**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** |

 

**Forthe quarterly period ended December 31, 2006**

**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.**

(Exactname of Registrant as specified in its charter)
|                                                                                                         |   |                                                |
|--------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------|
| **Illinois**(State or other jurisdiction

 of incorporation or  organization)                           |   | **36-2177380**(I.R.S. Employer

Identification No.) |
|                                                                                                         |   |                                                |
| **5999  New Wilke Road, Suite 504  Rolling Meadows, Illinois**(Address of principal executive  offices) |   | **60008**(Zip code)                                 |

 

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

**NotApplicable**(Former name, former address andformer fiscal year, if changed since last 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 February 9, 2007,there were 4,549,712 shares of common stock outstanding.
| ** ** |
|------------|

 

 

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**KIMBALLHILL, INC. AND SUBSIDIARIESFORM 10-Q**

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

 

2

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**PART I—FINANCIAL INFORMATION**

**Item 1.  Financial Statements.**

**Kimball Hill, Inc. and Subsidiaries**

**Unaudited CondensedConsolidated Balance Sheets**
| ** **                                                                                                                                          | ** ** | **December 31,** | ** ** | **September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|------------------------|------------|
| **(in thousands, except shares)**                                                                                                    | ** ** | **2006**              | ** ** | **2006**               | ** ** |
| **Assets**                                                                                                                                          |       |                  |       |                   |       |
| HOMEBUILDING:                                                                                                                                       |       |                  |       |                   |       |
| Cash and cash  equivalents                                                                                                                          |       | $                     | 11,136     |                   | $          | 16,042 |   |
| Receivables                                                                                                                                         |       | 21,960                |       | 35,323                 |       |
| Income taxes  receivable                                                                                                                            |       | 2,428                 |       |                   |       |
| Inventory                                                                                                                                           |       | 827,660               |       | 899,297                |       |
| Inventory not  owned                                                                                                                                |       | 50,154                |       | 37,821                 |       |
| Deferred  expenses and other assets                                                                                                                 |       | 21,251                |       | 19,229                 |       |
| Investments in  and advances to unconsolidated entities                                                                                             |       | 53,399                |       | 48,238                 |       |
| Deferred income  taxes                                                                                                                              |       | 28,864                |       | 14,133                 |       |
| Property and  equipment, net of accumulated depreciation                                                                                            |       | 10,899                |       | 10,635                 |       |
|                                                                                                                                                |       | 1,027,751             |       | 1,080,718              |       |
| MORTGAGE BANKING:                                                                                                                                   |       |                  |       |                   |       |
| Cash and cash  equivalents                                                                                                                          |       | 1,710                 |       | 2,623                  |       |
| Trade accounts  receivable                                                                                                                          |       | 2,464                 |       | 2,319                  |       |
| Mortgage loans  held for sale                                                                                                                       |       | 4,314                 |       | 5,663                  |       |
| Property and  equipment, net of accumulated depreciation                                                                                            |       | 239                   |       | 254                    |       |
|                                                                                                                                                |       | 8,727                 |       | 10,859                 |       |
| TOTAL ASSETS                                                                                                                                        |       | $                     | 1,036,478  |                   | $          | 1,091,577 |   |
| **Liabilities and equity**                                                                                                                          |       |                  |       |                   |       |
| HOMEBUILDING:                                                                                                                                       |       |                  |       |                   |       |
| Accounts payable  and accrued expenses                                                                                                              |       | $                     | 73,380     |                   | $          | 106,779 |   |
| Deposits on  sales of residential units                                                                                                             |       | 5,976                 |       | 6,333                  |       |
| Liabilities  related to inventory not owned                                                                                                         |       | 15,530                |       | 5,015                  |       |
| Income taxes  payable                                                                                                                               |       |                  |       | 3,702                  |       |
| Notes payable                                                                                                                                       |       | 489,951               |       | 500,208                |       |
|                                                                                                                                                |       | 584,837               |       | 622,037                |       |
| MORTGAGE BANKING:                                                                                                                                   |       |                  |       |                   |       |
| Accounts payable  and accrued expenses                                                                                                              |       | 595                   |       | 927                    |       |
| Other  liabilities                                                                                                                                  |       | 120                   |       | 196                    |       |
|                                                                                                                                                |       | 715                   |       | 1,123                  |       |
| Total  liabilities                                                                                                                                  |       | 585,552               |       | 623,160                |       |
|                                                                                                                                                |       |                  |       |                   |       |
| MINORITY INTEREST IN  CONSOLIDATED PARTNERSHIPS                                                                                                     |       | 46,320                |       | 43,244                 |       |
| MINORITY INTEREST IN  INVENTORY NOT OWNED                                                                                                           |       | 31,721                |       | 31,721                 |       |
|                                                                                                                                                |       |                  |       |                   |       |
| REDEEMABLE EQUITY:                                                                                                                                  |       |                  |       |                   |       |
| Redeemable  common stock, no par value; shares outstanding:   233,002 at December 31, 2006 and 228,002 at September 30, 2006                        |       | 21,483                |       | 26,334                 |       |
| SHAREHOLDERS’ EQUITY:                                                                                                                          |       |                  |       |                   |       |
| Common stock, no  par value; 10,000,000 shares authorized; shares outstanding:   4,316,859 at December 31, 2006 and 4,316,878 at September 30, 2006 |       | 111,668               |       | 111,305                |       |
| Retained  earnings                                                                                                                                  |       | 239,734               |       | 255,813                |       |
| Total  shareholders’ equity                                                                                                                    |       | 351,402               |       | 367,118                |       |
| TOTAL LIABILITIES AND EQUITY                                                                                                                        |       | $                     | 1,036,478  |                   | $          | 1,091,577 |   |
|                                                                                                                                                |       |                  |       |                   |       |

 

***See notes to unaudited condensed consolidated financial statements.***

3

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**Kimball Hill, Inc. and Subsidiaries**

## **Unaudited CondensedConsolidated Statements of Operations**

| **For the three months ended December 31, 2006 and 2005 (in thousands)** | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| HOMEBUILDING:                                                                                                                   |       |     |       |     |       |
| Revenues:                                                                                                                       |       |     |       |     |       |
| Sales of residential units and land                                                                                             |       | $        | 238,412    |     | $          | 221,028 |   |
| Rental and other income                                                                                                         |       | 417      |       | 1,518    |       |
| Total homebuilding revenues                                                                                                     |       | 238,829  |       | 222,546  |       |
| Expenses:                                                                                                                       |       |     |       |     |       |
| Cost of sales of residential units and land                                                                                     |       | 243,151  |       | 167,299  |       |
| General and administrative                                                                                                      |       | 16,626   |       | 20,494   |       |
| Sales and marketing                                                                                                             |       | 13,834   |       | 10,183   |       |
| Depreciation                                                                                                                    |       | 254      |       | 178      |       |
| Total homebuilding expenses                                                                                                     |       | 273,865  |       | 198,154  |       |
| Equity in income of unconsolidated joint ventures                                                                               |       | 500      |       | 157      |       |
| Minority interests in net earnings of consolidated  partnerships                                                                |       | (76      | )          | (359     | )          |
| Homebuilding (loss) earnings before income taxes                                                                                |       | (34,612  | )          | 24,190   |       |
| MORTGAGE  BANKING:                                                                                                              |       |     |       |     |       |
| Revenues:                                                                                                                       |       |     |       |     |       |
| Gain on sales of mortgage loans                                                                                                 |       | 1,742    |       | 1,369    |       |
| Interest income                                                                                                                 |       |     |       | 5        |       |
| Total mortgage banking revenues                                                                                                 |       | 1,742    |       | 1,374    |       |
| Expenses:                                                                                                                       |       |     |       |     |       |
| General and administrative                                                                                                      |       | 1,204    |       | 1,127    |       |
| Interest expense                                                                                                                |       |     |       | 4        |       |
| Depreciation                                                                                                                    |       | 22       |       | 28       |       |
| Total mortgage banking expenses                                                                                                 |       | 1,226    |       | 1,159    |       |
| Mortgage banking earnings before income taxes                                                                                   |       | 516      |       | 215      |       |
| (LOSS) EARNINGS  BEFORE INCOME TAXES                                                                                            |       | (34,096  | )          | 24,405   |       |
| (BENEFIT)  PROVISION FOR INCOME TAXES                                                                                           |       | (13,127  | )          | 8,858    |       |
| NET (LOSS)  EARNINGS                                                                                                            |       | $        | (20,969    | )        | $          | 15,547 |   |
|                                                                                                                            |       |     |       |     |       |

 

*See notes to unaudited condensed consolidatedfinancial statements.*

4

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**Kimball Hill, Inc. and Subsidiaries**

