UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

Form 10-K

 

 

Commission file number: 001-32322

 

TOUSA, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

 

Registrant’s telephone number, including area code:

(954) 364-4000

 

Securities registered pursuant to Section 12(b) of the Act:

None

 

Securities registered pursuant to Section 12(g) of the Act:

 

Title of Each Class

 

Common Stock, $.01 par value

9% Senior Notes due 2010 (CUSIP No. 872962 AA3)

9% Senior Notes due 2010 (CUSIP No. 872962 AB1)

103/8% Senior Subordinated Notes due 2012 (CUSIP No. 872962 AD7)

71/2% Senior Subordinated Notes due 2011 (CUSIP No. 872962 AC9)

71/2% Senior Subordinated Notes due 2015 (CUSIP No. 872962 AE5)

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes o     No þ

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

 

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

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

The aggregate market value of common stock held by non-affiliates of the Registrant was approximately $82.6 million as of June 30, 2007.

 

As of August 6, 2008, there were 59,604,169 shares of the Registrant’s common stock outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

None.

 

 

TABLE OF CONTENTS

 

 

 

 

Explanatory Note

 

In some instances we have attempted to provide information as of a date more current than December 31, 2007. The housing market has continued to deteriorate significantly since December 31, 2007 and we have not yet completed the analyses and processes required for the preparation of our quarterly reports on Form 10-Q for the periods ended March 31, 2008 and June 30, 2008. Therefore, the information contained herein does not include reserves or provisions for any period after the period ended December 31, 2007. As a result of the continued homebuilding and overall macroeconomic market deterioration and the impact of our Chapter 11 filing on our operations, it is likely that we will have material impairments, losses and provisions upon completion of the analyses and processes in connection with the preparation of our quarterly reports on Form 10-Q for the periods ended March 31, 2008 and June 30, 2008.

 

Introduction

 

TOUSA, Inc. (“TOUSA”, the “Company”, “we”, “us” and “our”) designs, builds and markets high-quality detached single-family residences, town homes and condominiums. We conduct homebuilding operations through our consolidated subsidiaries and unconsolidated joint ventures in various metropolitan markets in nine states, located in four major geographic regions, which are also our reportable segments: Florida, the Mid-Atlantic, Texas and the West.

 

Our predecessor company was founded in Houston, Texas in 1983. Our company was formed in 1994 as a Nevada corporation under the name Newark Homes Corp. We completed our initial public offering of common stock in March 1998. In March 2001, we changed the state of our incorporation from Nevada to Delaware. On April 15, 2002 we sold the stock of our wholly-owned subsidiary, Westbrooke Acquisition Corp., to Standard Pacific Corp. On June 25, 2002, Engle Holdings Corp., a wholly-owned subsidiary of our majority stockholder, Technical Olympic, S.A., merged with and into us and we changed our name to Technical Olympic USA, Inc. On October 4, 2002, we acquired the net assets of DS Ware Homes, LLC, a homebuilder operating in Jacksonville, Florida. On November 18, 2002, we acquired the net assets of Masonry Homes, Inc., a homebuilder operating in the northwestern suburbs of Baltimore, Maryland and southern Pennsylvania. On February 6, 2003, we acquired the net assets of Trophy Homes, Inc., a homebuilder operating in Las Vegas, Nevada. On February 28, 2003, we acquired the net assets of The James Construction Company, a homebuilder operating in the greater Denver, Colorado area. On September 28, 2004, we acquired substantially all of the assets of Gilligan Development, Inc., a homebuilder operating in Delaware, Maryland and Pennsylvania. On August 1, 2005, we formed a joint venture of which we held a 50% interest to acquire substantially all of the homebuilding assets of Transeastern Property, Inc. (“Transeastern JV”). On May 8, 2007, we changed our name to TOUSA, Inc.

 

On January 29, 2008, TOUSA, Inc. and certain of our subsidiaries (excluding our financial services subsidiaries and joint ventures) filed voluntary petitions for reorganization relief under the provisions of Chapter 11 of Title 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Southern District of Florida, Fort Lauderdale Division. The Chapter 11 cases have been consolidated solely on an administrative basis and are pending as Case No. 08-10928-JKO.

 

On February 5, 2008, pursuant to an interim order from the Bankruptcy Court dated January 31, 2008, TOUSA, Inc. entered into the Senior Secured Super-Priority Debtor in Possession Credit and Security Agreement. The agreement provided for a first priority and priming secured revolving credit interim commitment of up to $134.6 million. The agreement was subsequently amended to extend it to June 19, 2008. No funds were drawn under the agreement. The agreement was subsequently terminated and we entered into an agreement with our secured lenders to use cash collateral on hand (cash generated by our operations, including the sale of excess inventory and the proceeds of our federal tax refund of $207.3 million received in April 2008).

See Item 3, Legal Proceedings, of this Annual Report on Form 10-K for additional discussion.

 

As used in this Form 10-K, “consolidated” information refers only to information relating to our continuing operations, which are consolidated in our financial statements and exclude the results of our Dallas/Fort Worth division, which we have classified as a discontinued operation; and “combined” information includes consolidated information and information relating to our unconsolidated joint ventures. Unless otherwise noted, the information contained herein is shown on a consolidated basis. Our consolidated financial statements are presented on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business.

 

We market our homes to a diverse group of homebuyers, including “first-time” homebuyers, “move-up” homebuyers, homebuyers who are relocating to a new city or state, buyers of second or vacation homes, active-adult homebuyers and homebuyers with grown children who want a smaller home (“empty-nesters”).

 

As part of our objective to provide homebuyers a seamless home purchasing experience, we offer an array of financial services, which we provide to buyers of our homes, as well as to others. As part of this business, we offer mortgage financing to qualified buyers, title insurance and settlement services and property and casualty insurance products. Our mortgage financing operation’s revenues consist primarily of origination and premium fee income, interest income and the gain on the sale of the mortgages. We sell substantially all of our mortgages and the related servicing rights to third parties. Our mortgage financing operation derives most of its revenues from buyers of our homes, although existing homeowners may also use these services. In contrast, our title insurance and settlement services operation, as well as our insurance agency operations, are used by our homebuyers and a broad range of other clients purchasing or refinancing residential or commercial real estate.

