**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549**

**Form 10-Q**
| **(Mark One)**                                                                                                                                                   |       |                                                                                          |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|
|                                                                                                                                                             |       |                                                                                          |
| **x**                                                                                                                                                            | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|                                                                                                                                                             |       |                                                                                          |
| **For the  quarterly period ended June 30, 2006**                                                                                                                |
| ** **                                                                                                                                                       |       | ** **                                                                                    |
| **OR**                                                                                                                                                           |
|                                                                                                                                                             |       |                                                                                          |
| **o**                                                                                                                                                            | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                             |       |                                                                                          |
| **For  the transition period from            to           ** |

 

**Commissionfile number: 333-133278**

**KIMBALLHILL, INC.**(Exact name ofRegistrant as specified in its charter)

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

 

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

**NotApplicable**(Former name, former address 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.

Yes xNo o

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
| ** ** |
|------------|

 

 

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**KIMBALL HILL, INC. AND SUBSIDIARIESFORM 10-Q**

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

 

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**PART I—FINANCIAL INFORMATION**

**Item 1.  Financial Statements.**

**Kimball Hill, Inc. and Subsidiaries**

**Unaudited CondensedConsolidated Balance Sheets**
| ** **                                                                     | ** ** | **June 30,** | ** ** | **September 30,** | ** ** |
|--------------------------------------------------------------------------------|------------|-------------------|------------|------------------------|------------|
| **(in thousands, except shares)**                               | ** ** | **2006**          | ** ** | **2005**               | ** ** |
| **Assets**                                                                     | ** ** | ** **        |       |                   |       |
| HOMEBUILDING:                                                                  |       |              |       |                   |       |
| Cash and cash  equivalents                                                     |       | $                 | 26,172     |                   | $          | 16,763 |   |
| Receivables from  title companies                                              |       | 24,329            |       | 22,879                 |       |
| Inventory                                                                      |       | 973,243           |       | 808,778                |       |
| Inventory not  owned                                                           |       | 70,414            |       | 46,721                 |       |
| Deferred  expenses and other assets                                            |       | 17,865            |       | 11,207                 |       |
| Investments in  and advances to unconsolidated entities                        |       | 45,474            |       | 37,033                 |       |
| Deferred taxes                                                                 |       | 11,870            |       | 13,541                 |       |
| Property and  equipment, net of accumulated depreciation                       |       | 10,742            |       | 5,185                  |       |
|                                                                           |       | 1,180,109         |       | 962,107                |       |
| MORTGAGE BANKING:                                                              |       |              |       |                   |       |
| Cash and cash  equivalents                                                     |       | 3,073             |       | 4,697                  |       |
| Trade accounts  receivable                                                     |       | 1,941             |       | 1,586                  |       |
| Mortgage loans  held for sale                                                  |       | 4,219             |       | 1,785                  |       |
| Property and  equipment, net of accumulated depreciation                       |       | 272               |       | 320                    |       |
|                                                                           |       | 9,505             |       | 8,388                  |       |
| TOTAL ASSETS                                                                   |       | $                 | 1,189,614  |                   | $          | 970,495 |   |
| **Liabilities and equity**                                                     |       |              |       |                   |       |
| HOMEBUILDING:                                                                  |       |              |       |                   |       |
| Accounts payable  and accrued expenses                                         |       | $                 | 93,869     |                   | $          | 94,370 |   |
| Deposits on  sales of residential units                                        |       | 12,168            |       | 14,008                 |       |
| Liabilities  related to inventory not owned                                    |       | 33,624            |       | 10,402                 |       |
| Income tax  payable                                                            |       | 204               |       | 15,368                 |       |
| Notes payable                                                                  |       | 652,612           |       | 473,225                |       |
|                                                                           |       | 792,477           |       | 607,373                |       |
| MORTGAGE BANKING:                                                              |       |              |       |                   |       |
| Accounts payable  and accrued expenses                                         |       | 836               |       | 914                    |       |
| Other  liabilities                                                             |       | 108               |       | 234                    |       |
| Notes payable  for mortgage loans                                              |       |              |       | 186                    |       |
|                                                                           |       | 944               |       | 1,334                  |       |
| Total  liabilities                                                             |       | 793,421           |       | 608,707                |       |
|                                                                           |       |              |       |                   |       |
| MINORITY INTEREST IN  CONSOLIDATED PARTNERSHIPS                                |       | 42,738            |       | 45,495                 |       |
| MINORITY INTEREST IN  INVENTORY NOT OWNED                                      |       | 31,721            |       | 31,721                 |       |
|                                                                           |       |              |       |                   |       |
| REEDEEMABLE EQUITY:                                                            |       |              |       |                   |       |
| Redeemable  common stock, no par value; shares outstanding:                    |       |              |       |                   |       |
| 447,427 at June  30, 2006 and 298,000 at September 30, 2005                    |       | 51,678            |       | 33,763                 |       |
| SHAREHOLDERS’ EQUITY:                                                     |       |              |       |                   |       |
| Common stock, no  par value; 10,000,000 shares authorized; shares outstanding: |       |              |       |                   |       |
|  3,438,320 at June 30, 2006 and 3,578,486 at  September 30, 2005          |       | 16,956            |       | 20,216                 |       |
| Retained  earnings                                                             |       | 253,100           |       | 230,593                |       |
| Total  shareholders’ equity                                               |       | 270,056           |       | 250,809                |       |
| TOTAL LIABILITIES AND EQUITY                                                   |       | $                 | 1,189,614  |                   | $          | 970,495 |   |
|                                                                           |       |              |       |                   |       |

 

*See notes to unaudited condensedconsolidated financial statements.*

3

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**Kimball Hill, Inc. andSubsidiaries**

## **Unaudited CondensedConsolidated Statements of Operations**

| ** **                                                                | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                | ** ** | **June 30,**                | ** ** | **June 30,**               | ** ** |
| **(in thousands)**                                                   | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| HOMEBUILDING:                                                             |       |                             |       |                            |       |   |   |   |   |
| Revenues:                                                                 |       |                             |       |                            |       |   |   |   |   |
| Sales of residential units and land                                       |       | $                                | 309,753    |                            | $          | 295,637 |   | $ | 762,473 |   | $ | 699,232 |   |
| Rental and other income                                                   |       | 799                              |       | 1,228                           |       | 2,440 |   | 2,394 |   |
| Total homebuilding revenues                                               |       | 310,552                          |       | 296,865                         |       | 764,913 |   | 701,626 |   |
| Expenses:                                                                 |       |                             |       |                            |       |   |   |   |   |
| Cost of sales of residential units and land                               |       | 257,639                          |       | 219,216                         |       | 607,119 |   | 533,181 |   |
| General and administrative                                                |       | 19,620                           |       | 23,867                          |       | 61,076 |   | 61,295 |   |
| Sales and marketing                                                       |       | 15,829                           |       | 12,511                          |       | 38,673 |   | 33,335 |   |
| Depreciation                                                              |       | 208                              |       | 165                             |       | 558 |   | 561 |   |
| Total homebuilding expenses                                               |       | 293,296                          |       | 255,759                         |       | 707,426 |   | 628,372 |   |
| Equity in income (loss) of unconsolidated joint  ventures                 |       | 369                              |       | (117                            | )          | 899 |   | 2,778 |   |
| Minority interests in net losses (earnings) of  consolidated partnerships |       | 18                               |       | (1,465                          | )          | 216 |   | (3,389 | ) |
| Homebuilding earnings before income taxes                                 |       | 17,643                           |       | 39,524                          |       | 58,602 |   | 72,643 |   |
| MORTGAGE  BANKING:                                                        |       |                             |       |                            |       |   |   |   |   |
| Revenues:                                                                 |       |                             |       |                            |       |   |   |   |   |
| Gain on sales of mortgage loans                                           |       | 2,299                            |       | 1,540                           |       | 5,288 |   | 3,470 |   |
| Interest income                                                           |       | 1                                |       | 2                               |       | 10 |   | 52 |   |
| Total mortgage banking revenues                                           |       | 2,300                            |       | 1,542                           |       | 5,298 |   | 3,522 |   |
| Expenses:                                                                 |       |                             |       |                            |       |   |   |   |   |
| General and administrative                                                |       | 1,143                            |       | 1,157                           |       | 3,371 |   | 3,511 |   |
| Interest expense                                                          |       | 1                                |       | 2                               |       | 7 |   | 36 |   |
| Depreciation                                                              |       | 21                               |       | 27                              |       | 70 |   | 95 |   |
| Total mortgage banking expenses                                           |       | 1,165                            |       | 1,186                           |       | 3,448 |   | 3,642 |   |
| Mortgage banking earnings (losses) before income  taxes                   |       | 1,135                            |       | 356                             |       | 1,850 |   | (120 | ) |
| EARNINGS BEFORE  INCOME TAXES                                             |       | 18,778                           |       | 39,880                          |       | 60,452 |   | 72,523 |   |
| PROVISION FOR  INCOME TAXES                                               |       | 6,813                            |       | 14,697                          |       | 21,942 |   | 26,742 |   |
| NET EARNINGS                                                              |       | $                                | 11,965     |                            | $          | 25,183 |   | $ | 38,510 |   | $ | 45,781 |   |
|                                                                      |       |                             |       |                            |       |   |   |   |   |

 

*See notes to unaudited condensedconsolidated financial statements.*

4

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**Kimball Hill, Inc. and Subsidiaries**

**Unaudited Condensed Consolidated Statements of CashFlows**

 
| ** **                                                                                                                   | ** ** | **Nine Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| **(in thousands)**                                                                                                      | ** ** | **2006**                                           | ** ** | **2005** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                                                                       |       |                                               |       |   |   |
| Net earnings                                                                                                                 |       | $                                                  | 38,510     |   | $ | 45,781 |   |
| Adjustments to reconcile net earnings to net cash  used in operating activities:                                             |       |                                               |       |   |   |
| Depreciation                                                                                                                 |       | 628                                                |       | 656 |   |
| Write-down of inventory                                                                                                      |       | 3,200                                              |       |   |   |
| Amortization of deferred expenses                                                                                            |       | 3,920                                              |       | 4,505 |   |
| Equity-based compensation                                                                                                    |       | 616                                                |       | 9,249 |   |
| ESOP compensation expense                                                                                                    |       |                                               |       | 696 |   |
| Distributions of income from investments in  unconsolidated entities                                                         |       | 489                                                |       | 2,840 |   |
| Net earnings from investments in unconsolidated  entities                                                                    |       | (899                                               | )          | (2,778 | ) |
| Minority interest in consolidated (losses) earnings                                                                          |       | (216                                               | )          | 3,389 |   |
| Deferred income taxes                                                                                                        |       | 1,671                                              |       | (2,945 | ) |
| Changes in operating assets and liabilities:                                                                                 |       |                                               |       |   |   |
| Receivables                                                                                                                  |       | (1,805                                             | )          | (4,269 | ) |
| Mortgage loans held for sale                                                                                                 |       | (2,434                                             | )          | 3,371 |   |
| Inventory                                                                                                                    |       | (167,287                                           | )          | (163,103 | ) |
| Deferred expenses and other assets                                                                                           |       | (5,098                                             | )          | (7,396 | ) |
| Accounts payable and accrued expenses                                                                                        |       | (579                                               | )          | 12,460 |   |
| Deposits and other liabilities                                                                                               |       | (1,966                                             | )          | 2,012 |   |
| Income taxes payable                                                                                                         |       | (14,666                                            | )          | (2,227 | ) |
| Net cash used in operating activities                                                                                        |       | (145,916                                           | )          | (97,759 | ) |
|                                                                                                                         |       |                                               |       |   |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                                                                       |       |                                               |       |   |   |
| Purchases of property and equipment                                                                                          |       | (6,995                                             | )          | (434 | ) |
| Disposals of property and equipment                                                                                          |       | 858                                                |       |   |   |
| Distributions of contributed capital from  investments in unconsolidated entities                                            |       | 698                                                |       | 824 |   |
| Contributions and advances to investments in  unconsolidated entities                                                        |       | (8,460                                             | )          | (17,143 | ) |
| Net cash used in investing activities                                                                                        |       | (13,899                                            | )          | (16,753 | ) |
|                                                                                                                         |       |                                               |       |   |   |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                                                                       |       |                                               |       |   |   |
| Proceeds from issuance of notes and mortgage loans  payable                                                                  |       | 1,175,356                                          |       | 755,486 |   |
| Repayments of notes and mortgage loans payable                                                                               |       | (996,155                                           | )          | (610,936 | ) |
| Debt issuance costs                                                                                                          |       | (6,598                                             | )          |   |   |
| Proceeds from issuance of common stock                                                                                       |       | 712                                                |       | 4,012 |   |
| Repurchases of common stock                                                                                                  |       | (3,174                                             | )          | (1,711 | ) |
| Contributions from minority interests                                                                                        |       |                                               |       | 4,000 |   |
| Distributions to minority interests                                                                                          |       | (2,541                                             | )          | (19,799 | ) |
| Net cash provided by financing activities                                                                                    |       | 167,600                                            |       | 131,052 |   |
| NET INCREASE IN  CASH AND CASH EQUIVALENTS                                                                                   |       | 7,785                                              |       | 16,540 |   |
| CASH AND CASH  EQUIVALENTS—Beginning of period                                                                          |       | 21,460                                             |       | 7,656 |   |
| CASH AND CASH  EQUIVALENTS—End of period                                                                                |       | $                                                  | 29,245     |   | $ | 24,196 |   |
|                                                                                                                         |       |                                               |       |   |   |
| RECONCILIATION  TO CASH AND CASH EQUIVALENTS REPORTED ON THE CONDENSED CONSOLIDATED BALANCE  SHEETS:                         |       |                                               |       |   |   |
| Homebuilding                                                                                                                 |       | $                                                  | 26,172     |   |   |   |
| Mortgage banking                                                                                                             |       | 3,073                                              |       |   |   |
| TOTAL                                                                                                                        |       | $                                                  | 29,245     |   |   |   |
|                                                                                                                         |       |                                               |       |   |   |
| SUPPLEMENTAL  DISCLOSURE OF CASH FLOW INFORMATION:                                                                           |       |                                               |       |   |   |
| Cash paid for interest                                                                                                       |       | $                                                  | 34,999     |   | $ | 28,872 |   |
| Cash paid for income taxes                                                                                                   |       | $                                                  | 34,937     |   | $ | 31,914 |   |
| SUPPLEMENTAL  DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:                                                      |       |                                               |       |   |   |
| Inventory not  owned includes $33,624 of liabilities related to inventory not owned for the  nine months ended June 30, 2006 |       |                                               |       |   |   |

