Overview and Outlook

Industry Conditions

During 2008, the financial crisis and economic recession further exacerbated the existing downturn in the homebuilding market and resulted in additional downward pressure on home sales and asset values. Based on statistics from the Mortgage Bankers Association, processed foreclosures reached approximately 1.4 million in the last quarter of 2008 as compared to an average of about 500,000 per quarter during 2000-2007. These record-high foreclosure rates intensified competition for homebuyers in an already saturated marketplace with the influx of existing homes inventory, coupled with the lack of availability of mortgage financing resulting from the turmoil in the financial industry. Concern about the state of the economy and the job market further deteriorated consumer confidence, as unemployment rates rose in almost all of the metropolitan areas tracked by the U.S. Department of Labor, ending 2008 with a national average of 6.5% as compared to 4.5% in the prior year. We believe that the tepid demand we are experiencing reflects homebuyers' reluctance to make a purchasing decision until they are comfortable that the price declines are near bottom and that economic conditions have stabilized. We believe the current conditions could continue, and potentially worsen during 2009, and we expect that our operations will continue to remain depressed until the homebuilding industry and economy as a whole begin to rebound.

Summary Company Results

Our results for the year ended December 31, 2008 reflect the continued deterioration in the homebuilding and credit industries, as well as the recession that has impacted the U.S. economy during 2008.

Total home closing revenue was $1.5 billion for the year ended December 31, 2008, decreasing 35.5% from $2.3 billion for 2007 and 56.3% from $3.4 billion in 2006. We incurred a net loss for 2008 of ($291.9) million compared to a loss of ($288.9) million in 2007 and earnings of $225.4 million in 2006. Our 2008 results include $263.4 million (pre-tax) of real estate-related impairments and a $118.6 million deferred tax valuation allowance charge. In 2007, we incurred $130.5 million (pre-tax) of goodwill-related impairments and $398.3 million (pre-tax) of real estate-related impairments and in 2006, we had $78.3 million (pre-tax) of real estate impairments. Lower average home prices from competitive pressures and the

increased use of incentives over the last two years lowered gross margins generated on home closings to 0.4% in 2008, from 1.1% and 20.7%, respectively, in 2007 and 2006.

At December 31, 2008, our backlog of approximately $338.0 million was down 49.5% from $670.0 million at December 31, 2007. Our December 31, 2006 backlog was $1.2 billion. Fewer home sales, compounded by increased price concessions and incentives and higher cancellation rates, were primarily responsible for these declines. Our average sales price for homes in backlog decreased from $325,700 at December 31, 2006 to $292,800 at December 31, 2007 and was $263,900 at December 31, 2008. Our cancellation rate on sales orders remained above our historical rates and was 35.3%, 37.1% and 35.2%, respectively, as a percentage of gross sales, for the years ended December 31, 2008, 2007 and 2006. We do not expect that cancellation rates will begin to stabilize and begin to trend back to normal historical levels until the excess supply of existing home inventory is absorbed and home prices start to level.

Company Actions and Positioning

In response to industry conditions, we are focusing on the following initiatives:

† Winding down under-performing operations and consolidating overhead functions at all of our divisions and corporate offices to reduce general and administrative cost burden;

† Reducing our total lot supply by renegotiating or opting out of lot purchase and option contracts;

† Limiting unsold home inventory;

† Redesigning product offering to reduce sales prices and improve affordability;

† Exercising tight control over cash flows;

† Changing sales and marketing efforts to generate additional traffic;

† Renegotiating construction costs with our subcontractors where possible; and

† Monitoring our customer satisfaction scores and making improvements based on the results of the surveys

Our Credit Facility matures in May 2011. In July 2008, we amended our Credit Facility to: (i) eliminate the individual quarterly interest coverage test,
(ii) provide additional cushion by relaxing the minimum interest coverage, maximum leverage and tangible net worth covenants, (iii) reduce the borrowing capacity to $500 million from $800 million, (iv) increase the applicable interest rate by up to 100 basis points, (v) increase the unused commitment fee by 10 basis points depending on the Company's leverage ratio (as defined in the Credit Agreement), (vi) modify the advance rates by 5% to 15% for various components and reduce the maximum amounts of certain types of real estate that may be owned at any given time, and (vii) modify various other terms.