 

Since 2006, the homebuilding industry has experienced a significant and sustained decrease in demand for new homes, an oversupply of new and existing homes available for sale and a more restrictive mortgage lending environment. Although we operate in a number of markets, approximately 53% of our operations are concentrated in Florida and the West, based on 2007 deliveries, which suffered particularly severe downturns in home buying activity. The rapid increase in new and existing home prices in these markets over the past several years reduced housing affordability and tempered buyer demand. More recently, investors and speculators have reduced their purchasing activity and instead stepped up their efforts to sell the residential property they had earlier acquired. These trends, which were more pronounced in markets that had experienced the greatest levels of price appreciation, resulted in overall fewer home sales, greater cancellations of home purchase agreements by buyers, higher inventories of unsold and foreclosed homes and the increased use by homebuilders, speculators, investors and others of discounts, incentives, price concessions, broker commissions and advertising to close home sales compared to the past several years.

 

Reflecting these trends, we, like many other homebuilders, experienced severe liquidity challenges in the credit and mortgage markets, diminished consumer confidence, increased home inventories and foreclosures, and downward pressure on home prices. Potential buyers have exhibited both a reduction in confidence as to the economy in general and a willingness to delay purchase decisions based on a perception that prices will continue to decline. Prospective homebuyers continue to be concerned about interest rates and the inability to sell their current homes or to obtain appraisals at sufficient amounts to secure mortgage financing as a result of the recent disruption in the mortgage markets and the tightening of credit standards.

 

For the year ended December 31, 2007, our consolidated continuing operations delivered 6,580 homes, having an average sales price of $311,000, had 4,836 net sales orders and generated $2.2 billion in homebuilding revenues. At December 31, 2007, our continuing operations had 2,379 consolidated homes in backlog with an aggregate sales value of $736.3 million. At December 31, 2007, we had contracts for 511 homes, representing $115.6 million in revenue, with a third-party that marketed homes in the United Kingdom. These contracts were cancelled in 2008. As of December 31, 2007, we controlled approximately 32,200 homesites on a consolidated, continuing operations basis. During 2007, we also delivered 1,666 homes through our unconsolidated joint ventures. See additional discussion regarding our joint ventures located in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Financial Condition, Liquidity and Capital Resources.”

For the six months ended June 30, 2008, our consolidated continuing operations delivered 2,139 homes, having an average sales price of $265,000, had 1,340 net sales orders and generated $567.8 million in home sales revenues. At June 30, 2008, our continuing operations had 1,580 consolidated homes in backlog with an aggregate sales value of $479.3 million.

 

For the year ended December 31, 2007, we had a loss from continuing operations of $1.3 billion. As a result of deteriorating market conditions and liquidity constraints, we did not exercise certain homesite option contracts and reviewed our inventories, goodwill, investment in joint ventures and other assets for possible impairment charges. We recognized charges totaling $1.3 billion in 2007 related to inventory impairments, abandonment costs, joint venture impairments, goodwill impairments and the settlement of a loss contingency related to the Transeastern JV. Joint venture impairments and losses totaled $209.0 million for the year ended December 31, 2007 compared to $48.1 million for the year ended December 31, 2006. Additionally, in some cases our Chapter 11 filings have constituted an event of default under the joint venture lender agreements, which have resulted in the joint venture’s debt becoming immediately due and payable, limiting the joint ventures’ access to future capital.

 

On July 31, 2007, we consummated transactions to settle the disputes regarding the Transeastern JV with the lenders of the Transeastern JV, its land bankers and our joint venture partner in the Transeastern JV. Pursuant to the settlement, among other things, the Transeastern JV became a wholly-owned subsidiary by merger into one of our subsidiaries. The acquisition of the Transeastern JV was accounted for using the purchase method of accounting. The results of operations of the Transeastern JV have been included in our consolidated results beginning on July 31, 2007. Results of operations prior to July 31, 2007 are included in the results for the unconsolidated joint ventures.

 

On January 28, 2008, Preferred Home Mortgage Company, our wholly-owned residential mortgage lending subsidiary, entered into an Amended and Restated Agreement of Limited Liability Company with Wells Fargo Ventures, LLC. The limited liability company is known as PHMCWF, LLC but does business as “Preferred Home Mortgage Company, an affiliate of Wells Fargo.” Preferred Home Mortgage Company owns 49.9% of the venture with the balance owned by Wells Fargo. Effective April 1, 2008, the venture began to carry on the mortgage business of Preferred Home Mortgage Company. The venture is managed by a committee composed of six members, three from Preferred Home Mortgage Company and three from Wells Fargo. The venture entered into a revolving credit agreement with Wells Fargo Bank, N.A. providing for advances of up to $20.0 million. Wells Fargo Home Mortgage provides the general and administrative support (as well as all loan related processing, underwriting, closing functions), and is the end investor for the majority of the loans closed through the joint venture. Prior to the joint venture, Preferred Home Mortgage Company had a centralized operations center that provided those support functions. The majority of these support functions ceased in June 2008.

 

For financial information about our homebuilding and financial services operating segments, please see our consolidated financial statements on pages F-1 through F-66.

 

Business Strategy

 

We have taken and will continue to take aggressive actions to maximize cash receipts and minimize cash expenditures with the understanding that certain of these actions may make us less able to take advantage of future improvements in the homebuilding market. We continue to take steps to reduce our general and administrative expenses by streamlining activities and increasing efficiencies, which have led and will continue to lead to major reductions in the workforce. However, much of our efforts to reduce general and administrative expenses are being offset by professional and consulting fees associated with our Chapter 11 cases. In addition, we are working with our existing suppliers and seeking new suppliers, through competitive bid processes, to reduce construction material and labor costs. We have and will continue to analyze each community based on anticipated sales absorption rates, net cash flows and financial returns taking into consideration current market factors in the homebuilding industry such as the oversupply of homes available for sale in most of our markets, less demand, decreased consumer confidence, tighter mortgage loan underwriting criteria, higher foreclosures and the actions of competitors, including increased incentives and

price discounting. In order to generate cash and to reduce our inventory to levels consistent with our business plan, we have taken and will continue to take the following actions, to the extent possible given the limitations resulting from our Chapter 11 cases:

 

 

Homebuilding Operations

 

Operations

 

Although our homebuilding activities were previously operated on a decentralized basis, in light of current conditions in the homebuilding and financial markets, we have initiated a process to migrate toward a more centralized business platform. At December 31, 2007, we operated in various metropolitan markets managed as 12 separate homebuilding operating divisions. Generally, each operating division consists of a division president; land entitlement, acquisition and development personnel; a sales manager and sales personnel; a construction manager and construction superintendents; customer service personnel; a finance team; a purchasing manager and office staff. Before 2008, our division presidents reported to one of four regional executive vice presidents. Our current structure has eliminated the regional executive vice president structure and our division presidents now report to the newly created position of Chief Operating Officer. Our current structure is intended to reduce selling, general and administrative expenses necessitated by market conditions while at the same time recognizing that homebuilding is a market specific industry and therefore, requires significant involvement from local management. We believe that the division presidents and their management teams, who are familiar with local market conditions, have significant information on which to base decisions regarding local operations.