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

| **For the three months ended December 31, 2006 and 2005 (in thousands)**   | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| **Cash  flows from operating activities:**                                                                                        |       |     |       |     |       |
| Net (loss) earnings                                                                                                               |       | $        | (20,969    | )        | $          | 15,547 |   |
| Adjustments to reconcile net (loss) earnings to cash  flows from operating activities:                                            |       |     |       |     |       |
| Depreciation                                                                                                                      |       | 276      |       | 206      |       |
| Inventory valuation adjustments                                                                                                   |       | 39,988   |       |     |       |
| Write-off of land option costs                                                                                                    |       | 469      |       |     |       |
| Amortization of deferred expenses                                                                                                 |       | 1,407    |       | 1,333    |       |
| Unrealized loss on derivatives                                                                                                    |       | 33       |       |     |       |
| Equity-based compensation                                                                                                         |       | 205      |       | 205      |       |
| Distributions of income from investments in  unconsolidated entities                                                              |       | 195      |       | 157      |       |
| Net earnings from investments in unconsolidated  entities                                                                         |       | (500     | )          | (157     | )          |
| Minority interest in consolidated earnings                                                                                        |       | 76       |       | 359      |       |
| Deferred income taxes                                                                                                             |       | (14,731  | )          | (1,078   | )          |
| Changes in operating assets and liabilities:                                                                                      |       |     |       |     |       |
| Receivables                                                                                                                       |       | 13,218   |       | 526      |       |
| Mortgage loans held for sale                                                                                                      |       | 1,349    |       | 204      |       |
| Inventory                                                                                                                         |       | 29,882   |       | (60,115  | )          |
| Deferred expenses and other assets                                                                                                |       | (3,067   | )          | (11,305  | )          |
| Accounts payable and accrued expenses                                                                                             |       | (33,731  | )          | (17,105  | )          |
| Deposits and other liabilities                                                                                                    |       | (433     | )          | (1,693   | )          |
| Income taxes, net                                                                                                                 |       | (5,970   | )          | (13,156  | )          |
| Net cash provided by (used in) operating activities                                                                               |       | 7,697    |       | (86,072  | )          |
|                                                                                                                              |       |     |       |     |       |
| **Cash  flows from investing activities:**                                                                                        |       |     |       |     |       |
| Purchases of property and equipment                                                                                               |       | (525     | )          | (34      | )          |
| Disposals of property and equipment                                                                                               |       |     |       | 858      |       |
| Contributions and advances to investments in  unconsolidated entities                                                             |       | (4,856   | )          | (772     | )          |
| Net cash (used in) provided by investing activities                                                                               |       | (5,381   | )          | 52       |       |
|                                                                                                                              |       |     |       |     |       |
| **Cash  flows from financing activitie**s:                                                                                        |       |     |       |     |       |
| Proceeds from issuance of notes and mortgage loans  payable                                                                       |       | 74,474   |       | 873,476  |       |
| Repayments of notes and mortgage loans payable                                                                                    |       | (84,796  | )          | (775,631 | )          |
| Debt issuance costs                                                                                                               |       | (850     | )          |     |       |
| Net proceeds from issuance of common stock                                                                                        |       | 39       |       | 702      |       |
| Repurchases of common stock                                                                                                       |       | (2       | )          | (179     | )          |
| Contributions from minority interests                                                                                             |       | 3,000    |       |     |       |
| Distributions to minority interests                                                                                               |       |     |       | (1,493   | )          |
| Net cash (used in) provided by financing activities                                                                               |       | (8,135   | )          | 96,875   |       |
| **Net  (decrease) increase in cash and cash equivalents**                                                                         |       | (5,819   | )          | 10,855   |       |
| Cash and cash  equivalents—Beginning of period                                                                               |       | 18,665   |       | 21,460   |       |
| Cash and cash  equivalents—End of period                                                                                     |       | $        | 12,846     |     | $          | 32,315 |   |
|                                                                                                                              |       |     |       |     |       |
| **Reconciliation to cash and cash equivalents  reported on the condensed       consolidated balance sheets:** |       |     |       |     |       |
| Homebuilding                                                                                                                      |       | $        | 11,136     |     |       |   |
| Mortgage banking                                                                                                                  |       | 1,710    |       |     |       |
| Total                                                                                                                             |       | $        | 12,846     |     |       |   |
|                                                                                                                              |       |     |       |     |       |
| **Supplemental  disclosure of cash flow information:**                                                                            |       |     |       |     |       |
| Cash paid for interest                                                                                                            |       | $        | 17,296     |     | $          | 14,436 |   |
| Cash paid for income taxes                                                                                                        |       | $        | 7,574      |     | $          | 23,092 |   |
| **Supplemental  disclosure of noncash investing and financing activities:**                                                       |       |     |       |     |       |
| Increase  (decrease) in liabilities related to inventory not owned                                                                |       | $        | 10,515     |     | $          | (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 period ended December 31, 2006 is notnecessarily indicative of the results that may be expected for the fiscal yearending 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 ended December 31, 2006 and 2005, compensation cost of $0.2million related to deferred stock units is included in the Company’s condensedconsolidated statements of operations.

***Redeemable CommonStock—***Under the terms of the Company’s amended stockoption plans, the Company has contractual obligations to purchase shares of itsoutstanding common stock 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, termination, retirement or resignation. 

 

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

Based upon the most recent independent valuation ofthe Company as of December 31, 2006, the fair value of redeemable common stockwas valued at $92.20 per share.

***DerivativeFinancial Instruments—***The Company uses best-efforts andmandatory sales commitments to hedge 100% of its mortgage loans held for salefrom an unexpected 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 fair valuewith the changes in fair value recorded to current earnings.

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

**2.  Inventory**

Inventoryconsists of the following:
| ** **                                             | ** ** | **December 31,** | ** ** | **September 30,** | ** ** |
|--------------------------------------------------------|------------|-----------------------|------------|------------------------|------------|
| **(in thousands)**                                | ** ** | **2006**              | ** ** | **2006**               | ** ** |
| Residential  lots—developed and under development |       | $                     | 545,681    |                   | $          | 581,701 |   |
| Finished homes  and construction in progress           |       | 212,483               |       | 262,392                |       |
| Deposits on land  purchases                            |       | 13,792                |       | 15,499                 |       |
| Land held for  future development or sale              |       | 55,704                |       | 39,705                 |       |
| Total                                                  |       | $                     | 827,660    |                   | $          | 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 current change in market conditions, the nationalhomebuilding 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 an inventoryimpairment charge of $40 million during the three months endedDecember 31, 2006. This charge is included in cost of sales in the accompanyingcondensed consolidated statements of operations. The Company did not record anyinventory impairment charges during the three months ended December 31,2005.

For purposes of measuringimpairment, SFAS 144 distinguishes between long-lived assets held for saleand long-lived assets to be held and used. Long-lived assets held for saleshould be reported at the lower of the carrying amount or fair value, lesscosts to sell the assets. Long-lived assets to be held and used with a carryingvalue that will not be recoverable from future undiscounted cash flows shouldbe reported 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 December 31, 2006, theCompany has $52.5 million of land inventory that is held for sale. Forpurposes of these impairment calculations, the Company determined the fairvalue of each asset held for sale by using internal project modeling softwareto determine the present value of the estimated future cash flows on acommunity-

7

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by-community basis usingdiscount rates which are commensurate with the risk of the community andcomparing to recent comparable land sales and ongoing discussions with landbrokers and potential buyers. The Company recorded an impairment charge of $19.3 millionon land held for sale.

For purposes ofimpairment calculations on assets to be held and used, the Company determinedthe fair value of each asset to be held and used by using internal projectmodeling software to determine the present value of the estimated future cashflows on a community-by-community basis using discount rates which arecommensurate with the risk of the community and by comparing to recentcomparable land sales. The Company recorded an impairment charge of$20.7 million on housing projects where the Company intends to constructand sell homes.

The largest homebuilding project reviewed is in theMidwest region where the Company is developing land and currently intends toconstruct and sell approximately 1,100 homes over the next 6 years. Inaddition, the Company is obligated to purchase additional land in this project,on which it intends to construct and sell an additional 1,500 homes, forapproximately $42 million at various dates beginning in June 2009. Due to theproject’s overall size, timeline and complexity and the Company’s limitedexperience to date, its estimates of future recoverability are sensitive tomanagement’s judgments and expectations of future market conditions. Theproject’s total inventory balance was approximately $87 million at December 31,2006.

These evaluations for impairment are significantlyimpacted by estimates of revenues, costs and expenses and other factors. TheCompany will continue to monitor the homebuilding climate in each of itsmarkets and could change its intentions about whether to continue homebuildingactivities related to any assets in the future. Changes in the Company’sintentions or its expectations of market performance could have a materialimpact on the carrying value of its assets as certain of the assets determinedto be recoverable on an undiscounted cash flow basis may have carrying valuesgreater than fair value.

The Company capitalizesinterest during development and construction. Capitalized interest is chargedto cost of sales as residential units are closed. Interest costs for the threemonths ended December 31, 2006 and 2005 are as follows:
| **(in thousands)**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------------------|------------|----------|------------|----------|------------|
| Capitalized  interest—beginning of period |       | $        | 59,409     |     | $          | 40,076 |   |
| Interest  incurred                             |       | 11,827   |       | 11,183   |       |
| Interest  included in cost of sales            |       | (8,771   |       | (5,046   | )          |
| Capitalized  interest—end of period       |       | $        | 62,465     |     | $          | 46,213 |   |
|                                           |       |     |       |     |       |

 

**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 receiveexpected residual returns of the entity, if they occur. FIN 46R requires theconsolidation of VIEs in which an enterprise absorbs a majority of the entity’sexpected losses, receives a majority of the entity’s expected residual returns,or both, as a result of ownership, contractual or other financial interests inthe entity.

The Company has applied,as required, FIN 46R to 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.

8

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At December 31, 2006, theCompany has consolidated optioned land with an initial fair value of $50.2million for which it paid cash option deposits of $2.9 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 partners generally are unrelated homebuilders, land sellers or otherreal 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$53.4 million and $48.2 million at December 31, 2006 and September30, 2006, respectively. These joint ventures typically obtain securedacquisition, development and construction financing. At December 31, 2006 andSeptember 30, 2006, the Company’s unconsolidated joint ventures hadoutstanding third party borrowings of $922 million and $865 million,respectively. From time to time the Company has issued repayment guaranteesand/or loan-to-value maintenance guarantees in respect of this indebtedness.These guarantees require the Company to repay debt of the joint venture in theevent of a payment default or in the event that the debt of the joint ventureexceeds the value of the property securing the debt. At December 31, 2006and September 30, 2006, the Company had guarantees of $91.3 millionand $74.3 million, respectively, related to the outstanding indebtednessof these joint ventures.

**5.  Financing**

***Homebuilding***

The Company’s notes payable consist of the following:
| ** **                                               | ** ** | **December 31,** | ** ** | **September 30,** | ** ** |
|----------------------------------------------------------|------------|-----------------------|------------|------------------------|------------|
| **(in thousands)**                                  | ** ** | **2006**              | ** ** | **2006**               | ** ** |
| Senior subordinated  notes (net of unamortized discount) |       | $                     | 200,814    |                   | $          | 200,750 |   |
| Senior unsecured  credit facility                        |       | 249,947               |       | 244,947                |       |
| Other senior  secured credit facilities                  |       | 39,190                |       | 54,511                 |       |
| Total                                                    |       | $                     | 489,951    |                   | $          | 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 

9

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amount, plus a 5.25%premium declining ratably to par on December 15, 2011, plus accrued and unpaidinterest. In addition, at any time prior to December 15, 2008, the Company mayredeem up to 35% of the aggregate principal amount of the notes with theproceeds of qualified equity offerings at a redemption price equal to 110.5% ofthe principal amount, plus accrued and unpaid interest. The notes are unsecuredsenior subordinated obligations and subordinated in right of payment to all ofthe Company’s existing and future senior debt, including borrowings under theCompany’s senior unsecured credit facility. All of the Company’s wholly ownedsubsidiaries, other than the Company’s mortgage subsidiary, have fully andunconditionally guaranteed the notes on a joint and several, unsecured seniorsubordinated, basis. The guarantees are general unsecured obligations of theguarantors and will be subordinated in right of payment to all existing andfuture senior debt of the guarantors, which includes their guarantees of theCompany’s senior unsecured credit facility. The indenture governing the seniorsubordinated notes contains a number of significant covenants that could restrictthe Company’s ability and that of its restricted subsidiaries to, among otherthings: incur additional indebtedness, make certain distributions, investmentsand other restricted payments, create certain liens, enter into transactionswith affiliates, and merge, consolidate or sell substantially all of theCompany’s assets. As of December 31, 2006, the Company was restricted fromincurring additional indebtedness (excluding available borrowings under thesenior unsecured credit facility), except under certain limited 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 assublimits of $100 million for the issuance of letters of credit and $10 millionfor swing line loans. The Company has the right, without the consent of itslenders (other than those participating in the increase), to increase thecommitment by an amount of up to $200 million, provided that no such increaseshall cause the senior unsecured credit facility to exceed $700 million. Theapplicable borrowing base will be determined regularly throughout the life ofthe facility. The composition of the borrowing base will be limited toparameters set forth in the 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 the Company’s seniorleverage ratio, which is defined as the ratio of total liabilities toconsolidated net worth. Fees for letters of credit are based on LIBOR plus amargin of 1.5%. An unused commitment fee equal to 0.2% to 0.3% per year accrueson the undrawn portion of the facility and is payable quarterly in arrears. Asof December 31, 2006, the Company had $250 million of borrowings under thecredit facility at an effective rate of 7.34% and, after giving effect to theborrowing base limitation, had additional availability of $248 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.