Critical Accounting Policies

We have established various accounting policies that govern the application of United States generally accepted accounting principles ("GAAP") in the preparation and presentation of our consolidated financial statements. Our significant accounting policies are described in Note 1 of these consolidated financial statements. Certain of these policies involve significant judgments, assumptions and estimates by management that may have a material impact on the carrying value of certain assets and liabilities, and revenue and costs. We are subject to uncertainties such as the impact of future events, economic, environmental and political factors and changes in our business environment; therefore, actual results could differ from these estimates. Accordingly, the accounting estimates used in the preparation of our financial statements will change as new events occur, as more experience is acquired, as additional information is obtained and as our operating environment changes. Changes in estimates are revised when circumstances warrant. Such changes in estimates and refinements in methodologies are reflected in our reported results of operations and, if material, the effects of changes in estimates are disclosed in the notes to our consolidated financial statements. The judgments, assumptions and estimates we use and believe to be critical to our business are based on historical experience, knowledge of the accounts and other factors, which we believe to be reasonable under the circumstances. Because of the nature of the judgments and assumptions we have made, actual results may differ from these judgments and estimates, which could have a material impact on the carrying values of assets and liabilities and the results of our operations, particularly as related to our ability to accurately estimate tax valuation allowances, stock-based compensation, accruals, or impairments of real estate that could result in charges, or income, in future periods, which relate to activities or transactions in a preceding period.

The accounting policies that we deem most critical to us, and involve the most difficult, subjective or complex judgments, are as follows:

Revenue Recognition

In accordance with Statement of Financial Accounting Standards ("SFAS") No. 66, Accounting for Sales of Real Estate, we recognize revenue from home sales when title passes to the homeowner, the homeowner's initial and continuing investment is adequate to demonstrate a commitment to pay for the home, the receivable, if any, from the homeowner is not subject to future subordination and we do not have a substantial continuing involvement with the sold home. These conditions are typically achieved when a home closes.

Revenue from land sales is recognized when a significant down payment is received, the earnings process is relatively complete, title passes and collectibility of the receivable is reasonably assured.

Real Estate

Real estate is stated at cost unless the community or land is determined to be impaired, at which point the inventory is written down to fair value as required by SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets ("SFAS No. 144"). Inventory includes the costs of land acquisition, land development and home construction, capitalized interest, real estate taxes, direct overhead costs incurred during development and home construction that benefit the entire community and impairments, if any. Land and development costs are typically allocated to individual lots on a relative value basis and are transferred to homes under construction when construction begins. Home construction costs are accumulated on a per-home basis. Cost of home closings includes the specific construction costs of the home and all related land acquisition, land development and other common costs (both incurred and estimated to be incurred) based upon the total number of homes expected to be closed in each community or phase. Any changes to the estimated total development costs of a community or phase are allocated on a relative value basis to the remaining homes in the community or phase. When a home closes, we may have incurred costs for goods and services that have not yet been paid. In such cases, an accrual to capture such obligations is recorded in connection with the home closing and charged directly to cost of sales.

Typically, a community's life cycle ranges from three to five years, commencing with the acquisition of the entitled land and continuing through the land development phase and concluding with the sale, construction and closing of the homes. Actual community lives will vary based on the size of the community, the absorption rates and whether the land purchased was raw or finished lots. Master-planned communities encompassing several phases and super-block land parcels may have significantly longer lives and projects involving finished lot purchases may be significantly shorter. Additionally, the current slow-down in the housing market has negatively impacted our sales pace, thereby extending the lives of certain communities.