 

Operating Division Responsibilities

 

Each operating division is responsible for:

 

 

 

 

 

Centralized Controls

 

We centralize the key risk elements of our homebuilding business through our corporate offices. Our corporate executives and corporate departments are responsible for establishing our operational policies and internal control standards and for monitoring compliance with established policies and controls throughout our operations. Our corporate offices also have primary responsibility for the following centralized functions:

 

 

In response to market conditions, we have centralized certain approval processes and have established procedures requiring corporate approval before the construction of unsold homes may commence and prior to any purchases of homesites.

 

Markets

 

We operate in various metropolitan markets in nine states located in four major geographic regions: Florida, the Mid-Atlantic, Texas and the West. For the year ended December 31, 2007, our top two largest metropolitan markets, representing approximately 38% of our consolidated home deliveries, were Central Florida and Houston.

 

Florida.  Our Florida region is comprised of five metropolitan markets: Central Florida, which is comprised of Polk, Lake, Orange, Brevard, Volusia and Seminole Counties; Jacksonville; Southeast Florida, which is comprised of Miami-Dade, Broward, Palm Beach, Martin, St. Lucie and Indian River Counties; Southwest Florida, which is comprised of the Fort Myers/Naples area; and the Tampa/St. Petersburg area. For the year ended December 31, 2007, our consolidated continuing operations delivered 2,471 homes in Florida, generating revenue of $849.1 million, or 41% of our consolidated revenues from home sales as compared to 43% and 38% for the years ended December 31, 2006 and 2005, respectively.

 

Mid-Atlantic.  Our Mid-Atlantic region is comprised of four metropolitan markets: Baltimore/Southern Pennsylvania, Nashville and Northern Virginia. For the year ended December 31, 2007, our consolidated continuing operations delivered 649 homes in our Mid-Atlantic region generating revenue of $228.2 million, or 11% of our consolidated revenues from home sales as compared to 11% and 13% for the years ended December 31, 2006 and 2005, respectively.

 

Texas.  Our Texas region is comprised of three metropolitan markets: Austin, Houston and San Antonio. For the year ended December 31, 2007, our consolidated continuing operations delivered 2,421 homes in Texas, generating revenue of $625.4 million, or 31% of our consolidated revenues from home sales as compared to 26% and 19% for the years ended December 31, 2006 and 2005, respectively.

 

West.  Our West region is comprised of three metropolitan markets: Colorado, which is comprised of Denver, Boulder and Colorado Springs; Las Vegas, Nevada; and Phoenix, Arizona. For the year ended December 31, 2007, our consolidated continuing operations delivered 1,039 homes in our West region generating revenue of $346.7 million, or 17% of our consolidated revenues from home sales as compared to 20% and 30% for the years ended December 31, 2006 and 2005, respectively.

 

Product Mix

 

We select our product mix in a particular geographic market based on the demographics of the market, demand for a particular product, margins and the economic strength of the market. We regularly review our product mix in each of our markets so that we can quickly respond to market changes and opportunities. Percentage of deliveries by price range for the years ended December 31, 2007 and 2006 are as follows:

 

 

For the year ended December 31, 2007, 75% of our home deliveries were generated from single family homes and 25% of our home deliveries were generated from multi-family homes, as compared to 77% of our home deliveries from single family homes and 23% of our home deliveries from multi-family homes for the year ended December 31, 2006.

 

Land and Homesites

 

We believe acquiring land and homesites in premier locations is a key factor to a successful homebuilding business. We utilize a strategy of balancing owned homesites and land with those we can acquire under option contracts, together with limited participation in land development joint ventures. The downturn in the market and our liquidity situation has forced us to abandon options to acquire land in numerous markets resulting in the loss of cash deposits and draws on letters of credit posted as deposits under these option contracts and relinquishment of our rights under certain joint ventures.

Types of Land and Homesites

 

In our homebuilding operations, we generally acquire land or homesites that are “entitled”. Land is entitled when all requisite residential zoning has been obtained. We also generally seek to acquire entitled land and homesites that have water and sewage systems, streets and other infrastructure in place (we refer to these properties as “developed homesites”) because they are ready to have homes built on them. When we acquire entitled homesites that are not developed, we must first put in place the necessary infrastructure before commencing construction. However, we believe that there are economic benefits to undertaking the development of some of the land that we may acquire and, in those cases, we will attempt to take advantage of those economic benefits by engaging in land development activities.

 

In connection with the development of certain of our communities, community development or improvement districts may utilize tax-exempt bond financing to fund construction or acquisition of certain on-site and off-site infrastructure improvements. Some bonds are repaid directly by us while other bonds only require us to pay non-ad valorem assessments related to lots not yet delivered to residents. These bonds are typically secured by the property and are repaid from assessments levied on the property over time. We also guarantee district shortfalls under certain bond debt service agreements when the revenues, fees and assessments which are designed to cover principal and interest and other operating costs of the bonds are insufficient.

 

We generally acquire homesites that are located adjacent to or near our other homesites in a community, which enables us to build and market our homes more cost efficiently than if the homesites were scattered throughout the community. Cost efficiencies arise from economies of scale, such as shared marketing expenses and project management.

 

Land Acquisition Policies

 

We have adopted strict land acquisition policies and procedures that cover all homesite acquisitions, including homesites acquired through option contracts. All proposed land purchases are reviewed with the goal of minimizing risk and use of capital, while maximizing our financial returns.

 

Initially, our management teams in each of our divisions conduct extensive analysis on the local market to determine if we want to enter or expand our operations in that market. As part of this analysis, we consider a variety of factors, including:

 

 

We then evaluate and identify specific homesites that are consistent with our strategy for the particular market, including the type of home and anticipated sales price that we wish to offer in the community. In addition, we review:

 

 

In addition, we conduct environmental due diligence, including on-site inspection and soil testing, and confirming that the land has the necessary zoning and other governmental entitlements required to develop and use the property for residential home construction.

Each land acquisition proposal, including the purchase of lots under options, is subject to review and approval by our Asset Committee. The Asset Committee is comprised of representatives from our land, finance and supply management departments.

 

Land Supply and Asset Management Actions

 

We acquire the land and homesites through a combination of purchase agreements, option contracts and joint ventures. At December 31, 2007, we controlled approximately 32,200 consolidated homesites in continuing operations. Of this amount, we owned approximately 21,400 homesites and had option contracts on approximately 10,800 homesites. At December 31, 2006, we controlled approximately 60,600 consolidated homesites in continuing operations. Of this amount, we owned approximately 21,200 homesites and had option contracts on approximately 39,400 homesites.