 

*See notes to unaudited condensedconsolidated financial statements.*

5

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**Kimball Hill, Inc. and Subsidiaries**

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

**1.  Basis of Presentation and SignificantAccounting Policies**

The accompanyingunaudited condensed consolidated financial statements include the accounts of KimballHill, 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 forinterim financial information and in accordance with the instructions to Form10-Q and Article 10 of Regulation S-X. Such financial statements do not includeall of the information and disclosures required by accounting principles generallyaccepted in the United States of America for complete financial statements. Asa result, these financial statements should be read in conjunction with theaudited consolidated financial statements and accompanying notes for the fiscalyear ended September 30, 2005, appearing in the Company’s prospectus dated May4, 2006, which is a part of the Company’s registration statement on Form S-4,as amended. In the opinion of management, all adjustments (consisting ofnormal, recurring accruals) necessary for fair presentation have been includedin the accompanying financial statements.

Historically, thehomebuilding industry has experienced seasonal fluctuations; therefore, theoperating results for the three and nine month periods ended June 30, 2006 arenot necessarily indicative of the results that may be expected for the fiscalyear ending September 30, 2006.

***Segment Information and Concentrations******—In***accordancewith Statement of Financial Accounting Standards No. 131, *Disclosures about Segments of an Enterprise and Related Information*,the Company has identified two reportable segments: homebuilding and mortgagebanking. The Company’s chief decision maker is its chief executive officer. TheCompany’s homebuilding segment consists primarily of homebuilding operations,which is engaged in the acquisition and development of land and construction ofresidential homes. Since the Company’s geographic homebuilding regions havesimilar economic characteristics, housing products and class of prospectivebuyers, the geographic homebuilding regions have been aggregated into a singlehomebuilding segment. The Company’s mortgage banking segment originatesmortgages which are sold to third parties. Corporate expenses are allocated tothe segment that directly benefits from the expense. General corporate expensesthat benefit both segments are nominal and are allocated to the homebuildingsegment. During the three month periods ended June 30, 2006 and 2005, two ofthe Company’s five regions contributed 37% and 48%, respectively, of theCompany’s total homebuilding revenues. During the three month periods endedJune 30, 2006 and 2005, these two regions contributed 60% and 72% of the totalhomebuilding gross profit. During the nine month periods ended June 30, 2006and 2005, two of the Company’s five regions contributed 42% of the Company’stotal homebuilding revenues. During the nine month periods ended June 30, 2006and 2005, these two regions contributed 65% and 67%, respectively, of the totalhomebuilding gross profit.

Information about theCompany’s reportable segments is presented in its condensed consolidatedstatements of operations and condensed consolidated balance sheets. The Company’sreporting segments follow the same accounting policies used for the Company’sconsolidated financial statements as described in the summary of significantaccounting policies in the notes to the September 30, 2005 audited consolidatedfinancial statements. Corporate assets shared by the segments are nominal andare included within the homebuilding segment. Management evaluates a segment’sperformance based upon a number of factors including earnings before incometaxes.

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

6

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In April 2006, theCompany granted options to purchase 12,000 common shares of the Company to akey employee. The option price equals the estimated fair market value of thecommon shares on the day of the grant. The fair value of the options grantedwas estimated on the date of grant using a Black-Scholes option-pricing modelwith the following weighted average assumptions: risk-free interest rate of5.00%, expected life of 6.25 years and no volatility or dividend yield. Theweighted average fair value of the options granted in 2006 calculated using aBlack-Scholes option-pricing model is $30.36. If the Company had elected torecognize compensation cost based on the fair value of the options granted atthe grant date, which corresponds to their vesting date, as prescribed bySFAS 123, earnings before income taxes would have decreased byapproximately $23,000 for the three and nine months ended June 30, 2006.

During fiscal 2005, theCompany recognized employee compensation cost for certain of its stock optionsgranted that were considered to be variable awards. If the Company had electedto recognize compensation cost based on the fair value of the options grantedat the grant date, which corresponds to their vesting date, as prescribed bySFAS 123, earnings before income taxes would have increased by approximately$5.1 million and $9.0 million for the three and nine months ended June 30,2005, respectively.

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. Each year, the Company willrecognize compensation cost, for the relative service period covered, equal tothe market value of the underlying common shares of the Company on the date ofgrant. During the three and nine months ended June 30, 2006, compensation costof $206,000 and $616,000 related to deferred stock units is included in theCompany’s condensed consolidated statements of operations. During the three andnine months ended June 30, 2005, compensation cost of $205,000 related todeferred stock units is included in the Company’s condensed consolidatedstatements of operations.

**2.  Inventory**

Inventoryconsists of the following (in thousands):
| ** **                                             | ** ** | **June 30,** | ** ** | **September 30,** | ** ** |
|--------------------------------------------------------|------------|-------------------|------------|------------------------|------------|
| ** **                                             | ** ** | **2006**          | ** ** | **2005**               | ** ** |
| Residential  lots—developed and under development |       | $                 | 549,026    |                   | $          | 541,169 |   |
| Finished homes  and construction in progress           |       | 371,433           |       | 248,878                |       |
| Deposits on land  purchases                            |       | 17,202            |       | 15,612                 |       |
| Land held for  future development or sale              |       | 35,582            |       | 3,119                  |       |
| Total                                                  |       | $                 | 973,243    |                   | $          | 808,778 |   |
|                                                   |       |              |       |                   |       |

 

In March 2006, the Company decided to exit theCleveland market. As of June 30, 2006, the carrying value of inventory locatedin the Cleveland market has been reduced by $3.2 million to its estimatedrealizable value under the Company’s exit plans. The Company’s decision to exitthe Cleveland market reflects the Company’s perception regarding local marketconditions currently and in the foreseeable future.

 

The Company capitalizes interestduring development and construction. Capitalized interest is charged to cost ofsales as residential units are closed. Interest costs are (in thousands):

7

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| ** **                                     | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                     | ** ** | **June 30,**                | ** ** | **June 30,**               | ** ** |
| ** **                                     | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Capitalized  interest—beginning of period |       | $                                | 50,214     |                            | $          | 36,186 | ** ** | $ | 40,076 |   | $ | 29,551 |   |
| Interest  incurred                             |       | 14,877                           |       | 12,316                          | ** ** | 36,158 |   | 28,836 |   |
| Interest  included in cost of sales            |       | (9,445                           | )          | (7,483                          | )          | (20,588 | ) | (17,368 | ) |
| Capitalized interest—end  of period       |       | $                                | 55,646     |                            | $          | 41,019 | ** ** | $ | 55,646 |   | $ | 41,019 |   |
|                                           |       |                             |       |                            | ** ** |   |   |   |   |

 

**3*.* **InventoryNot 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 atfair value.

At June 30, 2006, theCompany has consolidated option agreements and purchase contracts to secureland with an initial fair value of approximately $70.4 million for which itpaid cash option deposits of $5.1 million. The Company has specific performanceobligations to purchase approximately $31.7 million of the consolidatedinventory not owned. The Company has estimated the initial fair value of theconsolidated optioned land based upon the Company’s option contract price. Inmany cases, the Company was unable to obtain the relevant financial informationfrom the selling entities, therefore, the Company has used the informationavailable to make an assumption as to whether the selling entity has additionalassets or has debt obligations outstanding. The difference between the initialfair value of the land under contract and any non-refundable deposit isrecorded in liabilities related to inventory not owned unless it is determinedby the Company that the selling entity does not carry debt in which case thedifference is recorded as minority interest in inventory not owned.

**4.  Investments In and Advances to UnconsolidatedEntities**

Investments in andadvances to unconsolidated entities represent the Company’s ownership interestin entities accounted for under the equity method when the Company holds lessthan a controlling interest in the entity or it is not the primary beneficiaryin a VIE as defined by FIN 46R. In instances where the Company expects topurchase land from the unconsolidated entity, the Company’s share of theunconsolidated entity’s earnings is deferred until homes related to the lotspurchased are delivered and title passes to a homebuyer. The Company’s partnersgenerally are unrelated homebuilders, land sellers or other real estateentities.

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, with the Company’sinterest in these entities ranging from 6% to 49%. The Company accounts for itsinterest in these joint ventures under the equity method, and the Company’scondensed consolidated balance sheets include investments in joint venturestotaling $45.5 million and $37.0 million at June 30, 2006 and September 30,2005, respectively. These joint ventures typically obtain secured acquisition,development and construction financing. At June 30, 2006 and

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September 30, 2005, theCompany’s unconsolidated joint ventures had outstanding third-party borrowingsof $838 million and $803 million, respectively. From time to time the Companyhas issued repayment guarantees and/or loan-to-value maintenance guarantees inrespect of this indebtedness. These guarantees require the Company to repaydebt of the joint venture in the event of a payment default, in the case of therepayment guarantees, or in the event that the debt of the joint ventureexceeds the value of the property securing the debt, in the case of theloan-to-value maintenance guarantees. At June 30, 2006 and September 30,2005, the Company had guarantees of $69.7 million and $67.6 million, respectively,related to the indebtedness of these joint ventures.

**5.  Financing**

***Homebuilding***

The Company’s notes payable, at their principalamounts, consist of the following (in thousands):
| ** **                                               | ** ** | **June 30,** | ** ** | **September 30,** | ** ** |
|----------------------------------------------------------|------------|-------------------|------------|------------------------|------------|
| ** **                                               | ** ** | **2006**          | ** ** | **2005**               | ** ** |
| Senior unsecured  credit facility                        |       | $                 | 403,632    |                   |       |   |
| Senior  subordinated notes (net of unamortized discount) |       | 200,687           |       |                   |       |
| Other senior  secured credit facilities                  |       | 48,293            |       | $                      | 115,178    |   |
| Other senior  debt                                       |       |              |       | 6,921                  |       |
| Senior secured  revolving credit facilities              |       |              |       | 306,126                |       |
| Working capital  loans                                   |       |              |       | 45,000                 |       |
| Total                                                    |       | $                 | 652,612    |                   | $          | 473,225 |   |
|                                                     |       |              |       |                   |       |

 

In December 2005, the Company issued $203 millionaggregate principal amount of senior subordinated notes due December 2012 in aprivate placement pursuant to Rule 144A promulgated under the Securities Act of1933, as amended. The senior subordinated notes were sold at 98.796% of par andaccrue interest at a coupon rate of 10.5% per annum. Interest is paidsemi-annually beginning June 2006. The net proceeds were used to repay amountsoutstanding under working capital loans and certain senior secured revolvingcredit facilities. The Company may redeem the notes, in whole or part, at anytime on or after December 15, 2009, at a redemption price equal to 100% of theprincipal amount, plus a 5.25% premium declining ratably to par on December 15,2011, plus accrued and unpaid interest. In addition, at any time prior toDecember 15, 2008, the Company may redeem up to 35% of the aggregate principalamount of the notes with the proceeds of qualified equity offerings at aredemption price equal to 110.5% of the principal amount, plus accrued andunpaid interest. The notes are unsecured senior subordinated obligations andsubordinated in right of payment to all of the Company’s existing and futuresenior debt, including borrowings under the Company’s senior unsecured creditfacility. All of the Company’s wholly owned subsidiaries, other than theCompany’s mortgage subsidiary, have fully and unconditionally guaranteed thenotes on a joint and several, unsecured senior subordinated, basis. Theguarantees are general unsecured obligations of the guarantors and will besubordinated in right of payment to all existing and future senior debt of theguarantors, which includes their guarantees of the Company’s senior unsecuredcredit facility. The indenture governing the senior subordinated notes containsa number of significant covenants that could restrict the Company’s ability andthat of its restricted subsidiaries to, among other things: incur additionalindebtedness, make certain distributions, investments and other restrictedpayments, create certain liens, enter into transactions with affiliates, andmerge, consolidate or sell substantially all of the Company’s assets.