In accordance with SFAS No. 144, all of our land inventory and related real estate assets are reviewed for recoverability when impairment indicators are present, as our inventory is considered "long-lived" in accordance with U.S. generally accepted accounting principles. If an asset is deemed not recoverable, SFAS No. 144 requires impairment charges to be recorded if the fair value of such assets is less than their carrying amounts. Our determination of fair value is based on projections and estimates. Changes in these expectations may lead to a change in the outcome of our impairment analysis. Our analysis is completed on a quarterly basis at a community level with each community or land parcel evaluated individually. We pay particular attention to communities experiencing a larger-than-anticipated reduction in their absorption rates or averages sales prices. For those assets deemed to be impaired, the impairment to be recognized is measured by the amount by which the assets' carrying amount exceeds their fair value. The impairment of a community is allocated to each lot on a straight-line basis.

Existing and continuing communities: When projections for the remaining income expected to be earned from existing communities are no longer positive, the underlying real estate assets are deemed not fully recoverable, and further analysis is performed to determine the required impairment. With each community or land parcel evaluated individually, the fair value of the community's assets is determined using either a discounted cash flow model for projects we intend to build out or a market-based approach for projects we intend to sell or that are in the preliminary development stage and product types have not yet been finalized. Impairments are charged to cost of home closings in the period during which the fair value is less than the assets' carrying amount. If a market-based approach is used, we determine fair value based on recent comparable purchase and sales activity in the local market, adjusted for known variances as determined by our knowledge of the region and general real estate expertise. Our key estimates in deriving fair value under our cash flow model are (i) home selling prices in the community adjusted for current and expected sales discounts and incentives, (ii) costs related to the community - both land development and home construction - including costs spent to date and budgeted remaining costs to spend, (iii) projected sales absorption rates, reflecting any product mix change strategies implemented to stimulate the sales pace,
(iv) alternative land uses including disposition of all or a portion of the land owned and (v) our discount rate, which is

currently 14-16%. These assumptions vary widely across different communities and geographies and are largely dependent on local market conditions. Community-level factors that may impact our key estimates include:

† The presence and significance of local competitors, including their offered product type and competitive actions;

† Economic and related demographic conditions for the population of the surrounding community; and

† Desirability of the particular community, including unique amenities or other favorable or unfavorable attributes.

These local circumstances may significantly impact our assumptions and the resulting computation of fair value, and are, therefore, closely evaluated by our division personnel in their creation of the discounted cash flow models. The models are also evaluated by regional and corporate personnel for consistency and integration, as decisions that affect pricing or absorption at one community may have resulting consequences for neighboring communities. We typically do not project market improvements in our discounted cash flow models, but may do so in limited circumstances in the latter years of a long-lived master-planned community.

Option deposits and pre-acquisition costs: We also evaluate assets associated with future communities for impairments on a quarterly basis. Using similar techniques described in the existing and continuing communities section above, we determine if the contributions to be generated by our future communities are acceptable to us. If the projections indicate that a community is still profitable and generating acceptable margins, those assets are determined to be fully recoverable and no impairments are required. In cases where we decide to abandon the project, we will fully impair all assets related to such project and will expense and accrue any additional costs that we are contractually obligated to incur. We may also elect to continue with a project because it has positive future cash flows, even though it may not be generating an accounting profit, or because of other strategic factors. In such cases, we will impair our pre-acquisition costs and deposits, as necessary, to record an impairment to bring the book value to fair value.

During 2008, we recorded $189.3 million of such impairment charges related to our home and land real estate inventories and real estate-related joint venture investments. Additionally, we wrote off $74.1 million of deposits and pre-acquisition costs relating to projects that were no longer economically feasible. Refer to Note 2 of these consolidated financial statements in this Annual Report on Form 10-K for further discussion regarding these impairments and the associated remaining fair values of impaired communities.

The impairment charges were based on our fair value calculations, which are affected by current market conditions, assumptions and expectations, all of which are highly subjective and may differ significantly from actual results if market conditions change.

Due to the volume of possible outcomes that can be generated from changes in the various model inputs for each community, we do not believe it is possible to create a sensitivity analysis that can provide meaningful information for the users of our financial statements.