Given the current marketconditions and the deterioration of profitability, the Company believed thatmaintaining its original debt covenants would become difficult. Therefore, onDecember 15, 2006, the Company amended certain covenants in its $500 millionsenior unsecured revolving credit facility. The amended covenants require theCompany to: maintain a minimum tangible net worth of at least $300 million plus50% of positive net income earned subsequent to September 30, 2006; maintain aratio of total liabilities to adjusted tangible net worth not to exceed 2.0x(decreasing to 1.75x as of June 30, 2007 and increasing to 2.5x as of December31, 2008); maintain a ratio of total debt to adjusted tangible net worth not toexceed 1.5x; maintain a ratio of total land (including undeveloped land, landunder development and finished lots on which home construction has yet tobegin) to adjusted tangible net worth not to exceed 1.5x; and maintain aninterest coverage ratio of no less than 1.75x through December 31, 2006(decreasing to 1.5x through March 31, 2007, decreasing to 1.4x through June 30,2007, decreasing to 1.35x through September 30, 2007, increasing to 1.5xthrough December 31, 2007, increasing to 1.75x through March 31, 2008 and thenincreasing to 2.25x through the remaining term of the facility). For purposesof these tests, adjusted tangible net worth 

10

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is benefited byadjustments of 50% of the Company’s outstanding senior subordinated debt (up toa maximum $100 million adjustment) and 100% of minority interests inconsolidated entities (up to a maximum $50 million adjustment). As of andduring the three months ended December 31, 2006, the Company was in compliancewith the covenants of this 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 December 31, 2006, theCompany has rights, under such agreements, to purchase approximately 9,900lots, within 50 separate developments, with an aggregate contract price of$437 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 andthe remaining $42 million at various dates beginning in June 2009.Approximately 2,200 of the lots, with an aggregate purchase price of $169 million,are to be purchased from joint ventures in which the Company has an investmentbalance of $39 million as of December 31, 2006. This investment is recorded ininvestments in and advances to unconsolidated entities on the condensedconsolidated balance sheets.

At December 31, 2006,excluding inventory not owned (see note 3), the Company was contingently liableto banks and financial institutions for approximately $52 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, termination, retirement or resignation. As of December 31,2006, the aggregate repurchase obligation, net of proceeds to be received fromany stock option exercises, would have been approximately $33.5 million in theevent that all of these obligations were triggered.

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 months ended December 31, 2006 and 2005 are asfollows:
| **(in thousands)**            | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------|------------|----------|------------|----------|------------|
| Balance at  beginning of period    |       | $        | 5,798      |     | $          | 5,844 |   |
| Warranties  issued                 |       | 964      |       | 1,584    |       |
| Settlements and  other adjustments |       | (1,355   | )          | (1,334   | )          |
| Balance at end of  period          |       | $        | 5,407      |     | $          | 6,094 |   |
|                               |       |     |       |     |       |

 

At December 31, 2006, theCompany was committed to fund approximately $15.8 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.

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**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 banking segmentoriginates mortgages, which are sold to third parties.

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 Company’s condensed consolidated financial statements.

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| **Revenues (in  thousands)   For the three months ended December 31:** | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Florida                                                                               |       | $        | 23,941     |     | $          | 22,210 |   |
| Midwest                                                                               |       | 46,122   |       | 42,520   |       |
| Nevada                                                                                |       | 55,030   |       | 33,689   |       |
| Pacific Coast                                                                         |       | 39,269   |       | 66,315   |       |
| Texas                                                                                 |       | 69,916   |       | 56,614   |       |
| Mortgage banking                                                                      |       | 1,742    |       | 1,374    |       |
| Segment revenue  subtotal                                                             |       | 236,020  |       | 222,722  |       |
| Corporate and  unallocated (a)                                                        |       | 177      |       | 1,198    |       |
| GAAP adjustment(b)                                                                    |       | 4,374    |       |     |       |
| Consolidated revenues                                                                 |       | $        | 240,571    |     | $          | 223,920 |   |
|                                                                                  |       |     |       |     |       |

(a)      Corporate and unallocated includes rental and other income where the assetwas held in the Company’s corporate department rather than one of the Company’soperating segments.

(b)     The GAAP adjustment is for certain closing costs andbrokers commissions that are included in revenue in the Company’s internalmeasurement system that are reported as expenses in accordance with GAAP. 
| **(Loss) Earnings Before Income Taxes (in thousands)  For the three months ended December 31:** | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Florida                                                                                                                                                     |       | $        | (7,385     | )        | $          | 107 |   |
| Midwest                                                                                                                                                     |       | (11,530  | )          | 817      |       |
| Nevada                                                                                                                                                      |       | 19,662   |       | 11,403   |       |
| Pacific Coast                                                                                                                                               |       | (16,261  | )          | 21,929   |       |
| Texas                                                                                                                                                       |       | (241     | )          | 2,002    |       |
| Mortgage banking                                                                                                                                            |       | 516      |       | 215      |       |
| Segment (loss)  earnings before income taxes subtotal                                                                                                       |       | (15,239  | )          | 36,473   |       |
| Corporate and  unallocated                                                                                                                                  |       | (7,717   | )          | (10,955  | )          |
|                                                                                                                                                        |       | (22,956  | )          | 25,518   |       |
| Homebuilding  interest expense                                                                                                                              |       | (8,771   | )          | (5,046   | )          |
| GAAP adjustment(c)                                                                                                                                          |       | (2,369   | )          | 3,933    |       |
| Consolidated (loss)  earnings before income taxes                                                                                                           |       | $        | (34,096    | )        | $          | 24,405 |   |
|                                                                                                                                                        |       |     |       |     |       |

(c)      Included in the GAAP adjustment is (a) timing differences for certaincapitalizable indirect construction costs that are expensed as incurred in theCompany’s internal measurement system and (b)minority interest expense which is not included in the Company’s internalmeasurement system.
| ** **                          | ** ** | **December 31,** | ** ** | **September 30,** | ** ** |
|-------------------------------------|------------|------------------|------------|-------------------|------------|
| **Assets (in thousands)** | ** ** | **2006**         | ** ** | **2006**          | ** ** |
| Florida                             |       | $                | 80,988     |              | $          | 91,226 |   |
| Midwest                             |       | 250,286          |       | 267,519           |       |
| Nevada                              |       | 214,950          |       | 224,331           |       |
| Pacific Coast                       |       | 159,194          |       | 181,289           |       |
| Texas                               |       | 177,274          |       | 197,604           |       |
| Mortgage banking                    |       | 8,727            |       | 10,859            |       |
| Segment assets  subtotal            |       | 891,419          |       | 972,828           |       |
| Corporate and  unallocated          |       | 145,059          |       | 118,749           |       |
| Consolidated assets                 |       | $                | 1,036,478  |              | $          | 1,091,577 |   |
|                                |       |             |       |              |       |

 

** **

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**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 shouldbe considered when quantifying misstatements in the current financialstatements. SAB 108 was issued in order to eliminate the diversity of practicesurrounding how public companies quantify financial statement misstatements.SAB 108 will require the Company to quantify misstatements using both a balancesheet and income statement approach, with adjustment required if either methodresults in a material error. SAB 108 is effective for financial statementsissued for fiscal years beginning after November 15, 2006. The Company is inthe process of determining the effect, if any, the adoption of SAB 108 willhave 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 December 31, 2006  (in thousands)** | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                                           |       |       |       |                        |       |                            |       |             |       |             |       |
| HOMEBUILDING:                                                        |       |       |       |                        |       |                            |       |             |       |             |       |
| Cash and cash equivalents                                            |       | $          | 2,611      |                        | $          | 8,476                           |       | $                | 49         |             | $          | — |   | $ | 11,136 |   |
| Receivables                                                          |       |       |       | 20,489                      |       | 1,471                           |       |             |       | 21,960           |       |
| Income taxes receivable                                              |       | 2,428      |       |                        |       |                            |       |             |       | 2,428            |       |
| Inventory                                                            |       |       |       | 641,062                     |       | 186,598                         |       |             |       | 827,660          |       |
| Inventory not owned                                                  |       |       |       | 50,154                      |       |                            |       |             |       | 50,154           |       |
| Deferred expenses and other assets                                   |       | 9,136      |       | 11,747                      |       | 368                             |       |             |       | 21,251           |       |
| Investments in and advances to unconsolidated entities               |       |       |       | 53,399                      |       |                            |       |             |       | 53,399           |       |
| Deferred income taxes                                                |       | 28,864     |       |                        |       |                            |       |             |       | 28,864           |       |
| Property and equipment, net of accumulated  depreciation             |       | 8,481      |       | 2,418                       |       |                            |       |             |       | 10,899           |       |
| Investments in subsidiaries                                          |       | 286,136    |       | 21,270                      |       |                            |       | (307,406         | )          |             |       |
|                                                                 |       | 337,656    |       | 809,015                     |       | 188,486                         |       | (307,406         | )          | 1,027,751        |       |
| MORTGAGE BANKING                                                     |       |       |       |                        |       | 8,727                           |       |             |       | 8,727            |       |
| TOTAL ASSETS                                                         |       | $          | 337,656    |                        | $          | 809,015                         |       | $                | 197,213    |             | $          | (307,406 | ) | $ | 1,036,478 |   |
| **Liabilities  and equity**                                          |       |       |       |                        |       |                            |       |             |       |             |       |
| HOMEBUILDING:                                                        |       |       |       |                        |       |                            |       |             |       |             |       |
| Accounts payable and accrued expenses                                |       | $          | 183        |                        | $          | 72,782                          |       | $                | 415        |             | $          | — |   | $ | 73,380 |   |
| Deposits on sales of residential units                               |       |       |       | 5,837                       |       | 139                             |       |             |       | 5,976            |       |
| Liabilities related to inventory not owned                           |       |       |       | 15,530                      |       |                            |       |             |       | 15,530           |       |
| Notes payable                                                        |       | 459,703    |       |                        |       | 30,248                          |       |             |       | 489,951          |       |
| Intercompany                                                         |       | (495,115   | )          | 400,678                     |       | 94,437                          |       |             |       |             |       |
|                                                                 |       | (35,229    | )          | 494,827                     |       | 125,239                         |       |             |       | 584,837          |       |
| MORTGAGE BANKING                                                     |       |       |       |                        |       | 715                             |       |             |       | 715              |       |
| Total liabilities                                                    |       | (35,229    | )          | 494,827                     |       | 125,954                         |       |             |       | 585,552          |       |
|                                                                 |       |       |       |                        |       |                            |       |             |       |             |       |
| MINORITY  INTEREST IN CONSOLIDATED PARTNERSHIPS                      |       |       |       |                        |       | 46,903                          |       | (583)            |       | 46,320           |       |
| MINORITY  INTEREST IN INVENTORY NOT OWNED                            |       |       |       | 31,721                      |       |                            |       |             |       | 31,721           |       |
|                                                                 |       |       |       |                        |       |                            |       |             |       |             |       |
| REDEEMABLE  EQUITY                                                   |       | 21,483     |       |                        |       |                            |       |             |       | 21,483           |       |
| SHAREHOLDERS’  EQUITY                                           |       | 351,402    |       | 282,467                     |       | 24,356                          |       | (306,823         | )          | 351,402          |       |
| TOTAL  LIABILITIES AND EQUITY                                        |       | $          | 337,656    |                        | $          | 809,015                         |       | $                | 197,213    |             | $          | (307,406 | ) | $ | 1,036,478 |   |
|                                                                 |       |       |       |                        |       |                            |       |             |       |             |       |

