasset held for sale by using internal project modeling software to determinethe present value of the estimated future cash flows on acommunity-by-community basis using discount rates which are commensurate withthe risk of the community and by comparing to recent comparable land sales andrecent discussions with land brokers and potential buyers. The Company recordedan impairment charge of $6.1 million and $25.4 million on land held for saleduring the three and six months ended March 31, 2007.***

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***For purposes of impairment calculations on assets to be heldand used, the Company determined the fair value of each asset to be held andused by using internal project modeling software to determine the present valueof the estimated future cash flows on a community-by-community basis usingdiscount rates which are commensurate with the risk of the community and bycomparing to recent comparable land sales. The Company recorded an impairmentcharge on housing projects where the Company intends to construct and sellhomes************of $6.3 million and $27.0 millionduring the three and six months ended March 31, 2007.***

***The largest homebuilding project reviewed is in the Midwestregion where the Company is developing land and currently intends to constructand sell approximately 1,100 homes over the next 6 years. In addition, theCompany is obligated to purchase additional land in this project,************for approximately $42 million atvarious dates beginning in June 2009, on which it intends to construct and sellan additional 1,500 homes. Due to the project’s overall size, timeline andcomplexity and the Company’s limited experience to date, its estimates offuture recoverability are sensitive to management’s judgments and expectationsof future market conditions. The Company’s current projection of cash flowsfrom this project was updated based on recent results of this project andcurrent market conditions. The projection shows positive undiscounted cashflows, albeit at levels below prior estimates. Should market conditionscontinue to deteriorate and projected project revenues decline, projectedproject costs could exceed projected revenues. Should this occur, a potentiallymaterial impairment charge may be recognized. The project’s total inventorybalance was approximately $119 million at March 31, 2007, which includes thefuture purchase of land that the Company has consolidated in accordance with FIN46R at its initial fair value of $31.7 million.***

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

Given the continueddeterioration in market conditions and uncertainty about the timing and pace ofany recovery, the Company has tightened its land acquisition criteria and isworking with land sellers to renegotiate land purchase and option contracts toextend purchase dates and reduce purchase prices. If the Company is unable toobtain satisfactory terms, the Company will not exercise its land optionagreements and will abandon its earnest money if contractually obligated to doso. During the three and six months ended March 31, 2007, the Company wrote-off$7.0 million and $7.4 million of costs related to the abandonment of landoption contracts.

TheCompany capitalizes interest during development and construction. Capitalizedinterest is charged to cost of sales as residential units are closed. Interestcosts for the three and six months ended March 31, 2007 and 2006 are asfollows:
| ** **                                     | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                     | ** ** | **March 31,**               | ** ** | **March 31,**             | ** ** |
| **(in thousands)**                        | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Capitalized  interest—beginning of period |       | $                                | 62,465     |                           | $          | 46,213 |   | $ | 59,409 |   | $ | 40,076 |   |
| Interest  incurred                             |       | 11,371                           |       | 10,098                         |       | 23,198 |   | 21,281 |   |
| Interest  included in cost of sales            |       | (7,710                           | )          | (6,097                         | )          | (16,481 | ) | (11,143 | ) |
| Capitalized  interest—end of period       |       | $                                | 66,126     |                           | $          | 50,214 |   | $ | 66,126 |   | $ | 50,214 |   |
|                                           |       |                             |       |                           |       |   |   |   |   |

 

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**3*.* **Inventory Not Owned

In December 2003,the Financial Accounting Standards Board (“FASB”) issued FIN 46R, *Consolidation of Variable Interest Entities*. Under FIN 46R,a variable interest entity (“VIE”) is created when (i) the equityinvestment at risk is not sufficient to permit the entity to finance itsactivities without additional subordinated financial support from other partiesor (ii) equity holders either (a) lack a direct or indirect abilityto make decisions about the entity, (b) are not obligated to absorbexpected losses of the entity or (c) do not have the right to receive expectedresidual 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 all variable interests and has determined that many ofits options on land represent a variable interest in VIEs. The Company hasdetermined it is the primary beneficiary of certain of these option contracts,and although the Company does not have legal title to the optioned land, underFIN 46R, it is required that the Company consolidate the land under option atinitial fair value.

At March 31, 2007, theCompany has consolidated optioned land with an initial fair value of $50million for which it paid cash option deposits of $4.3 million. The Companyestimated the initial fair value of the consolidated optioned land based uponthe Company’s option contract price. In many cases, the Company was unable toobtain the relevant financial information from the selling entities, therefore,the Company has used the information available to make an assumption as towhether the selling entity has additional assets or has debt obligationsoutstanding. The difference between the fair value of the land under contractand the Company’s non-refundable deposit is recorded in liabilities related toinventory not owned unless it is determined by the Company that the sellingentity does not carry debt in which case the difference is recorded as minorityinterest in inventory not owned.

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

Investments in andadvances to unconsolidated entities represent the Company’s ownership interestin entities accounted for under the equity method when it has a significantinfluence over the entity but holds less than a controlling interest in theentity or it is not the primary beneficiary in a VIE as defined by FIN 46R. TheCompany’s business partners generally are unrelated homebuilders, land sellersor other real estate entities.

In the ordinary course ofbusiness, the Company periodically enters into arrangements with landdevelopers or other homebuilders to acquire land and develop lots. Thesearrangements include the creation of joint ventures, in which the Company’scurrent interests range from 6% to 49%. The Company accounts for its interestin these joint ventures under the equity method, and the Company’s condensedconsolidated balance sheets include investments in joint ventures totaling$51.5 million and $48.2 million at March 31, 2007 and September 30, 2006,respectively. These joint ventures typically obtain secured acquisition,development and construction financing. At March 31, 2007 and September 30,2006, the Company’s unconsolidated joint ventures had outstanding third partyborrowings of $958 million and $865 million, respectively. From time to timethe Company has issued repayment guarantees and/or loan-to-value maintenanceguarantees in respect of this indebtedness. These guarantees require theCompany to repay debt of the joint venture in the event of a payment default orin the event that the debt of the joint venture exceeds the value of the propertysecuring the debt. At March 31, 2007 and September 30, 2006, the Company hadguarantees of $97.1 million and $74.3 million, respectively, related to theoutstanding indebtedness of these joint ventures.

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**5.  Financing**

***Homebuilding***

The Company’s notes payable consist of the following:
| ** **                                               | ** ** | **March 31,** | ** ** | **September 30,** | ** ** |
|----------------------------------------------------------|------------|--------------------|------------|------------------------|------------|
| **(in thousands)**                                  | ** ** | **2007**           | ** ** | **2006**               | ** ** |
| Senior  subordinated notes (net of unamortized discount) |       | $                  | 200,881    |                   | $          | 200,750 |   |
| Senior unsecured  credit facility                        |       | 286,759            |       | 244,947                |       |
| Other senior  secured credit facilities                  |       | 42,202             |       | 54,511                 |       |
| Total                                                    |       | $                  | 529,842    |                   | $          | 500,208 |   |
|                                                     |       |               |       |                   |       |

 

In December 2005, theCompany issued $203 million aggregate principal amount of senior subordinatednotes due December 2012 in a private placement pursuant to Rule 144Apromulgated under the Securities Act of 1933. In May 2006, the Companyexchanged all of the senior subordinated notes issued in the private placementfor an issue of notes registered with the SEC with terms substantiallyidentical to the notes issued in the private placement. The senior subordinatednotes were sold at 98.796% of par and accrue interest at a coupon rate of 10.5%per annum. Interest is paid semi-annually in June and December. The netproceeds were used to repay amounts outstanding under working capital loans andcertain senior secured revolving credit facilities. The Company may redeem thenotes, in whole or part, at any time on or after December 15, 2009, at aredemption price equal to 100% of the principal amount, plus a 5.25% premiumdeclining ratably to par on December 15, 2011, plus accrued and unpaidinterest. At any time prior to December 15, 2008, the Company may also redeemup to 35% of the aggregate principal amount of the notes with the proceeds ofqualified equity offerings at a redemption price equal to 110.5% of theprincipal amount, plus accrued and unpaid interest. In addition, if the Companyexperiences specific kinds of changes of control, the Company is required tomake an offer to purchase all of the notes at a purchase price of 101% of theprincipal amount thereof, plus accrued and unpaid interest. The notes areunsecured senior subordinated obligations and subordinated in right of paymentto all of the Company’s existing and future senior debt, including borrowingsunder the Company’s senior unsecured credit facility. All of the Company’swholly owned subsidiaries, other than the Company’s mortgage subsidiary, havefully and unconditionally guaranteed the notes on a joint and several,unsecured senior subordinated, basis. The guarantees are general unsecuredobligations of the guarantors and will be subordinated in right of payment toall existing and future senior debt of the guarantors, which includes theirguarantees of the Company’s senior unsecured credit facility. The indenturegoverning the senior subordinated notes contains a number of significantcovenants that could restrict the Company’s ability and that of its restrictedsubsidiaries to, among other things: incur additional indebtedness, makecertain distributions, investments and other restricted payments, createcertain liens, enter into transactions with affiliates, and merge, consolidateor sell substantially all of the Company’s assets. As of March 31, 2007, theCompany was restricted from incurring additional indebtedness (excluding availableborrowings under the senior unsecured credit facility), except under certainlimited circumstances.

In December 2005, theCompany entered into a new senior unsecured credit facility to finance itsbusiness operations. Proceeds of the new credit facility were used to retireits existing senior secured revolving credit facilities and substantially allof its other senior secured credit facilities. The credit facility has amaximum availability of $500 million, subject to a borrowing base as well as sublimitsof $100 million for the issuance of letters of credit and $10 million for swingline loans. The Company has the right, without the consent of its lenders(other than those participating in the increase), to increase the commitment byan amount of up to $200 million, provided that no such increase shall cause thesenior unsecured 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

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alternate base rate. Theapplicable margin for interest ranges from 1.5% to 2.25%, depending upon theCompany’s senior leverage ratio, which is defined as the ratio of totalliabilities to consolidated net worth. Fees for letters of credit are based onLIBOR plus a margin of 1.5%. An unused commitment fee equal to 0.2% to 0.3% peryear accrues on the undrawn portion of the facility and is payable quarterly inarrears. As of March 31, 2007, the Company had $287 million of borrowings underthe credit facility at an effective rate of 6.93% and, after giving effect tothe borrowing base limitation, had additional availability of $183 million. TheCompany’s obligations under the senior unsecured credit facility are guaranteedby all of its wholly-owned subsidiaries, other than the Company’s mortgagesubsidiary, and are subject to a number of customary financial and operatingcovenants.

In December 2006, the Company amended certaincovenants in its $500 million senior unsecured credit facility. The amendedcovenants require the Company to: maintain a minimum tangible net worth of atleast $300 million plus 50% of positive net income earned subsequent to September30, 2006; maintain a ratio of total liabilities to adjusted tangible net worthnot to exceed 2.0x (decreasing to 1.75x as of June 30, 2007 and increasing to2.5x as of December 31, 2008); maintain a ratio of total debt to adjustedtangible net worth not to exceed 1.5x; maintain a ratio of total land(including undeveloped land, land under development and finished lots on whichhome construction has yet to begin) to adjusted tangible net worth not toexceed 1.5x; and maintain an interest coverage ratio of no less than 1.75xthrough December 31, 2006 (decreasing to 1.5x through March 31, 2007,decreasing to 1.4x through June 30, 2007, decreasing to 1.35x through September30, 2007, increasing to 1.5x through December 31, 2007, increasing to 1.75xthrough March 31, 2008 and then increasing to 2.25x through the remaining termof the facility). 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 March31, 2007, the Company was in compliance with the covenants of this facility.However, given the continued deterioration of the homebuilding market, theCompany does not expect to be able to maintain compliance with the currentcovenants throughout the remainder of its fiscal year. Therefore, the Companywill be exploring alternatives with its lenders, which would permit continuedaccess to financing sufficient to support the Company’s current and futureoperations. The Company’s continued borrowing availability depends on itsability to negotiate revised covenants of this facility with which the Companywill be able to maintain compliance or to arrange a new credit facility withacceptable terms and convenants. Additionally, should debt rating agenciesissue a negative outlook on, or downgrade, the Company’s debt rating, it maybecome more difficult and/or expensive to obtain necessary financing.

As of March 31, 2007, theCompany was not in compliance with an interest coverage covenant provided forin a secured project credit facility with an outstanding balance of $32million. The Company obtained a waiver for this covenant violation and isworking to amend the secured project credit facility.

**6.  Commitments and Contingencies**

In the normal course ofbusiness, the Company acquires rights under option agreements to purchase landfor future development and/or developed lots. The agreements generally arecontingent upon municipality approvals. As of March 31, 2007, the Company hasrights, under such agreements, to purchase approximately 8,500 lots,within 40 separate developments, with an aggregate contract price of$350 million. Approximately 1,600 of the lots contain specific performancerequirements, with an aggregate purchase price of $44 million, of which theCompany is obligated to pay $2 million within the next twelve months and theremaining $42 million at various dates beginning in June 2009. Approximately2,200 of the lots, with an aggregate purchase price of $169 million, are to bepurchased from joint ventures in which the Company has an investment balance of$40 million as of March 31,

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2007. This investment isrecorded in investments in and advances to unconsolidated entities on thecondensed consolidated balance sheets.