Warranty Reserves

We use subcontractors for nearly all aspects of home construction. Although our subcontractors are generally required to repair and replace any product or labor defects, we are ultimately responsible to the homeowner for making such repairs. As such, warranty reserves are recorded to cover our exposure to absorb the costs for materials and labor not expected to be covered by our subcontractors as they relate to warranty-type claims subsequent to the delivery of a home to the homeowner. Reserves are reviewed on a regular basis and, with the assistance of an actuary, we determine their sufficiency based on our and industry-wide historical data and trends with respect to product types and geographical areas.

At December 31, 2008, our warranty reserve was $28.9 million, reflecting an accrual of 0.1% to 1.8% of a home's sale price depending on our loss history in the geographic area in which the home was built. A 10% increase in our warranty reserve rate would have increased our accrual and corresponding cost of sales by $1.1 million in 2008. While we believe that the warranty reserve is sufficient to cover our projected costs, there can be no assurances that historical data and trends will accurately predict our actual warranty costs. Furthermore, there can be no assurances that future economic or financial developments might not lead to a significant change in the reserve.

Off-Balance Sheet Arrangements

During the normal course of business, we invest in entities that acquire and develop land for sale to us in connection with our homebuilding operations or for sale to third parties. Our partners generally are unaffiliated homebuilders, land sellers and financial or other strategic partners.

All unconsolidated entities through which we acquire and develop land are accounted for by either the cost or the equity method of accounting as the criteria for consolidation set forth in FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities ("FIN 46R") have not been met. We record our investments in these entities in our consolidated balance sheets as "Investments in unconsolidated entities" and our pro rata share of the entities' earnings or losses in our consolidated statements of earnings as "(Loss)/earnings from unconsolidated entities, net."

We determine if we are the primary beneficiary of, or have a controlling interest in, an unconsolidated entity. Factors considered in our determination include the profit/loss sharing terms of the entity, experience and financial condition of the other partners, voting rights, involvement in day-to-day capital and operating decisions and continuing involvement.

As of December 31, 2008, we believe that the equity method of accounting is appropriate for our investments in unconsolidated entities where we are not the primary beneficiary, we do not have a controlling interest, and our ownership interest exceeds 20%. At December 31, 2008, our equity investments of $16.4 million related to unconsolidated entities with total assets of $546.6 million and total liabilities of $392.4 million. See Note 4 in the accompanying consolidated financial statements for additional information related to these investments.

We also enter into option or purchase agreements to acquire land or lots, for which we generally pay non-refundable deposits. We analyze these agreements under FIN 46R to determine whether we are the primary beneficiary of the variable interest entity ("VIE"), if applicable, using a model developed by management. If we are deemed to be the primary beneficiary of the VIE, we will consolidate the VIE in our consolidated financial statements. See Note 3 in the accompanying financial statements for additional information related to our off-balance-sheet arrangements. In cases where we are the primary beneficiary, we consolidate these purchase/option agreements and reflect such assets and liabilities as "Real estate not owned" in our consolidated balance sheets. The liabilities related to consolidated VIEs are excluded from our debt covenant calculations.

Valuation of Deferred Tax Assets

We account for income taxes using the asset and liability method, which requires that deferred tax assets and liabilities be recognized based on future tax consequences of both temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply in the years in which the temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in earnings in the period when the changes are enacted.

In accordance with SFAS No. 109, "Accounting for Income Taxes" ("SFAS No. 109"), we evaluate our deferred tax assets, including net operating losses, to determine if a valuation is required. SFAS No. 109 requires that companies assess whether a valuation allowance should be established based on the consideration of all available evidence using a "more likely than not" standard with significant weight being given to evidence that can be objectively verified. This assessment considers, among other matters, the nature, frequency and severity of current and cumulative losses, forecasts of future profitability, the length of statutory carryforward periods, our experience with operating losses and tax credit carryforwards not expiring unused and tax planning alternatives. Our current and prior year losses presented significant negative evidence that we needed to reduce our deferred tax assets with a valuation allowance. Given the continued downturn in the homebuilding industry during 2008, the degree of the economic recession, the current instability and deterioration of the financial markets, and the resulting uncertainty in projections of our future taxable income, we determined the weight of the negative evidence exceeded that of the positive evidence during 2008 and that it was more likely than not that we would not be able to utilize all of our deferred tax assets. Therefore, we have recorded a full valuation allowance on the remaining deferred tax asset balance, which increased losses from continuing operations by $118.6 million, or $(4.04) per share, during 2008.