 

As part of our land inventory management strategy, we review the size, geographic allocation and components of our inventory to better align these assets with estimated future deliveries. Based on current market conditions, existing inventory levels and our historical and projected results, we have excess land inventory. We are and will continue to take necessary actions to reduce our inventory. These actions include, to the extent possible given the limitations resulting from our Chapter 11 cases: limiting new arrangements to acquire land by submitting proposals to a rigorous review; engaging in bulk sales of land and unsold homes; reducing the number of unsold homes under construction and limiting and/or curtailing development activities in any development where we do not expect to deliver homes in the near future; re-negotiating terms or abandoning our rights under option contracts; considering other asset dispositions including the possible sale of underperforming assets, communities, divisions and joint venture interests; reducing our speculative inventory levels and pursuing other initiatives designed to monetize our assets. Revenues from land sales for the year ended December 31, 2007 were $109.4 million, as compared to $131.9 million for the year ended December 31, 2006. However, due to challenging housing market conditions, we may not be able to continue to sell land profitably or at all.

 

Option Contracts

 

We have utilized option contracts to acquire land whenever feasible. Under the option contracts, we typically have the right, but not the obligation, to buy homesites at predetermined prices on a predetermined takedown schedule anticipated to be commensurate with home starts. Option contracts generally require the payment of a cash deposit or the posting of a letter of credit, which is typically less than 20% of the underlying purchase price, and may require monthly maintenance payments. These option contracts are either with land sellers or financial investors who have acquired the land to enter into the option contract with us. In some cases, these contracts give the other party the right to require us to purchase homesites or guarantee minimum returns. (see Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Financial Condition, Liquidity and Capital Resources — Off-Balance Sheet Arrangements”)

 

In certain instances, we have entered into development agreements under these option contracts which require us to complete the development of the land even if we choose not to exercise our option and forfeit our deposit. Although we are typically compensated for this work, in most cases we are responsible for any cost overruns.

 

At December 31, 2007, we had option contracts on approximately 10,800 homesites and had approximately $56.9 million in non-refundable cash deposits and $44.9 million in letters of credit under those option contracts. At December 31, 2006, we had option contracts on approximately 39,400 homesites and had approximately $216.6 million in cash deposits and $257.8 million in letters of credit under those option contracts. As a result of worsening market conditions and liquidity constraints, during the year ended December 31, 2007, we abandoned our rights under certain option agreements. In connection with the abandonment of our rights under these option contracts, we forfeited $82.5 million in cash deposits and had letters of credit totaling $98.5 million drawn at December 31, 2007, which increased our outstanding borrowings. Through June 30, 2008 an additional $72.8 million of letters of credit have been drawn related to the abandonment of option contracts.

Joint Ventures

 

We have used strategic joint ventures to acquire and develop land and/or to acquire, develop, build and market homes to mitigate and share the risks associated with land ownership and development, increase our return on equity and extend our capital resources. Our partners in these joint ventures (generally) are unrelated homebuilders, land sellers, financial investors, or other real estate entities. In joint ventures where the acquisition, development and/or construction of the property are being financed with debt, the borrowings are non-recourse to us, except that we have agreed to complete certain property development in the event the joint ventures default and to indemnify the lenders for losses resulting from fraud, misappropriation and similar acts. In some cases, we have agreed to make capital contributions to the joint venture sufficient to comply with a specified debt to value ratio. Our obligations become full recourse upon certain bankruptcy events at the joint venture.

 

In some cases our Chapter 11 filings have constituted an event of default under the joint venture lender agreements which have resulted in the debt becoming immediately due and payable, limiting the joint ventures’ access to future capital. As a result of our Chapter 11 cases and our reduced investments in joint ventures, we anticipate only limited use of joint ventures in the future.

 

At December 31, 2007 our unconsolidated joint ventures controlled approximately 3,600 homesites, which included 1,100 homesites under option contracts compared to approximately 5,000 controlled homesites, which included 2,100 homesites under option contracts at December 31, 2006. At December 31, 2007 and 2006, we had investments in and receivables from unconsolidated joint ventures of $9.3 million and $156.2 million, respectively. The decrease in 2007 compared to 2006 is primarily due to joint venture impairments recognized during the year ended December 31, 2007 totaling $194.1 million as a result of our evaluation of the recoverability of our investments in the joint ventures under Accounting Principles Board Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock (“APB 18”). During the year ended December 31, 2007 our unconsolidated joint ventures had a total of 815 net sales orders and 1,666 homes delivered compared to 456 net sales orders and 3,951 homes delivered for the year ended December 31, 2006. At December 31, 2007, our unconsolidated joint ventures had 94 homes in backlog with a sales value of $24.7 million compared to 1,199 homes in backlog with a sales value of $365.6 million at December 31, 2006.

 

See additional discussion regarding joint ventures located in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Off-Balance Sheet Arrangements.”

 

Transeastern JV

 

We acquired our 50% interest in the Transeastern JV on August 1, 2005, when the Transeastern JV acquired substantially all of the homebuilding assets and operations of Transeastern Properties, Inc. including work in process, finished lots and certain land option rights. The Transeastern JV paid approximately $826.2 million for these assets and operations (which included the assumption of $127.1 million of liabilities and certain transaction costs, net of $30.1 million of cash). The other member of the joint venture was an entity controlled by the former majority owners of Transeastern Properties, Inc. We functioned as the managing member of the Transeastern JV through a wholly-owned subsidiary. As a result of, among other factors, lower than expected deliveries resulting from lower than expected gross sales and higher cancellations, we evaluated the recoverability of our investment in the joint venture under APB 18 and determined that our investment was fully impaired. As of September 30, 2006 we wrote off $143.6 million related to our investment in the Transeastern JV, which included $35.0 million of our member loans receivable and $16.2 million of receivables for management fees, advances and interest due to us from the joint venture.

 

On October 31, 2006 and November 1, 2006, we received demand letters from the administrative agent for the lenders to the Transeastern JV demanding payment under certain guarantees. The demand letters alleged that potential defaults and events of default had occurred under the credit agreements and that such potential defaults or events of default had triggered our obligations under the guarantees. The lenders claimed that our guarantee obligations equaled or exceeded all of the outstanding obligations under each of the credit agreements and that we were liable for default interest, costs and expenses.