On April 13, 2006, theCompany filed a registration statement with the U.S. Securities and ExchangeCommission (the “Commission”) relating to an offer to exchange the notes for anissue of registered notes with terms substantially identical to the notes. OnMay 4, 2006, the Commission declared the Company’s amended registrationstatement effective, and the Company offered the exchange notes in return forthe notes during the exchange offer period. The

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exchange offer expired at5:00 p.m., New York City time, on Monday, June 5, 2006.****Alloutstanding senior subordinated notes, in the aggregate principal amount of$203 million, were tendered and exchanged.

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 June 30, 2006, the Company had $404 million of borrowings under the creditfacility at an effective rate of 6.83% and, after giving effect to theborrowing base limitation, had additional availability of $95 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, including covenants requiring the Company to: maintain a minimumtangible net worth of at least $225 million plus 50% of positive net income asearned subsequent to September 30, 2005; maintain a ratio of total liabilitiesto adjusted tangible net worth not to exceed 2.50x; maintain a ratio of totaldebt to adjusted tangible net worth not in excess of 2.0x (decreasing to 1.75xas of March 31, 2007); maintain an interest coverage ratio of no less than2.25x; and limit the number of speculative housing units owned by the Company,excluding foundations, as of the end of any fiscal quarter to a maximum of 30%of the Company’s housing unit closings during the previous 12-month period; andlimit the number of speculative housing units in any building region, excludingfoundations, as of the end of any fiscal quarter to a maximum of 35% of theCompany’s housing unit closings in such region during the previous 12-monthperiod. In addition to these covenants, the credit facility includesrestrictions upon debt and investments which permit: subordinated debt up to$300 million; other unsecured debt up to $25 million; secured debt up to 25% oftangible net worth; guarantees of minority-owned joint venture debt up to 35%of adjusted tangible net worth; and investments in minority-owned jointventures up to 30% of tangible net worth. For purposes of these tests, adjustedtangible net worth is benefited by adjustments of 50% of the Company’soutstanding senior subordinated debt (up to a maximum $100 million adjustment)and 100% of minority interests in consolidated entities (up to a maximum $50million adjustment). As of and during the three and nine months ended June 30,2006, the Company was in compliance with 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 June 30, 2006, the Company hasrights, under such agreements, to purchase approximately 14,400 lots,within 74 separate developments, with an aggregate contract price ofapproximately $631 million, including inventory not owned which wasconsolidated under the accounting guidance of FIN 46R. Approximately 1,600 ofthe lots, with an aggregate purchase price of approximately $48 million,contain specific performance requirements. Approximately 1,800 of the lots,with an aggregate purchase price of approximately $165 million, are to bepurchased from joint ventures in

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which the Company has aninvestment balance of approximately $33 million as of June 30, 2006. Thisinvestment is recorded in investments in and advances to unconsolidatedentities on the condensed consolidated balance sheets.

At June 30, 2006,excluding inventory not owned (see note 3), the Company was contingently liableto banks and financial institutions for approximately $49 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 the Company’s common stock, including shares issuableunder outstanding options, from the Company’s directors and certain of theCompany’s executive officers and other key employees in the event oftermination of board membership or employment, as applicable, by reason ofspecified circumstances, including death, disability, termination, retirementor resignation. The terms of the original stock option agreements required therepurchase obligation at an amount other than fair market value. During theCompany’s quarter ended December 31, 2005, the stock option agreements wereamended so that the repurchase obligation of stock is at fair market value. Asof June 30, 2006, the aggregate repurchase obligation, net of proceeds to bereceived from any stock option exercises, would have been approximately $64million in the event that all of these obligations were triggered. Included withinthe $64 million repurchase obligation, as part of a separation agreement with aformer executive officer, the Company has agreed to repurchase 77,000 shares ofits common stock at the fair market value of approximately $8.9 million, withpayment in full by January 31, 2007.

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

The Company providesproduct warranties to its customers covering workmanship, materials, andcertain mechanical systems for two years, and structural systems for ten years.The Company estimates and records warranty liabilities based on historicalexperience and known risks at the time a home closes, and in the case ofunexpected claims, upon identification and quantification of the obligations.The Company’s warranty accrual is included in accounts payable and accruedexpenses in its condensed consolidated balance sheets. Changes in the Company’swarranty liability for the three and nine months ended June 30, 2006 and 2005are as follows (in thousands):
| ** **                         | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                         | ** ** | **June 30,**                | ** ** | **June 30,**               | ** ** |
| ** **                         | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Balance at  beginning of period    |       | $                                | 6,338      |                            | $          | 4,278 | ** ** | $ | 5,844 |   | $ | 3,324 |   |
| Warranties  issued                 |       | 1,793                            |       | 1,403                           | ** ** | 4,628 |   | 3,804 |   |
| Settlements and  other adjustments |       | (1,466                           | )          | (791                            | )          | (3,807 | ) | (2,238 | ) |
| Balance at end of  period          |       | $                                | 6,665      |                            | $          | 4,890 | ** ** | $ | 6,665 |   | $ | 4,890 |   |
|                               |       |                             |       |                            | ** ** |   |   |   |   |

 

At June 30, 2006 theCompany was committed to fund approximately $39 million in mortgage loans tohomebuyers. The Company has entered into best-efforts and mandatory salecommitments to sell these mortgages to third parties. The Company is party to a$100 million flexible early purchase facility agreement which allows theCompany to sell qualifying mortgage loans to the holder of the flexible earlypurchase facility after such loans have been originated subject to the Company’sobligation to sell the loan to an investor in the secondary market. At June 30,2006, approximately $47 million of the facility was in use by the Company.

**7.  Recent Accounting Pronouncements**

In December 2004, theFASB issued Statement of Financial Accounting Standards No. 123 (revised 2004),*Share-Based Payment*, (“SFAS 123R”). SFAS123R is a revision of SFAS 123 and supersedes APB No. 25. SFAS 123R requiresthat the cost resulting from all share-based payment transactions be recognizedin the financial statements and establishes fair value as the measurementobjective in accounting for share-based payment arrangements. SFAS

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123R is effective as ofthe beginning of the first annual reporting period that begins after December15, 2005. SFAS 123R applies to all awards granted, modified, repurchased orcancelled after the effective date, and all outstanding portions of awardsgranted prior to the effective date which are unvested as of the effective dateof the pronouncement.

Entities may adopt theprovisions of SFAS 123R using either the modified prospective or modifiedretrospective methods. Under the modified prospective method, compensation costis recognized on or after the required effective date for the portion ofoutstanding awards for which the requisite service has not yet been rendered,based on the grant-date fair value of those awards calculated under SFAS 123for either recognition or pro forma disclosure. For periods before the requiredeffective date, the modified retrospective application may be applied to either (a) all prior years for which SFAS 123was effective or (b) only to prior interim periods in the year of initialadoption, on a basis consistent with the pro forma disclosures required forthose periods by SFAS 123. SFAS 123R becomes effective for the Company onOctober 1, 2006. The Company is currently evaluating the requirements of SFAS123R.

In May 2005, theFASB issued SFAS No. 154, *Accounting Changes andError Corrections — a replacement for APB Opinion No. 20 and FASBStatement No. 3* (“SFAS 154”). SFAS 154 requires prior periodfinancial statements to be restated for changes in accounting principles. SFAS154 also redefines restatement as the revision of previously issued financialstatements to reflect the correction of an error. SFAS 154 is effective foraccounting changes and corrections of errors made in fiscal years beginningafter December 15, 2005. SFAS 154 is not expected to have a materialimpact on the Company’s results of operations or financial position.

In June 2005, theEmerging Issues Task Force (“EITF”) released Issue No. 04-5, *Determining Whether a General Partner, or the General Partners as aGroup, Controls a Limited Partnership or Similar Entity When the LimitedPartners Have Certain Rights* (“EITF 04-5”). EITF 04-5 creates aframework for evaluating whether a general partner or a group of general partnerscontrols a limited partnership and therefore should consolidate thepartnership. EITF 04-5 states that the presumption of general partner controlwould be overcome only when the limited partners have certain specific rightsas outlined in EITF 04-5. EITF 04-5 is effective immediately for all newlyformed limited partnerships and for existing limited partnership agreementsthat are modified. For general partners in all other limited partnerships, EITF04-5 is effective no later than the beginning of the first reporting period infiscal years beginning after December 15, 2005. Implementation of EITF04-5 is not expected to have a material impact on the Company’s results ofoperations or financial position.

In July 2006, theFASB issued FASB Interpretation No. 48, *Accountingfor Uncertainty in Income Taxes* (“FIN 48”)*,*which prescribes a recognition threshold and measurement process for recordingin the financial statements uncertain tax positions taken or expected to betaken in a tax return. Additionally, FIN 48 provides guidance on thederecognition, classification, accounting in interim periods and disclosurerequirements for uncertain tax positions. The accounting provisions of FIN 48will be effective for the Company beginning October 1, 2007. The Company is inthe process of determining the effect, if any, the adoption of FIN 48 will haveon its financial statements.

**8. **Summarized FinancialInformation

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 audited financial statements for the GuarantorSubsidiaries, consolidated condensed financial statements are presented below.Separate financial 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 June 30, 2006  (in thousands)** | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                                       |       |       |       |                        |       |                            |       |             |       |             |       |
| HOMEBUILDING:                                                    |       |       |       |                        |       |                            |       |             |       |             |       |
| Cash and cash equivalents                                        |       | $          | 1,892      |                        | $          | 24,255                          |       | $                | 25         |             | $          | — |   | $ | 26,172 |   |
| Receivables from title companies                                 |       |       |       | 24,323                      |       | 6                               |       |             |       | 24,329           |       |
| Inventory                                                        |       |       |       | 809,614                     |       | 163,629                         |       |             |       | 973,243          |       |
| Inventory not owned                                              |       |       |       | 70,414                      |       |                            |       |             |       | 70,414           |       |
| Deferred expenses and other assets                               |       | 8,213      |       | 9,596                       |       | 56                              |       |             |       | 17,865           |       |
| Investments in and advances to unconsolidated  entities          |       |       |       | 45,474                      |       |                            |       |             |       | 45,474           |       |
| Deferred taxes                                                   |       | 11,870     |       |                        |       |                            |       |             |       | 11,870           |       |
| Property and equipment, net of accumulated  depreciation         |       | 8,173      |       | 2,569                       |       |                            |       |             |       | 10,742           |       |
| Investments in subsidiaries                                      |       | 306,529    |       | 12,713                      |       |                            |       | (319,242         | )          |             |       |
|                                                             |       | 336,677    |       | 998,958                     |       | 163,716                         |       | (319,242         | )          | 1,180,109        |       |
| MORTGAGE BANKING                                                 |       |       |       |                        |       | 9,505                           |       |             |       | 9,505            |       |
| TOTAL ASSETS                                                     |       | $          | 336,677    |                        | $          | 998,958                         |       | $                | 173,221    |             | $          | (319,242 | ) | $ | 1,189,614 |   |
| **Liabilities  and equity**                                      |       |       |       |                        |       |                            |       |             |       |             |       |
| HOMEBUILDING:                                                    |       |       |       |                        |       |                            |       |             |       |             |       |
| Accounts payable and accrued expenses                            |       | $          | 33         |                        | $          | 93,588                          |       | $                | 248        |             | $          | — |   | $ | 93,869 |   |
| Deposits on sales of residential units                           |       |       |       | 11,918                      |       | 250                             |       |             |       | 12,168           |       |
| Liabilities related to inventory not owned                       |       |       |       | 33,624                      |       |                            |       |             |       | 33,624           |       |
| Income tax payable                                               |       | 204        |       |                        |       |                            |       |             |       | 204              |       |
| Notes payable                                                    |       | 613,135    |       | 9,800                       |       | 29,677                          |       |             |       | 652,612          |       |
| Intercompany                                                     |       | (598,429   | )          | 516,707                     |       | 81,722                          |       |             |       |             |       |
|                                                             |       | 14,943     |       | 665,637                     |       | 111,897                         |       |             |       | 792,477          |       |
| MORTGAGE BANKING                                                 |       |       |       |                        |       | 944                             |       |             |       | 944              |       |
| Total liabilities                                                |       | 14,943     |       | 665,637                     |       | 112,841                         |       |             |       | 793,421          |       |
|                                                             |       |       |       |                        |       |                            |       |             |       |             |       |
| MINORITY  INTEREST IN CONSOLIDATED PARTNERSHIPS                  |       |       |       |                        |       | 43,322                          |       | (584             | )          | 42,738           |       |
| MINORITY  INTEREST IN INVENTORY NOT OWNED                        |       |       |       | 31,721                      |       |                            |       |             |       | 31,721           |       |
|                                                             |       |       |       |                        |       |                            |       |             |       |             |       |
| REEDEMABLE  EQUITY                                               |       | 51,678     |       |                        |       |                            |       |             |       | 51,678           |       |
| SHAREHOLDERS’  EQUITY                                       |       | 270,056    |       | 301,600                     |       | 17,058                          |       | (318,658         | )          | 270,056          |       |
| TOTAL LIABILITIES AND  EQUITY                                    |       | $          | 336,677    |                        | $          | 998,958                         |       | $                | 173,221    |             | $          | (319,242 | ) | $ | 1,189,614 |   |
|                                                             |       |       |       |                        |       |                            |       |             |       |             |       |