At March 31, 2007,excluding inventory not owned (see note 3), the Company was contingently liableto banks and financial institutions for approximately $39 million foroutstanding letters of credit and performance bonds securing performance ofcertain contractual obligations and land option contracts.

Under the terms of theCompany’s amended stock option plans, the Company has contractual obligationsto purchase shares of its common stock, including shares issuable underoutstanding options, from its directors and certain of its executive officersand other key employees in the event of termination of board membership oremployment, as applicable, by reason of specified circumstances, includingdeath, disability, involuntary termination or retirement. As of March 31, 2007,the Company’s aggregate repurchase obligation, net of proceeds to be receivedfrom any stock option exercises, would have been approximately $21.5 million inthe event that all of these obligations were triggered. The Company’s abilityto satisfy its repurchase obligations is subject to certain limitations setforth in the Trust Indenture governing the senior subordinated notes issued bythe Company.

The Company is involvedin litigation incidental to its business, the disposition of which should nothave a material effect on the Company’s financial position or results ofoperations.

The Company providesproduct warranties to its customers covering workmanship, materials, andcertain mechanical systems for two years, and structural systems for ten years.The Company estimates and records warranty liabilities based on historicalexperience and known risks at the time a home closes, and in the case ofunexpected claims, upon identification and quantification of the obligations.The Company’s warranty accrual is included in accounts payable and accruedexpenses in its condensed consolidated balance sheets. Changes in the Company’swarranty liability for the three and six months ended March 31, 2007 and 2006are as follows:
| ** **                         | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                         | ** ** | **March 31,**               | ** ** | **March 31,**             | ** ** |
| **(in thousands)**            | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Balance at  beginning of period    |       | $                                | 5,407      |                           | $          | 6,094 |   | $ | 5,798 |   | $ | 5,844 |   |
| Warranties  issued                 |       | 832                              |       | 1,251                          |       | 1,796 |   | 2,835 |   |
| Settlements and  other adjustments |       | (1,045                           | )          | (1,007                         | )          | (2,400 | ) | (2,341 | ) |
| Balance at end  of period          |       | $                                | 5,194      |                           | $          | 6,338 |   | $ | 5,194 |   | $ | 6,338 |   |
|                               |       |                             |       |                           |       |   |   |   |   |

 

At March 31, 2007, the Companywas committed to fund approximately $25.7 million in mortgage loans tohomebuyers at agreed-upon rates. The Company has entered into best-effortsand mandatory sale commitments to sell these mortgages to third parties.

**7.**   SegmentInformation and Concentrations

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

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The Company’s chiefdecision maker, its chief executive officer, routinely reviews information onthe Company’s operating segments. Management evaluates a segment’s performancebased upon a number of factors including segment earnings before income taxes.

The Company’s corporatedepartments provide certain services that are advantageous to perform in acentralized manner, given certain cost efficiencies or required technicalexpertise. The Company’s corporate functions include: financial analysis, humanresources, information technology, legal, planning, risk management, salestraining, strategic marketing and treasury. Only corporate costs that aredeemed to directly benefit certain operating segments are allocated to thoseoperating segments.

Operations within theCompany’s reportable homebuilding segments have been determined to have similareconomic characteristics, including: similar historical and expected futureoperating performance, employment trends, land availability, acquisition anddevelopment constraints, and municipality behavior and meet the otheraggregation criteria in SFAS 131. The reportable homebuilding segments includeoperations in the following geographical regions:

Florida

Midwest: Illinois, Ohio and Wisconsin

Nevada

Pacific Coast: California, Oregon and Washington

Texas

The Company’s internalmeasurement system has established accountabilities to continually improvebusiness focus and increase its ability to react quickly to changes inparticular markets as well as changes to the overall homebuilding businesscycle. This measurement system, which is not based on GAAP, is intended tomotivate behavior of employees and drive performance. The sales and costinformation used for internal purposes varies from the Company’s consolidated,externally reported information resulting in reconciling items.

The following tablesillustrate the revenue, earnings before income taxes and assets of the Company’sreportable segments. Included are reconciliations to the amounts reported inthe condensed consolidated financial statements.
|                                       | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                            | ** ** | **March 31,**               | ** ** | **March 31,**             | ** ** |
| **Revenues (in thousands)** | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Florida                               |       | $                                | 21,714     |                           | $          | 22,589 |   | $ | 45,655 |   | $ | 44,799 |   |
| Midwest                               |       | 33,206                           |       | 40,371                         |       | 79,328 |   | 82,891 |   |
| Nevada                                |       | 35,412                           |       | 26,801                         |       | 90,442 |   | 60,490 |   |
| Pacific Coast                         |       | 30,002                           |       | 77,487                         |       | 69,271 |   | 143,802 |   |
| Texas                                 |       | 66,127                           |       | 64,532                         |       | 136,043 |   | 121,146 |   |
| Mortgage banking                      |       | 1,494                            |       | 1,624                          |       | 3,236 |   | 2,998 |   |
| Segment revenue  subtotal             |       | 187,955                          |       | 233,404                        |       | 423,975 |   | 456,126 |   |
| Corporate and  unallocated (a)        |       | 56                               |       | 35                             |       | 233 |   | 1,233 |   |
| GAAP adjustment (b)                   |       | 4,193                            |       |                           |       | 8,567 |   |   |   |
| Consolidated  revenues                |       | $                                | 192,204    |                           | $          | 233,439 |   | $ | 432,775 |   | $ | 457,359 |   |
|                                  |       |                             |       |                           |       |   |   |   |   |

 

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

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

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| ** **                                                                           | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                           | ** ** | **March 31,**               | ** ** | **March 31,**             | ** ** |
| **(Loss) Earnings Before Income Taxes (in thousands)** | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Florida                                                                              |       | $                                | (2,117     | )                              | $          | 2,452 |   | $ | (9,502 | ) | $ | 2,559 |   |
| Midwest                                                                              |       | (7,181                           | )          | (3,534                         | )          | (18,711 | ) | (2,717 | ) |
| Nevada                                                                               |       | 6,444                            |       | 6,103                          |       | 26,106 |   | 17,506 |   |
| Pacific Coast                                                                        |       | (10,445                          | )          | 23,042                         |       | (26,706 | ) | 44,971 |   |
| Texas                                                                                |       | 5,264                            |       | 3,292                          |       | 5,023 |   | 5,294 |   |
| Mortgage banking                                                                     |       | 128                              |       | 500                            |       | 644 |   | 715 |   |
| Segment (loss)  earnings before income taxes subtotal                                |       | (7,907                           | )          | 31,855                         |       | (23,146 | ) | 68,328 |   |
| Corporate and unallocated                                                            |       | (5,994                           | )          | (11,732                        | )          | (13,711 | ) | (22,687 | ) |
|                                                                                 |       | (13,901                          | )          | 20,123                         |       | (36,857 | ) | 45,641 |   |
| Homebuilding  interest expense                                                       |       | (7,710                           | )          | (6,097                         | )          | (16,481 | ) | (11,143 | ) |
| GAAP adjustment(c)                                                                   |       | (1,558                           | )          | 3,243                          |       | (3,927 | ) | 7,176 |   |
| Consolidated (loss)  earnings before income taxes                                    |       | $                                | (23,169    | )                              | $          | 17,269 |   | $ | (57,265 | ) | $ | 41,674 |   |
|                                                                                 |       |                             |       |                           |       |   |   |   |   |

 

(c)  Includedin the GAAP adjustment are (i) timing differences for certain capitalizable indirectconstruction costs that are expensed as incurred in the Company’s internalmeasurement system and (ii) minority interestexpense which is not included in the Company’s internal measurement system.
| ** **                          | ** ** | **March 31,** | ** ** | **September 30,** | ** ** |
|-------------------------------------|------------|--------------------|------------|------------------------|------------|
| **Assets (in thousands)** | ** ** | **2007**           | ** ** | **2006**               | ** ** |
| Florida                             |       | $                  | 85,010     |                   | $          | 91,226 |   |
| Midwest                             |       | 244,727            |       | 267,519                |       |
| Nevada                              |       | 216,338            |       | 224,331                |       |
| Pacific Coast                       |       | 158,105            |       | 181,289                |       |
| Texas                               |       | 173,856            |       | 197,604                |       |
| Mortgage banking                    |       | 8,817              |       | 10,859                 |       |
| Segment assets  subtotal            |       | 886,853            |       | 972,828                |       |
| Corporate and  unallocated          |       | 157,576            |       | 118,749                |       |
| Consolidated assets                 |       | $                  | 1,044,429  |                   | $          | 1,091,577 |   |
|                                |       |               |       |                   |       |

 

**8.  Recent AccountingPronouncements**

In July 2006, theFASB issued FASB Interpretation No. 48, *Accountingfor Uncertainty in Income Taxes*(“FIN 48”), which prescribes arecognition threshold and measurement process for recording in the financialstatements uncertain tax positions taken or expected to be taken in a taxreturn. Additionally, FIN 48 provides guidance on the derecognition,classification, accounting in interim periods and disclosure requirements foruncertain tax positions. The accounting provisions of FIN 48 will be effectivefor the Company beginning October 1, 2007. The Company is in the process ofdetermining the effect, if any, the adoption of FIN 48 will have on itsfinancial statements.

In September 2006,the FASB issued SFAS No. 157, *Fair Value Measurements*(“SFAS157”), which defines fair value, establishes a framework for measuring fairvalue in generally accepted accounting principles and expands disclosure aboutfair value measurements. SFAS 157 is effective for financial statements issuedfor fiscal years beginning after November 15, 2007, and interim periods withinthose fiscal years. The Company is in the process of determining the effect, ifany, the adoption of SFAS 157 will have on its financial statements.

In September 2006,the SEC issued Staff Accounting Bulletin No. 108, *Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements*(“SAB 108”), which providesguidance as to how the effects on prior year uncorrected misstatements should beconsidered when quantifying misstatements in the current financial statements.SAB 108 was issued in order to eliminate the diversity of practice

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surrounding how publiccompanies quantify financial statement misstatements. SAB 108 will require theCompany to quantify misstatements using both a balance sheet and incomestatement approach, with adjustment required if either method results in amaterial error. SAB 108 is effective for financial statements issued for fiscalyears beginning after November 15, 2006. The Company is in the process ofdetermining the effect, if any, the adoption of SAB 108 will have on itsfinancial statements.

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

**9. **SummarizedFinancial Information

The Company’s seniorsubordinated notes and senior unsecured credit facility are fully andunconditionally guaranteed, on a joint and several basis, by all of the Company’swholly owned subsidiaries (“Guarantor Subsidiaries”), other than the Company’smortgage subsidiary. The Company’s mortgage subsidiary and majority owned andcontrolled subsidiaries are non-guarantors (“Non-Guarantor Subsidiaries”) ofthe senior subordinated notes and the senior unsecured credit facility. In lieuof providing separate financial statements for the Guarantor Subsidiaries,consolidated condensed financial statements are presented below. Separatefinancial statements and other disclosures concerning the GuarantorSubsidiaries are not presented because management has determined that they arenot material to investors.