 

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

 

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| **For the three months ended  December 31, 2006 (in thousands)** | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| HOMEBUILDING:                                                                                            |       |       |       |                        |       |                            |       |             |       |             |       |
| Revenues:                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |
| Sales of residential units and land                                                                      |       | $          | —     |                        | $          | 231,493                         |       | $                | 6,919      |             | $          | — |   | $ | 238,412 |   |
| Rental and other income                                                                                  |       | 36         |       | 380                         |       | 1                               |       |             |       | 417              |       |
| Total homebuilding revenues                                                                              |       | 36         |       | 231,873                     |       | 6,920                           |       |             |       | 238,829          |       |
| Expenses:                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |
| Cost of sales of residential units and land                                                              |       |       |       | 232,813                     |       | 10,338                          |       |             |       | 243,151          |       |
| General and administrative                                                                               |       | 6,003      |       | 10,590                      |       | 33                              |       |             |       | 16,626           |       |
| Sales and marketing                                                                                      |       |       |       | 13,351                      |       | 483                             |       |             |       | 13,834           |       |
| Depreciation                                                                                             |       | 62         |       | 192                         |       |                            |       |             |       | 254              |       |
| Total homebuilding expenses                                                                              |       | 6,065      |       | 256,946                     |       | 10,854                          |       |             |       | 273,865          |       |
| Intercompany charge                                                                                      |       | 6,029      |       | (6,029                      | )          |                            |       |             |       |             |       |
| Equity in income of unconsolidated joint ventures                                                        |       |       |       | 500                         |       |                            |       |             |       | 500              |       |
| Minority interests in net earnings of consolidated  partnerships                                         |       |       |       |                        |       | (76                             | )          |             |       | (76              | )          |
| Homebuilding loss before income taxes                                                                    |       | —     |       | (30,602                     | )          | (4,010                          | )          |             |       | (34,612          | )          |
| MORTGAGE  BANKING:                                                                                       |       |       |       |                        |       |                            |       |             |       |             |       |
| Revenues:                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |
| Gain on sales of mortgage loans                                                                          |       |       |       |                        |       | 1,742                           |       |             |       | 1,742            |       |
| Total mortgage banking revenues                                                                          |       |       |       |                        |       | 1,742                           |       |             |       | 1,742            |       |
| Expenses:                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |
| General and administrative                                                                               |       |       |       |                        |       | 1,204                           |       |             |       | 1,204            |       |
| Depreciation                                                                                             |       |       |       |                        |       | 22                              |       |             |       | 22               |       |
| Total mortgage banking expenses                                                                          |       |       |       |                        |       | 1,226                           |       |             |       | 1,226            |       |
| Mortgage banking earnings before income taxes                                                            |       |       |       |                        |       | 516                             |       |             |       | 516              |       |
| EQUITY IN LOSS  OF CONSOLIDATED SUBSIDIARIES                                                             |       | (34,096    | )          | (4,010                      | )          |                            |       | 38,106           |       |             |       |
| LOSS BEFORE  INCOME TAXES                                                                                |       | (34,096    | )          | (34,612                     | )          | (3,494                          | )          | 38,106           |       | (34,096          | )          |
| BENEFIT FOR  INCOME TAXES                                                                                |       | (13,127    | )          | (13,326                     | )          | (1,345                          | )          | 14,671           |       | (13,127          | )          |
| NET LOSS                                                                                                 |       | $          | (20,969    | )                           | $          | (21,286                         | )          | $                | (2,149     | )                | $          | 23,435 |   | $ | (20,969 | ) |
|                                                                                                     |       |       |       |                        |       |                            |       |             |       |             |       |

 

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| **For the three months ended  December 31, 2005 (in thousands)** | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| HOMEBUILDING:                                                                                            |       |       |       |                        |       |                            |       |             |       |             |       |
| Revenues:                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |
| Sales of residential units and land                                                                      |       | $          | —     |                        | $          | 218,512                         |       | $                | 2,516      |             | $          | — |   | $ | 221,028 |   |
| Rental and other income                                                                                  |       | 60         |       | 766                         |       | 692                             |       |             |       | 1,518            |       |
| Total homebuilding revenues                                                                              |       | 60         |       | 219,278                     |       | 3,208                           |       |             |       | 222,546          |       |
| Expenses:                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |
| Cost of sales of residential units and land                                                              |       |       |       | 165,260                     |       | 2,039                           |       |             |       | 167,299          |       |
| General and administrative                                                                               |       | 8,045      |       | 12,418                      |       | 31                              |       |             |       | 20,494           |       |
| Sales and marketing                                                                                      |       |       |       | 10,021                      |       | 162                             |       |             |       | 10,183           |       |
| Depreciation                                                                                             |       | 26         |       | 152                         |       |                            |       |             |       | 178              |       |
| Total homebuilding expenses                                                                              |       | 8,071      |       | 187,851                     |       | 2,232                           |       |             |       | 198,154          |       |
| Intercompany charge                                                                                      |       | 8,011      |       | (8,011                      | )          |                            |       |             |       |             |       |
| Equity in income of unconsolidated joint ventures                                                        |       |       |       | 157                         |       |                            |       |             |       | 157              |       |
| Minority interests in net earnings of consolidated  partnerships                                         |       |       |       |                        |       | (359                            | )          |             |       | (359             | )          |
| Homebuilding earnings before income taxes                                                                |       | —     |       | 23,573                      |       | 617                             |       |             |       | 24,190           |       |
| MORTGAGE  BANKING:                                                                                       |       |       |       |                        |       |                            |       |             |       |             |       |
| Revenues:                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |
| Gain on sales of mortgage loans                                                                          |       |       |       |                        |       | 1,369                           |       |             |       | 1,369            |       |
| Interest income                                                                                          |       |       |       |                        |       | 5                               |       |             |       | 5                |       |
| Total mortgage banking revenues                                                                          |       |       |       |                        |       | 1,374                           |       |             |       | 1,374            |       |
| Expenses:                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |
| General and administrative                                                                               |       |       |       |                        |       | 1,127                           |       |             |       | 1,127            |       |
| Interest expense                                                                                         |       |       |       |                        |       | 4                               |       |             |       | 4                |       |
| Depreciation                                                                                             |       |       |       |                        |       | 28                              |       |             |       | 28               |       |
| Total mortgage banking expenses                                                                          |       |       |       |                        |       | 1,159                           |       |             |       | 1,159            |       |
| Mortgage banking earnings before income taxes                                                            |       |       |       |                        |       | 215                             |       |             |       | 215              |       |
| EQUITY IN INCOME  OF CONSOLIDATED SUBSIDIARIES                                                           |       | 24,405     |       | 490                         |       |                            |       | (24,895          | )          |             |       |
| EARNINGS BEFORE  INCOME TAXES                                                                            |       | 24,405     |       | 24,063                      |       | 832                             |       | (24,895          | )          | 24,405           |       |
| PROVISION FOR  INCOME TAXES                                                                              |       | 8,858      |       | 8,735                       |       | 302                             |       | (9,037           | )          | 8,858            |       |
| NET EARNINGS                                                                                             |       | $          | 15,547     |                        | $          | 15,328                          |       | $                | 530        |             | $          | (15,858 | ) | $ | 15,547 |   |
|                                                                                                     |       |       |       |                        |       |                            |       |             |       |             |       |

 