 

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

 

14

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

 

15

----

 
| **For the three months ended  June 30, 2005 (in thousands)** | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| HOMEBUILDING:                                                                                        |       |       |       |                        |       |                            |       |             |       |             |       |
| Revenues:                                                                                            |       |       |       |                        |       |                            |       |             |       |             |       |
| Sales of  residential units and land                                                                 |       | $          | —     |                        | $          | 290,941                         |       | $                | 4,696      |             | $          | — |   | $ | 295,637 |   |
| Rental and other  income                                                                             |       | 63         |       | 1,043                       |       | 122                             |       |             |       | 1,228            |       |
| Total  homebuilding revenues                                                                         |       | 63         |       | 291,984                     |       | 4,818                           |       |             |       | 296,865          |       |
| Expenses:                                                                                            |       |       |       |                        |       |                            |       |             |       |             |       |
| Cost of sales of  residential units and land                                                         |       |       |       | 215,487                     |       | 3,729                           |       |             |       | 219,216          |       |
| General and  administrative                                                                          |       | 6,443      |       | 17,359                      |       | 65                              |       |             |       | 23,867           |       |
| Sales and  marketing                                                                                 |       |       |       | 12,306                      |       | 205                             |       |             |       | 12,511           |       |
| Depreciation                                                                                         |       | 27         |       | 129                         |       | 9                               |       |             |       | 165              |       |
| Total  homebuilding expenses                                                                         |       | 6,470      |       | 245,281                     |       | 4,008                           |       |             |       | 255,759          |       |
| Intercompany  charge                                                                                 |       | 6,407      |       | (6,407                      | )          |                            |       |             |       |             |       |
| Equity in loss of  unconsolidated joint ventures                                                     |       |       |       | (117                        | )          |                            |       |             |       | (117             | )          |
| Minority  interests in net earnings of consolidated partnerships                                     |       |       |       | (1,422                      | )          | (43                             | )          |             |       | (1,465           | )          |
| Homebuilding  earnings before income taxes                                                           |       | —     |       | 38,757                      |       | 767                             |       |             |       | 39,524           |       |
| MORTGAGE BANKING:                                                                                    |       |       |       |                        |       |                            |       |             |       |             |       |
| Revenues:                                                                                            |       |       |       |                        |       |                            |       |             |       |             |       |
| Gain on sales of  mortgage loans                                                                     |       |       |       |                        |       | 1,540                           |       |             |       | 1,540            |       |
| Interest income                                                                                      |       |       |       |                        |       | 2                               |       |             |       | 2                |       |
| Total mortgage  banking revenues                                                                     |       |       |       |                        |       | 1,542                           |       |             |       | 1,542            |       |
| Expenses:                                                                                            |       |       |       |                        |       |                            |       |             |       |             |       |
| General and  administrative                                                                          |       |       |       |                        |       | 1,157                           |       |             |       | 1,157            |       |
| Interest expense                                                                                     |       |       |       |                        |       | 2                               |       |             |       | 2                |       |
| Depreciation                                                                                         |       |       |       |                        |       | 27                              |       |             |       | 27               |       |
| Total mortgage  banking expenses                                                                     |       |       |       |                        |       | 1,186                           |       |             |       | 1,186            |       |
| Mortgage banking  earnings before income taxes                                                       |       |       |       |                        |       | 356                             |       |             |       | 356              |       |
| EQUITY IN INCOME OF CONSOLIDATED  SUBSIDIARIES                                                       |       | 39,880     |       | 745                         |       |                            |       | (40,625          | )          |             |       |
| EARNINGS BEFORE INCOME  TAXES                                                                        |       | 39,880     |       | 39,502                      |       | 1,123                           |       | (40,625          | )          | 39,880           |       |
| PROVISION FOR INCOME  TAXES                                                                          |       | 14,697     |       | 14,576                      |       | 415                             |       | (14,991          | )          | 14,697           |       |
| NET EARNINGS                                                                                         |       | $          | 25,183     |                        | $          | 24,926                          |       | $                | 708        |             | $          | (25,634 | ) | $ | 25,183 |   |
|                                                                                                 |       |       |       |                        |       |                            |       |             |       |             |       |

 

16

----

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

 

17

----

 
| **For the nine months ended  June 30, 2005 (in thousands)** | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| HOMEBUILDING:                                                                                       |       |       |       |                        |       |                            |       |             |       |             |       |
| Revenues:                                                                                           |       |       |       |                        |       |                            |       |             |       |             |       |
| Sales of residential units and land                                                                 |       | $          | —     |                        | $          | 693,173                         |       | $                | 6,059      |             | $          | — |   | $ | 699,232 |   |
| Rental and other income                                                                             |       | 230        |       | 1,893                       |       | 271                             |       |             |       | 2,394            |       |
| Total homebuilding revenues                                                                         |       | 230        |       | 695,066                     |       | 6,330                           |       |             |       | 701,626          |       |
| Expenses:                                                                                           |       |       |       |                        |       |                            |       |             |       |             |       |
| Cost of sales of residential units and land                                                         |       |       |       | 528,502                     |       | 4,679                           |       |             |       | 533,181          |       |
| General and administrative                                                                          |       | 17,127     |       | 43,968                      |       | 200                             |       |             |       | 61,295           |       |
| Sales and marketing                                                                                 |       |       |       | 32,874                      |       | 461                             |       |             |       | 33,335           |       |
| Depreciation                                                                                        |       | 79         |       | 456                         |       | 26                              |       |             |       | 561              |       |
| Total homebuilding expenses                                                                         |       | 17,206     |       | 605,800                     |       | 5,366                           |       |             |       | 628,372          |       |
| Intercompany charge                                                                                 |       | 16,976     |       | (16,976                     | )          |                            |       |             |       |             |       |
| Equity in income of unconsolidated joint ventures                                                   |       |       |       | 2,778                       |       |                            |       |             |       | 2,778            |       |
| Minority interests in net earnings of consolidated  partnerships                                    |       |       |       | (3,346                      | )          | (43                             | )          |             |       | (3,389           | )          |
| Homebuilding earnings before income taxes                                                           |       | —     |       | 71,722                      |       | 921                             |       |             |       | 72,643           |       |
| MORTGAGE  BANKING:                                                                                  |       |       |       |                        |       |                            |       |             |       |             |       |
| Revenues:                                                                                           |       |       |       |                        |       |                            |       |             |       |             |       |
| Gain on sales of mortgage loans                                                                     |       |       |       |                        |       | 3,470                           |       |             |       | 3,470            |       |
| Interest income                                                                                     |       |       |       |                        |       | 52                              |       |             |       | 52               |       |
| Total mortgage banking revenues                                                                     |       |       |       |                        |       | 3,522                           |       |             |       | 3,522            |       |
| Expenses:                                                                                           |       |       |       |                        |       |                            |       |             |       |             |       |
| General and administrative                                                                          |       |       |       |                        |       | 3,511                           |       |             |       | 3,511            |       |
| Interest expense                                                                                    |       |       |       |                        |       | 36                              |       |             |       | 36               |       |
| Depreciation                                                                                        |       |       |       |                        |       | 95                              |       |             |       | 95               |       |
| Total mortgage banking expenses                                                                     |       |       |       |                        |       | 3,642                           |       |             |       | 3,642            |       |
| Mortgage banking losses before income taxes                                                         |       |       |       |                        |       | (120                            | )          |             |       | (120             | )          |
| EQUITY IN INCOME  OF CONSOLIDATED SUBSIDIARIES                                                      |       | 72,523     |       | 924                         |       |                            |       | (73,447          | )          |             |       |
| EARNINGS BEFORE  INCOME TAXES                                                                       |       | 72,523     |       | 72,646                      |       | 801                             |       | (73,447          | )          | 72,523           |       |
| PROVISION FOR  INCOME TAXES                                                                         |       | 26,742     |       | 26,806                      |       | 296                             |       | (27,102          | )          | 26,742           |       |
| NET EARNINGS                                                                                        |       | $          | 45,781     |                        | $          | 45,840                          |       | $                | 505        |             | $          | (46,345 | ) | $ | 45,781 |   |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |

 

18

----

 
| **For the nine months ended  June 30, 2006 (in thousands)** | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                               |       |       |       |                        |       |                            |       |             |       |             |       |
| Net earnings                                                                                        |       | $          | 38,510     |                        | $          | 37,027                          |       | $                | 1,874      |             | $          | (38,901 | ) | $ | 38,510 |   |
| Adjustments to reconcile net earnings to net cash  flows used in operating activities               |       | (44,813    | )          | (149,738                    | )          | (27,333                         | )          | 37,458           |       | (184,426         | )          |
| Net cash used in operating activities                                                               |       | (6,303     | )          | (112,711                    | )          | (25,459                         | )          | (1,443           | )          | (145,916         | )          |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                               |       |       |       |                        |       |                            |       |             |       |             |       |
| Purchases of property and equipment                                                                 |       | (5,711     | )          | (1,262                      | )          | (22                             | )          |             |       | (6,995           | )          |
| Disposals of property and equipment                                                                 |       |       |       |                        |       | 858                             |       |             |       | 858              |       |
| Distributions of contributed capital from investments  in unconsolidated entities                   |       |       |       | 698                         |       |                            |       |             |       | 698              |       |
| Contributions to investments in unconsolidated  entities                                            |       |       |       | (8,460                      | )          |                            |       |             |       | (8,460           | )          |
| Contributions to investments in subsidiaries                                                        |       |       |       | (2,463                      | )          |                            |       | 2,463            |       |             |       |
| Net cash (used in) provided by investing activities                                                 |       | (5,711     | )          | (11,487                     | )          | 836                             |       | 2,463            |       | (13,899          | )          |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                               |       |       |       |                        |       |                            |       |             |       |             |       |
| Proceeds from issuance of notes and mortgage loans  payable                                         |       | 832,073    |       | 323,189                     |       | 20,094                          |       |             |       | 1,175,356        |       |
| Repayments of notes and mortgage loans payable                                                      |       | (223,064   | )          | (710,427                    | )          | (62,664                         | )          |             |       | (996,155         | )          |
| Debt issuance costs                                                                                 |       | (6,598     | )          |                        |       |                            |       |             |       | (6,598           | )          |
| Proceeds from issuance of common stock                                                              |       | 712        |       |                        |       |                            |       |             |       | 712              |       |
| Repurchases of common stock                                                                         |       | (3,174     | )          |                        |       |                            |       |             |       | (3,174           | )          |
| Distributions to minority interests                                                                 |       |       |       | 127                         |       | (2,668                          | )          |             |       | (2,541           | )          |
| Contributions from parent and guarantors                                                            |       |       |       |                        |       | 2,463                           |       | (2,463           | )          |             |       |
| Distributions to parent and guarantors                                                              |       |       |       |                        |       | (1,443                          | )          | 1,443            |       |             |       |
| Intercompany                                                                                        |       | (592,918   | )          | 525,778                     |       | 67,140                          |       |             |       |             |       |
| Net cash provided by financing activities                                                           |       | 7,031      |       | 138,667                     |       | 22,922                          |       | (1,020           | )          | 167,600          |       |
| NET (DECREASE)  INCREASE IN CASH AND CASH EQUIVALENTS                                               |       | (4,983     | )          | 14,469                      |       | (1,701                          | )          | —           |       | 7,785            |       |
| CASH AND CASH EQUIVALENTS—  Beginning of period                                           |       | 6,875      |       | 9,786                       |       | 4,799                           |       |             |       | 21,460           |       |
| CASH AND CASH  EQUIVALENTS—  End of period                                                     |       | $          | 1,892      |                        | $          | 24,255                          |       | $                | 3,098      |             |       |   | $ | 29,245 |   |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |
| RECONCILIATION TO CASH AND CASH EQUIVALENTS REPORTED  ON THE CONSOLIDATED BALANCE SHEETS:           |       |       |       |                        |       |                            |       |             |       |             |       |
| Homebuilding                                                                                        |       | $          | 1,892      |                        | $          | 24,255                          |       | $                | 25         |             |       |   | $ | 26,172 |   |
| Mortgage banking                                                                                    |       |       |       |                        |       | 3,073                           |       |             |       | 3,073            |       |
| TOTAL                                                                                               |       | $          | 1,892      |                        | $          | 24,255                          |       | $                | 3,098      |             |       |   | $ | 29,245 |   |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |
|                                                                                                     |            |            |            |                             |            |                                 |            |                  |            |                  |            |  |  |  |  |  |