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| **As of March 31, 2007**

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

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

**Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------|------------|------------|------------|---------------------------------|------------|-------------------------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                                            | ** ** | ** ** | ** ** | ** **                      | ** ** | ** **                          | ** ** | ** **       | ** ** | ** **       | ** ** |
| HOMEBUILDING:                                                         |       |       |       |                            |       |                                |       |             |       |             |       |
| Cash and cash equivalents                                             |       | $          | 1,853      |                            | $          | 5,658                               |       | $                | 29         |             | $          | — |   | $ | 7,540 |   |
| Receivables                                                           |       |       |       | 19,426                          |       | 659                                 |       |             |       | 20,085           |       |
| Income taxes receivable                                               |       | 7,256      |       |                            |       |                                |       |             |       | 7,256            |       |
| Inventory                                                             |       |       |       | 738,556                         |       | 94,706                              |       |             |       | 833,262          |       |
| Inventory not owned                                                   |       |       |       | 49,999                          |       |                                |       |             |       | 49,999           |       |
| Deferred expenses and other assets                                    |       | 9,042      |       | 11,792                          |       | 77                                  |       |             |       | 20,911           |       |
| Investments in and advances to unconsolidated  entities               |       |       |       | 51,546                          |       |                                |       |             |       | 51,546           |       |
| Deferred income taxes                                                 |       | 34,095     |       |                            |       |                                |       |             |       | 34,095           |       |
| Property and equipment, net of accumulated  depreciation              |       | 8,419      |       | 2,499                           |       |                                |       |             |       | 10,918           |       |
| Investments in subsidiaries                                           |       | 272,895    |       | 16,775                          |       |                                |       | (289,670         | )          |             |       |
|                                                                  |       | 333,560    |       | 896,251                         |       | 95,471                              |       | (289,670         | )          | 1,035,612        |       |
| MORTGAGE BANKING                                                      |       |       |       |                            |       | 8,817                               |       |             |       | 8,817            |       |
| TOTAL ASSETS                                                          |       | $          | 333,560    |                            | $          | 896,251                             |       | $                | 104,288    |             | $          | (289,670 | ) | $ | 1,044,429 |   |
| **Liabilities  and equity**                                           | ** ** | ** ** | ** ** | ** **                      | ** ** | ** **                          | ** ** | ** **       | ** ** | ** **       | ** ** |
| HOMEBUILDING:                                                         |       |       |       |                            |       |                                |       |             |       |             |       |
| Accounts payable and accrued expenses                                 |       | $          | 140        |                            | $          | 81,054                              |       | $                | 125        |             | $          | — |   | $ | 81,319 |   |
| Deposits on sales of residential units                                |       |       |       | 6,524                           |       | 111                                 |       |             |       | 6,635            |       |
| Liabilities related to inventory not owned                            |       |       |       | 13,939                          |       |                                |       |             |       | 13,939           |       |
| Notes payable                                                         |       | 497,825    |       |                            |       | 32,017                              |       |             |       | 529,842          |       |
| Intercompany                                                          |       | (516,443   | )          | 493,855                         |       | 22,588                              |       |             |       |             |       |
|                                                                  |       | (18,478    | )          | 595,372                         |       | 54,841                              |       |             |       | 631,735          |       |
| MORTGAGE BANKING                                                      |       |       |       |                            |       | 636                                 |       |             |       | 636              |       |
| Total liabilities                                                     |       | (18,478    | )          | 595,372                         |       | 55,477                              |       |             |       | 632,371          |       |
|                                                                  |       |       |       |                            |       |                                |       |             |       |             |       |
| MINORITY  INTEREST IN CONSOLIDATED PARTNERSHIPS                       |       |       |       |                            |       | 28,882                              |       | (583             | )          | 28,299           |       |
| MINORITY  INTEREST IN INVENTORY NOT OWNED                             |       |       |       | 31,721                          |       |                                |       |             |       | 31,721           |       |
| REDEEMABLE  EQUITY                                                    |       | 11,857     |       |                            |       |                                |       |             |       | 11,857           |       |
| SHAREHOLDERS’  EQUITY                                            |       | 340,181    |       | 269,158                         |       | 19,929                              |       | (289,087         | )          | 340,181          |       |
| TOTAL LIABILITIES AND  EQUITY                                         |       | $          | 333,560    |                            | $          | 896,251                             |       | $                | 104,288    |             | $          | (289,670 | ) | $ | 1,044,429 |   |
|                                                                  |       |       |       |                            |       |                                |       |             |       |             |       |

 

16

----

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

 

17

----

 
| **For the three months ended**

**March 31, 2007 (in thousands)** | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| ** **                                                                                                | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** | ** **       | ** ** |
| HOMEBUILDING:                                                                                             |       |       |       |                        |       |                            |       |             |       |             |       |
| Revenues:                                                                                                 |       |       |       |                        |       |                            |       |             |       |             |       |
| Sales of residential units and land                                                                       |       | $          | —     |                        | $          | 183,586                         |       | $                | 101,978    |             | $          | (95,194 | ) | $ | 190,370 |   |
| Rental and other income                                                                                   |       | 101        |       | 239                         |       |                            |       |             |       | 340              |       |
| Total homebuilding revenues                                                                               |       | 101        |       | 183,825                     |       | 101,978                         |       | (95,194          | )          | 190,710          |       |
| Expenses:                                                                                                 |       |       |       |                        |       |                            |       |             |       |             |       |
| Cost of sales of residential units and land                                                               |       |       |       | 180,630                     |       | 83,180                          |       | (76,531          | )          | 187,279          |       |
| General and administrative                                                                                |       | 4,673      |       | 9,416                       |       | 35                              |       |             |       | 14,124           |       |
| Sales and marketing                                                                                       |       |       |       | 12,291                      |       | 509                             |       |             |       | 12,800           |       |
| Depreciation                                                                                              |       | 119        |       | 212                         |       |                            |       |             |       | 331              |       |
| Total homebuilding expenses                                                                               |       | 4,792      |       | 202,549                     |       | 83,724                          |       | (76,531          | )          | 214,534          |       |
| Intercompany charge                                                                                       |       | 4,691      |       | (4,691                      | )          |                            |       |             |       |             |       |
| Equity in income of unconsolidated joint ventures                                                         |       |       |       | 598                         |       |                            |       |             |       | 598              |       |
| Minority interests in net earnings of consolidated  partnerships                                          |       |       |       |                        |       | (8,985                          | )          | 8,914            |       | (71              | )          |
| Homebuilding (loss) earnings before income taxes                                                          |       | —     |       | (22,817                     | )          | 9,269                           |       | (9,749           | )          | (23,297          | )          |
| MORTGAGE  BANKING:                                                                                        |       |       |       |                        |       |                            |       |             |       |             |       |
| Revenues:                                                                                                 |       |       |       |                        |       |                            |       |             |       |             |       |
| Gain on sales of mortgage loans                                                                           |       |       |       |                        |       | 1,494                           |       |             |       | 1,494            |       |
| Total mortgage banking revenues                                                                           |       |       |       |                        |       | 1,494                           |       |             |       | 1,494            |       |
| Expenses:                                                                                                 |       |       |       |                        |       |                            |       |             |       |             |       |
| General and administrative                                                                                |       |       |       |                        |       | 1,352                           |       |             |       | 1,352            |       |
| Depreciation                                                                                              |       |       |       |                        |       | 14                              |       |             |       | 14               |       |
| Total mortgage banking expenses                                                                           |       |       |       |                        |       | 1,366                           |       |             |       | 1,366            |       |
| Mortgage banking earnings before income taxes                                                             |       |       |       |                        |       | 128                             |       |             |       | 128              |       |
| EQUITY IN LOSS  OF CONSOLIDATED SUBSIDIARIES                                                              |       | (23,169    | )          | (480                        | )          |                            |       | 23,649           |       |             |       |
| (LOSS) EARNINGS  BEFORE INCOME TAXES                                                                      |       | (23,169    | )          | (23,297                     | )          | 9,397                           |       | 13,900           |       | (23,169          | )          |
| (BENEFIT)  PROVISION FOR INCOME TAXES                                                                     |       | (9,927     | )          | (9,988                      | )          | 3,721                           |       | 6,267            |       | (9,927           | )          |
| NET (LOSS)  EARNINGS                                                                                      |       | $          | (13,242    | )                           | $          | (13,309                         | )          | $                | 5,676      |             | $          | 7,633 |   | $ | (13,242 | ) |
|                                                                                                      |       |       |       |                        |       |                            |       |             |       |             |       |

 

18

----

 
| **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 (LOSS)  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 |   |
|                                                                                                  |       |       |       |                        |       |                            |       |             |       |             |       |

 

19

----

 
| **For the six months ended  March 31, 2007 (in thousands)** | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| HOMEBUILDING:                                                                                       |       |       |       |                        |       |                            |       |             |       |             |       |
| Revenues:                                                                                           |       |       |       |                        |       |                            |       |             |       |             |       |
| Sales of residential units and land                                                                 |       |       |       | $                           | 415,079    |                            | $          | 108,897          |       | $                | (95,194    | ) | $ | 428,782 |   |
| Rental and other income                                                                             |       | 137        |       | 619                         |       | 1                               |       |             |       | 757              |       |
| Total homebuilding revenues                                                                         |       | 137        |       | 415,698                     |       | 108,898                         |       | (95,194          | )          | 429,539          |       |
| Expenses:                                                                                           |       |       |       |                        |       |                            |       |             |       |             |       |
| Cost of sales of residential units and land                                                         |       |       |       | 413,443                     |       | 93,518                          |       | (76,531          | )          | 430,430          |       |
| General and administrative                                                                          |       | 10,676     |       | 20,006                      |       | 68                              |       |             |       | 30,750           |       |
| Sales and marketing                                                                                 |       |       |       | 25,642                      |       | 992                             |       |             |       | 26,634           |       |
| Depreciation                                                                                        |       | 181        |       | 404                         |       |                            |       |             |       | 585              |       |
| Total homebuilding expenses                                                                         |       | 10,857     |       | 459,495                     |       | 94,578                          |       | (76,531          | )          | 488,399          |       |
| Intercompany charge                                                                                 |       | 10,720     |       | (10,720                     | )          |                            |       |             |       |             |       |
| Equity in income of unconsolidated joint ventures                                                   |       |       |       | 1,098                       |       |                            |       |             |       | 1,098            |       |
| Minority interests in net earnings of consolidated  partnerships                                    |       |       |       |                        |       | (9,061                          | )          | 8,914            |       | (147             | )          |
| Homebuilding loss before income taxes                                                               |       | —     |       | (53,419                     | )          | 5,259                           |       | (9,749           | )          | (57,909          | )          |
| MORTGAGE  BANKING:                                                                                  |       |       |       |                        |       |                            |       |             |       |             |       |
| Revenues:                                                                                           |       |       |       |                        |       |                            |       |             |       |             |       |
| Gain on sales of mortgage loans                                                                     |       |       |       |                        |       | 3,236                           |       |             |       | 3,236            |       |
| Total mortgage banking revenues                                                                     |       |       |       |                        |       | 3,236                           |       |             |       | 3,236            |       |
| Expenses:                                                                                           |       |       |       |                        |       |                            |       |             |       |             |       |
| General and administrative                                                                          |       |       |       |                        |       | 2,556                           |       |             |       | 2,556            |       |
| Depreciation                                                                                        |       |       |       |                        |       | 36                              |       |             |       | 36               |       |
| Total mortgage banking expenses                                                                     |       |       |       |                        |       | 2,592                           |       |             |       | 2,592            |       |
| Mortgage banking earnings before income taxes                                                       |       |       |       |                        |       | 644                             |       |             |       | 644              |       |
| EQUITY IN LOSS  OF CONSOLIDATED SUBSIDIARIES                                                        |       | (57,265    | )          | (4,490                      | )          |                            |       | 61,755           |       |             |       |
| (LOSS) EARNINGS  BEFORE INCOME TAXES                                                                |       | (57,265    | )          | (57,909                     | )          | 5,903                           |       | 52,006           |       | (57,265          | )          |
| (BENEFIT)  PROVISION FOR INCOME TAXES                                                               |       | (23,054    | )          | (23,314                     | )          | 2,376                           |       | 20,938           |       | (23,054          | )          |
| NET (LOSS)  EARNINGS                                                                                |       | $          | (34,211    | )                           | $          | (34,595                         | )          | $                | 3,527      |             | $          | 31,068 |   | $ | (34,211 | ) |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |
|                                                                                                     |            |            |            |                             |            |                                 |            |                  |            |                  |            |  |  |  |  |  |

 

20

----

 
| **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 |   |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |

 

21

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| **For the six months ended  March 31, 2007 (in thousands)** | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| **Cash  flows from operating activities:**                                                          | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** | ** **       | ** ** |
| Net (loss) earnings                                                                                 |       | $          | (34,211    | )                           | $          | (34,595                         | )          | $                | 3,527      |             | $          | 31,068 |   | $ | (34,211 | ) |
| Adjustments to  reconcile net (loss) earnings to net cash flows from operating activities           |       | 7,721      |       | (27,015                     | )          | 97,679                          |       | (52,810          | )          | 25,575           |       |
| Net cash (used in) provided by operating activities                                                 |       | (26,490    | )          | (61,610                     | )          | 101,206                         |       | (21,742          | )          | (8,636           | )          |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |
| **Cash  flows from investing activities:**                                                          | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** | ** **       | ** ** |
| Purchases of  property and equipment                                                                |       | (309       | )          | (558                        | )          | (27                             | )          |             |       | (894             | )          |
| Distributions of  contributed capital from investments in unconsolidated entities                   |       |       |       | 3,241                       |       |                            |       |             |       | 3,241            |       |
| Contributions  and advances to investments in unconsolidated entities                               |       |       |       | (5,920                      | )          |                            |       |             |       | (5,920           | )          |
| Contributions to  investments in subsidiaries                                                       |       |       |       | (4,213                      | )          |                            |       | 4,213            |       |             |       |
| Net cash used in investing activities                                                               |       | (309       | )          | (7,450                      | )          | (27                             | )          | 4,213            |       | (3,573           | )          |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |
| **Cash  flows from financing activities:**                                                          | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** | ** **       | ** ** |
| Proceeds from  issuance of notes and mortgage loans payable                                         |       | 143,674    |       |                        |       | 8,667                           |       |             |       | 152,341          |       |
| Repayments of  notes and mortgage loans payable                                                     |       | (100,645   | )          | (9,801                      | )          | (12,392                         | )          |             |       | (122,838         | )          |
| Debt issuance  costs                                                                                |       | (850       | )          |                        |       |                            |       |             |       | (850             | )          |
| Net proceeds  from issuance of common stock                                                         |       | 39         |       |                        |       |                            |       |             |       | 39               |       |
| Repurchases of  common stock                                                                        |       | (7,812     | )          |                        |       |                            |       |             |       | (7,812           | )          |
| Contributions  from minority interests                                                              |       |       |       |                        |       | 3,000                           |       |             |       | 3,000            |       |
| Distributions to  minority interests                                                                |       |       |       |                        |       | (27,006                         | )          | 8,914            |       | (18,092          | )          |
| Contributions  from parent and guarantors                                                           |       |       |       |                        |       | 4,213                           |       | (4,213           | )          |             |       |
| Distributions to  parent and guarantors                                                             |       |       |       |                        |       | (12,828                         | )          | 12,828           |       |             |       |
| Intercompany                                                                                        |       | (7,272     | )          | 70,008                      |       | (62,736                         | )          |             |       |             |       |
| Net cash provided by (used in) financing activities                                                 |       | 27,134     |       | 60,207                      |       | (99,082                         | )          | 17,529           |       | 5,788            |       |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |
| **Net  increase (decrease) in cash and cash equivalents**                                           |       | 335        |       | (8,853                      | )          | 2,097                           |       |             |       | (6,421           | )          |
| Cash and cash  equivalents—Beginning of period                                                 |       | 1,518      |       | 14,511                      |       | 2,636                           |       |             |       | 18,665           |       |
| Cash and cash  equivalents—End of period                                                       |       | $          | 1,853      |                        | $          | 5,658                           |       | $                | 4,733      |             |       |   | $ | 12,244 |   |
| ** **                                                                                          | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** | ** **       | ** ** |
| **Reconciliation  to cash and cash equivalents reported on the consolidated balance sheets:**       | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** | ** **       | ** ** |
| Homebuilding                                                                                        |       | $          | 1,853      |                        | $          | 5,658                           |       | $                | 29         |             |       |   | $ | 7,540 |   |
| Mortgage banking                                                                                    |       |       |       |                        |       | 4,704                           |       |             |       | 4,704            |       |
| Total                                                                                               |       | $          | 1,853      |                        | $          | 5,658                           |       | $                | 4,733      |             |       |   | $ | 12,244 |   |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |
|                                                                                                     |            |            |            |                             |            |                                 |            |                  |            |                  |            |  |  |  |  |  |