On July 31, 2007, we consummated transactions to settle the disputes regarding the Transeastern JV with the lenders to the Transeastern JV, its land bankers and our joint venture partner in the Transeastern JV. Pursuant to the settlement, among other things,

 

 

To effect the settlement of the Transeastern JV dispute, on July 31, 2007, we also entered into:

 

 

The proceeds from the first lien and second lien term loans were used to satisfy claims of the senior secured lenders against the Transeastern JV, and to pay related expenses. Our existing $800.0 million revolving loan facility was amended and restated to reduce the revolving commitments thereunder by $100.0 million and permit the incurrence of the first and second lien term loan facilities (and make other conforming changes relating to the facilities). Net proceeds from these financings at closing were $470.6 million which is net of a 1% discount and transaction costs.

 

In connection with the Transeastern JV settlement, we recognized a loss of $426.6 million, of which $151.6 million was recognized during the year ended December 31, 2007, and $275.0 million was recognized during the year ended December 31, 2006.

 

We also paid:

 

 

Supply Management

 

We use our purchasing power and a team-oriented sourcing methodology to achieve volume discounts and/or rebates and the best possible service from our suppliers, thereby reducing costs, ensuring timely

deliveries and reducing the risk of supply shortages due to allocations of materials. Our team-oriented sourcing methodology involves the use of corporate and divisional teams of supply management personnel who are responsible for identifying which commodities should be purchased and used on a national, regional, or divisional level to optimize our purchasing power. We have negotiated price arrangements, which we believe are favorable, to purchase lumber, sheetrock, appliances, heating and air conditioning, bathroom fixtures, roofing and insulation products, concrete, bricks, floor coverings and other housing equipment and materials. Our purchase contracts are with high quality national, regional, and local suppliers.

 

Our supply management team uses our quality control procedures to monitor and assess the effectiveness of our suppliers and subcontractors within our overall building processes. In addition, our design process includes input from our supply management team to develop product designs that take into account standard material sizes and quantities with the goal of creating product designs that eliminate unnecessary material and labor costs.

 

Design

 

To appeal to the tastes and preferences of local communities, we expend considerable effort in developing an appropriate design and marketing concept for each community, including determining the size, style and price range of the homes and, in certain projects, the layout of streets, individual homesites and overall community design. In addition, in certain markets, outside architects who are familiar with the local communities in which we build, assist us in preparing home designs and floor plans. The product line that we offer in a particular community depends upon many factors, including the housing generally available in the area, the needs of the particular market and our costs of homesites in the community. To improve the efficiency of our design process and make full use of our resources and expertise, we maintain a company-wide database, or product library, of detailed information relating to the design and construction of our homes, including architectural plans previously or currently used in our communities. Periodically, we review the product library to determine which plans have high and low sales paces, as well as the high and low margins. We then attempt to remove the lesser performing plans from our product library. This enables us to lower the cost of maintaining a large number of plans and lower construction costs by increasing the efficiency of the building process by building better performing plans more frequently.

 

Design Centers

 

We maintain design centers in most of our markets as part of our marketing process and to assist our homebuyers in selecting options and upgrades, which can result in additional revenues. The design centers heighten interest in our homes by allowing homebuyers to participate in the design process and introducing homebuyers to the various finishes and colors including flooring, lighting, fixtures and hardware options available to them. While the size and content of our design centers vary between markets, the focus of all of our design centers is on making the homebuyers’ selection process less complicated and an enjoyable experience, while increasing our profitability.

 

Construction

 

Subcontractors perform substantially all of our construction work. Our construction superintendents monitor the construction of each home, coordinate the activities of subcontractors and suppliers, subject the work of subcontractors to quality and cost controls and monitor compliance with zoning and building codes. We typically retain subcontractors pursuant to a contract that obligates the subcontractor to complete construction at a fixed price in a good and “workmanlike manner” at or above industry standards. In addition, under these contracts the subcontractor generally provides us with standard indemnifications and warranties. Typically, we work with the same subcontractors within each market, which provides us with a stable and reliable trade base and better control over the costs and quality of the work performed. Although we compete with other homebuilders for qualified subcontractors, we have established long-standing relationships with many of our subcontractors and have not experienced any material difficulties in obtaining the services of desired subcontractors.

We typically complete the construction of a home within four to ten months after the receipt of relevant permits. Construction time, however, depends on weather, availability of labor, materials and supplies and other factors. We do not maintain significant inventories of construction materials, except for materials related to work in progress for homes under construction. While the availability and cost of construction materials may be negatively impacted from time to time due to various factors, including weather conditions, generally, the construction materials used in our operations are readily available from numerous sources. We have established price arrangements or contracts, which we believe are favorable, with suppliers of certain of our building materials, but we are not under specific purchasing requirements.

 

We have, and will continue to establish and maintain, information systems and other practices and procedures that allow us to effectively manage our subcontractors and the construction process. For example, we have implemented information systems that monitor homebuilding production, scheduling and budgeting. We believe that this program has and will continue to improve our efficiency and decrease our construction time.

 

Marketing and Sales

 

We currently market our homes primarily under the Engle Homes brand name in Florida, most of the Mid-Atlantic and the West and under the Newmark Homes and Fedrick Harris Estate Homes brand names in Texas and in Nashville, Tennessee. We also market our homes targeted to “first-time” homebuyers under the Trophy Homes brand name, primarily in Texas. We believe our brands are widely recognized in the markets in which we operate for providing quality homes in desirable locations.

 

We build and market different types of homes to meet the needs of different homebuyers and the needs of different markets. We employ a variety of marketing techniques to attract potential homebuyers through numerous avenues, including Internet web sites for our various homebuilding brands, advertising and other marketing programs. We advertise on radio, in newspapers and other publications, through our own brochures and newsletters, on billboards, on the web, where permitted, and in brochures and newsletters produced and distributed by real estate and mortgage brokers.

 

We typically conduct home sales activities from sales offices located in furnished model homes in each community. We use commissioned sales personnel who assist prospective buyers by providing them with floor plans, price information, tours of model homes and information on the available options and other custom features. We provide our sales personnel with extensive training, and we keep them updated as to the availability of financing, construction schedules and marketing and advertising plans to facilitate their marketing and sales activities. We supplement our in-house training program with training by outside marketing and sales consultants.

 

We market and sell homes through our own sales personnel and in cooperation with independent real estate brokers. Because a portion of our sales originate from independent real estate brokers, we sponsor a variety of programs and events to provide the brokers with a level of familiarity with our communities, homes and financing options necessary to successfully market our homes.

 

Sales of our homes generally are made pursuant to a standard sales contract that is tailored to the requirements of each jurisdiction. Generally, our sales contracts require a deposit of a fixed amount or percentage, typically averaging about five percent of the purchase price, plus additional deposits for options and upgrades selected by homebuyers. The contract may include contingencies, such as financing or the prior sale of a buyer’s existing home. We estimate that the average period between the execution of a sales contract for a pre-sold home and closing ranges from four months to over a year, depending on the market and size and complexity of home being built.