 

19

----

 
| **For the nine months ended  June 30, 2005 (in thousands)** | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                               |       |       |       |                        |       |                            |       |             |       |             |       |
| Net earnings                                                                                        |       | $          | 45,781     |                        | $          | 45,840                          |       | $                | 505        |             | $          | (46,345 | ) | $ | 45,781 |   |
| Adjustments to reconcile net earnings to net cash  flows used in operating activities               |       | (34,825    | )          | (144,869                    | )          | (10,191                         | )          | 46,345           |       | (143,540         | )          |
| Net cash provide by (used in) operating activities                                                  |       | 10,956     |       | (99,029                     | )          | (9,686                          | )          | —           |       | (97,759          | )          |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                               |       |       |       |                        |       |                            |       |             |       |             |       |
| Purchases of property and equipment                                                                 |       |       |       | (345                        | )          | (89                             | )          |             |       | (434             | )          |
| Distributions of contributed capital from investments  in unconsolidated entities                   |       |       |       | 824                         |       |                            |       |             |       | 824              |       |
| Contributions to investments in unconsolidated  entities                                            |       |       |       | (17,143                     | )          |                            |       |             |       | (17,143          | )          |
| Contributions to investments in subsidiaries                                                        |       |       |       | (2,804                      | )          |                            |       | 2,804            |       |             |       |
| Net cash used in investing activities                                                               |       |       |       | (19,468                     | )          | (89                             | )          | 2,804            |       | (16,753          | )          |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                               |       |       |       |                        |       |                            |       |             |       |             |       |
| Proceeds from issuance of notes and mortgage loans  payable                                         |       |       |       | 742,032                     |       | 13,454                          |       |             |       | 755,486          |       |
| Repayments of notes and mortgage loans payable                                                      |       | (85        | )          | (598,601                    | )          | (12,250                         | )          |             |       | (610,936         | )          |
| Proceeds from issuance of common stock                                                              |       | 4,012      |       |                        |       |                            |       |             |       | 4,012            |       |
| Repurchases of common stock                                                                         |       | (1,711     | )          |                        |       |                            |       |             |       | (1,711           | )          |
| Contributions from minority interests                                                               |       |       |       |                        |       | 4,000                           |       |             |       | 4,000            |       |
| Distributions to minority interests                                                                 |       |       |       | (19,799                     | )          |                            |       |             |       | (19,799          | )          |
| Contributions from parent and guarantors                                                            |       |       |       |                        |       | 2,804                           |       | (2,804           | )          |             |       |
| Intercompany                                                                                        |       | (2,168     | )          | (2,594                      | )          | 4,762                           |       |             |       |             |       |
| Net cash provided by financing activities                                                           |       | 48         |       | 121,038                     |       | 12,770                          |       | (2,804           | )          | 131,052          |       |
| NET INCREASE IN  CASH AND CASH EQUIVALENTS                                                          |       | 11,004     |       | 2,541                       |       | 2,995                           |       | —           |       | 16,540           |       |
| CASH AND CASH  EQUIVALENTS—  Beginning of period                                               |       | 3,227      |       | 2,829                       |       | 1,600                           |       |             |       | 7,656            |       |
| CASH AND CASH  EQUIVALENTS—  End of period                                                     |       | $          | 14,231     |                        | $          | 5,370                           |       | $                | 4,595      |             |       |   | $ | 24,196 |   |
|                                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |
|                                                                                                     |            |            |            |                             |            |                                 |            |                  |            |                  |            |  |  |  |  |  |

 

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**Item 2.  Management’s Discussionand 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 theU.S., as measured by home deliveries and revenues. We design, build and markethigh-quality single-family detached, single-family attached and multi-familyhomes. Since we were founded in 1969, we have delivered over 40,000 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 five regions:Florida, the Midwest, Nevada, the Pacific Coast and Texas.
| Florida   | ** ** | **Midwest**   | ** ** | **Nevada** | ** ** | **Pacific Coast** | ** ** | **Texas**   |
|-----------|------------|---------------|------------|------------|------------|-------------------|------------|-------------|
| Ft. Myers |       | Chicago, IL   |       | Las Vegas  |       | Portland, OR      |       | Austin      |
| Naples    |       | Cleveland, OH |       |       |       | Sacramento, CA    |       | Dallas      |
| Sarasota  |       | Milwaukee, WI |       |       |       | Stockton, CA      |       | Ft. Worth   |
| Tampa     |       |          |       |       |       | Vancouver, WA     |       | Houston     |
|      |       |          |       |       |       |              |       | San Antonio |

 

Our revenues areprimarily generated from designing, building, marketing and deliveringhigh-quality, for sale single-family detached, single-family attached andmulti-family homes. We also sell land and lots to third parties as a means ofmanaging inventory and obtaining the desired asset mix for our homebuildingoperations. We also conduct mortgage origination and title services for thebenefit of our homebuilding operations, although revenues generated by theseancillary services have historically comprised less than 1% of our totalrevenues, and are not expected to be significant in the future.

**Recent Trends**

Over the last six months,the national business environment for the homebuilding industry has become morechallenging than in recent years, primarily due to increasing interest rates,concerns about home affordability, more rigorous underwriting standards formortgage loans, and increased levels of homes for sale on the market that aregenerally taking longer to sell. Many view the current homebuilding environmentand the anticipated changes as a return to a more normalized homebuildingmarketplace, which may continue to show erosion of home sales and profitabilitythrough the next year. The changing marketplace has been amplified in thecoastal markets and Las Vegas, as some of these recently hot markets have givenback a portion of their recent gains. Many of our competitors have reacted tothese concerns with greater utilization of a wide assortment of incentives. Wehave increased the use of incentives in many of our markets and have alsoremained focused on product development to meet an expectation of a shiftingdemand to smaller more affordable homes and more attached product in several ofour markets. We continually review our land acquisition criteria and our landpurchase agreements and option contracts and will renegotiate with sellers whenadvantageous or necessary to do so. We believe that our company’s history andgeographic diversification will continue to benefit us as the homebuildingindustry transitions through a changing environment.

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**Recent Events**

In March 2006, we decidedto exit the Cleveland market. As of June 30, 2006, the carrying value ofinventory located in the Cleveland market has been reduced by $3.2 million toits estimated realizable value under our exit plans. Our decision to exit theCleveland market reflects our perception regarding local market conditionscurrently and in the foreseeable future. We intend to wind down operations overthe next several months with the objective of completing all construction andsales activities by December 31, 2006. We believe our exit from the Clevelandmarket will not have a material adverse impact on our financial condition orresults of operations.

**Results ofOperations and Other Data**

The following tablepresents selected statement of operations and other data for the three and ninemonth periods ended June 30, 2006 and 2005:
| ** **                                                                | ** ** | **Three months ended** | ** ** | **2006**   | ** ** | **Nine months ended** | ** ** | **2006**          | ** ** |
|---------------------------------------------------------------------------|------------|----------------------------------|------------|------------|------------|---------------------------------|------------|-------------------|------------|
| ** **                                                                | ** ** | **June 30,**                | ** ** | **vs.**    | ** ** | ** **                      | ** ** | **June 30,** | ** ** | **vs.** | ** ** |
| **(Dollars in thousands)**                                      | ** ** | **2006**                         | ** ** | **2005**   | ** ** | **2005**                        | ** ** | **2006**          | ** ** | **2005** | ** ** | **2005** | ** ** |
| **Statement  of operations data:**                                        | ** ** | ** **                       | ** ** | ** ** | ** ** | ** **                      | ** ** | ** **        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total  homebuilding revenues                                              |       | $                                | 310,552    |       | $          | 296,865                         |       | 4.6               | %          | $ | 764,913 |   | $ | 701,626 |   | 9.0 | % |
| Cost of sales of  residential units and land                              |       | 257,639                          |       | 219,216    |       | 17.5                            | %          | 607,119           |       | 533,181 |   | 13.9 | % |
| Gross  homebuilding profit                                                |       | 52,913                           |       | 77,649     |       | (31.9                           | )%         | 157,794           |       | 168,445 |   | (6.3 | )% |
| Homebuilding  operating expenses                                          |       | 35,657                           |       | 36,543     |       | (2.4                            | )%         | 100,307           |       | 95,191 |   | 5.4 | % |
| Equity in income  (loss) of unconsolidated entities                       |       | 369                              |       | (117       | )          | —                          |       | 899               |       | 2,778 |   | (67.6 | )% |
| Minority  interests in net losses (earnings) of consolidated partnerships |       | 18                               |       | (1,465     | )          | —                          |       | 216               |       | (3,389 | ) | — |   |
| Homebuilding  earnings before income taxes                                |       | 17,643                           |       | 39,524     |       | (55.4                           | )%         | 58,602            |       | 72,643 |   | (19.3 | )% |
| Mortgage banking  earnings (losses) before income taxes                   |       | 1,135                            |       | 356        |       | 218.8                           | %          | 1,850             |       | (120 | ) | — |   |
| Earnings before  income taxes                                             |       | 18,778                           |       | 39,880     |       | (52.9                           | )%         | 60,452            |       | 72,523 |   | (16.6 | )% |
| Provision for  income taxes                                               |       | 6,813                            |       | 14,697     |       | (53.6                           | )%         | 21,942            |       | 26,742 |   | (17.9 | )% |
| Net earnings                                                              |       | $                                | 11,965     |       | $          | 25,183                          |       | (52.5             | )%         | $ | 38,510 |   | $ | 45,781 |   | (15.9 | )% |
| ** **                                                                | ** ** | ** **                       | ** ** | ** ** | ** ** | ** **                      | ** ** | ** **        | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Other  financial data:**                                                | ** ** | ** **                       | ** ** | ** ** | ** ** | ** **                      | ** ** | ** **        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest  incurred(1)                                                     |       | $                                | 14,878     |       | $          | 12,318                          |       | 20.8              | %          | $ | 36,165 |   | $ | 28,872 |   | 25.3 | % |
| Depreciation                                                              |       | 229                              |       | 192        |       | 19.3                            | %          | 628               |       | 656 |   | (4.3 | )% |
| EBITDA(2)                                                                 |       | 28,453                           |       | 47,557     |       | (40.2                           | )%         | 81,675            |       | 90,583 |   | (9.8 | )% |
| Gross  homebuilding profit margin(3)                                      |       | 17.0                             | %          | 26.2       | %          | —                          |       | 20.6              | %          | 24.0 | % | — |   |
| ** **                                                                | ** ** | ** **                       | ** ** | ** ** | ** ** | ** **                      | ** ** | ** **        | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Other  data:**                                                          | ** ** | ** **                       | ** ** | ** ** | ** ** | ** **                      | ** ** | ** **        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net new home  orders (units)(4)                                           |       | 942                              |       | 1,016      |       | (7.3                            | )%         | 2,726             |       | 2,867 |   | (4.9 | )% |
| Homes delivered  (units)                                                  |       | 1,109                            |       | 942        |       | 17.7                            | %          | 2,679             |       | 2,412 |   | 11.1 | % |
| Average sales  price of homes delivered                                   |       | $                                | 273        |       | $          | 291                             |       | (6.2              | )%         | $ | 278 |   | $ | 279 |   | (0.4 | )% |
| Backlog at end  of period (units)(5)                                      |       | 1,517                            |       | 2,103      |       | (27.9                           | )%         | 1,517             |       | 2,103 |   | (27.9 | )% |
| Backlog at end of  period (contract value)(5)                        |       | $                                | 413,749    |       | $          | 629,862                         |       | (34.3             | )%         | $ | 413,749 |   | $ | 629,862 |   | (34.3 | )% |

 

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(1)      Interest incurred is theamount of interest paid and the net amount accrued (whether expensed orcapitalized), excluding amortization of interest previously capitalized.