 

22

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| **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 from 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 and  advances to investments in unconsolidated entities                               |       |       |       | (2,318                      | )          |                            |       |             |       | (2,318           | )          |
| Contributions to  investments in subsidiaries                                                       |       |       |       | (3,170                      | )          |                            |       | 3,170            |       |             |       |
| Net cash (used  in) 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         | )          |
| Net 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 |   |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |
|                                                                                                     |            |            |            |                             |            |                                 |            |                  |            |                  |            |  |  |  |  |  |

 

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**10.  Related Party Transactions**

In January 2007, theCompany sold its ownership interest in a San Jose, California high-riseresidential real estate project to an entity controlled by the Company’sChairman and Chief Executive Officer for $2.9 million, which was equal to theCompany’s total financial investment in the project. This transaction wasapproved by the Company’s board of directors.

In two separatetransactions during March 2007, the Company purchased developed lots from twoconsolidated joint ventures at fair market value in accordance with theunderlying joint venture agreements. After closing the transaction, theconsolidated joint ventures distributed $25.8 million in accordance with thejoint venture agreements to an entity that indirectly owns approximately 21% ofthe Company’s issued and outstanding common stock as of March 31, 2007.

**11.  Subsequent Events**

In May 2007, the Companydecided to exit the Portland, Oregon and Vancouver, Washington markets. As ofMarch 31, 2007, the Company had $27.4 million of assets deployed in thesemarkets. A decision to continue in these markets would have required near terminvestments to provide lots for the future to sustain operations. The Companydecided to redeploy its capital and narrow its management focus to its otherexisting markets. The Company believes that its exit from the Portland andVancouver markets will not have a material adverse impact on its financialcondition or results of operations.

In May 2007, the Companydecided to exit the Milwaukee, Wisconsin market. As of March 31, 2007, theCompany had $9.7 million of assets deployed in this market. The Company’sdecision to exit the Milwaukee market reflects its perception regarding localmarket conditions currently and in the foreseeable future. The Company believesthat its exit from the Milwaukee market will not have a material adverse impacton its financial condition or results of operations.

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

*Thefollowing discussion provides an assessment of our results of operations,liquidity and capital resources and should be read in conjunction with thecondensed consolidated financial statements and notes thereto includedelsewhere in this report.*

**Overview**

We are one of the largestprivately-owned homebuilders and one of the 30 largest homebuilders in theUnited States, as measured by home deliveries and revenues. We design, buildand market single-family detached, single-family attached and multi-family homes.Since we were founded in 1969, we have delivered over 44,000 homes to a broadrange of customers, including first-time buyers and first- and second-timemove-up buyers. Throughout this period, we have grown our business organicallyand operate within 17 markets across nine states located in five geographicregions: 
| **Florida** | ** ** | **Midwest**      | ** ** | **Nevada** | ** ** | **Pacific Coast** | ** ** | **Texas**   |
|-------------|------------|------------------|------------|------------|------------|-------------------|------------|-------------|
| Ft. Myers   |       | Chicago, IL      |       | Las Vegas  |       | Portland, OR(b)   |       | Austin      |
| Naples      |       | Cleveland, OH(a) |       |       |       | Sacramento, CA    |       | Dallas      |
| Sarasota    |       | Milwaukee, WI(b) |       |       |       | Stockton, CA      |       | Ft. Worth   |
| Tampa       |       |             |       |       |       | Vancouver, WA(b)  |       | Houston     |
|        |       |             |       |       |       |              |       | San Antonio |

 

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

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

Our revenues areprimarily generated from designing, building, marketing and delivering for salesingle-family detached, single-family attached and multi-family homes. We alsosell land and lots to third parties as a means of managing inventory andobtaining the desired asset mix for our homebuilding operations. We alsoconduct mortgage origination and title services for the benefit of ourhomebuilding operations, although revenues generated by these ancillaryservices have historically comprised less than 1% of our total revenues, andare not expected to be significant in the future.

**Recent Trends**

Market conditions for newhome sales continued to deteriorate during our second fiscal quarter. Thebeginning of the spring selling season did not show the improvement in marketconditions that many anticipated and the overall for-sale residential realestate market has begun to experience the negative effects caused by pastlending practices. Further, the for-sale residential real estate market may benegatively impacted as we expect financial institutions will tighten theirfuture underwriting standards, making it more difficult for potentialhomebuyers to obtain the financing necessary to purchase a home. We do not seeconditions in the homebuilding market improving significantly in the near term,which will significantly reduce our quarterly and full-year revenues andearnings when compared to 2006 results. 

The following describesome of the factors present in the marketplace during our second fiscal quarterof 2007:

·       decreased levels of customer traffic andbuyer sentiment;

·       increased cancellation rates resulting indecreased net sales;

·       increased frequency and level of customerincentive packages;

25

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·       increased use and compensation of realestate brokers; and

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

Given these significantmarket changes and uncertainty about the timing and pace of recovery, we haveadopted a strategy to manage our business through this current downturn. Ourstrategy focuses on:

·       using free cash flow to reduce our debtand interest costs, and to maximize our liquidity;

·       tailoring our product offerings and optionpackages to address affordability constraints;

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

·       renegotiating with vendors andsubcontractors to manage our construction costs;

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

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

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

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

**Recent Events**

In May 2007, we decidedto exit the Portland, Oregon and Vancouver, Washington markets. As of March 31,2007, we had $27.4 million of assets deployed in these markets. A decision tocontinue in these markets would have required near term investments to providelots for the future to sustain our operations. We decided to redeploy ourcapital and narrow our management focus to our other existing markets. Webelieve that our exit from the Portland and Vancouver markets will not have amaterial adverse impact on our financial condition or results of operations.

In May 2007, we decidedto exit the Milwaukee, Wisconsin market. As of March 31, 2007, we had $9.7million of assets deployed in this market. Our decision to exit the Milwaukeemarket reflects our perception regarding local market conditions currently andin the foreseeable future. We believe that our exit from the Milwaukee marketwill not have a material adverse impact on our financial condition or resultsof operations.

In January 2007, we soldour 35% ownership interest in a joint venture to develop a high-rise mixed-usetower in San Jose, California to an entity controlled by our Chairman and ChiefExecutive Officer for $2.9 million, which was equal to our total financialinvestment in the project. This transaction was approved by our board ofdirectors.

As part of our currentoperating strategy, we are selling certain land inventory to: increase ourliquidity and reduce our debt, adjust the balance of our land holdings byregion and reduce our overall investment in land. We have

26

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identified certain landparcels that we intend to sell and are actively marketing the properties fordelivery within the next 12 months. We believe that these properties are notcritical to our homebuilding operations. As of March 31, 2007, we have $54.2million of land inventory that is held for sale.

Due to the continueddeterioration in market conditions, the national homebuilding climate and ourexpectations regarding the recoverability of certain assets, we reviewed all ofour inventory for impairment and recorded inventory impairment charges of $12.4million and $52.4 million during the three and six months ended March 31,2007. Additionally, during the three and six months ended March 31, 2007, theCompany wrote-off $7.0 million and $7.4 million of costs related to the abandonmentof land option contracts. These charges are included in cost of sales in theaccompanying condensed consolidated statements of operations.

**Financing Overview**

In December 2006, weamended our $500 million senior unsecured credit facility. Many of our debt covenantswere modified under the amendment, including the most restrictive covenantrequiring us to maintain an interest coverage ratio of no less than 2.25x,which was modified to require an interest coverage ratio of no less than 1.75xthrough December 31, 2006, decreasing to 1.5x through March 31, 2007,decreasing to 1.4x through June 30, 2007, decreasing to 1.35x through September30, 2007, increasing to 1.5x through December 31, 2007, increasing to 1.75xthrough March 31, 2008 and then increasing to 2.25x through the remaining termof the facility.

As of and during the three and six months ended March31, 2007, we were in compliance with the covenants of this facility. However,given the continued deterioration of the homebuilding market, we do not expectto be able to maintain compliance with the current covenants throughout theremainder of our fiscal year. Therefore, we will be exploring alternatives withour lenders, which would permit continued access to financing sufficient tosupport our current and future operations. Our continued borrowing availabilitydepends on our ability to negotiate revised covenants of this facility withwhich we will be able to maintain compliance or to arrange a new credit facilitywith acceptable terms and covenants. Additionally, should debt rating agenciesissue a negative outlook on, or downgrade, our debt rating, it may become moredifficult and/or expensive to obtain necessary financing.

As of March 31, 2007, wewere not in compliance with an interest coverage covenant provided for in a securedproject credit facility with an outstanding balance of $32 million. We obtaineda waiver for this covenant violation and are working to amend the securedproject credit facility.

In November 2006, weentered into a two year interest rate cap agreement to protect $100 million ofour borrowings from sharp increases in the prevailing short-term interestrates. Under the terms of the agreement, the LIBOR rate is capped at 5.5% perannum.

In two separate transactionsduring March 2007, we purchased developed lots from two consolidated jointventures at fair market value in accordance with the underlying joint ventureagreements. After closing the transaction, the consolidated joint venturesdistributed $25.8 million in accordance with the joint venture agreements to anentity that indirectly owns approximately 21% of our issued and outstandingcommon stock as of March 31, 2007.