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| **For the three months ended  December 31, 2006 (in thousands)** | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| **Cash  flows from operating activities:**                                                               |       |       |       |                        |       |                            |       |             |       |             |       |
| Net loss                                                                                                 |       | $          | (20,969    | )                           | $          | (21,286                         | )          | $                | (2,149     | )                | $          | 23,435 |   | $ | (20,969 | ) |
| Adjustments to reconcile net loss to net cash flows  from operating activities                           |       | 4,097      |       | 57,556                      |       | (6,827                          | )          | (26,160          | )          | 28,666           |       |
| Net cash (used in) provided by operating activities                                                      |       | (16,872    | )          | 36,270                      |       | (8,976                          | )          | (2,725           | )          | 7,697            |       |
|                                                                                                     |       |       |       |                        |       |                            |       |             |       |             |       |
| **Cash  flows from investing activities:**                                                               |       |       |       |                        |       |                            |       |             |       |             |       |
| Purchases of  property and equipment                                                                     |       | (252       | )          | (265                        | )          | (8                              | )          |             |       | (525             | )          |
| Contributions and  advances to investments in unconsolidated entities                                    |       |       |       | (4,856                      | )          |                            |       |             |       | (4,856           | )          |
| Contributions to  investments in subsidiaries                                                            |       |       |       | (4,213                      | )          |                            |       | 4,213            |       |             |       |
| Net cash used in investing activities                                                                    |       | (252       | )          | (9,334                      | )          | (8                              | )          | 4,213            |       | (5,381           | )          |
|                                                                                                     |       |       |       |                        |       |                            |       |             |       |             |       |
| **Cash  flows from financing activities:**                                                               |       |       |       |                        |       |                            |       |             |       |             |       |
| Proceeds from  issuance of notes and mortgage loans payable                                              |       | 67,616     |       |                        |       | 6,858                           |       |             |       | 74,474           |       |
| Repayments of  notes and mortgage loans payable                                                          |       | (62,643    | )          | (9,801                      | )          | (12,352                         | )          |             |       | (84,796          | )          |
| Debt issuance  costs                                                                                     |       | (850       | )          |                        |       |                            |       |             |       | (850             | )          |
| Net proceeds  from issuance of common stock                                                              |       | 39         |       |                        |       |                            |       |             |       | 39               |       |
| Repurchases of  common stock                                                                             |       | (2         | )          |                        |       |                            |       |             |       | (2               | )          |
| Contributions  from minority interests                                                                   |       |       |       |                        |       | 3,000                           |       |             |       | 3,000            |       |
| Contributions  from parent and guarantors                                                                |       |       |       |                        |       | 4,213                           |       | (4,213           | )          |             |       |
| Distributions to  parent and guarantors                                                                  |       |       |       |                        |       | (2,725                          | )          | 2,725            |       |             |       |
| Intercompany                                                                                             |       | 14,057     |       | (23,170                     | )          | 9,113                           |       |             |       |             |       |
| Net cash provided by (used in) financing activities                                                      |       | 18,217     |       | (32,971                     | )          | 8,107                           |       | (1,488           | )          | (8,135           | )          |
| **Net increase  (decrease) in cash and cash equivalents**                                                |       | 1,093      |       | (6,035                      | )          | (877                            | )          |             |       | (5,819           | )          |
| Cash and cash equivalents—  Beginning of period                                                     |       | 1,518      |       | 14,511                      |       | 2,636                           |       |             |       | 18,665           |       |
| Cash and cash equivalents—  End of period                                                           |       | $          | 2,611      |                        | $          | 8,476                           |       | $                | 1,759      |             |       |   | $ | 12,846 |   |
|                                                                                                     |       |       |       |                        |       |                            |       |             |       |             |       |
| **Reconciliation  to cash and cash equivalents reported on the consolidated balance sheets:**            |       |       |       |                        |       |                            |       |             |       |             |       |
| Homebuilding                                                                                             |       | $          | 2,611      |                        | $          | 8,476                           |       | $                | 49         |             |       |   | $ | 11,136 |   |
| Mortgage banking                                                                                         |       |       |       |                        |       | 1,710                           |       |             |       | 1,710            |       |
| Total                                                                                                    |       | $          | 2,611      |                        | $          | 8,476                           |       | $                | 1,759      |             |       |   | $ | 12,846 |   |
|                                                                                                     |       |       |       |                        |       |                            |       |             |       |             |       |
|                                                                                                          |            |            |            |                             |            |                                 |            |                  |            |                  |            |  |  |  |  |  |

 

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| **For the three months ended  December 31, 2005 (in thousands)** | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| **Cash  flows from operating activities:**                                                               |       |       |       |                        |       |                            |       |             |       |             |       |
| Net earnings                                                                                             |       | $          | 15,547     |                        | $          | 15,328                          |       | $                | 530        |             | $          | (15,858 | ) | $ | 15,547 |   |
| Adjustments to reconcile net earnings to net cash  flows from operating activities                       |       | (34,886    | )          | (70,522                     | )          | (11,745                         | )          | 15,534           |       | (101,619         | )          |
| Net cash used in operating activities                                                                    |       | (19,339    | )          | (55,194                     | )          | (11,215                         | )          | (324             | )          | (86,072          | )          |
|                                                                                                     |       |       |       |                        |       |                            |       |             |       |             |       |
| **Cash  flows from investing activities:**                                                               |       |       |       |                        |       |                            |       |             |       |             |       |
| Purchases of  property and equipment                                                                     |       |       |       | (30                         | )          | (4                              | )          |             |       | (34              | )          |
| Disposals of  property and equipment                                                                     |       |       |       |                        |       | 858                             |       |             |       | 858              |       |
| Contributions and  advances to investments in unconsolidated entities                                    |       |       |       | (772                        | )          |                            |       |             |       | (772             | )          |
| Net cash (used in) provided by investing activities                                                      |       |       |       | (802                        | )          | 854                             |       |             |       | 52               |       |
|                                                                                                     |       |       |       |                        |       |                            |       |             |       |             |       |
| **Cash  flows from financing activities:**                                                               |       |       |       |                        |       |                            |       |             |       |             |       |
| Proceeds from  issuance of notes and mortgage loans payable                                              |       | 543,359    |       | 319,081                     |       | 11,036                          |       |             |       | 873,476          |       |
| Repayments of  notes and mortgage loans payable                                                          |       | (19,019    | )          | (710,426                    | )          | (46,186                         | )          |             |       | (775,631         | )          |
| Net proceeds from  issuance of common stock                                                              |       | 702        |       |                        |       |                            |       |             |       | 702              |       |
| Repurchases of  common stock                                                                             |       | (179       | )          |                        |       |                            |       |             |       | (179             | )          |
| Distributions to  minority interests                                                                     |       |       |       | 142                         |       | (1,635                          | )          |             |       | (1,493           | )          |
| Distributions to  parent and guarantors                                                                  |       |       |       |                        |       | (324                            | )          | 324              |       |             |       |
| Intercompany                                                                                             |       | (499,519   | )          | 447,707                     |       | 51,812                          |       |             |       |             |       |
| Net cash provided by financing activities                                                                |       | 25,344     |       | 56,504                      |       | 14,703                          |       | 324              |       | 96,875           |       |
| **Net  increase in cash and cash equivalents**                                                           |       | 6,005      |       | 508                         |       | 4,342                           |       |             |       | 10,855           |       |
| Cash and cash equivalents—  Beginning of period                                                     |       | 6,875      |       | 9,786                       |       | 4,799                           |       |             |       | 21,460           |       |
| Cash and cash equivalents—  End of period                                                           |       | $          | 12,880     |                        | $          | 10,294                          |       | $                | 9,141      |             |       |   | $ | 32,315 |   |
|                                                                                                     |       |       |       |                        |       |                            |       |             |       |             |       |
|                                                                                                          |            |            |            |                             |            |                                 |            |                  |            |                  |            |  |  |  |  |  |

 

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**Item 2. Management’s Discussion and Analysis ofFinancial Condition and Results 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-familyhomes. Since we were founded in 1969, we have delivered over 44,000 homes to abroad range of customers, including first-time buyers and first- andsecond-time move-up buyers. Throughout this period, we have grown our businessorganically and operate within 17 markets across nine states located in fivegeographic regions: 
| **Florida** | ** ** | **Midwest**      | ** ** | **Nevada** | ** ** | **Pacific Coast** | ** ** | **Texas**   |
|-------------|------------|------------------|------------|------------|------------|-------------------|------------|-------------|
| Ft. Myers   |       | Chicago, IL      |       | Las Vegas  |       | Portland, OR      |       | Austin      |
| Naples      |       | Cleveland, OH(a) |       |       |       | Sacramento, CA    |       | Dallas      |
| Sarasota    |       | Milwaukee, WI    |       |       |       | Stockton, CA      |       | Ft. Worth   |
| Tampa       |       |             |       |       |       | Vancouver, WA     |       | Houston     |
|        |       |             |       |       |       |              |       | San Antonio |

(a)             We decided to exit the Cleveland market based on ourperception regarding local market conditions currently and in the foreseeablefuture. We have been winding down operations with the objective of completingall construction and sales activities during our second fiscal quarter of 2007.We believe that our exit from the Cleveland market will not have a materialadverse impact on our future operating results.

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**

During the first quarterof fiscal 2007, market conditions for new home sales remained more difficultthan those conditions experienced over the past decade. Many view the currenthomebuilding environment as a return to a more stabilized homebuildingmarketplace, which may continue to show erosion of home sales andprofitability. Currently we do not see conditions in the housing marketimproving significantly in the near term.

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

·       decreasing customer traffic and decliningbuyer sentiment;

·       increasing cancellation rates resultingin lower net sales;

·       increasing frequency and level ofcustomer incentive packages;

·       increasing use and compensation of realestate brokers; and

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

 

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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 balance sheet management, and includes:

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

·       tailoring ourproduct offerings and option packages to address affordability constraints;

·       refining our pricing stragegy 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 environment.

**Recent Events**

Given the current marketconditions and the deterioration of profitability, we believed that maintainingour original debt covenants would become difficult. Therefore, onDecember 15, 2006, we paid fees of $0.9 million to amend our $500million senior unsecured revolving 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 throughSeptember 30, 2007, increasing to 1.5x through December 31, 2007, increasingto 1.75x through March 31, 2008 and then increasing to 2.25x through theremaining term of the 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.

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 identified certainland parcels that we intend to sell and are actively marketing the propertiesfor delivery within the next 12 months. We believe that these properties arenot critical to our homebuilding operations. As of December 31, 2006, we have $52.5million of land inventory that is held for sale.

Due to the current changein market conditions, the national homebuilding climate and our expectationsregarding the recoverability of certain assets, we reviewed all of our inventoryfor impairment and recorded an inventory impairment charge of $40 millionduring the three months ended December 31, 2006. The impairment charge consistsof $20.7 million in housing projects where we intend to construct and sellhomes and $19.3 million for land held for sale. This charge is included in costof sales in the accompanying condensed consolidated statements of operations.