(2)      “EBITDA” represents netearnings before interest expense, depreciation and amortization and provisionfor income taxes. EBITDA is included in this report because it is a means ofassessing our operational performance. We believe it is therefore useful tosecurities analysts, investors and other interested parties in the evaluationof companies like ours. EBITDA is not a measure of our liquidity or financialperformance under GAAP and should not be considered as an alternative to ournet earnings or any other performance measure derived in accordance with GAAP,or as an alternative to cash flow from operating activities. EBITDA haslimitations as an analytical tool, and you should not consider it in isolation,or as a substitute for an analysis of our results as reported under GAAP. Somelimitations are:

·                  EBITDAdoes not reflect our cash expenditures, future requirements for capitalexpenditures or contractual commitments;

·                  EBITDAdoes not reflect changes in, or cash requirements for, our working capitalneeds;

·                    EBITDAdoes not reflect the significant interest expense, or the cash requirementsnecessary to service interest or principal payments on our indebtedness;

·                  EBITDA does notreflect the significant expense or cash requirements for federal and stateincome tax obligations;

·                  althoughdepreciation and amortization are non-cash charges, the assets beingdepreciated and amortized will often have to be replaced in the future, andEBITDA does not reflect any cash requirements for such replacements; and

·                  other companiesin our industry may calculate EBITDA differently than we do, limiting itsusefulness as a comparative measure.

Because of theselimitations, EBITDA should not be considered as a measure of discretionary cashavailable to us to invest in the growth of our business or to service ourindebtedness. We compensate for these limitations by relying primarily on ourGAAP results and using EBITDA only supplementally. See the condensedconsolidated statements of operations and cash flow presented in our condensedconsolidated financial statements included elsewhere in this report. Thefollowing is a reconciliation of EBITDA to net earnings, the most directlycomparable GAAP measure:
| ** **                                       | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                       | ** ** | **June 30,**                | ** ** | **June 30,**               | ** ** |
| **(Dollars in thousands)**             | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net earnings                                     |       | $                                | 11,965     |                            | $          | 25,183 |   | $ | 38,510 |   | $ | 45,781 |   |
| Provision for  income taxes                      |       | 6,813                            |       | 14,697                          |       | 21,942 |   | 26,742 |   |
| Interest expense  in cost of sales               |       | 9,445                            |       | 7,483                           |       | 20,588 |   | 17,368 |   |
| Interest expense  in mortgage banking operations |       | 1                                |       | 2                               |       | 7 |   | 36 |   |
| Depreciation and  amortization(a)                |       | 229                              |       | 192                             |       | 628 |   | 656 |   |
| EBITDA                                           |       | $                                | 28,453     |                            | $          | 47,557 |   | $ | 81,675 |   | $ | 90,583 |   |
|                                             |       |                             |       |                            |       |   |   |   |   |

 

(a) For the periods shown, amortization was $0.

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

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

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

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Thefollowing table presents information concerning our revenues from the sales ofresidential units and land, average sales price of homes, homes delivered, netnew home orders, backlog units and backlog contract value by region:
| **Three Months Ended  June 30,  (Dollars in thousands)** | ** ** | **Sales of  residential  units and  land** | ** ** | **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                                                                           |       | $                                                    | 28,133     |                                         | $          | 251                  |       | 112                               |       | 69                                               |       | 155                                                        |       | $ | 46,540 |   |
| Midwest                                                                           |       | 76,632                                               |       | 349                                          |       | 215                  |       | 146                               |       | 314                                              |       | 111,898                                                    |       |
| Nevada                                                                            |       | 44,603                                               |       | 405                                          |       | 110                  |       | 111                               |       | 159                                              |       | 63,245                                                     |       |
| Pacific Coast                                                                     |       | 71,104                                               |       | 453                                          |       | 157                  |       | 127                               |       | 140                                              |       | 62,265                                                     |       |
| Texas                                                                             |       | 89,281                                               |       | 164                                          |       | 515                  |       | 489                               |       | 749                                              |       | 129,801                                                    |       |
| Total                                                                             |       | $                                                    | 309,753    |                                         | $          | 273                  |       | 1,109                             |       | 942                                              |       | 1,517                                                      |       | $ | 413,749 |   |
| 2005                                                                              |       |                                                 |       |                                         |       |                 |       |                              |       |                                             |       |                                                       |       |
| Florida                                                                           |       | $                                                    | 20,355     |                                         | $          | 226                  |       | 90                                |       | 94                                               |       | 451                                                        |       | $ | 104,993 |   |
| Midwest                                                                           |       | 64,608                                               |       | 386                                          |       | 162                  |       | 196                               |       | 378                                              |       | 145,698                                                    |       |
| Nevada                                                                            |       | 53,399                                               |       | 388                                          |       | 102                  |       | 123                               |       | 167                                              |       | 64,261                                                     |       |
| Pacific Coast                                                                     |       | 88,919                                               |       | 408                                          |       | 218                  |       | 253                               |       | 528                                              |       | 219,663                                                    |       |
| Texas                                                                             |       | 68,356                                               |       | 170                                          |       | 370                  |       | 350                               |       | 579                                              |       | 95,247                                                     |       |
| Total                                                                             |       | $                                                    | 295,637    |                                         | $          | 291                  |       | 942                               |       | 1,016                                            |       | 2,103                                                      |       | $ | 629,862 |   |

 

| **Nine Months Ended  June 30,  (Dollars in thousands)** | ** ** | **Sales of  residential  units and  land** | ** ** | **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                                                                          |       | $                                                    | 72,917     |                                         | $          | 239                  |       | 305                               |       | 196                                              |       | 155                                                        |       | $ | 46,540 |   |
| Midwest                                                                          |       | 159,401                                              |       | 364                                          |       | 427                  |       | 486                               |       | 314                                              |       | 111,898                                                    |       |
| Nevada                                                                           |       | 104,993                                              |       | 396                                          |       | 265                  |       | 312                               |       | 159                                              |       | 63,245                                                     |       |
| Pacific Coast                                                                    |       | 214,818                                              |       | 455                                          |       | 472                  |       | 328                               |       | 140                                              |       | 62,265                                                     |       |
| Texas                                                                            |       | 210,344                                              |       | 163                                          |       | 1,210                |       | 1,404                             |       | 749                                              |       | 129,801                                                    |       |
| Total                                                                            |       | $                                                    | 762,473    |                                         | $          | 278                  |       | 2,679                             |       | 2,726                                            |       | 1,517                                                      |       | $ | 413,749 |   |
| 2005                                                                             |       |                                                 |       |                                         |       |                 |       |                              |       |                                             |       |                                                       |       |
| Florida                                                                          |       | $                                                    | 65,499     |                                         | $          | 239                  |       | 274                               |       | 305                                              |       | 451                                                        |       | $ | 104,993 |   |
| Midwest                                                                          |       | 173,496                                              |       | 371                                          |       | 461                  |       | 453                               |       | 378                                              |       | 145,698                                                    |       |
| Nevada                                                                           |       | 117,514                                              |       | 345                                          |       | 289                  |       | 252                               |       | 167                                              |       | 64,261                                                     |       |
| Pacific Coast                                                                    |       | 177,052                                              |       | 399                                          |       | 444                  |       | 740                               |       | 528                                              |       | 219,663                                                    |       |
| Texas                                                                            |       | 165,671                                              |       | 169                                          |       | 944                  |       | 1,117                             |       | 579                                              |       | 95,247                                                     |       |
| Total                                                                            |       | $                                                    | 699,232    |                                         | $          | 279                  |       | 2,412                             |       | 2,867                                            |       | 2,103                                                      |       | $ | 629,862 |   |

 

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

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

***Homebuilding revenues.******  ***Homebuilding revenues increased 4.6% to $310.6million for the three month period ended June 30, 2006 from $296.9 million forthe three month period ended June 30, 2005. The increase was primarily due to a17.7% increase in the number of new home deliveries offset by a 6.2% decreasein the average sales price of homes delivered during the three month periodended June 30, 2006 as compared to the three month period ended June 30, 2005.Land sales revenue was $6.6 million for the three month period ended June 30,2006 compared to $21.3 million for the three month period ended June 30, 2005.

24

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Homebuildingrevenues for the three month period ended June 30, 2006 benefited from anincrease in the number of homes delivered in our Florida, Midwest and Texasregions. The decline in average sales price in the Midwest and Texas regionspartially offset the increase in home deliveries for the three month periodended June 30, 2006. Home deliveries in our Pacific Coast region decreased by28% during the three month period ended June 30, 2006 as compared to 2005 dueto a lower backlog at the beginning of the period and a sluggish salesenvironment. The Nevada region’s homebuilding revenue for the three monthsended June 30, 2005 includes $13.8 million of revenue related to anopportunistic land sale, whereas, there were no land sales in the Nevada regionduring the three month period ended June 30, 2006.

Homebuildingrevenues increased 9.0% to $764.9 million for the nine month period ended June30, 2006 from $701.6 million for the nine month period ended June 30, 2005. Theincrease was primarily due to a 11.1% increase in the number of new homedeliveries offset by a slight decrease in the average sales price of homesdelivered during the nine month period ended June 30, 2006 as compared to thenine month period ended June 30, 2005. Land sales revenue for the nine monthperiod ended June 30, 2006 decreased to $17.1 million from $26.8 million forthe nine month period ended June 30, 2005.

Homebuildingrevenues for the nine month period ended June 30, 2006 benefited from anincrease in the number of homes delivered in our Florida, Pacific Coast andTexas regions, partially offset by a decrease in the number of homes deliveredin our Midwest and Nevada regions. An increase in the average sales price ofhomes delivered in our Nevada and Pacific Coast regions also contributed to theincreased revenues for the nine month period ended June 30, 2006 as compared to2005. The Nevada region’s homebuilding revenue for the nine months ended June30, 2005 includes $18.0 million of revenue related to land sales, whereas,there were no land sales in the Nevada region during the nine month periodended June 30, 2006.

***Home sales and backlog.******  ***Net new home orders for the three month period endedJune 30, 2006 were 942, a 7.3% decrease from 1,016 net new home orders for thethree month period ended June 30, 2005. Net new home orders for the nine monthperiod ended June 30, 2006 were 2,726, a 4.9% decrease from 2,867 net new homeorders for the nine month period ended June 30, 2005.

Duringthe three and nine month periods ended June 30, 2006, net new home orders inour Florida region decreased by 26.6% and 35.7%, respectively, and net new homeorders in the Pacific Coast region decreased by 49.8% and 55.7%, respectively.These decreases are the result of both weakened customer demand and increasedlevels of homes for sale on the market that are generally taking longer tosell. This changing marketplace is resulting in the increased utilization andmagnitude of sales incentives to remain competitive within the homebuildingindustry.  During the three and ninemonth periods ended June 30, 2006, net new home orders in our Texas regionincreased 39.7% and 25.7%, respectively. During the three and nine monthperiods ended June 30, 2006, net new home orders in our Midwest regiondecreased by 25.5% and increased by 7.3%, respectively, and net new home ordersin our Nevada region decreased by 9.8% and increased by 23.8%, respectively.

At June30, 2006, the contract value of our backlog was $413.7 million, as compared to$629.9 million at June 30, 2005. At June 30, 2006, the average sales price perhome in backlog was $273,000, down $27,000, or 9.0%, over the average salesprice per home in backlog of $300,000 at June 30, 2005. The reduction inbacklog units reflects the current market conditions in our Florida and PacificCoast regions partially offset by increased sales in our Texas region.

***Gross homebuilding profit margin.******  ***Gross homebuilding profit margin decreased to 17.0%for the three month period ended June 30, 2006, compared to 26.2% for the threemonth period ended June 30, 2005. The gross profit decrease reflects areduction in the homebuilding gross profit margin across all of our regions.Although gross margins in the Nevada and Pacific Coast remain above our averagegross profit margin on a consolidated basis, the gross margin in these regionshas decreased significantly in 2006 as a result of sales price pressure and

25

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increasedconstruction costs and land prices. During the three month period ended June30, 2006, the Nevada and Pacific Coast regions contributed 37% of the totalhomebuilding revenues and 60% of the total homebuilding gross profit. Duringthe three month periods ended June 30, 2005, these two regions contributed 48%of the total homebuilding revenues and 72% of the total homebuilding grossprofit.

Grosshomebuilding profit margin decreased to 20.6% for the nine month period endedJune 30, 2006, compared to 24.0% for the nine month period ended June 30, 2005.The gross profit decrease reflects a reduction in the homebuilding gross profitmargin in the Midwest, Nevada and Pacific Coast regions. Included within ourgross profit is a charge related to our decision to exit the Cleveland market.Although gross margins in the Nevada and Pacific Coast regions remain above ouraverage gross profit margin on a consolidated basis, the gross margin in theseregions has decreased significantly in 2006 as a result of sales price pressureand increased construction costs and land prices. During the nine month periodended June 30, 2006, the Nevada and Pacific Coast regions contributed 42% ofthe total homebuilding revenues and 65% of the total homebuilding gross profit.During the nine month period ended June 30, 2005, the Nevada and Pacific Coastregions contributed 42% of the total homebuilding revenues and 67% of the totalhomebuilding gross profit.

***Homebuilding operating expenses.******  ***Homebuilding operating expenses, which consist of allhomebuilding expenses other than cost of sales, decreased 2.4% to $35.7 millionfor the three month period ended June 30, 2006 from $36.5 million for the threemonth period ended June 30, 2005. Homebuilding operating expenses increased5.4% to $100.3 million for the nine month period ended June 30, 2006 from $95.2million for the nine month period ended June 30, 2005.