27

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**Results of Operations and Other Data**

Thefollowing table presents selected statements of operations and other data forthe three and six month periods ended March 31, 2007 and 2006:
| ** **                                                                     | ** ** | **Three months ended** | ** ** | **2007**   | ** ** | **Six months ended** | ** ** | **2007**   | ** ** |
|--------------------------------------------------------------------------------|------------|----------------------------------|------------|------------|------------|--------------------------------|------------|------------|------------|
| ** **                                                                     | ** ** | **March 31,**               | ** ** | **vs.**    | ** ** | **March 31,**             | ** ** | **vs.**    | ** ** |
| **(Dollars in thousands)**                                           | ** ** | **2007**                         | ** ** | **2006**   | ** ** | **2006**                       | ** ** | **2007**   | ** ** | **2006** | ** ** | **2006** | ** ** |
| **Statement  of operations data:**                                             | ** ** | ** **                       | ** ** | ** ** | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total  homebuilding revenues                                                   |       | $                                | 190,710    |       | $          | 231,815                        |       | (17.7      | )%         | $ | 429,539 |   | $ | 454,361 |   | (5.5 | )% |
| Cost of sales of  residential units and land(1)                                |       | 187,279                          |       | 182,181    |       | 2.8                            | %          | 430,430    |       | 349,480 |   | 23.2 | % |
| Gross  homebuilding profit (loss)                                              |       | 3,431                            |       | 49,634     |       | (93.1                          | )%         | (891       | )          | 104,881 |   | (100.8 | )% |
| Homebuilding  operating expenses                                               |       | 27,255                           |       | 33,795     |       | (19.4                          | )%         | 57,969     |       | 64,650 |   | (10.3 | )% |
| Equity in income  of unconsolidated entities                                   |       | 598                              |       | 373        |       | 60.3                           | %          | 1,098      |       | 530 |   | 107.2 | % |
| Minority  interests in net (earnings) losses of consolidated partnerships |       | (71                              | )          | 557        |       | (112.7                         | )%         | (147       | )          | 198 |   | (174.2 | )% |
| Homebuilding  (loss) earnings before income taxes                              |       | (23,297                          | )          | 16,769     |       | (238.9                         | )%         | (57,909    | )          | 40,959 |   | (241.4 | )% |
| Mortgage banking  earnings before income taxes                                 |       | 128                              |       | 500        |       | (74.4                          | )%         | 644        |       | 715 |   | (9.9 | )% |
| (Loss) earnings  before income taxes                                           |       | (23,169                          | )          | 17,269     |       | (234.2                         | )%         | (57,265    | )          | 41,674 |   | (237.4 | )% |
| (Benefit)  provision for income taxes                                          |       | (9,927                           | )          | 6,271      |       | (258.3                         | )%         | (23,054    | )          | 15,129 |   | (252.4 | )% |
| Net (loss)  earnings                                                           |       | $                                | (13,242    | )          | $          | 10,998                         |       | (220.4     | )%         | $ | (34,211 | ) | $ | 26,545 |   | (228.9 | )% |
| ** **                                                                     | ** ** | ** **                       | ** ** | ** ** | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Other  financial data:**                                                     | ** ** | ** **                       | ** ** | ** ** | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest  incurred(2)                                                          |       | $                                | 11,371     |       | $          | 10,100                         |       | 12.6       | %          | $ | 23,198 |   | $ | 21,287 |   | 9.0 | % |
| Depreciation                                                                   |       | 345                              |       | 193        |       | 78.8                           | %          | 621        |       | 399 |   | 55.6 | % |
| EBITDA(3)                                                                      |       | (15,114                          | )          | 23,561     |       | (164.1                         | )%         | (40,163    | )          | 53,222 |   | (175.5 | )% |
| Gross  homebuilding profit margin(4)                                           |       | 1.8                              | %          | 21.4       | %          | —                         |       | (0.2       | )%         | 23.1 | % | — |   |
| ** **                                                                     | ** ** | ** **                       | ** ** | ** ** | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Other  data:**                                                               | ** ** | ** **                       | ** ** | ** ** | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net new home  orders (units)(5)                                                |       | 970                              |       | 1,146      |       | (15.4                          | )%         | 1,692      |       | 1,784 |   | (5.2 | )% |
| Homes delivered  (units)                                                       |       | 699                              |       | 807        |       | (13.4                          | )%         | 1,498      |       | 1,570 |   | (4.6 | )% |
| Average sales  price of homes delivered                                        |       | $                                | 261        |       | $          | 281                            |       | (7.1       | )%         | $ | 266 |   | $ | 282 |   | (5.7 | )% |
| Backlog at end  of period (units)(6)                                           |       | 952                              |       | 1,684      |       | (43.5                          | )%         | 952        |       | 1,684 |   | (43.5 | )% |
| Backlog at end  of period (contract value)(6)                             |       | $                                | 255,497    |       | $          | 468,033                        |       | (45.4      | )%         | $ | 255,497 |   | $ | 468,033 |   | (45.4 | )% |
|                                                                           |       |                             |       |       |       |                           |       |       |       |   |   |   |   |

 

(1)      Inventory impairment and land option abandonmentcharges of $19.4 million and $59.8 are included in cost of sales of residentialunits and land for the three and six months ended March 31, 2007. There were$3.0 million of impairment and land option abandonment charges recorded duringthe three and six months ended March 31, 2006.

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

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

·                   EBITDA does not reflect our cashexpenditures, future requirements for capital expenditures or contractualcommitments;

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·                   EBITDA does not reflect changes in, orcash requirements 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 significant expense or cashrequirements for federal and state income tax obligations;

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

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

Because of theselimitations, EBITDA should not be considered as a measure of discretionary cashavailable to us to invest in the growth of our business or to service ourindebtedness. We compensate for these limitations by relying primarily on ourGAAP results and using EBITDA only supplementally. See the condensedconsolidated statements of operations and cash flows presented in our condensedconsolidated financial statements included elsewhere in this report. Thefollowing is a reconciliation of EBITDA to net earnings, the most directlycomparable GAAP measure:
| ** **                                       | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                       | ** ** | **March 31,**               | ** ** | **March 31,**             | ** ** |
| **(Dollars in thousands)**             | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net (loss)  earnings                             |       | $                                | (13,242    | )                              | $          | 10,998 |   | $ | (34,211 | ) | $ | 26,545 |   |
| (Benefit)  provision for income taxes            |       | (9,927                           | )          | 6,271                          |       | (23,054 | ) | 15,129 |   |
| Interest expense  in cost of sales               |       | 7,710                            |       | 6,097                          |       | 16,481 |   | 11,143 |   |
| Interest expense  in mortgage banking operations |       |                             |       | 2                              |       |   |   | 6 |   |
| Depreciation and  amortization                   |       | 345                              |       | 193                            |       | 621 |   | 399 |   |
| EBITDA                                           |       | $                                | (15,114    | )                              | $          | 23,561 |   | $ | (40,163 | ) | $ | 53,222 |   |
|                                             |       |                             |       |                           |       |   |   |   |   |

 

(4)             Represents gross homebuilding profitdivided by total homebuilding revenues.

(5)             Net new home orders represents the numberof new sales contracts executed with customers, net of sales contractcancellations.

(6)             Backlog represents homes under salescontracts but not yet delivered at the end of the period.

***Homebuilding revenues.******  ***Homebuilding revenues decreased 17.7% to $190.7million for the three month period ended March 31, 2007 from $231.8 million forthe three month period ended March 31, 2006. New home deliveries decreased by13.4% and the average sales price of homes delivered decreased by 7.1%. Thedecreases in new home deliveries and average sales prices were partially offsetby increased land sales of $7.7 million for the three months ended March 31,2007 as compared to $4.7 million for the three months ended March 31, 2006.

Homebuildingrevenues decreased 5.5% to $429.5 million for the six month period ended March31, 2007 from $454.4 million for the six month period ended March 31, 2006. Newhome deliveries decreased by 4.6% and the average sales price of homesdelivered decreased by 5.7%. The decreases in new home deliveries and averagesales prices were partially offset by increased land sales of $30.4 million forthe six months ended March 31, 2007 as compared to $10.5 million for the sixmonths ended March 31, 2006.

***Home sales and backlog.******  ***Net new home orders for the three month period endedMarch 31, 2007 were 970, a 15.4% decrease from 1,146 net new home orders forthe thee month period ended March 31, 2006. Net new home orders for the sixmonth period ended March 31, 2007 were 1,692, a 5.2% decrease from 1,784 netnew home orders for the six month period ended March 31, 2006.

AtMarch 31, 2007, the contract value of our backlog was $255.5 million, ascompared to $468.0 million at March 31, 2006. At March 31, 2007, the averagesales price per home in backlog was $268,000 down $10,000, or 3.4%, from theaverage sales price per home in backlog of $278,000 at March 31, 2006.

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***Gross homebuilding profit margin.******  ***During the three and six month period ended March 31, 2007, we experiencedmargin pressures across all of our regions and a there was a significant shiftin home deliveries from regions that historically had higher than average grossprofit margins to regions with lower than average gross profit margins.

Grosshomebuilding profit margin decreased to 1.8% for the three month period endedMarch 31, 2007, compared to 21.4% for the three month period ended March 31,2006. Included in gross profit for the three months ended March 31, 2007are inventory valuation charges of $12.4 million related to our expectationsregarding the recoverability of certain assets from both active residentialconstruction projects and land held for sale and $7.0 million of costs relatedto the abandonment of projects and write-off of deposits on cancelled landoption contracts. Included in grossprofit for the three months ended March 31, 2006 are inventory valuationcharges of $3.0 million.

Grosshomebuilding profit margin decreased to (0.2)% for the six month period endedMarch 31, 2007, compared to 23.1% for the six month period ended March 31,2006. Included in gross profit for the six months ended March 31, 2007are inventory valuation charges of $52.4 million related to our expectationsregarding the recoverability of certain assets from both active residentialconstruction projects and land held for sale and $7.4 million of costs relatedto the abandonment of projects and write-off of deposits on cancelled landoption contracts. Included in grossprofit for the six months ended March 31, 2006 are inventory valuation chargesof $3.0 million. Included within the gross profit for the six month periodended March 31, 2007 is $14.5 million from land sales, as compared with $2.5million from land sales for the six month period ended March 31, 2006.

***Homebuilding operating expenses.******  ***Homebuilding operating expenses, which consist of all homebuilding expensesother than cost of sales, decreased 19.4% to $27.3 million for the three monthsended March 31, 2007 from $33.8 million for the three months ended March 31,2006. Homebuilding operating expenses were 14.3% and 14.6% of homebuildingrevenue for the three months ended March 31, 2007 and 2006, respectively.

Homebuilding operating expensesdecreased 10.3% to $58.0 million for the six months ended March 31, 2007 from$64.6 million for the six months ended March 31, 2006. Homebuilding operatingexpenses were 13.5% and 14.2% of homebuilding revenue for the six months endedMarch 31, 2007 and 2006, respectively.

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

***Income Taxes.******  ***Werecorded income tax benefit of $9.9 million and $23.1 million for the three andsix month periods ended March 31, 2007. Included within the tax benefit for the three and six month periodsended March 31, 2007 is a $1.3 million beneficial adjustment to reduce priorincome tax estimates. We recorded income tax expense of $6.3 million and $15.1million for the three and six month periods ended March 31, 2006.

**Segment analysis**

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

Thefive reportable homebuilding segments include operations in the followinggeographic regions:

Florida

Midwest:Illinois, Ohio and Wisconsin

Nevada

30

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PacificCoast: California, Oregon and Washington

Texas

Thefollowing table presents financial and operational information for our fivereportable homebuilding segments:
| **Three Months Ended  March 31,  (Dollars in thousands)** | ** ** | **Average  sales price  of homes** | ** ** | **Homes  delivered** | ** ** | **Net new  home  orders**(1) | ** ** | **Backlog  (units) at   period end**(2) | ** ** | **Backlog  (contract  value) at  period end**(2) | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|----------------------|------------|-----------------------------------|------------|--------------------------------------------------------|------------|------------------------------------------------------------|------------|
| 2007                                                                               |       |                                         |       |                 |       |                              |       |                                                   |       |                                                       |       |
| Florida                                                                            |       | $                                            | 283        |                 | 79         |                              | 119        |                                                   | 96         |                                                       | $          | 22,442 |   |
| Midwest                                                                            |       | 348                                          |       | 94                   |       | 153                               |       | 195                                                    |       | 68,801                                                     |       |
| Nevada                                                                             |       | 387                                          |       | 85                   |       | 102                               |       | 81                                                     |       | 29,724                                                     |       |
| Pacific Coast                                                                      |       | 387                                          |       | 80                   |       | 128                               |       | 143                                                    |       | 54,956                                                     |       |
| Texas                                                                              |       | 176                                          |       | 361                  |       | 468                               |       | 437                                                    |       | 79,574                                                     |       |
| Total                                                                              |       | $                                            | 261        |                 | 699        |                              | 970        |                                                   | 952        |                                                       | $          | 255,497 |   |
| 2006                                                                               |       |                                         |       |                 |       |                              |       |                                                   |       |                                                       |       |
| Florida                                                                            |       | $                                            | 231        |                 | 98         |                              | 113        |                                                   | 198        |                                                       | $          | 56,682 |   |
| Midwest                                                                            |       | 372                                          |       | 108                  |       | 228                               |       | 383                                                    |       | 138,416                                                    |       |
| Nevada                                                                             |       | 400                                          |       | 67                   |       | 122                               |       | 158                                                    |       | 62,661                                                     |       |
| Pacific Coast                                                                      |       | 456                                          |       | 170                  |       | 119                               |       | 170                                                    |       | 81,136                                                     |       |
| Texas                                                                              |       | 165                                          |       | 364                  |       | 564                               |       | 775                                                    |       | 129,138                                                    |       |
| Total                                                                              |       | $                                            | 281        |                 | 807        |                              | 1,146      |                                                   | 1,684      |                                                       | $          | 468,033 |   |

 
| **Six Months Ended  March 31,  (Dollars in thousands)** | ** ** | **Average  sales price  of homes** | ** ** | **Homes  delivered** | ** ** | **Net new  home  orders**(1) | ** ** | **Backlog  (units) at   period end**(2) | ** ** | **Backlog  (contract  value) at  period end**(2) | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------------------------------|------------|----------------------|------------|-----------------------------------|------------|--------------------------------------------------------|------------|------------------------------------------------------------|------------|
| 2007                                                                             |       |                                         |       |                 |       |                              |       |                                                   |       |                                                       |       |
| Florida                                                                          |       | $                                            | 293        |                 | 161        |                              | 184        |                                                   | 96         |                                                       | $          | 22,442 |   |
| Midwest                                                                          |       | 335                                          |       | 233                  |       | 269                               |       | 195                                                    |       | 68,801                                                     |       |
| Nevada                                                                           |       | 384                                          |       | 182                  |       | 218                               |       | 81                                                     |       | 29,724                                                     |       |
| Pacific Coast                                                                    |       | 415                                          |       | 172                  |       | 235                               |       | 143                                                    |       | 54,956                                                     |       |
| Texas                                                                            |       | 176                                          |       | 750                  |       | 786                               |       | 437                                                    |       | 79,574                                                     |       |
| Total                                                                            |       | $                                            | 266        |                 | 1,498      |                              | 1,692      |                                                   | 952        |                                                       | $          | 255,497 |   |
| 2006                                                                             |       |                                         |       |                 |       |                              |       |                                                   |       |                                                       |       |
| Florida                                                                          |       | $                                            | 232        |                 | 193        |                              | 127        |                                                   | 198        |                                                       | $          | 56,682 |   |
| Midwest                                                                          |       | 379                                          |       | 212                  |       | 340                               |       | 383                                                    |       | 138,416                                                    |       |
| Nevada                                                                           |       | 390                                          |       | 155                  |       | 201                               |       | 158                                                    |       | 62,661                                                     |       |
| Pacific Coast                                                                    |       | 456                                          |       | 315                  |       | 201                               |       | 170                                                    |       | 81,136                                                     |       |
| Texas                                                                            |       | 163                                          |       | 695                  |       | 915                               |       | 775                                                    |       | 129,138                                                    |       |
| Total                                                                            |       | $                                            | 282        |                 | 1,570      |                              | 1,784      |                                                   | 1,684      |                                                       | $          | 468,033 |   |