 

Customer Service and Quality Control

 

Our operating divisions are responsible for both pre-delivery quality control inspections and responding to customers’ post-delivery needs. We believe that the prompt, courteous response to homebuyers’ needs reduces post-delivery repair costs, enhances our reputation for quality and service and ultimately leads to significant

repeat and referral business. We conduct home orientations and pre-delivery inspections with homebuyers immediately before closing.

 

An integral part of our customer service program includes post-delivery surveys. We contract with independent third parties to conduct periodic post-delivery evaluations of the customer’s satisfaction with their home, as well as the customer’s experience with our sales personnel, construction department and title and mortgage services. We use a national customer satisfaction survey company to mail customer satisfaction surveys to homeowners within 60 days of their home closing. These surveys provide us with a direct link to the customer’s perception of the entire buying experience as well as valuable feedback on the quality of the homes we deliver and the services we provide.

 

Warranty Program

 

For all homes we sell, we provide our homebuyers with a limited warranty that provides a one-year or two-year limited warranty on workmanship and materials, and a five to ten-year limited warranty covering major structural defects. The extent of these warranties may differ in some or all of the states in which we operate. We currently have liability insurance coverage in place which covers repair costs associated with warranty claims for structure and design defects related to homes sold by us during the policy period, subject to a significant self-insured retention per occurrence. We have a warranty administration program, including mandatory alternative dispute resolution procedures that we believe will allow us to more effectively manage and resolve our warranty claims. We subcontract homebuilding work to subcontractors who generally are required to indemnify us and provide evidence of required insurance coverage before receiving payments for their work. Therefore, claims relating to workmanship and materials are the primary responsibility of our subcontractors; however, we may be unable to enforce these contractual indemnities.

 

After we deliver a home, we process all warranty requests through our customer service departments located in each of our markets. If a warranty repair is necessary, we manage and supervise the repair to ensure that the appropriate subcontractor takes prompt and appropriate corrective action. Additionally, we have developed a proactive response and remediation protocol to address any warranty claim that may result in mold damage. We generally have not had any material litigation or claims regarding warranties or latent defects with respect to construction of homes. Current claims and litigation are expected to be substantially covered by our reserves or insurance.

 

To support our warranty program, we implemented an automated warranty application in 2007 in approximately half of our divisions. It allows management, customers and associates the ability to track and manage warranty requests from reporting through resolution to improve communication and customer satisfaction. This application also helps us to objectively select and manage vendors that deliver quality work on time.

 

To address homebuyer concerns regarding our fulfillment of warranty obligations at the inception of our Chapter 11 cases, we entered into an agreement with an affiliate of Zurich Financial Services Group, which guarantees our warranty obligations for the first ten years and assumes all liability for structural claims in years three through ten. The agreement covered all homes in backlog on January 21, 2008 and homes sold or delivered between January 21, 2008 and June 30, 2008.

 

Financial Services

 

As part of our objective to provide homebuyers with a seamless home purchasing experience, we offer an array of financial services, which we provide to buyers of our homes, as well as to others. As part of this business, we provide mortgage financing, title insurance and settlement services, and property and casualty insurance products. Our mortgage financing operation derives most of its revenues from buyers of our homes, although existing homeowners may also use these services. In contrast, our title and settlement services and our insurance agency operations are used by our homebuyers and a broad range of other clients purchasing or refinancing residential or commercial real estate.

Our mortgage business provides a full selection of conventional, FHA-insured and VA-guaranteed mortgage products to our homebuyers. We are an approved Fannie Mae seller / servicer. All of our loans are originated and underwritten in accordance with the guidelines of Fannie Mae, Freddie Mac, FHA, VA or other institutional third parties. We sell substantially all of our loans and the related servicing rights to third party investors. We conduct this business through our subsidiary, Preferred Home Mortgage Company, which has its headquarters in Tampa, Florida and has offices in each of our markets. For the year ended December 31, 2007, approximately 10% of our homebuyers paid in cash and 70% of our non-cash homebuyers utilized the services of our mortgage business. During 2007, we closed 5,192 loans totaling $1.3 billion in principal amount.

 

On January 28, 2008, Preferred Home Mortgage Company, our wholly-owned residential mortgage lending subsidiary, entered into an Amended and Restated Agreement of Limited Liability Company with Wells Fargo Ventures, LLC. The limited liability company is known as PHMCWF, LLC but does business as “Preferred Home Mortgage Company, an affiliate of Wells Fargo.” Preferred Home Mortgage Company owns 49.9% of the venture with the balance owned by Wells Fargo. Effective April 1, 2008, the venture began to carry on the mortgage business of Preferred Home Mortgage Company. The venture is managed by a committee composed of six members, three from Preferred Home Mortgage Company and three from Wells Fargo. The venture entered into a revolving credit agreement with Wells Fargo Bank, N.A. providing for advances of up to $20.0 million. Wells Fargo Home Mortgage provides the general and administrative support (as well as all loan related processing, underwriting and closing functions), and is the end investor for the majority of the loans closed through the joint venture. Prior to the joint venture, Preferred Home Mortgage Company had a centralized operations center that provided those support functions. The majority of these support functions ceased in June 2008.

 

Through our title services business, we, as agent, obtain competitively-priced title insurance for, and provide settlement services to our homebuyers as well as third party homebuyers. We conduct this business through our subsidiary, Universal Land Title, Inc. and its subsidiaries and affiliates.

 

Our Universal Land Title subsidiary works with national underwriters and lenders to facilitate client service and coordinates closings at its offices. It is equipped to handle e-commerce applications, e-mail closing packages and digital document delivery. The principal sources of revenues generated by our title insurance business are fees paid to Universal Land Title for title insurance obtained for our homebuyers and other third party residential purchasers. Universal Land Title operates as a title agency with its headquarters in West Palm Beach, Florida and has 21 additional offices.

 

For the year ended December 31, 2007, approximately 97% of our homebuyers used Universal Land Title or its affiliates for their title insurance and settlement services. Third party homebuyers (or non-company customers) accounted for 41% of our title services business revenue for the year ended December 31, 2007.

 

Alliance Insurance and Information Services, LLC, owned by Universal Land Title, is a full service insurance agency serving all of our markets. Alliance markets homeowners’, flood and auto insurance directly to homebuyers and others in all of our markets and also markets life insurance in Florida. Interested homebuyers obtain free quotes and have the necessary paperwork delivered directly to the closing table for added convenience. For the year ended December 31, 2007, 2% of our new homebuyers used Alliance for their insurance needs.