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**Results of Operations and Other Data**

The following tablepresents selected statement of operations and other data for the three monthperiod ended December 31, 2006 and 2005:
| ** **                                                       | ** ** | **Three months ended** | ** ** | **2006** | ** ** |
|------------------------------------------------------------------|------------|----------------------------------|------------|----------|------------|
| ** **                                                       | ** ** | **December 31,**            | ** ** | **vs.**  | ** ** |
| **(Dollars in thousands)**                             | ** ** | **2006**                         | ** ** | **2005** | ** ** | **2005** | ** ** |
| **Statement of operations data:**                                |       |                             |       |     |       |   |   |
| Total homebuilding  revenues                                     |       | $                                | 238,829    |     | $          | 222,546 |   | 7.3 | % |
| Cost of sales of  residential units and land(1)                  |       | 243,151                          |       | 167,299  |       | 45.3 | % |
| Gross homebuilding  (loss) profit                                |       | (4,322                           | )          | 55,247   |       | (107.8 | )% |
| Homebuilding operating  expenses                                 |       | 30,714                           |       | 30,855   |       | (0.5 | )% |
| Equity in income of  unconsolidated entities                     |       | 500                              |       | 157      |       | 218.5 | % |
| Minority interests in  net earnings of consolidated partnerships |       | (76                              | )          | (359     | )          | (78.8 | )% |
| Homebuilding (loss)  earnings before income taxes                |       | (34,612                          | )          | 24,190   |       | (243.1 | )% |
| Mortgage banking  earnings before income taxes                   |       | 516                              |       | 215      |       | 140.0 | % |
| (Loss) earnings before  income taxes                             |       | (34,096                          | )          | 24,405   |       | (239.7 | )% |
| (Benefit) provision for  income taxes                            |       | (13,127                          | )          | 8,858    |       | (248.2 | )% |
| Net (loss) earnings                                              |       | $                                | (20,969    | )        | $          | 15,547 |   | (234.9 | )% |
| ** **                                                       |       |                             |       |     |       |   |   |
| **Other financial data:**                                        |       |                             |       |     |       |   |   |
| Interest incurred(2)                                             |       | $                                | 11,827     |     | $          | 11,187 |   | 5.7 | % |
| Depreciation and  amortization                                   |       | 276                              |       | 239      |       | 15.5 | % |
| EBITDA(3)                                                        |       | (25,049                          | )          | 29,694   |       | (184.4 | )% |
| Gross homebuilding  profit margin(4)                             |       | (1.8                             | )%         | 24.8     | %          | — |   |
| ** **                                                       |       |                             |       |     |       |   |   |
| **Other data:**                                                  |       |                             |       |     |       |   |   |
| Net new home orders  (units)(5)                                  |       | 722                              |       | 638      |       | 13.2 | % |
| Homes delivered (units)                                          |       | 799                              |       | 763      |       | 4.7 | % |
| Average sales price of  homes delivered                          |       | $                                | 270        |     | $          | 282 |   | (4.3 | )% |
| Backlog at end of  period (units)(6)                             |       | 681                              |       | 1,345    |       | (49.4 | )% |
| Backlog at end of period (contract value)(6)                |       | $                                | 190,796    |     | $          | 389,174 |   | (51.0 | )% |

 

(1)      Inventoryimpairment charges of $40 million and $0 are included in cost of sales ofresidential units and land for the three months ended December 31, 2006 and2005, respectively.

(2)      Interest incurred is the amount of interestpaid and the net amount accrued (whether expensed or capitalized), and theamortization of debt issuance costs.

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

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

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

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

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

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

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

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Because of these limitations, EBITDA should not beconsidered as a measure of discretionary cash available to us to invest in thegrowth of our business or to service our indebtedness. We compensate for theselimitations by relying primarily on our GAAP results and using EBITDA onlysupplementally. See the condensed consolidated statements of operations andcash flows presented in our condensed consolidated financial statementsincluded elsewhere in this report. The following is a reconciliation of EBITDAto net earnings, the most directly comparable GAAP measure:
|                                                  | ** ** | **Three Months Ended December 31,** | ** ** |
|--------------------------------------------------|------------|---------------------------------------------------------|------------|
| **(Dollars in thousands)**             | ** ** | **2006**                                                | ** ** | **2005** | ** ** |
| Net (loss) earnings                              |       | $                                                       | (20,969    | ) | $ | 15,547 |   |
| (Benefit) provision  for income taxes            |       | (13,127                                                 | )          | 8,858 |   |
| Interest expense  in cost of sales               |       | 8,771                                                   |       | 5,046 |   |
| Interest expense  in mortgage banking operations |       |                                                    |       | 4 |   |
| Depreciation and  amortization                   |       | 276                                                     |       | 239 |   |
| EBITDA                                           |       | $                                                       | (25,049    | ) | $ | 29,694 |   |
|                                             |       |                                                    |       |   |   |

 

(4)      Represents gross homebuilding profit dividedby total homebuilding revenues.

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

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

***Three months endedDecember 31, 2006 compared to three months ended December 31, 2005***

***Homebuilding revenues.***   Homebuilding revenues increased 7.3% to $238.8 million for the threemonth period ended December 31, 2006 from $222.5 million for the three monthperiod ended December 31, 2005. The increase was primarily due to increasedland sales of $22.6 million for the three months ended December 31, 2006 ascompared to $5.8 million for the three months ended December 31, 2005. Theincrease in new home deliveries of 4.7% was offset by a 4.3% decrease in theaverage sales price of homes delivered. The decrease in average sales price isattributed to an increase in home deliveries in our Texas region, which has ourlowest average sales price, and a decrease in home deliveries in our PacificCoast region, which has our highest average sales price.

***Home sales and backlog.***   Net new home orders for the three month period ended December 31,2006 were 722, a record sales order activity level for the first quarter. Theincrease in net new home orders is attributed to adjusting net sales prices,where necessary, to reduce completed but unsold homes and increase net homeorders per open selling location. 

AtDecember 31, 2006, the contract value of our backlog was $190.8 million, ascompared to $389.2 million at December 31, 2005. At December 31, 2006, theaverage sales price per home in backlog was $280,000, down $9,000, or 3.1%,over the average sales price per home in backlog of $289,000 at December 31,2005.

***Gross homebuilding profit margin.  ***Gross homebuilding profit margin decreased to (1.8)%for the three month period ended December 31, 2006, compared to 24.8% for thethree month period ended December 31, 2005. Included in gross profit for thethree months ended December 31, 2006 are inventory valuation charges of $40million related to our expectations regarding the recoverability of certainassets from both active residential construction projects and land held forsale. During the three month period ended December 31, 2006, 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.Included within the gross profit for the three month period ended December 31,2006 is $13.6 million from land sales, as compared with $1.5 million from landsales for the three month period ended December 31, 2005.

***Homebuilding operatingexpenses***.   Homebuilding operatingexpenses, which consist of all homebuilding expenses other than cost of sales,decreased 0.5% to $30.7 million for the three months endedDecember 31, 2006 from $30.9

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millionfor the three months ended December 31, 2005. Homebuilding operatingexpenses were 12.9% and 13.9% of homebuilding revenue for the three monthsended December 31, 2006 and 2005, 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.

**Segment analysis**

We aggregate our homebuilding operating segments into five reportablesegments and our mortgage banking operations into one reportable segment. Wehistorically aggregated our homebuilding operating segments into one reportablesegment and accordingly have revised that historical presentation for allperiods to conform to the current year presentation of five reportablehomebuilding segments. Our homebuilding segments are engaged in the acquisitionand development of land, and construction and sale of residential homes. Ourmortgage banking segment originates mortgages, which are sold to third parties.

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

Florida

Midwest:Illinois, Ohio and Wisconsin

Nevada

PacificCoast: California, Oregon and Washington

Texas

The following tablepresents financial and operational information for our five reportablehomebuilding segments:
| **Three Months Ended  December 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) | ** ** |
|---------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|----------------------|------------|-----------------------------------|------------|--------------------------------------------------|------------|------------------------------------------------------------|------------|
| 2006                                                                                  |       |                                         |       |                 |       |                              |       |                                             |       |                                                       |       |
| Florida                                                                               |       | $                                            | 302        |                 | 82         |                              | 65         |                                             | 56         |                                                       | $          | 17,380 |   |
| Midwest                                                                               |       | 326                                          |       | 139                  |       | 116                               |       | 136                                              |       | 47,816                                                     |       |
| Nevada                                                                                |       | 382                                          |       | 97                   |       | 116                               |       | 64                                               |       | 24,511                                                     |       |
| Pacific Coast                                                                         |       | 440                                          |       | 92                   |       | 107                               |       | 95                                               |       | 39,466                                                     |       |
| Texas                                                                                 |       | 175                                          |       | 389                  |       | 318                               |       | 330                                              |       | 61,623                                                     |       |
| Total                                                                                 |       | $                                            | 270        |                 | 799        |                              | 722        |                                             | 681        |                                                       | $          | 190,796 |   |
| 2005                                                                                  |       |                                         |       |                 |       |                              |       |                                             |       |                                                       |       |
| Florida                                                                               |       | $                                            | 234        |                 | 95         |                              | 14         |                                             | 183        |                                                       | $          | 43,839 |   |
| Midwest                                                                               |       | 385                                          |       | 104                  |       | 112                               |       | 263                                              |       | 99,061                                                     |       |
| Nevada                                                                                |       | 382                                          |       | 88                   |       | 79                                |       | 103                                              |       | 41,916                                                     |       |
| Pacific Coast                                                                         |       | 457                                          |       | 145                  |       | 82                                |       | 221                                              |       | 110,683                                                    |       |
| Texas                                                                                 |       | 161                                          |       | 331                  |       | 351                               |       | 575                                              |       | 93,675                                                     |       |
| Total                                                                                 |       | $                                            | 282        |                 | 763        |                              | 638        |                                             | 1,345      |                                                       | $          | 389,174 |   |

 