 

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

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

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

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| **For the three months ended March 31:  (Dollars in thousands)** | ** ** | **Revenues** | ** ** | **(Loss) earnings before  income taxes** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|--------------|------------|---------------------------------------------------------|------------|
| **2007**                                                                                                 | ** ** | ** **   | ** ** | ** **                                              | ** ** |
| Florida                                                                                                  |       | $            | 21,714     |                                                    | $          | (2,117 | ) |
| Midwest                                                                                                  |       | 33,206       |       | (7,181                                                  | )          |
| Nevada                                                                                                   |       | 35,412       |       | 6,444                                                   |       |
| Pacific Coast                                                                                            |       | 30,002       |       | (10,445                                                 | )          |
| Texas                                                                                                    |       | 66,127       |       | 5,264                                                   |       |
| Mortgage banking                                                                                         |       | 1,494        |       | 128                                                     |       |
| Segment subtotal                                                                                         |       | 187,955      |       | (7,907                                                  | )          |
| Corporate and unallocated                                                                                |       | 56           |       | (5,994                                                  | )          |
|                                                                                                     |       | 188,011      |       | (13,901                                                 | )          |
| Homebuilding interest expense(1)                                                                         |       |         |       | (7,710                                                  | )          |
| GAAP adjustment(2)                                                                                       |       | 4,193        |       | (1,558                                                  | )          |
| Consolidated total                                                                                       |       | $            | 192,204    |                                                    | $          | (23,169 | ) |
| **2006**                                                                                                 | ** ** | ** **   | ** ** | ** **                                              | ** ** |
| Florida                                                                                                  |       | $            | 22,589     |                                                    | $          | 2,452 |   |
| Midwest                                                                                                  |       | 40,371       |       | (3,534                                                  | )          |
| Nevada                                                                                                   |       | 26,801       |       | 6,103                                                   |       |
| Pacific Coast                                                                                            |       | 77,487       |       | 23,042                                                  |       |
| Texas                                                                                                    |       | 64,532       |       | 3,292                                                   |       |
| Mortgage banking                                                                                         |       | 1,624        |       | 500                                                     |       |
| Segment subtotal                                                                                         |       | 233,404      |       | 31,855                                                  |       |
| Corporate and unallocated                                                                                |       | 35           |       | (11,732                                                 | )          |
|                                                                                                     |       | 233,439      |       | 20,123                                                  |       |
| Homebuilding interest expense(1)                                                                         |       |         |       | (6,097                                                  | )          |
| GAAP adjustment(2)                                                                                       |       |         |       | 3,243                                                   |       |
| Consolidated total                                                                                       |       | $            | 233,439    |                                                    | $          | 17,269 |   |

 

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| **For the six months ended March 31:  (Dollars in thousands)** | ** ** | **Revenues** | ** ** | **(Loss) earnings before  income taxes** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|--------------|------------|---------------------------------------------------------|------------|
| **2007**                                                                                               | ** ** | ** **   | ** ** | ** **                                              | ** ** |
| Florida                                                                                                |       | $            | 45,655     |                                                    | $          | (9,502 | ) |
| Midwest                                                                                                |       | 79,328       |       | (18,711                                                 | )          |
| Nevada                                                                                                 |       | 90,442       |       | 26,106                                                  |       |
| Pacific Coast                                                                                          |       | 69,271       |       | (26,706                                                 | )          |
| Texas                                                                                                  |       | 136,043      |       | 5,023                                                   |       |
| Mortgage banking                                                                                       |       | 3,236        |       | 644                                                     |       |
| Segment subtotal                                                                                       |       | 423,975      |       | (23,146                                                 | )          |
| Corporate and unallocated                                                                              |       | 233          |       | (13,711                                                 | )          |
|                                                                                                   |       | 424,208      |       | (36,857                                                 | )          |
| Homebuilding interest expense(1)                                                                       |       |         |       | (16,481                                                 | )          |
| GAAP adjustment(2)                                                                                     |       | 8,567        |       | (3,927                                                  | )          |
| Consolidated total                                                                                     |       | $            | 432,775    |                                                    | $          | (57,265 | ) |
| **2006**                                                                                               | ** ** | ** **   | ** ** | ** **                                              | ** ** |
| Florida                                                                                                |       | $            | 44,799     |                                                    | $          | 2,559 |   |
| Midwest                                                                                                |       | 82,891       |       | (2,717                                                  | )          |
| Nevada                                                                                                 |       | 60,490       |       | 17,506                                                  |       |
| Pacific Coast                                                                                          |       | 143,802      |       | 44,971                                                  |       |
| Texas                                                                                                  |       | 121,146      |       | 5,294                                                   |       |
| Mortgage banking                                                                                       |       | 2,998        |       | 715                                                     |       |
| Segment subtotal                                                                                       |       | 456,126      |       | 68,328                                                  |       |
| Corporate and unallocated                                                                              |       | 1,233        |       | (22,687                                                 | )          |
|                                                                                                   |       | 457,359      |       | 45,641                                                  |       |
| Homebuilding interest expense(1)                                                                       |       |         |       | (11,143                                                 | )          |
| GAAP adjustment(2)                                                                                     |       |         |       | 7,176                                                   |       |
| Consolidated total                                                                                     |       | $            | 457,359    |                                                    | $          | 41,674 |   |

 

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

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

***Florida.  ***Homebuilding revenues decreased in thequarter ended March 31, 2007, compared to the quarter ended March 31, 2006,primarily due to a 19.4% decrease in the number of homes delivered, offsetpartially by a $52 thousand increase in the average sales price of homesdelivered. Homebuilding gross profit margins were (0.7)% in the second fiscalquarter of 2007, compared to 23.1% in the second fiscal quarter of 2006. Grossprofit for the three month period ended March 31, 2007 was negatively impactedby $1.7 million of inventory valuation charges and $0.1 million of costsrelated to the abandonment of projects and write-off of deposits on cancelledland option contracts.

Homebuilding revenues increased in the six monthperiod ended March 31, 2007, compared to the six month period ended March 31,2006, primarily due to a $61 thousand increase in the average sales price ofhomes delivered, offset partially by a 16.6% decrease in the number of homesdelivered. Homebuilding gross profit margins were (11.3)% in the six monthsended March 31, 2007, compared to 23.5% in the six months ended March 31, 2006.Gross profit for the six month period ended March 31, 2007 was negativelyimpacted by $9.2 million of inventory valuation charges and $0.1 million ofcosts related to the abandonment of projects and write-off of deposits oncancelled land option contracts.

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***Midwest.  ***Homebuildingrevenues decreased in the quarter ended March 31, 2007, compared to the quarterended March 31, 2006, primarily due to an 13.0% decrease in the number of homesdelivered and a $24 thousand decrease in the average sales price of homesdelivered. Homebuilding gross profit margins were (12.8)% in the second fiscalquarter of 2007, compared to 3.3% in the second fiscal quarter of 2006. Grossprofit for the three month period ended March 31, 2007 was negatively impactedby $3.0 million of inventory valuation charges and $3.1 million of costsrelated to the abandonment of projects and write-off of deposits on cancelledland option contracts. Gross profit for thethree month period ended March 31, 2006 was negatively impacted by $3.0 millionof inventory valuation charges.

Homebuilding revenues decreased in the six monthperiod ended March 31, 2007, compared to the six month period ended March 31,2006, primarily due to a $44 thousand decrease in the average sales price ofhomes delivered, offset partially by an 9.9% increase in the number of homesdelivered. Homebuilding gross profit margins were (15.9)% in the six months endedMarch 31, 2007, compared to 6.3% in the six months ended March 31, 2006. Grossprofit for the six month period ended March 31, 2007 was negatively impacted by$13.6 million of inventory valuation charges and $3.1 million of costs relatedto the abandonment of projects and write-off of deposits on cancelled landoption contracts. Gross profit for the sixmonth period ended March 31, 2006 was negatively impacted by $3.0 million ofinventory valuation charges.

***Nevada.  ***Homebuildingrevenues increased in the quarter ended March 31, 2007, compared to the quarterended March 31, 2006, primarily due to a 26.9% increase in the number of homesdelivered and a $3.8 million increase in land sales. Homebuilding gross profitmargins were 20.4% in the second fiscal quarter of 2007, compared to 31.2% inthe second fiscal quarter of 2006.

Homebuilding revenuesincreased in the six month period ended March 31, 2007, compared to the sixmonth period ended March 31, 2006, primarily due to a $23.2 million increase inland sales and a 17.4% increase in the number of homes delivered. Homebuildinggross profit margins were 29.9% in the six months ended March 31, 2007,compared to 35.6% in the six months ended March 31, 2006. Included within grossprofit for the six months ended March 31, 2007 is $14.1 million from landsales.

***Pacific Coast.  ***Homebuilding revenues decreased in thequarter ended March 31, 2007, compared to the quarter ended March 31, 2006,primarily due to a 52.9% decrease in the number of homes delivered and a $69 thousanddecrease in the average sales price of homes delivered. Homebuilding grossprofit margins were (26.7)% in the second fiscal quarter of 2007, compared to32.9% in the second fiscal quarter of 2006. Gross profit for the three monthperiod ended March 31, 2007 was negatively impacted by $7.7 million ofinventory valuation charges and $3.8 million of costs related to theabandonment of projects and write-off of deposits on cancelled land optioncontracts.

Homebuilding revenues decreased in the six monthperiod ended March 31, 2007, compared to the six month period ended March 31,2006, primarily due to a 45.4% decrease in the number of homes delivered and a$41 thousand decrease in the average sales price of homes delivered.Homebuilding gross profit margins were (32.1)% in the six months ended March31, 2007, compared to 34.6% in the six months ended March 31, 2006. Grossprofit for the six month period ended March 31, 2007 was negatively impacted by$26.1 million of inventory valuation charges and $3.8 million of costs relatedto the abandonment of projects and write-off of deposits on cancelled landoption contracts.

***Texas.  ***Homebuildingrevenues increased in the quarter ended March 31, 2007, compared to the quarterended March 31, 2006, primarily due to a $11 thousand increase in the averagesales price of homes delivered. Homebuilding gross profit margins were 12.9% inthe second fiscal quarter of 2007, compared to 15.5% in the second fiscalquarter of 2006.

Homebuilding revenues increased in the six monthperiod ended March 31, 2007, compared to the six month period ended March 31,2006, primarily due to a 7.9% increase in the number of homes delivered and a$13 thousand

34

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increase in the average sales price of homesdelivered. Homebuilding gross profit margins were 8.8% in the six months endedMarch 31, 2007, compared to 14.6% in the six months ended March 31, 2006. Grossprofit for the six month period ended March 31, 2007 was negatively impacted by$3.5 million of inventory valuation charges and $0.4 million of costs relatedto the abandonment of projects and write-off of deposits on cancelled landoption contracts.

***Mortgage banking.  ***Mortgagebanking earnings before taxes decreased to $0.1 million in the second fiscalquarter of 2007, compared to $0.5 million in the second fiscal quarter of 2006.Mortgage banking earnings before taxes decreased to $0.6 million during the sixmonths ended March 31, 2007, compared to $0.7 million during the six monthperiod ended March 31, 2006. The decrease in earnings before taxes wasprimarily due to a decrease in home closings, a decrease in the averagemortgage loan size and a reduced mortgage capture rate.

***Corporate and unallocated.  ***Corporateand unallocated costs totaled $6.0 million in the second fiscal quarter of 2007and $11.7 million in the second fiscal quarter of 2006. Corporate andunallocated costs as a percentage of total consolidated revenues were 3.1% forthe three months ended March 31, 2007 and 5.0% for the three months ended March31, 2006.