 

Governmental Regulation

 

We must comply with federal, state and local laws and regulations relating to, among other things, zoning, treatment of waste, land development, required construction materials, density requirements, building design and elevation of homes in connection with the construction of our homes. These include laws requiring use of construction materials that reduce the need for energy-consuming heating and cooling systems. In addition, we and our subcontractors are subject to laws and regulations relating to employee health and safety. These laws and regulations are subject to frequent change and often increase construction costs. In some cases, there are laws requiring that commitments to provide roads and other infrastructure be in place prior to the commencement of new construction. These laws and regulations are usually administered by individual counties and municipalities and may result in fees and assessments or building moratoriums. In addition,

certain new development projects are subject to assessments for schools, parks, streets and highways and other public improvements, the costs of which can be substantial.

 

The residential homebuilding industry also is subject to a variety of local, state and federal statutes, ordinances, rules and regulations concerning the protection of health and the environment. The requirements, interpretation and/or enforcement of these environmental laws and regulations are subject to change. Environmental laws and conditions may result in delays, may cause us to incur substantial compliance and other costs and can prohibit or severely restrict homebuilding activity in environmentally sensitive regions or areas. In recent years, several cities and counties in which we have developments have submitted to voters and/or approved “slow growth” or “no growth” initiatives and other ballot measures, which could impact the affordability and availability of homes and land within those localities.

 

Our title insurance agency subsidiaries must comply with applicable state and federal insurance laws and regulations. Our mortgage financing subsidiary must comply with applicable real estate lending laws and regulations. In addition, to make it possible for purchasers of some of our homes to obtain FHA-insured or VA-guaranteed mortgages, we must construct those homes in compliance with regulations promulgated by those agencies.

 

The mortgage financing and title insurance subsidiaries are licensed in the states in which they do business and must comply with laws and regulations in those states regarding mortgage financing, homeowners’ insurance and title insurance agencies. These laws and regulations include provisions regarding capitalization, operating procedures, investments, forms of policies and premiums.

 

Competition and Market Forces

 

The development and sale of residential properties is a highly competitive business. We compete in each of our markets with numerous national, regional and local builders on the basis of a number of interrelated factors including location, price, reputation, amenities, design, quality and financing. Builders of new homes compete for homebuyers and for desirable properties, raw materials and reliable, skilled subcontractors. We also compete with resales of existing homes, available rental housing and, to a lesser extent, resales of condominiums. We believe we generally compare favorably to other builders in the markets in which we operate, due primarily to:

 

 

The housing industry is cyclical and is affected by consumer confidence levels and prevailing economic conditions, including interest rate levels. A variety of other factors affect the housing industry and demand for new homes, including the availability of labor and materials and increases in the costs thereof, changes in costs associated with home ownership such as increases in property taxes, energy costs, changes in consumer preferences, demographic trends and the availability of and changes in mortgage financing programs.

 

Our mortgage operation competes with other mortgage lenders, including national, regional and local mortgage bankers, mortgage brokers, banks and other financial institutions, in the origination, sale and servicing of mortgage loans. Principal competitive factors include interest rates and other features of mortgage loan products available to the consumer. Our title and insurance operations compete with other insurance agencies, including national, regional and local insurance agencies and attorneys in the sale of title insurance, homeowner insurance and related insurance services. Principal competitive factors include the level of service available, technology, cost and other features of insurance products available to the consumer.

 

We are required under certain contracts to provide performance bonds. The market for performance bonds was severely impacted by certain corporate failures in recent years and continues to be impacted by general economic conditions. Consequently, less overall bonding capacity is available in the market than in the past,

and surety bonds have become more expensive and restrictive. Additionally, in certain cases where we have stopped activities in a community, we may have failed to complete the infrastructure for which the performance bond was posted. In such cases, sureties for our performance bonds are required to fulfill our obligations and in the future, may be unwilling to issue performance bonds or may require additional collateral to issue or renew performance bonds.

 

The past year has seen intense competition in the homebuilding industry for a decreased group of homebuyers. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Financial Condition, Liquidity and Capital Resources,” for discussion of 2007 developments.

 

Seasonality

 

The homebuilding industry tends to be seasonal, as generally there are more homes sold in the spring and summer months when the weather is milder, although the number of sales contracts for new homes is highly dependent on the number of active communities and the timing of new community openings. Because new home deliveries trail new home contracts by a number of months, we typically have the greatest percentage of home deliveries in the fall and winter, and slow sales in the spring and summer months could negatively affect our full year results. We operate primarily in the Southwest and Southeast, where weather conditions are more suitable to a year-round construction process than in other parts of the country. Our operations in Florida and Texas are at risk of repeated and potentially prolonged disruptions during the Atlantic hurricane season, which lasts from June 1 until November 30.

 

Backlog

 

At December 31, 2007, our consolidated continuing operations had 2,379 homes in backlog representing $736.3 million in revenue, as compared to 3,869 homes in backlog representing $1.4 billion in revenue as of December 31, 2006. At December 31, 2007, we had contracts for 511 homes, representing $115.6 million in revenue, with a third-party that marketed homes in the United Kingdom. These contracts were cancelled in 2008. At June 30, 2008, our consolidated continuing operations had 1,580 homes in backlog representing $479.3 million in revenue. Backlog represents home purchase contracts that have been executed and for which earnest money deposits have been received, but for which the sale has not yet closed. We do not record home sales as revenues until the closings occur. Our consolidated sales order cancellation rate for the year ended December 31, 2007 was approximately 38%, as compared to 32% for the year ended December 31, 2006. The increase in the sales order cancellation rate is a result of the continued deterioration of conditions in most of our markets during 2007 characterized by record levels of new and existing homes available for sale, speculative investors canceling existing contracts, reduced affordability, increased competition among builders, diminished buyer confidence and tightening of available mortgage financing. All of our markets are experiencing patterns of lower traffic, increased cancellations, higher incentives, lower margins and reduced absorption.

 

Employees

 

At December 31, 2007, we employed 1,461 people in our consolidated operations and 9 people in our unconsolidated Engle/Sunbelt joint venture as compared to 2,007 people in our consolidated operations and 297 people in our unconsolidated joint ventures at December 31, 2006. At June 30, 2008, we employed 1,039 people in our consolidated operations. The decrease in staffing levels in 2008 and 2007 compared to 2006 is in response to the decline in business levels. Our ability to attract, motivate and retain key and essential personnel is impacted by the Bankruptcy Code which limits our ability to implement a retention program or take other measures intended to motivate employees to remain with us. As part of our business strategy initiatives and as a result of uncertainties involving our Chapter 11 cases, we expect to experience further reductions in workforce. None of our employees are covered by collective bargaining agreements.

 

In 2007, our division presidents received performance bonuses based upon achieving targeted financial and operational measures in their operating divisions. We are currently evaluating our compensation structure for our division presidents in light of our Chapter 11 cases.