Duringthe three and nine month periods ended June 30, 2005, we recorded $5.1 millionand $9.0 million of compensation expense related to certain stock optionsgranted that were considered to be variable awards. We have since amended ourequity-based compensation agreements to amend the terms that resulted invariable accounting treatment. The increase for the nine month period endedJune 30, 2006 is primarily due to increased personnel costs and the increasedutilization of outside real estate brokers to sell our homes.

Homebuildingoperating expenses were 11.5% and 12.3% of total homebuilding revenue for thethree month periods ended June 30, 2006 and 2005 and homebuilding operatingexpenses were 13.1% and 13.6% of total homebuilding revenue for the nine monthperiods ended June 30, 2006 and 2005, respectively.

***Net mortgage operations.******  ***Mortgage banking earnings before taxesincreased to $1.1 million for the three month period ended June 30, 2006,compared to $0.4 million for the three month period ended June 30, 2005.Mortgage banking earnings before taxes increased to $1.9 million for the ninemonth period ended June 30, 2006, compared to a loss of $0.1 million for thenine month period ended June 30, 2005. The increase in earnings for the threeand nine month periods ended June 30, 2006 was due to increased mortgage volumeand reduced operating costs.

***Income taxes.******  ***We recorded income tax expense of $6.8million and $14.7 million for the three month periods ended June 30, 2006 and2005 and income tax expense of $21.9 million and $26.7 million for the ninemonth periods ended June 30, 2006 and 2005, respectively. Our consolidatedeffective tax rates were 36.3% and 36.9% for the three and nine months endedJune 30, 2006 and 2005.

***Net earnings.***   As a result of the above factors, our netearnings decreased 52.5% to $12.0 million for the three month period ended June30, 2006 from $25.2 million for the three month period ended June 30, 2005. Ournet earnings for the nine month period ended June 30, 2006 decreased 15.9% to$38.5 million from $45.8 million for the nine month period ended June 30, 2005.

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**Liquidity and Capital Resources**

Ourprincipal uses of cash are land purchases, lot development and homeconstruction. As a result, our financing needs depend principally on salesvolume, land acquisition and inventory balances. We fund our operations with cashflows from operating activities, borrowings under a senior unsecured creditfacility, other bank debt, and minority interests in consolidated partnerships.We do not hold cash for investment purposes and we manage our cash and debtpositions to minimize financing costs.

***Operating cash flow activities***

In the nine months endedJune 30, 2006, cash flows used in operating activities totaled $145.9 million,compared to cash flows used in operating activities of $97.8 million in thesame period last year. The decrease in operating cash flows consisted primarilyof an increase in inventories, resulting from land purchases, lot developmentand home construction, and the change in other operating assets andliabilities, including receivables, deferred expenses and other assets,accounts payable and accrued expenses and income taxes payable.

***Investing cash flow activities***

Cash flows used ininvesting activities totaled $13.9 million in the nine months ended June 30,2006, compared to cash flows used in investing activities of $16.8 million inthe same period last year. The decrease in cash flows used in investingactivities was primarily due to a reduction in the cash contributed andadvanced to unconsolidated entities, partially offset by the purchase of a buildingto be used as our new principal executive office.

***Financing cash flow activities***

Cash flows provided byfinancing activities totaled $167.6 million in the nine months ended June30, 2006, compared to $131.1 million in the same period last year. Netborrowings of $179.2 million were used to increase our investment in inventory,to purchase our new principal executive office and to fund our constructionoperations.

In December 2005, weissued $203 million aggregate principal amount of senior subordinated notes dueDecember 2012 in a private placement pursuant to Rule 144A promulgated underthe Securities Act of 1933, as amended. The senior subordinated notes were soldat 98.796% of par and accrue interest at a coupon rate of 10.5% per annum. Interestis paid semi-annually beginning June 2006. The net proceeds were used to repayamounts outstanding under working capital loans and certain senior securedrevolving credit facilities. We may redeem the notes, in whole or part, at anytime on or after December 15, 2009, at a redemption price equal to 100% of theprincipal amount, plus a 5.25% premium declining ratably to par on December 15,2011, plus accrued and unpaid interest. In addition, at any time prior toDecember 15, 2008, we may redeem up to 35% of the aggregate principal amount ofthe notes with the proceeds of qualified equity offerings at a redemption priceequal to 110.5% of the principal amount, plus accrued and unpaid interest. Thenotes are unsecured senior subordinated obligations and subordinated in rightof payment to all of our existing and future senior debt, including borrowingsunder our senior unsecured credit facility. All of the our wholly ownedsubsidiaries, other than our mortgage subsidiary, have fully andunconditionally guaranteed the notes on a joint and several, unsecured seniorsubordinated, basis. The guarantees are general unsecured obligations of theguarantors and will be subordinated in right of payment to all existing andfuture senior debt of the guarantors, which includes their guarantees of oursenior unsecured credit facility. The indenture governing the seniorsubordinated notes contains a number of significant covenants that couldrestrict our ability and that of our 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 ourassets.

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On April 13, 2006, we fileda registration statement with the U.S. Securities and Exchange Commission (the “Commission”)relating to an offer to exchange the notes for an issue of registered noteswith terms substantially identical to the notes. On May 4, 2006, the Commissiondeclared our amended registration statement effective, and we offered theexchange notes in return for the notes during the exchange offer period. Theexchange offer expired at 5:00 p.m., New York City time, on Monday, June 5,2006.****All outstanding senior subordinatednotes, in the aggregate principal amount of $203 million, were tenderedand exchanged.

In December 2005, weentered into a new senior unsecured credit facility to finance our businessoperations. Proceeds of the new credit facility were used to retire ourexisting senior secured revolving credit facilities and substantially all ofour other senior secured credit facilities. The credit facility has a maximumavailability of $500 million, subject to a borrowing base as well as sublimits of$100 million for the issuance of letters of credit and $10 million for swingline loans. We have the right, without the consent of our lenders (other thanthose participating in the increase), to increase the commitment by an amountof up to $200 million, provided that no such increase shall cause the seniorunsecured credit facility to exceed $700 million. The applicable borrowing basewill be determined regularly throughout the life of the facility. Thecomposition of the borrowing base will be limited to parameters set forth inthe credit facility agreement and certain types of real estate (such asunimproved entitled land and lots under development) will be removed from theborrowing base if held beyond specified maturity dates. Borrowings under the creditfacility will generally bear interest based on an applicable margin plus LIBORor an alternate base rate. The applicable margin for interest ranges from 1.5%to 2.25%, depending upon our senior leverage ratio, which is defined as theratio of total liabilities to consolidated net worth. Fees for letters ofcredit are based on LIBOR plus a margin of 1.5%. An unused commitment fee equalto 0.2% to 0.3% per year accrues on the undrawn portion of the facility and ispayable quarterly in arrears. As of June 30, 2006, we had $404 million ofborrowings under the credit facility at an effective rate of 6.83% and, aftergiving effect to the borrowing base limitation, had additional availability of$95 million. Our obligations under the senior unsecured credit facility areguaranteed by all of our wholly-owned subsidiaries, other than our mortgagesubsidiary, and are subject to a number of customary financial and operatingcovenants, including covenants requiring us to: maintain a minimum tangible networth of at least $225 million plus 50% of positive net income as earnedsubsequent to September 30, 2005; maintain a ratio of total liabilities toadjusted tangible net worth not to exceed 2.50x; maintain a ratio of total debtto adjusted tangible net worth not in excess of 2.0x (decreasing to 1.75x as ofMarch 31, 2007); maintain an interest coverage ratio of no less than 2.25x; andlimit the number of speculative housing units owned by us, excludingfoundations, as of the end of any fiscal quarter to a maximum of 30% of ourhousing unit closings during the previous 12-month period; and limit the numberof speculative housing units in any building region, excluding foundations, asof the end of any fiscal quarter to a maximum of 35% of our housing unitclosings in such region during the previous 12-month period. In addition tothese covenants, the credit facility includes restrictions upon debt andinvestments which permit: subordinated debt up to $300 million; other unsecureddebt up to $25 million; secured debt up to 25% of tangible net worth;guarantees of minority-owned joint venture debt up to 35% of adjusted tangiblenet worth; and investments in minority-owned joint ventures up to 30% oftangible net worth. 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 and nine months ended June 30, 2006, we were in compliancewith the covenants of this facility.

In addition to the seniorunsecured credit facility, we are party to senior secured project specificacquisition, development and construction loans with an aggregate amountoutstanding as of June 30, 2006 of $48.3 million. These loans bear interest atfloating rates ranging from the prime rate to the prime rate plus 1%, withmaturities generally tied to the sale of the underlying inventory.

We are party to unsecuredloan agreements that fund our operations on an ongoing basis. In addition, KHFinancial, L.P., our wholly owned mortgage subsidiary, is party to a $5.0million warehouse line of credit, used to fund its

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mortgage originationoperations. This facility bears interest at a floating rate equal to LIBOR plus1.75%, and as of June 30, 2006, there were no amounts outstanding under thewarehouse facility.

We are also party to a$100 million flexible early purchase facility agreement which allows us to sellqualifying mortgage loans to the holder of the flexible early purchase facilityafter such loans have been originated subject to our obligation to sell theloan to an investor in the secondary market. At June 30, 2006, approximately$47 million of the facility was in use.

Webelieve that our cash, other liquid assets and operating cash flow, togetherwith available borrowings and potential access to credit and capital markets,will be sufficient to meet our operating expenses and capital expenditures andservice our debt requirements as they become due. However, our ongoing abilityto meet our substantial debt service and other obligations, includingcompliance with financial covenants in our senior unsecured credit facility,will be dependent upon our future performance which will be subject tobusiness, financial and other factors. We will not be able to control many ofthese factors, such as economic conditions in the markets where we operate andpressure from competitors. We cannot be certain that our cash flow will besufficient to allow us to pay principal and interest on our debt, including thesenior subordinated notes, support our operations and meet our otherobligations. If we do not have enough money, we may be required to refinanceall or part of our existing debt, sell assets or borrow more money. We cannotguarantee that we will be able to do so on terms acceptable to us, if at all.In addition, the terms of existing or future debt agreements, including oursenior unsecured credit facility and the indenture for the senior subordinatednotes, may restrict us from pursuing any of these alternatives.

**ContractualObligations**

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

Thefollowing summarizes our aggregate contractual commitments at June 30, 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)                     |       | $                                         | 892,434    |   | $ | 51,953 |   | $ | 148,618 |   | $ | 459,568 |   | $ | 232,295 |   |
| Operating leases                     |       | 11,456                                    |       | 2,421 |   | 5,021 |   | 3,000 |   | 1,014 |   |
| Purchase  obligations(2)             |       | 47,631                                    |       | 5,776 |   | 41,855 |   |   |   |   |   |
| Total                                |       | $                                         | 951,521    |   | $ | 60,150 |   | $ | 195,494 |   | $ | 462,568 |   | $ | 233,309 |   |
|                                 |       |                                      |       |   |   |   |   |   |   |   |   |

 

(1)             Includesour senior subordinated notes due 2012, our senior unsecured credit facility,other homebuilding debt and mortgage loans relating to our mortgage bankingoperations, and related interest payments for the life of the debt. Interest onvariable rate obligations is based on rates effective as of June 30, 2006.

(2)             Representsobligations under land option agreements and purchase contracts with specificperformance provisions, net of cash deposits.

Under the terms of ourstock option agreements, we may be required to purchase shares of our commonstock at fair market value, including shares issuable under outstanding optionsor deferred stock units, from our directors and certain of our executiveofficers and other key employees, in the event of termination of boardmembership or employment, as applicable, by reason of specified circumstances,including death, disability, termination, retirement or resignation. As of June30, 2006, our aggregate repurchase obligation, net of proceeds to be receivedfrom any stock option exercises, is approximately $64 million in the eventthat all of these obligations were triggered. Included within the $64 millionrepurchase obligation, as part of a separation agreement with a formerexecutive officer, we have agreed to repurchase 77,000 shares of our commonstock at the fair market value of approximately $8.9 million, with payment infull by January 31, 2007.

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We are contingentlyliable to banks and financial institutions for approximately $49 million foroutstanding letters of credit and performance bonds securing performance ofcertain contractual obligations and land purchase contracts. Approximately $3million of the outstanding letters of credit have been issued by a wholly ownedsubsidiary. We do not believe that any of these letters of credit or bonds arelikely to be drawn upon. At June 30, 2006, we had committed to fundapproximately $39 million in mortgage loans to homebuyers. We have entered intobest-efforts and mandatory sale commitments to sell these mortgages to thirdparties.