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

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

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 December 31:  (Dollars in thousands)** | ** ** | **Revenues** | ** ** | **(Loss) earnings before  income taxes** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|--------------|------------|---------------------------------------------------------|------------|
| **2006**                                                                                                          |       |         |       |                                                    |       |   |   |
| Florida                                                                                                           |       | $            | 23,941     |                                                    | $          | (7,385 | ) |
| Midwest                                                                                                           |       |         | 46,122     |                                                    |       | (11,530 | ) |
| Nevada                                                                                                            |       |         | 55,030     |                                                    |       | 19,662 |   |
| Pacific Coast                                                                                                     |       |         | 39,269     |                                                    |       | (16,261 | ) |
| Texas                                                                                                             |       |         | 69,916     |                                                    |       | (241 | ) |
| Mortgage banking                                                                                                  |       |         | 1,742      |                                                    |       | 516 |   |
| Segment subtotal                                                                                                  |       |         | 236,020    |                                                    |       | (15,239 | ) |
| Corporate and unallocated                                                                                         |       |         | 177        |                                                    |       | (7,717 | ) |
|                                                                                                              |       |         | 236,197    |                                                    |       | (22,956 | ) |
| Homebuilding interest expense(1)                                                                                  |       |         |       |                                                    |       | (8,771 | ) |
| GAAP adjustment(2)                                                                                                |       |         | 4,374      |                                                    |       | (2,369 | ) |
| Consolidated total                                                                                                |       | $            | 240,571    |                                                    | $          | (34,096 | ) |
| **2005**                                                                                                          |       |         |       |                                                    |       |   |   |
| Florida                                                                                                           |       | $            | 22,210     |                                                    | $          | 107 |   |
| Midwest                                                                                                           |       |         | 42,520     |                                                    |       | 817 |   |
| Nevada                                                                                                            |       |         | 33,689     |                                                    |       | 11,403 |   |
| Pacific Coast                                                                                                     |       |         | 66,315     |                                                    |       | 21,929 |   |
| Texas                                                                                                             |       |         | 56,614     |                                                    |       | 2,002 |   |
| Mortgage banking                                                                                                  |       |         | 1,374      |                                                    |       | 215 |   |
| Segment subtotal                                                                                                  |       |         | 222,722    |                                                    |       | 36,473 |   |
| Corporate and unallocated                                                                                         |       |         | 1,198      |                                                    |       | (10,955 | ) |
|                                                                                                              |       |         | 223,920    |                                                    |       | 25,518 |   |
| Homebuilding interest expense(1)                                                                                  |       |         |       |                                                    |       | (5,046 | ) |
| GAAP adjustment(2)                                                                                                |       |         |       |                                                    |       | 3,933 |   |
| Consolidated  total                                                                                               |       | $            | 223,920    |                                                    | $          | 24,405 |   |

 

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

(2)      The GAAP adjustment to revenues is for certain closing costs and brokers commissionsthat are included in revenue in our internal measurement system that arereported as expenses in accordance with GAAP. The GAAP adjustment to earnings before income taxes relate to: (a) timingdifferences of certain capitalizable indirect construction costs that areexpensed as incurred in our internal measurement system, and (b) minorityinterest expense which is not included in our internal measurement system.

***Three months endedDecember 31, 2006 compared to three months ended December 31, 2005***

***Florida.  ***Homebuilding revenues increased in thequarter ended December 31, 2006, compared to the quarter ended December 31,2005, primarily due to a $68thousand increase in the average sales price of homes delivered, offsetpartially by an 13.7% decrease in the number of homes delivered. Homebuildinggross profit margins were (21.0)% in the first fiscal quarter of 2007, comparedto 24.1% in the first fiscal quarter of 2006. Gross profit for the three monthperiod ended December 31, 2006 was negatively impacted by $7.5 million ofinventory valuation charges.

***Midwest.  ***Homebuildingrevenues increased in the quarter ended December 31, 2006,compared to the quarter ended December 31, 2005, primarily due to an 33.7%increase in the number of homes delivered, offset partially by a $59 thousanddecrease in the average sales price of homes delivered. Homebuilding grossprofit margins were (18.2)% in the first fiscal quarter of 2007, compared to9.1% in the first fiscal quarter of 2006. Gross profit for the three monthperiod ended December 31, 2006 was negatively impacted by $10.6 million ofinventory valuation charges.

***Nevada.  ***Homebuildingrevenues increased in the quarter ended December 31, 2006, compared to thequarter ended December 31, 2005, primarily due to a $19.4 million increase inland sales and a 10.2% increase in the number of homes delivered. Homebuildinggross profit margins were 36.1% in the first fiscal quarter of 2007, comparedto 39.3% in the first fiscal quarter of 2006. Included within gross profit for the three months ended December 31,2006 is $13.2 million from land sales.

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***Pacific Coast.  ***Homebuilding revenues decreased in thequarter ended December 31, 2006, compared to the quarter ended December 31,2005, primarily due to a 36.6% decrease in the number of homes delivered and a$17 thousand decrease in the average sales price of homes delivered.Homebuilding gross profit margins were (36.3)% in the first fiscal quarter of2007, compared to 36.6% in the first fiscal quarter of 2006. Gross profit forthe three month period ended December 31, 2006 was negatively impacted by $18.4million of inventory valuation charges.

***Texas.  ***Homebuilding revenuesincreased in the quarter ended December 31, 2006, compared to the quarter endedDecember 31, 2005, primarily due to a 17.5% increase in the number of homesdelivered and a $14 thousand increase in the average sales price of homes delivered.Homebuilding gross profit margins were 4.8% in the first fiscal quarter of2007, compared to 13.7% in the first fiscal quarter of 2006. Gross profit forthe three month period ended December 31, 2006 was negatively impacted by $3.5million of inventory valuation charges.

***Mortgage banking.  ***Mortgagebanking earnings before taxes increased to $0.5 million in the first fiscalquarter of 2007, compared to $0.2 million in the first fiscal quarter of 2006.The increase in earnings before taxes was primarily due to a higher capturerate, a reduction in operating costs and an increase in the average mortgageloan size.

***Corporate and unallocated.  ***Corporateand unallocated costs totaled $7.7 million in the first fiscal quarter of 2007and $11.0 million in the first fiscal quarter of 2006. The reduction incorporate and unallocated costs is primarily related to a decrease in incentivecompensation due to lower overall corporate earnings. Corporate and unallocatedcosts as a percentage of total consolidated revenues were 3.2% for the threemonths ended December 31, 2006 and 4.9% for the three months ended December 31,2005.

**Liquidity and Capital Resources**

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

***Operating cashflows activities***

Cashprovided by operating activities totaled $7.7 million during the three monthsended December 31, 2006, compared to $86.1 million of cash used in operating activities during the three months ended December 31,2005. The increase in operating cash flows is primarily due to a significant reductionin the net investment in inventory related to land purchases, lot developmentand home construction.

***Investing cashflows activities***

Cash used in investingactivities totaled $5.4 million during thethree months ended December 31, 2006, compared to $52,000 net cash provided byinvesting activities during the three months ended December 31, 2005.The decrease in investing cash flows was primarily due to an increase in cashcontributed and advanced to unconsolidated entities and increased purchases offixed assets.

***Financing cashflows activities***

Cashused in financing activities totaled $8.1million during the three months ended December 31, 2006, compared to $96.9million cash provided by financing activities during the three months ended December31, 2005. During the three months ended December 31, 2006, we reduced ouroutstanding borrowings by $10.3 million as we reduced our investment in inventory.

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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. Inaddition, at any time prior to December 15, 2008, we may redeem up to 35%of the aggregate principal amount of the notes with the proceeds of qualifiedequity offerings at a redemption price equal to 110.5% of the principal amount,plus accrued and unpaid interest. The notes are unsecured senior subordinatedobligations and subordinated in right of payment to all of our existing andfuture senior debt, including borrowings under our senior unsecured creditfacility. All of our wholly owned subsidiaries, other than our mortgagesubsidiary, have fully and unconditionally guaranteed the notes on a joint andseveral, unsecured senior subordinated, basis. The guarantees are generalunsecured obligations of the guarantors and will be subordinated in right ofpayment to all existing and future senior debt of the guarantors, whichincludes their guarantees of our senior unsecured credit facility. Theindenture governing the senior subordinated notes contains a number ofsignificant covenants that restricts our ability and that of our 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 our assets. As of December 31, 2006, we wererestricted from incurring additional indebtedness (excluding availableborrowings under the senior unsecured credit facility), except under certainlimited 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 December 31,2006, we had $250 million of borrowings under the credit facility at aneffective interest rate of 7.34% and, after giving effect to the borrowing baselimitation, had additional availability of approximately $248 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.

Giventhe current market conditions and the deterioration of profitability, webelieved that maintaining our original debt covenants would become difficult.Therefore, on December 15, 2006, we amended certain covenants in our $500million senior unsecured revolving credit facility. The covenants as amended,require us to: maintain a minimum tangible net worth of at least$300 million plus 50% of positive net income earned subsequent toSeptember 30, 2006; maintain a ratio of total liabilities to adjustedtangible net worth not to exceed 2.0x(decreasing to 1.75x as of June 30, 2007 and increasing to 2.5x as ofDecember 31, 2008); maintain a ratio of total debt to adjusted tangiblenet worth not 

28

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toexceed 1.5x; maintain a ratio of total land (including undeveloped land, landunder development and finished lots on which home construction has yet tobegin) to adjusted tangible net worth not to exceed 1.5x; and maintain aninterest coverage ratio of no less than 1.75x through December 31, 2006(decreasing to 1.5x through March 31, 2007, decreasing to 1.4x throughJune 30, 2007, decreasing to 1.35x through September 30, 2007, increasingto 1.5x through December 31, 2007, increasing to 1.75x throughMarch 31, 2008 and then increasing to 2.25x through the remaining term ofthe facility). For purposes of these tests, adjusted tangible net worth isbenefited by adjustments of 50% of our outstanding senior subordinated debt (upto a maximum $100 million adjustment) and 100% of minority interests inconsolidated entities (up to a maximum $50 million adjustment). As of andduring the three months ended December 31, 2006, we were in compliance with thecovenants of this 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.

We are party to seniorsecured project-specific acquisition, development and construction loans. Theseloans bear interest at a floating rate ranging from LIBOR to LIBOR plus 2.25%with maturities generally tied to the sale of the underlying inventory. As of December31, 2006, we had $30.4 million outstanding related to theseproject-specific acquisition, development and construction loans.

We are party to severalunsecured loan agreements that fund our operations on an ongoing basis. Inaddition, KH Financial, L.P., our wholly owned mortgage subsidiary, is party toa $5 million warehouse line of credit, used to fund its mortgageorigination operations. This facility bears interest at a floating rate equalto LIBOR plus 2.25%, and as of December 31, 2006 there were no amountsoutstanding under the warehouse facility.

We are also party to a$100 million flexible early purchase facility agreement which allows us tosell qualifying mortgage loans to the holder of the flexible early purchasefacility after such loans have been originated subject to our obligation tosell the loan to an investor in the secondary market. At December 31, 2006, thefacility held $28 million of loans sold by KH Financial, L.P.

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

**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.

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Thefollowing summarizes our aggregatecontractual commitments at December 31, 2006:
| ** **                           | ** ** | **Payments due by period** | ** ** |
|--------------------------------------|------------|-------------------------------------------|------------|
| **(Dollars in thousands)** | ** ** | **Total**                                 | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than  5 years** | ** ** |
| Notes payable(1)                     |       | $                                         | 675,387    |   | $ | 46,344 |   | $ | 365,896 |   | $ | 42,171 |   | $ | 220,976 |   |
| Operating leases                     |       | 10,209                                    |       | 2,405 |   | 4,771 |   | 2,299 |   | 734 |   |
| Purchase  obligations(2)             |       | 43,902                                    |       | 2,047 |   | 41,855 |   |   |   |   |   |
| Total                                |       | $                                         | 729,498    |   | $ | 50,796 |   | $ | 412,522 |   | $ | 44,470 |   | $ | 221,710 |   |
|                                 |       |                                      |       |   |   |   |   |   |   |   |   |

 

(1)      Includes our senior subordinated notes, seniorunsecured 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 December 31, 2006.