Corporate and unallocatedcosts totaled $13.7 million in the six months ended March 31, 2007 and $22.7million in the six months ended March 31, 2006. Corporate and unallocated costsas a percentage of total consolidated revenues were 3.2% for the six months endedMarch 31, 2007 and 5.0% for the six months ended March 31, 2006.

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

**Liquidity and Capital Resources**

Our principaluses of cash are land purchases, lot development and home construction. As aresult, our financing needs depend principally on sales volume, landacquisition and inventory balances. We fund our operations with cash flows fromoperating activities, borrowings under a senior unsecured credit facility,other bank debt and minority interests in consolidated partnerships. We do nothold cash for investment purposes and we manage our cash and debt positions tominimize financing costs.

***Operating cash flowsactivities***

Cash usedin operating activities totaled $8.6 million during the six months ended March31, 2007, compared to $131.6 million of cash used in operating activitiesduring the six months ended March 31, 2006. The increase in operating cash flowsis primarily due to a significant reduction in the net investment in inventoryrelated to land purchases, lot development and home construction.

***Investing cashflows activities***

Cash used in investingactivities totaled $3.6 million during the sixmonths ended March 31, 2007, compared to $8.0 million cash used in investingactivities during the six months ended March 31, 2006. The increase ininvesting cash flows was primarily due to a decrease in fixed asset purchases.

***Financing cashflows activities***

Cash providedby financing activities totaled $5.8 million during the six months ended March31, 2007, compared to $139.4 million cash provided by financing activitiesduring the six months ended March 31, 2006. During the six months ended March31, 2007, we increased our outstanding borrowings by $29.6 million. During thesix months ended March 31, 2007, we distributed $18.1 million of cash to jointventure partners.

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InDecember 2005, we issued $203 million aggregate principal amount of seniorsubordinated notes due December 2012 in a private placement pursuant toRule 144A promulgated under the Securities Act of 1933. In May 2006,we exchanged all of the senior subordinated notes issued in December 2005for an issue of notes registered with the SEC with terms substantiallyidentical to the notes issued in the private placement. The senior subordinatednotes were sold at 98.796% of par and accrue interest at a coupon rate of 10.5%per annum. Interest is paid semi-annually in June and December. The netproceeds were used to repay amounts outstanding under working capital loans andcertain senior secured revolving credit facilities. We may redeem the notes, inwhole or part, at any time on or after December 15, 2009, at a redemptionprice equal to 100% of the principal amount, plus a 5.25% premium decliningratably to par on December 15, 2011, plus accrued and unpaid interest. Atany time prior to December 15, 2008, we may also redeem up to 35% of theaggregate principal amount of the notes with the proceeds of qualified equityofferings at a redemption price equal to 110.5% of the principal amount, plusaccrued and unpaid interest. In addition, if we experience specific kinds ofchanges of control, we are required to make an offer to purchase all of thenotes at a purchase price of 101% of the principal amount thereof, plus accruedand unpaid interest. The notes are unsecured senior subordinated obligationsand subordinated in right of payment to all of our existing and future seniordebt, including borrowings under our senior unsecured credit facility. All ofour wholly owned subsidiaries, other than our mortgage subsidiary, have fullyand unconditionally guaranteed the notes on a joint and several, unsecuredsenior subordinated, basis. The guarantees are general unsecured obligations ofthe guarantors and will be subordinated in right of payment to all existing andfuture senior debt of the guarantors, which includes their guarantees of oursenior unsecured credit facility. The indenture governing the seniorsubordinated notes contains a number of significant covenants that restrictsour ability and that of our restricted subsidiaries to, among other things:incur additional indebtedness, make certain distributions, investments andother restricted payments, create certain liens, enter into transactions withaffiliates, and merge, consolidate or sell substantially all of our assets. Asof March 31, 2007, we were restricted from incurring additional indebtedness(excluding available borrowings under the senior unsecured credit facility),except under certain limited circumstances.

InDecember 2005, we entered into a new senior unsecured credit facility tofinance our business operations. Proceeds of the new credit facility were usedto retire our existing senior secured revolving credit facilities andsubstantially all of our other senior secured credit facilities. The creditfacility has a maximum availability of $500 million, subject to a borrowingbase as well as sublimits of $100 million for the issuance of letters of creditand $10 million for swing line loans. We have the right, without the consent ofour lenders (other than those participating in the increase), to increase thecommitment by an amount of up to $200 million, provided that no such increaseshall cause the senior unsecured credit facility to exceed $700 million. Theapplicable borrowing base will be determined regularly throughout the life ofthe facility. The composition of the borrowing base will be limited toparameters set forth in the credit facility agreement and certain types of realestate (such as unimproved entitled land and lots under development) will beremoved from the borrowing base if held beyond specified maturity dates.Borrowings under the credit facility will generally bear interest based on anapplicable margin plus LIBOR or an alternate base rate. The applicable marginfor interest ranges from 1.5% to 2.25%, depending upon our senior leverageratio, which is defined as the ratio of total liabilities to consolidated networth. Fees for letters of credit are based on LIBOR plus a margin of 1.5%. Anunused commitment fee equal to 0.2% to 0.3% per year accrues on the undrawnportion of the facility and is payable quarterly in arrears. As of March 31,2007, we had $287 million of borrowings under the credit facility at aneffective interest rate of 6.93% and, after giving effect to the borrowing baselimitation, had additional availability of approximately $183 million. Ourobligations under the senior unsecured credit facility are guaranteed by all ofour wholly-owned subsidiaries, other than our mortgage subsidiary, and aresubject to a number of customary financial and operating covenants.

In December 2006,we amended certain covenants in our $500 million senior unsecured revolvingcredit facility. The covenants as amended, require us to: maintain a minimumtangible net worth of at least $300 million plus 50% of positive netincome earned subsequent to September 30, 2006; maintain a ratio of totalliabilities to adjusted tangible net worth not to exceed 2.0x (decreasing to1.75x as of June 30, 2007 and increasing to 2.5x as of December 31,2008); maintain a ratio of total debt to adjusted tangible net worth not toexceed 1.5x; maintain a ratio of total land (including undeveloped land, landunder development and finished lots on which home construction has yet tobegin)

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toadjusted tangible net worth not to exceed 1.5x; and maintain an interest coverageratio of no less than 1.75x through December 31, 2006 (decreasing to 1.5xthrough March 31, 2007, decreasing to 1.4x through June 30, 2007,decreasing to 1.35x through September 30, 2007, increasing to 1.5x throughDecember 31, 2007, increasing to 1.75x through March 31, 2008 andthen increasing to 2.25x through the remaining term of the facility). Forpurposes of these tests, adjusted tangible net worth is benefited byadjustments of 50% of our outstanding senior subordinated debt (up to a maximum$100 million adjustment) and 100% of minority interests in consolidatedentities (up to a maximum $50 million adjustment).

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

We areparty to senior secured project-specific acquisition, development andconstruction loans. These loans bear interest at a floating rate ranging fromLIBOR to LIBOR plus 2.25% with maturities generally tied to the sale of theunderlying inventory. As of March 31, 2007, we had $32 million outstandingrelated to these project-specific acquisition, development and construction loans.

We areparty to several unsecured loan agreements that fund our operations on anongoing basis. In addition, KH Financial, L.P., our wholly owned mortgagesubsidiary, is party to a $5 million warehouse line of credit, used tofund its mortgage origination operations. This facility bears interest at afloating rate equal to LIBOR plus 2.25%, and as of March 31, 2007 there were noamounts outstanding under the warehouse facility.

We arealso party to a $100 million flexible early purchase facility agreementwhich allows us to sell qualifying mortgage loans to the holder of the flexibleearly purchase facility after such loans have been originated subject to ourobligation to sell the loan to an investor in the secondary market. At March31, 2007, the facility held $28 million of loans sold by KH Financial,L.P.

As of and during the three and six months ended March31, 2007, we were in compliance with the covenants of our $500 million seniorunsecured credit facility. However, given the continued deterioration of thehomebuilding market, we do not expect to be able to maintain compliance withthe current covenants throughout the remainder of our fiscal year. Therefore,we will be exploring alternatives with our lenders, which would permitcontinued access to financing sufficient to support our current and futureoperations. Our continued borrowing availability depends on our ability tonegotiate revised covenants of this facility with which we will be able tomaintain compliance or to arrange a new credit facility with acceptable terms andcovenants. Additionally, should debt rating agencies issue a negative outlookon, or downgrade, our debt rating, it may become more difficult and/orexpensive to obtain necessary financing.

As of March 31, 2007, wewere not in compliance with an interest coverage covenant provided for in a securedproject credit facility with an outstanding balance of $32 million. We obtaineda waiver for this covenant violation and are working to amend the securedproject credit facility.

Webelieve that our cash, other liquid assets and operating cash flow, togetherwith available borrowings and potential access to credit and capital markets,will be sufficient to meet our operating expenses and capital expenditures andservice our debt requirements over the next twelve months. However, our ongoingability to meet our substantial debt service and other obligations, includingcompliance with financial covenants in our senior unsecured credit facility andsenior subordinated notes, will be dependent upon our future performance whichwill be subject to business, financial and other factors. We will not be ableto control many of these factors, such as the continued deterioration in thehomebuilding industry, economic conditions in the markets where we operate andpressure from competitors. We cannot be certain that our cash flow will besufficient to allow us to pay principal and interest on our debt, including

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oursenior unsecured credit facility and senior subordinated notes, support ouroperations and meet our other obligations. If we do not have enough money, wemay be required to refinance all or part of our existing debt, sell assets orborrow more money. We cannot guarantee that we will be able to do so on termsacceptable to us, if at all. In addition, the terms of existing or future debtagreements, including our senior unsecured credit facility and the indenturefor our senior subordinated notes, may restrict us from pursuing any of thesealternatives.

**Contractual Obligations**

Our primary contractualcash obligations for our operations are payments under our debt agreements andpurchase obligations with specific performance requirements under land optionagreements and purchase contracts. These land option agreements and purchasecontracts may require us to purchase land contingent upon us and the sellermeeting certain obligations. We expect to fund our contractual obligations inthe ordinary course of business through our operating cash flows and our creditfacilities.

Thefollowing summarizes our aggregate contractual commitments at March 31, 2007:
| ** **                           | ** ** | **Payments due by period** | ** ** |
|--------------------------------------|------------|-------------------------------------------|------------|
| **(Dollars in thousands)** | ** ** | **Total**                                 | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than 5  years** | ** ** |
| Notes payable(1)                     |       | $                                         | 708,157    |   | $ | 49,159 |   | $ | 401,254 |   | $ | 42,185 |   | $ | 215,559 |   |
| Operating leases                     |       | 10,099                                    |       | 2,616 |   | 4,837 |   | 2,034 |   | 612 |   |
| Purchase  obligations(2)             |       | 43,632                                    |       | 1,777 |   | 41,855 |   |   |   |   |   |
| Total                                |       | $                                         | 761,888    |   | $ | 53,552 |   | $ | 447,946 |   | $ | 44,219 |   | $ | 216,171 |   |
|                                 |       |                                      |       |   |   |   |   |   |   |   |   |

 

(1)   Includes our senior subordinated notes,senior unsecured credit facility, other homebuilding debt, and related interestpayments for the life of the debt. Interest on variable rate obligations isbased on rates effective as of March 31, 2007.

(2)   Represents obligations under land option agreementsand purchase contracts with specific performance provisions, net of cashdeposits.

Under the terms of ourstock option plans, we may be required to purchase shares of our common stockat fair market value, including shares issuable under outstanding options ordeferred stock units, from our directors and certain of our executive officersand other key employees, in the event of termination of board membership oremployment, as applicable, by reason of specified circumstances, includingdeath, disability, involuntary termination or retirement. As of March 31, 2007,the aggregate repurchase obligation, net of proceeds to be received from anystock option exercises, would have been $21.5 million in the event thatall of these obligations were triggered. Our ability to satisfy our repurchaseobligations is subject to certain limitations set forth in the Trust Indenturegoverning the senior subordinated notes.

We are contingentlyliable to banks and financial institutions for approximately $39 million for outstandingletters of credit and performance bonds securing performance of certaincontractual obligations and land purchase contracts. Approximately $2.8 millionof the outstanding letters of credit have been issued by a wholly ownedsubsidiary. At March 31, 2007, we had committed to fund approximately $25.7million in mortgage loans to homebuyers at agreed-upon rates. We have enteredinto best-efforts and mandatory sale commitments to sell these mortgages tothird parties.

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

AtMarch 31, 2007, we owned and controlled 22,589 lots, approximately 38% of whichwere pursuant to option agreements and purchase contracts. The following is asummary of our land/lot position as of March 31, 2007:
| ** **                                                         | ** ** | **Number of lots** | ** ** |
|--------------------------------------------------------------------|------------|------------------------------|------------|
| Finished lots  owned                                               |       | 4,988                        |       |
| Lots under  development owned                                      |       | 9,052                        |       |
| Total lots owned(1)                                                |       | 14,040                       |       |
| Lots controlled  under option agreements and purchase contracts(2) |       | 8,549                        |       |
| Total land/lots  controlled                                        |       | 22,589                       |       |
|                                                               |       |                         |       |

 

(1)   Includes 1,388 lots that have been identifiedas held for sale, which we intend to sell and are actively marketing fordelivery within the next 12 months.