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

At June30, 2006, we owned and controlled 30,717 lots, approximately 47% of which werepursuant to option agreements and purchase contracts. The following is asummary of our land/lot position:
| ** **                                                         | ** ** | **At June 30,** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------|------------|
| ** **                                                         | ** ** | **2006**                  | ** ** |
| Finished lots  owned                                               |       | 5,381                     |       |
| Lots under  development owned                                      |       | 10,962                    |       |
| Total lots owned                                                   |       | 16,343                    |       |
| Lots controlled  under option agreements and purchase contracts(1) |       | 14,374                    |       |
| Total land/lots  controlled                                        |       | 30,717                    |       |
|                                                               |       |                      |       |

 

(1)             Includes 2,518 lots included in inventory not ownedwhich were consolidated under the accounting guidance of FIN 46R and 1,777 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.

***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 byboth us and the sellers. Otherwise, our liabilities under option agreements andpurchase contracts are generally limited to forfeiture of the nonrefundabledeposits, letters of credit and other nonrefundable amounts incurred. Below isa summary of the aggregate exercise price of all option agreements and purchasecontracts as of June 30, 2006:
| **(Dollars in thousands)**                                       | ** ** | **Aggregate  exercise price  of options**(1) | ** ** |
|----------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|
| Option  agreements and purchase contracts with specific performance        |       | $                                                      | 5,776      |   |
| Options  agreements and purchase contracts without specific performance(2) |       | 544,328                                                |       |
| Total option agreements  and purchase contracts                            |       | $                                                      | 550,104    |   |
|                                                                       |       |                                                   |       |

 

(1)    Excludes$80.6 million related to inventory not owned included on our condensedconsolidated balance sheet at an initial fair value of $70.4 million.

(2)    Includes$165 million related to purchases from joint ventures in which we have aninvestment balance of approximately $33million as of June 30, 2006. These investments are recorded in investments inand advances to unconsolidated entities on our condensed consolidated balancesheets.

We expect to exercise allof our option agreements and purchase contracts with specific performanceobligations and, subject to market conditions, substantially all of our optionagreements and purchase contracts without specific performance obligations.

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

Investments in andadvances to unconsolidated entities represent our ownership interest inentities accounted for under the equity method when we hold less than acontrolling interest in the entity or we are not the primary beneficiary in a variableinterest entity (“VIE”) as defined by FIN 46R. In instances where we expect topurchase land from the unconsolidated entity, our share of the unconsolidatedentity’s earnings is deferred until homes related to the lots purchased aredelivered and title passes to a homebuyer. Our partners generally are unrelatedhomebuilders, 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, with our interest in these entities ranging from 6%to 49%. We account for our interest in these joint ventures under the equity method,and our condensed consolidated balance sheets include investments in jointventures totaling $45.5 million and $37.0 million at June 30, 2006 andSeptember 30, 2005, respectively. These joint ventures typically obtain securedacquisition, development and construction financing. At June 30, 2006 andSeptember 30, 2005, our unconsolidated joint ventures had outstandingthird-party borrowings of $838 million and $803 million, respectively. Fromtime to time we issue repayment guarantees and/or loan-to-value maintenanceguarantees in respect of this indebtedness. These guarantees require us torepay debt of the joint venture in the event of a payment default, in the caseof the repayment guarantees, or in the event that the debt of the joint ventureexceeds the value of the property securing the debt, in the case of theloan-to-value maintenance guarantees. At June 30, 2006 and September 30,2005, we had guarantees of $69.7 million and $67.6 million, respectively,related to the indebtedness of these joint ventures.

**Seasonality and Variability in Quarterly Results**

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

**Backlog**

Our sales contractsrequire cash deposits in line with respective market practices and may besubject to certain contingencies such as the buyer’s ability to qualify forfinancing. Homes covered by such sales contracts but not yet delivered areconsidered “backlog.” We do not recognize revenue upon the sale of a home untilit is delivered to the homebuyer and other criteria for sale and profitrecognition are met. We sometimes build homes before obtaining a salescontract; however, these homes are excluded from backlog until a sales contractis signed. At June 30, 2006, 8% of the number of homes in inventory consistedof completed homes without sales contracts. At September 30, 2005, 7% of thenumber of homes in inventory consisted of completed homes without salescontracts. Our cancellation rates for the three month periods ended June 30,2006 and 2005 were 30% and 25%, respectively. Our cancellation rates for thenine month periods ended June 30, 2006 and 2005 were 28% and 23%, respectively.

**Interest Rates and Inflation**

Our business issignificantly affected by the level of interest rates. Higher interest ratesmay decrease demand for our homes by making it more difficult for homebuyers toqualify for mortgages or to obtain mortgages at interest rates that areacceptable to them. Higher interest rates would also increase our borrowingcosts because a portion of our bank loans fluctuate with LIBOR and primelending rates.

We may be adverselyaffected during periods of high inflation because of higher land, financing,labor and material costs. We attempt to pass to our customers any increases inour costs through increased sales prices. To date, inflation has not had amaterial adverse effect on our results of operations. However, there is noassurance that inflation will not have a material adverse impact on our futureresults of operations.

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**Critical Accounting Estimates and Policies**

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

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

·              Revenuerecognition;

·              Homebuildinginventory and costs of sales;

·              Variable interest entities;

·              Investments in and advances to unconsolidatedentities;

·              Warranty costs;

·              Litigation reserves;

·              Insurance claims costs;

·              Valuation of deferred tax assets; and

·              Stock-based compensation.

Therehave been no significant changes in the above critical accounting policies, ascompared to those we disclosed in the prospectus dated May 4, 2006, which is apart of our amended registration statement on Form S-4.

**Recent AccountingPronouncements**

In December 2004, theFASB issued Statement of Financial Accounting Standards No. 123 (revised 2004),*Share-Based Payment*, (“SFAS 123R”). SFAS123R is a revision of SFAS 123 and supersedes APB No. 25. SFAS 123R requiresthat the cost resulting from all share-based payment transactions be recognizedin the financial statements and establishes fair value as the measurementobjective in accounting for share-based payment arrangements. SFAS 123R iseffective as of the beginning of the first annual reporting period that beginsafter December 15, 2005. SFAS 123R applies to all awards granted, modified,repurchased or cancelled after the effective date, and all outstanding portionsof awards granted prior to the effective date which are unvested as of theeffective date of the pronouncement.

Entities may adopt theprovisions of SFAS 123R using either the modified prospective or modifiedretrospective methods. Under the modified prospective method, compensation costis recognized on or after the required effective date for the portion ofoutstanding awards for which the requisite service has not yet been rendered,based on the grant-date fair value of those awards calculated under SFAS 123for either recognition or pro forma disclosure. For periods before the requiredeffective date, the modified retrospective application may be applied to either (a) all prior years for which SFAS 123was effective or (b) only to prior interim periods in the year of initialadoption, on a basis

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consistent with the proforma disclosures required for those periods by SFAS 123. SFAS 123R becomeseffective for us on October 1, 2006. We are currently evaluating therequirements of SFAS 123R.

In May 2005, theFASB issued SFAS No. 154, *Accounting Changes andError Corrections — a replacement for APB Opinion No. 20 and FASBStatement No. 3* (“SFAS 154”). SFAS 154 requires prior periodfinancial statements to be restated for changes in accounting principles. SFAS154 also redefines restatement as the revision of previously issued financialstatements to reflect the correction of an error. SFAS 154 is effective foraccounting changes and corrections of errors made in fiscal years beginningafter December 15, 2005. SFAS 154 is not expected to have a materialimpact on our results of operations or financial position.

In June 2005, theEmerging Issues Task Force (“EITF”) released Issue No. 04-5, *Determining Whether a General Partner, or the General Partners as aGroup, Controls a Limited Partnership or Similar Entity When the LimitedPartners Have Certain Rights* (“EITF 04-5”). EITF 04-5 creates aframework for evaluating whether a general partner or a group of generalpartners controls a limited partnership and therefore should consolidate thepartnership. EITF 04-5 states that the presumption of general partner controlwould be overcome only when the limited partners have certain specific rightsas outlined in EITF 04-5. EITF 04-5 is effective immediately for all newlyformed limited partnerships and for existing limited partnership agreementsthat are modified. For general partners in all other limited partnerships, EITF04-5 is effective no later than the beginning of the first reporting period in fiscalyears beginning after December 15, 2005. Implementation of EITF 04-5 isnot expected to have a material impact on our results of operations orfinancial position.

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 the effect,if any, the adoption of FIN 48 will have on our financial statements.

**Cautionary FactorsThat May Affect Future Results**

Our disclosure andanalysis in this report contain forward-looking statements about our financialresults and estimates and business prospects that involve substantial risks anduncertainties. From time to time, we also may provide oral or writtenforward-looking statements in other materials we release to analysts, debtholders and the public. Forward-looking statements give our currentexpectations or forecasts of future events. You can identify these statementsby the fact that they do not relate strictly to historic or current facts. Theyuse words such as “anticipate”, “believe”, “estimate”, “expect”, “forecast”, “goal”,“intend”, “objective”, “plan”, “projection”, “seek”, “strategy”, or other wordsand terms of similar meaning. Any or all of the forward-looking statementsincluded in this report and in any other of our reports or public statementsmay not approximate actual experience, and the expectations derived from themmay not be realized, due to known or unknown risks and uncertainties. As aresult, 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.

·                                          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;

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·                                          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;

·                                          the growth or expansion of our operations;

·                                          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; and

·                                          geopolitical risks and market disruption.

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

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# **Item3.     Quantitative and QualitativeDisclosures About Market Risk.**

We are exposed to anumber of market risks in the ordinary course of business. Our primary marketrisk exposure for financial instruments relates to fluctuations in interestrates. We do not enter into or hold derivatives for trading or speculativepurposes. As of June 30, 2006, we had a total of $443 million of floating ratedebt outstanding, including our senior unsecured credit facility and otherfacilities. Borrowings under these facilities generally bear interest based onapplicable margin plus LIBOR or an alternate base rate. As of June 30, 2006, wewere not a party to any interest rate swap agreements. Holding our variablerate debt balances constant as of June 30, 2006, each one percentage pointincrease in interest rates would result in an increase in interest incurred forthe next twelve month period of approximately $4.4 million. A one percentagepoint increase in interest rates on our average variable rate debt outstandingduring the twelve month period ended June 30, 2006 would have resulted in anincrease in interest incurred of approximately $4.4 million.

# **Item 4.     Controls andProcedures.**

***Disclosurecontrols and procedures.*** We maintain disclosure controls and procedures (as defined in Rule13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Act”)) thatare designed to provide reasonable assurance that information required to bedisclosed by us, including our consolidated entities, in the reports that wefile or submit under the Act, is recorded, processed, summarized and reported,within the time periods specified in the Securities and Exchange Commission’srules and forms and that such information is accumulated and communicated tomanagement, including the Chairman and Chief Executive Officer (the “PrincipalExecutive Officer”) and Chief Financial Officer (the “Principal FinancialOfficer”), as appropriate, to allow timely decisions regarding requireddisclosure. Prior to the filing of this report, we completed an evaluationunder the supervision and with the participation of senior management,including our Principal Executive Officer and our Principal Financial Officer,of the effectiveness of the design and operation of our disclosure controls andprocedures as of June 30, 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 June 30, 2006.

***Changesin internal control over financial reporting.***  There were no changes in our internal controlover financial reporting that occurred during the third fiscal quarter of 2006that have materially affected, or are reasonably likely to materially affect,our internal control over financial reporting.

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**PARTII—OTHER INFORMATION**

**Item 1.    Legal Proceedings.**

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

**Item 1A.   RiskFactors.**

There have been nomaterial changes in our risk factors from those disclosed in our prospectusdated May 4, 2006 under the heading entitled “Risk factors.” The risk factorsdisclosed in our prospectus, in addition to the other information set forth inthis report, could materially affect our business, financial condition orresults. Additional risks and uncertainties not currently known to us or thatare deemed to be immaterial also may materially adversely affect our business,financial condition or results.

# **Item 6.      Exhibits.**

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

 

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**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
|                       |   |                                              |
|----------------------------|--------|---------------------------------------------------|
|                       |   | KIMBALL HILL, INC.                                |
|                       |   | Registrant                                        |
|                       |   |                                              |
| Dated August 11, 2006 |   | /s/ DAVID K. HILL                                 |
|                       |   | David K. Hill                                     |
|                       |   | Chairman and Chief Executive Officer              |
|                       |   | (Principal Executive Officer)                     |
|                       |   |                                              |
| Dated August 11, 2006 |   | /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 and Chief Executive Officer.                 |
|            |       |                                                                                                              |
| 31.2            |       | Rule 13a-14(a) / 15d-14(a) Certification of Eugene  K. Rowehl, Senior Vice President and Chief Financial Officer. |
|            |       |                                                                                                              |
| 32.1            |       | Section 1350 Certification of David K. Hill,  Chairman and Chief Executive Officer.                               |
|            |       |                                                                                                              |
| 32.2            |       | Section 1350 Certification of Eugene K. Rowehl,  Senior Vice President and Chief Financial Officer.               |

 

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