Income tax receivable consisted of tax refunds that we expect to receive within one year. Our income tax receivable balance at December 31, 2008 and 2007 was $111.5 million and $67.4 million, respectively.

Share-Based Payments

We have stock options and restricted common stock units ("nonvested shares") outstanding under two stock compensation plans. Per the terms of these plans, the exercise price of our stock options may not be less than the closing market value of our common stock on the date of grant, nor may options granted under the plans be exercised within one year from the date of the grant. After one year, exercises are permitted in pre-determined installments based upon a vesting schedule established at the time of grant. Each stock option expires on a date determined at the time of the grant, but not to exceed seven years from the date of the grant.

The calculation of employee compensation expense involves estimates that require management judgments. These estimates include determining the value of each of our stock options on the date of grant using a Black-Scholes option-pricing model discussed in Note 10 in the accompanying consolidated financial statements. The fair value of our stock options, which typically vest ratably over a five-year period, is determined at the time of grant and is expensed on a straight-line basis over the vesting life of the options. Expected volatility is based on a composite of historical volatility of our stock and implied volatility from our traded options. The risk-free rate for periods within the contractual life of the stock option award is based on the rate of a zero-coupon Treasury bond on the date the stock option is granted with a maturity equal to the expected term of the stock option. We use historical data to estimate stock option exercises and forfeitures within our valuation model. The expected life of our stock option awards is derived from historical experience under our share-based payment plans and represents the period of time that we expect our stock options to be outstanding. A 10% decrease in our forfeiture rate would have increased our stock compensation by approximately $320,000 in 2008.

Home Closing Revenue, Home Orders and Order Backlog - Segment Analysis



The tables provided below show operating and financial data regarding our
homebuilding activities (dollars in thousands).



                               Years Ended December 31,
                           2008          2007          2006
Home Closing Revenue
Total
Dollars                 $ 1,505,117   $ 2,334,141   $ 3,444,286
Homes closed                  5,627         7,687        10,487
Average sales price     $     267.5   $     303.6   $     328.4

West Region

California
Dollars                 $   241,792   $   421,220   $   820,583
Homes closed                    581           908         1,471
Average sales price     $     416.2   $     463.9   $     557.8

Nevada
Dollars                 $    65,734   $    88,837   $   244,343
Homes closed                    247           261           620
Average sales price     $     266.1   $     340.4   $     394.1

West Region Totals
Dollars                 $   307,526   $   510,057   $ 1,064,926
Homes closed                    828         1,169         2,091
Average sales price     $     371.4   $     436.3   $     509.3

Central Region

Arizona
Dollars                 $   271,646   $   567,888   $ 1,102,662
Homes closed                  1,084         1,718         3,355
Average sales price     $     250.6   $     330.6   $     328.7

Texas
Dollars                 $   783,835   $ 1,043,160   $   996,739
Homes closed                  3,217         4,164         4,263
Average sales price     $     243.7   $     250.5   $     233.8

Colorado
Dollars                 $    50,213   $    60,069   $    40,875
Homes closed                    145           160           112
Average sales price     $     346.3   $     375.4   $     365.0

Central Region Totals
Dollars                 $ 1,105,694   $ 1,671,117   $ 2,140,276
Homes closed                  4,446         6,042         7,730
Average sales price     $     248.7   $     276.6   $     276.9

East Region

Florida
Dollars                 $    91,897   $   152,967   $   239,084
Homes closed                    353           476           666
Average sales price     $     260.3   $     321.4   $     359.0

. . .