(2)      Represents obligations under land optionagreements and purchase contracts with specific performance provisions, net ofcash deposits.

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, termination, retirement or resignation. As of December 31,2006, the aggregate repurchase obligation, net of proceeds to be received fromany stock option exercises, would have been $33.5 million in the eventthat all of these obligations were triggered.

We are contingentlyliable to banks and financial institutions for approximately $52 million foroutstanding letters of credit and performance bonds securing performance ofcertain contractual obligations and land purchase contracts. Approximately $2.6million of the outstanding letters of credit have been issued by a wholly ownedsubsidiary. At December 31, 2006, we had committed to fund approximately $15.8million in mortgage loans to homebuyers at agreed-upon rates. We have enteredinto best-efforts and mandatory sale commitments to sell these mortgages tothird parties.

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

At December31, 2006, we owned and controlled 24,512 lots, approximately 40% of which werepursuant to option agreements and purchase contracts. The following is a summary of our land/lot position asof December 31, 2006:
| ** **                                                         | ** ** | **Number of lots** | ** ** |
|--------------------------------------------------------------------|------------|------------------------------|------------|
| Finished lots  owned                                               |       | 4,595                        |       |
| Lots under  development owned                                      |       | 9,992                        |       |
| Total lots owned(1)                                                |       | 14,587                       |       |
| Lots controlled  under option agreements and purchase contracts(2) |       | 9,925                        |       |
| Total land/lots  controlled                                        |       | 24,512                       |       |
|                                                               |       |                         |       |

 

(1)      Includes 1,291 lots that have been identified as heldfor sale, which we intend to sell and are actively marketing for deliverywithin the next 12 months.

(2)      Includes 2,065 lots included in inventory not ownedwhich were consolidated under the accounting guidance of FIN 46R and 2,156 lotsthat we expect to purchase from unconsolidated entities in which we have aninvestment 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.

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

In the ordinary course ofbusiness, we enter into option agreements and purchase contracts to secure landfor the construction of homes. These agreements generally require us to pay adeposit to the seller as consideration for the right to acquire land during aspecified period, usually at predetermined prices. Some of these optionagreements and purchase contracts contain specific performance clauses, whichrequire us to purchase the land upon satisfaction of certain requirements.Otherwise, our liabilities under option agreements and purchase contracts aregenerally limited to forfeiture of the nonrefundable deposits, letters of creditand other nonrefundable amounts incurred. Below is a summary of the aggregateexercise price of all option agreements and purchase contracts as of December31, 2006:
| **(Dollars in thousands)**                                       | ** ** | **Aggregate exercise  price of land  options**(1) | ** ** |
|----------------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|
| Option  agreements and purchase contracts with specific performance        |       | $                                                                | 2,047      |   |
| Options  agreements and purchase contracts without specific performance(2) |       | 374,254                                                          |       |
| Total option agreements  and purchase contracts                            |       | $                                                                | 376,301    |   |
|                                                                       |       |                                                             |       |

 

(1)      Excludes $60 million related to inventory not ownedincluded on our condensed consolidated balance sheet, of which $42 millioncontains specific performance obligations.

(2)      Includes $169 million related to purchases from jointventures in which we have an investment balance of $39 million as of December31, 2006. These investments are recorded in investments in and advances tounconsolidated entities on our condensed consolidated balance sheets.

Given the recent marketdeterioration and uncertainty about the timing and pace of any recovery, wehave tightened our land acquisition criteria and are working with land sellersto renegotiate land purchase and option contracts to extend purchase dates andreduce purchase prices. If we are unable to obtain satisfactory terms, we willnot exercise our land option agreements and will abandon our earnest money ifcontractually obligated to do so. We expect to exercise all of our land optionagreements and purchase contracts with specific performance obligations.

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

Investments in andadvances 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 partners generally are unaffiliatedhomebuilders, land sellers or other real estate entities.

In the ordinary course ofbusiness, we periodically enter into arrangements with land developers or otherhomebuilders to acquire land and develop lots. These arrangements include thecreation of joint ventures, in which our current interests range from 6% to49%. We account for our interest in these joint ventures under the equitymethod, and our condensed consolidated balance sheets include investments inand advances to joint ventures totaling $53.4 million and $48.2 million atDecember 31, 2006 and September 30, 2006, respectively. These jointventures typically obtain secured acquisition,development and construction financing. At December 31, 2006 and September30, 2006, our unconsolidated joint ventures had outstanding third partyborrowings of $922 million and $865 million, respectively. From time to time wehave issued repayment guarantees and/or loan-to-value maintenance guarantees inrespect of this indebtedness. These guarantees require us to repay debt of thejoint venture in the event of a payment default or in the event that the debtof the joint venture exceeds the value of the property securing the debt. AtDecember 31, 2006 and September 30, 2006, we had guarantees of$91.3 million and $74.3 million, respectively, related to theoutstanding indebtedness of these joint ventures.

 

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**Seasonality and Variability in Quarterly Results**

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

**Backlog**

Our sales contractsrequire cash deposits in line with respective market practices and may besubject to certain contingencies such as the buyer’s ability to qualify for financing.Homes covered by such sales contracts but not yet delivered are considered “backlog”.We do not recognize revenue upon the sale of a home until it is delivered tothe homebuyer and other criteria for sale and profit recognition are met. Wesometimes build homes before obtaining a sales contract; however, these homesare excluded from backlog until a sales contract is signed. At December 31,2006, we had 224 units of completed homes in inventory without sales contractswhich represented 19% of our total home inventory. Our cancellation rates forthe three months ended December 31, 2006 and 2005 were 26% and 32%,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 becoming increasinglydifficult given the recent deterioration in the homebuilding market. To date,inflation has not had a material adverse effect on our results of operations.However, there is no assurance that inflation will not have a material adverseimpact on our future results of operations.

**Critical Accounting Estimates and Policies**

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

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

·         Revenue recognition;

·         Homebuildinginventory and costs of sales;

·         Variableinterest entities;

·         Investmentsin and advances to unconsolidated entities;

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·         Warrantycosts;

·         Litigationreserves;

·         Insuranceclaims costs;

·         Valuationof deferred tax assets; and

·         Stock-basedcompensation.

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, theSEC issued Staff Accounting Bulletin No. 108, *Considering the Effects of Prior Year Misstatements when QuantifyingMisstatements in Current Year Financial Statements*(“SAB 108”),which provides guidance as to how the effects on prior year uncorrected misstatementsshould be considered when quantifying misstatements in the current financialstatements. SAB 108 was issued in order to eliminate the diversity of practicesurrounding how public companies quantify financial statement misstatements.SAB 108 will require us to quantify misstatements using both a balance sheetand income statement approach, with adjustment required if either methodresults in a material error. SAB 108 is effective for financial statementsissued for fiscal years beginning after November 15, 2006. We are in theprocess of determining the effect, if any, the adoption of SAB 108 will have onour 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. Other factors beyond those listed below could alsoadversely affect us. 

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·         high interest rates, changes in tax laws andinflation;

·         changes in macroeconomic conditions in our marketsand regions;

·         the availability of sufficient capital;

·         fluctuations in inventory values and carrying costs;

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

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

·         adverse weather conditions and natural disasters inour markets;

·         the availability and quality of subcontractors andraw materials;

·         utility shortages and price increases;

·         our ability to develop our communities successfully;

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

·         the future availability of insurance at reasonablecost;

·         fluctuations in real estate values;

·         poor relations with residents of our communities;

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

·         changes in our legal and regulatory environment;

·         changes in environmental laws and regulations;

·         restrictions on our financial services companies;

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

·         geopolitical risks and market disruption; 

·         our substantial level of indebtedness;

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

·         the growth or expansion of our operations; and

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

Given these uncertainties, you are cautioned not toplace undue reliance on these forward-looking statements. These forward-lookingstatements are made as of the date of this report. We undertake no obligationto update or revise any forward-looking statements, whether as a result of newinformation, future events or otherwise. However, any further disclosures madeon related subjects in subsequent reports or communications should beconsidered. Additional information about factors that could lead to materialchanges in performance is contained in our Annual Report on Form 10-K for thefiscal year ended September 30, 2006. You should understand that it is notpossible to predict or 

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identify all suchfactors. Consequently, you should not consider any such list to be a completeset of all potential risks or uncertainties.

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

We areexposed to a number of market risks in the ordinary course of business. Ourprimary market risk exposure for financial instruments relates to fluctuationsin interest rates. We do not believe our exposure in this area is material tocash flows or earnings. As of December 31, 2006, we had a total of $280.3million of floating rate debt outstanding, including our senior unsecuredcredit facility and other facilities. Borrowings under these facilitiesgenerally bear interest based on applicable margins plus LIBOR or an alternatebase rate. Holding our variable rate debt balances constant as of December 31,2006, each one percentage point increase in interest rates would result in anincrease in interest incurred for the next twelve month period of approximately$2.8 million. A one percentage point increase in interest rates on our average variablerate debt outstanding during the twelve month period ended December 31, 2006would have resulted in an increase in interest incurred of approximately $3.7million.

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

# **Item 4.        Controls andProcedures.**

***Disclosurecontrols and procedures.*** We maintain disclosure controls and procedures (as defined in Rule13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Act”)) thatare designed to provide reasonable assurance that information required to be disclosedby us, including our consolidated entities, in the reports that we file orsubmit under the Act, is recorded, processed, summarized and reported, withinthe time periods specified in the Securities and Exchange Commission’s rulesand 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 December 31, 2006. 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 December 31, 2006.

***Changesin internal control over financial reporting.***  There were no changes in our internal controlover financial reporting that occurred during the first 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.**          LegalProceedings.

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.**              Risk Factors.

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

# **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 therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
|                         | KIMBALL HILL, INC.                                |
|-------------------------|---------------------------------------------------|
|                    | Registrant                                        |
|                    |                                              |
| Dated February 14, 2007 | /s/ DAVID K. HILL                                 |
|                    | David K. Hill                                     |
|                    | Chairman, Chief Executive Officer and Director    |
|                    | (Principal Executive Officer)                     |
|                    |                                              |
| Dated February 14, 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.               |

 

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