(2)   Includes 2,065 lots included in inventory notowned which were consolidated under the accounting guidance of FIN 46R and2,156 lots that we expect to purchase from unconsolidated entities in which wehave an investment as an equity member.

**Off-Balance Sheet Arrangements**

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

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

In the ordinary course ofbusiness, we enter into option agreements and purchase contracts to secure landfor the construction of homes. These agreements generally require us to pay adeposit to the seller as consideration for the right to acquire land during aspecified period, usually at predetermined prices. Some of these optionagreements and purchase contracts contain specific performance clauses, whichrequire us to purchase the land upon satisfaction of certain requirements.Otherwise, our liabilities under option agreements and purchase contracts aregenerally limited to forfeiture of the nonrefundable deposits, letters ofcredit and other nonrefundable amounts incurred. Below is a summary of theaggregate exercise price of all option agreements and purchase contracts as of March31, 2007:
| **(Dollars in thousands)**                                       | ** ** | **Aggregate exercise  price of land  options**(1) | ** ** |
|----------------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|
| Option  agreements and purchase contracts with specific performance        |       | $                                                                | 1,777      |   |
| Options  agreements and purchase contracts without specific performance(2) |       | 287,784                                                          |       |
| Total option agreements  and purchase contracts                            |       | $                                                                | 289,561    |   |
|                                                                       |       |                                                             |       |

 

(1)   Excludes $60 million of purchase obligationsrelated to inventory not owned included on our condensed consolidated balance sheetsat an initial fair value of $50 million, of which $42 million of the purchaseobligations contains specific performance obligations.

(2)   Includes $169 million related to purchasesfrom joint ventures in which we have an investment balance of $40 million as of March 31, 2007. These investments arerecorded in investments in and advances to unconsolidated entities on ourcondensed consolidated balance sheets.

Given the continueddeterioration in market conditions and uncertainty about the timing and pace ofany recovery, we have tightened our land acquisition criteria and are workingwith land sellers to renegotiate land purchase and option contracts to extendpurchase dates and reduce purchase prices. If we are unable to obtainsatisfactory terms, we will not exercise our land option agreements and willabandon our earnest money if contractually obligated to do so. During the threeand six months ended March 31, 2007, we wrote-off $7.0 million and $7.4 millionof costs related to the abandonment of land option contracts. We expect toexercise all of our land option agreements and purchase contracts with specificperformance obligations.

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

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

In theordinary course of business, we periodically enter into arrangements with landdevelopers or other homebuilders to acquire land and develop lots. Thesearrangements include the creation of joint ventures, in which our currentinterests range from 6% to 49%. We account for our interest in these jointventures under the equity method, and our condensed consolidated balance sheetsinclude investments in and advances to joint ventures totaling $51.5 millionand $48.2 million at March 31, 2007 and September 30, 2006, respectively. Thesejoint ventures typically obtain secured acquisition, development and constructionfinancing. At March 31, 2007 and September 30, 2006, our unconsolidated jointventures had outstanding third party borrowings of $958 million and $865million, respectively. From time to time we have issued repayment guaranteesand/or loan-to-value maintenance guarantees in respect of this indebtedness.These guarantees require us to repay debt of the joint venture in the event ofa payment default or in the event that the debt of the joint venture exceedsthe value of the property securing the debt. At March 31, 2007 and September30, 2006, we had guarantees of $97.1 million and $74.3 million, respectively,related to the outstanding 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 local market practices and may be subject tocertain contingencies such as the buyer’s ability to qualify for financing.Homes covered by such sales contracts but not yet delivered are considered “backlog”.We do not recognize revenue upon the sale of a home until it is delivered tothe homebuyer and other criteria for sale and profit recognition are met. Wesometimes build homes before obtaining a sales contract; however, these homes areexcluded from backlog until a sales contract is signed. At March 31, 2007, wehad 133 units of completed homes in inventory without sales contracts whichrepresented 7% of our total home inventory. Our cancellation rates for both thethree months ended March 31, 2007 and 2006 were 23%. Our cancellationrates for the six months ended March 31, 2007 and 2006 were 25% and 27%,respectively.

**Interest Rates and Inflation**

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

We may be adverselyaffected during periods of high inflation because of higher land, financing,labor and material costs. We attempt to pass to our customers any increases inour costs through increased sales prices, although this is becomingincreasingly difficult given the continued weakness in the homebuilding market.To date, inflation has not

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had a material adverseeffect on our results of operations. However, there is no assurance thatinflation will not have a material adverse impact on our future results ofoperations.

**Critical Accounting Estimates and Policies**

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

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

·                  Revenuerecognition;

·                  Homebuildinginventory and costs of sales;

·                  Variable interest entities;

·                  Investments in and advances to unconsolidatedentities;

·                  Warranty costs;

·                  Litigation reserves;

·                  Insurance claims costs;

·                  Valuation of deferred tax assets; and

·                  Stock-based compensation.

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

**Recent Accounting Pronouncements**

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

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

In September 2006,the SEC issued Staff Accounting Bulletin No. 108, *Considering the Effects of Prior Year Misstatementswhen Quantifying Misstatements in Current Year Financial Statements*(“SAB108”), which provides

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guidance as to how theeffects on prior year uncorrected misstatements should be considered whenquantifying misstatements in the current financial statements. SAB 108 wasissued in order to eliminate the diversity of practice surrounding how publiccompanies quantify financial statement misstatements. SAB 108 will require usto quantify misstatements using both a balance sheet and income statementapproach, with adjustment required if either method results in a materialerror. SAB 108 is effective for financial statements issued for fiscal yearsbeginning after November 15, 2006. We are in the process of determiningthe effect, if any, the adoption of SAB 108 will have on our financialstatements.

In February 2007,the FASB issued SFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities, including an amendment of FASBStatement No. 115*(“SFAS 159”). SFAS 159 permits a company tomeasure certain financial instruments and other items at fair value. SFAS 159is effective for financial statements issued for fiscal years beginning after November15, 2007. We are in the process of determining the effect, if any, the adoptionof SFAS 159 will have on our financial statements.

**Cautionary Factors That May Affect Future Results**

Our disclosure andanalysis in this report contain forward-looking statements about our financialresults and estimates and business prospects that involve substantial risks anduncertainties. From time to time, we also may provide oral or writtenforward-looking statements in other materials we release to analysts, debt holdersand the public. Forward-looking statements give our current expectations orforecasts of future events. You can identify these statements by the fact thatthey do not relate strictly to historic or current facts. They use words suchas “anticipate”, “believe”, “estimate”, “expect”, “forecast”, “goal”, “intend”,“objective”, “plan”, “projection”, “seek”, “strategy”, or other words and termsof similar meaning. Any or all of the forward-looking statements included inthis report and in any other of our reports or public statements may notapproximate actual experience, and the expectations derived from them may notbe realized, due to known or unknown risks and uncertainties. As a result,actual results may differ materially from the results discussed in andanticipated by the forward-looking statements. The following risks anduncertainties relevant to our business include factors we believe couldadversely affect us:

·                  high interest rates, changes in tax laws andinflation;

·                  changes in macroeconomic conditions in our marketsand regions;

·                  the availability of sufficient capital;

·                  fluctuations in inventory values and carrying costs;

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

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

·                  adverse weather conditions and natural disasters inour markets;

·                  the availability and quality of subcontractors andraw materials;

·                  utility shortages and price increases;

·                  our ability to develop our communities successfully;

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

·                  the future availability of insurance at reasonablecost;

·                  fluctuations in real estate values;

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·                  poor relations with residents of our communities;

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

·                  changes in our legal and regulatory environment;

·                  changes in environmental laws and regulations;

·                  restrictions on our financial services companies;

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

·                  geopolitical risks and market disruption; 

·                  our substantial level of indebtedness;

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

·                  the growth or expansion of our operations; and

·      ourcontrolling stockholder’s interests may conflict with the interests of otherstakeholders.

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

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

We areexposed to a number of market risks in the ordinary course of business. Our primarymarket risk exposure for financial instruments relates to fluctuations ininterest rates. We do not believe our exposure in this area is material to cashflows or earnings. As of March 31, 2007, we had a total of $320.2 million offloating rate debt outstanding, including our senior unsecured credit facilityand other facilities. Borrowings under these facilities generally bear interestbased on applicable margins plus LIBOR or an alternate base rate. Holding ourvariable rate debt balances constant as of March 31, 2007, each one percentagepoint increase in interest rates would result in an increase in interestincurred for the next twelve month period of approximately $3.2 million. A onepercentage point increase in interest rates on our average variable rate debtoutstanding during the twelve month period ended March 31, 2007 would haveresulted in an increase in interest incurred of approximately $3.4 million.

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

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# **Item 4.     Controls andProcedures.**

***Disclosurecontrols and procedures.*** We maintain disclosure controls and procedures (as defined in Rule13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Act”)) thatare designed to provide reasonable assurance that information required to bedisclosed by us, including our consolidated entities, in the reports that wefile or submit under the Act, is recorded, processed, summarized and reported,within the time periods specified in the Securities and Exchange Commission’srules and forms and that such information is accumulated and communicated tomanagement, including the Chairman and Chief Executive Officer (the “PrincipalExecutive Officer”) and Chief Financial Officer (the “Principal FinancialOfficer”), as appropriate, to allow timely decisions regarding requireddisclosure. Prior to the filing of this report, we completed an evaluationunder the supervision and with the participation of senior management,including our Principal Executive Officer and our Principal Financial Officer,of the effectiveness of the design and operation of our disclosure controls andprocedures as of March 31, 2007. Based on this evaluation, our PrincipalExecutive Officer and our Principal Financial Officer concluded that ourdisclosure controls and procedures were effective at the reasonable assurancelevel as of March 31, 2007.

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

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**PARTII—OTHER INFORMATION**

**Item 1.    Legal Proceedings.**

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

**Item 1A.   RiskFactors.**

There have been nomaterial changes in our risk factors from those disclosed in Part I, Item 1A ofour Annual Report on Form 10-K for the fiscal year ended September 30, 2006.The risk factors disclosed in our Annual Report on Form 10-K, in addition tothe other information set forth in this report, could materially affect ourbusiness, financial condition or results. Additional risks and uncertaintiesnot currently known to us or that are deemed to be immaterial also maymaterially adversely affect our business, financial condition or results.

# **Item 6.      Exhibits.**

| **Exhibits** | ** ** | ** **                                                                                                        |
|--------------|------------|-------------------------------------------------------------------------------------------------------------------|
| 31.1         |       | Rule 13a-14(a) / 15d-14(a) Certification of David K.  Hill, Chairman, Chief Executive Officer and Director.       |
|         |       |                                                                                                              |
| 31.2         |       | Rule 13a-14(a) / 15d-14(a) Certification of Eugene  K. Rowehl, Senior Vice President and Chief Financial Officer. |
|         |       |                                                                                                              |
| 32.1         |       | Section 1350 Certification of David K. Hill,  Chairman, Chief Executive Officer and Director.                     |
|         |       |                                                                                                              |
| 32.2         |       | Section 1350 Certification of Eugene K. Rowehl,  Senior Vice President and Chief Financial Officer.               |

 

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**SIGNATURES**

Pursuant to the requirementsof the Securities Exchange Act of 1934, the Registrant has duly caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized.
|                     |   |                                              |
|---------------------|--------|---------------------------------------------------|
|                |   | KIMBALL HILL, INC.                                |
|                |   | Registrant                                        |
|                |   |                                              |
| Dated May 15,  2007 |   | /s/ DAVID K. HILL                                 |
|                |   | David K. Hill                                     |
|                |   | Chairman, Chief Executive Officer and Director    |
|                |   | (Principal Executive Officer)                     |
|                |   |                                              |
| Dated May 15,  2007 |   | /s/ EUGENE K. ROWEHL                              |
|                |   | Eugene K. Rowehl                                  |
|                |   | Senior Vice President and Chief Financial Officer |
|                |   | (Principal Financial Officer)                     |

 

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# **EXHIBITINDEX**

| Exhibit  Number | ** ** | **Description**                                                                                                   |
|-----------------|------------|-------------------------------------------------------------------------------------------------------------------|
| 31.1            |       | Rule 13a-14(a) / 15d-14(a) Certification of David K.  Hill, Chairman, Chief Executive Officer and Director.       |
|            |       |                                                                                                              |
| 31.2            |       | Rule 13a-14(a) / 15d-14(a) Certification of Eugene  K. Rowehl, Senior Vice President and Chief Financial Officer. |
|            |       |                                                                                                              |
| 32.1            |       | Section 1350 Certification of David K. Hill,  Chairman, Chief Executive Officer and Director.                     |
|            |       |                                                                                                              |
| 32.2            |       | Section 1350 Certification of Eugene K. Rowehl,  Senior Vice President and Chief Financial Officer.               |

 

47

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