Availability of Reports and Other Information

 

Our corporate website is www.TOUSA.com. We make available, free of charge, access to our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Proxy Statements on Schedule 14A and amendments to those materials filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 on our website under “Investor Information — SEC Filings,” as soon as reasonably practicable after we electronically file such material with, or furnish it to, the United States Securities and Exchange Commission. We also make available on our website under “Investor Information — Corporate Governance” copies of materials regarding our corporate governance policies and practices, including our Corporate Governance Guidelines, our Code of Business Ethics and the charters relating to the committees of our Board of Directors. This information is available in print free of charge to any stockholder who submits a written request for such document to TOUSA, Inc., Attn: Investor Relations, 4000 Hollywood Blvd., Suite 500 N, Hollywood, Florida 33021. Information on our website is not part of this document.

 

Additional information regarding our Chapter 11 cases, including access to court documents and other general information about the Chapter 11 cases, is available at www.kccllc.net/tousa. Financial information on the website is prepared according to requirements of federal bankruptcy law. While such financial information reflects information required under federal bankruptcy law, such information may be unconsolidated, unaudited and prepared in a format different than that used in our consolidated financial statements incorporated herein prepared in accordance with generally accepted accounting principles in the United States and filed under the securities laws. Moreover, the materials filed with the Bankruptcy Court are not prepared for the purpose of providing a basis for investment decisions relating to our stock or debt or for comparison with other financial information filed with the Securities and Exchange Commission.

 

 

Risks Relating to the Chapter 11 Cases

 

We are subject to the risks and uncertainties associated with our Chapter 11 cases.

 

We are operating our businesses as debtors and debtors-in-possession under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court. As a result, we are subject to the risks and uncertainties associated with our Chapter 11 cases which include, among other things:

 

 

These risks and uncertainties could negatively affect our business and operations in various ways. For example, events or publicity associated with our Chapter 11 cases could adversely affect our relationships with

existing and potential homebuyers, vendors and employees, which in turn could adversely affect our operations and financial condition, particularly if such cases are protracted.

 

As a result of our Chapter 11 cases and the other matters described herein, including the uncertainties related to the fact that we have not yet had time to complete and obtain confirmation of a plan of reorganization, there is substantial doubt about our ability to continue as a going concern. Our ability to continue as a going concern, including our ability to meet our ongoing operational obligations, is dependent upon, among other things:

 

 

These challenges are in addition to those operational and competitive challenges that we face in connection with our business. In conjunction with our advisors, we are implementing strategies to aid our liquidity and our ability to continue as a going concern. However, such efforts may not be successful.

 

In light of the foregoing, trading in our securities during the pendency of our Chapter 11 cases is highly speculative and poses substantial risks. These risks include extremely volatile trading prices. In addition, during the pendency of the Chapter 11 cases, the Bankruptcy Court has entered an order that places certain limitations on trading in our common stock and certain securities, including options convertible into our common stock, and has also provided the potentially retroactive application of notice and sell-down procedures for trading in claims against the debtors’ estates (in the event that such procedures are approved in the future). Holders of our securities, especially holders of our common stock, may not be able to resell such securities and, in connection with our reorganization, may have their securities cancelled and in return receive no payment or other consideration, or a payment or other consideration that is less than the par value or the purchase price of such securities.

 

A long period of operating under Chapter 11 may harm our business.

 

A long period of operating under Chapter 11 could adversely affect our businesses and operations. So long as the Chapter 11 cases continue, our senior management will be required to spend a significant amount of time and effort dealing with the Chapter 11 reorganization instead of focusing exclusively on business operations. A prolonged period of operating under Chapter 11 will also make it more difficult to attract and retain management and other key personnel necessary to the success and growth of our businesses. In addition, the longer the Chapter 11 cases continue, the more likely it is that our customers and suppliers will lose confidence in our ability to successfully reorganize our businesses and seek to establish alternative commercial relationships.

 

Furthermore, so long as the Chapter 11 cases continue, we will be required to incur substantial costs for professional fees and other expenses associated with the cases. A prolonged continuation of the Chapter 11 cases may also require us to seek additional financing and obtain relief from certain terms contained in the cash collateral order. It may not be possible for us to obtain additional financing during the term of the Chapter 11 cases on commercially favorable terms or at all. If we require additional financing during the Chapter 11 cases and we are unable to obtain the financing on favorable terms or at all, our chances of successfully reorganizing our businesses may be seriously jeopardized.

 

Operating under the Bankruptcy Code may restrict our ability to pursue our business strategies.

 

Among other things, the Bankruptcy Code limits our ability to:

 

 

 

These restrictions may place us at a competitive disadvantage compared to our competitors who are not subject to similar restrictions, which may adversely affect our results of operations.

 

Our cash collateral order includes operating budgets and financial covenants that limit our operating flexibility.

 

The cash collateral order requires us to maintain certain financial budgets and covenants that, among other things, restrict our ability to take specific actions, even if we believe such actions are in our best interest. These include, among other things, restrictions on our ability to:

 

 

Limitations in the cash collateral order on making capital expenditures and incurring additional debt may prevent us from pursing new business initiatives, which may place us at a competitive disadvantage.

 

The cash collateral order limits the amount of money that we may spend on capital expenditures. Accordingly, we could be unable to make capital expenditures to pursue new business initiatives. Our inability to pursue new business initiatives may put us at a competitive disadvantage to our competitors who are not subject to these restrictions. If our competitors successfully pursue new business initiatives, these restrictions may limit our ability to react effectively, and our results of operations or financial condition could be adversely affected.

 

We require a significant amount of cash, which may not be available to us.

 

Our ability to make payments on, repay or refinance our debt, to fund planned capital expenditures and to generate sufficient working capital to operate our business will depend largely upon our future operating performance. Our future performance is subject to general economic, financial, competitive, legislative, regulatory and other factors beyond our control. In addition, our ability to borrow funds depends on the satisfaction of the covenants of our debt agreements that we will have upon our exit from Chapter 11.

Additionally, our working capital needs may increase to the extent that our suppliers are unwilling to extend credit to us on satisfactory terms. Our business may not generate sufficient cash flow from operations and future borrowings may not be available to us in an amount sufficient to enable us to pay our debt, fund capital expenditures or fund our working capital or other liquidity needs.

 

We may not be able to confirm or consummate a plan of reorganization.

 

In order to successfully emerge from our Chapter 11 cases as a viable company, we must develop, obtain requisite creditor and Bankruptcy Court approval of, and consummate a Chapter 11 plan of reorganization. This process requires us to meet certain statutory requirements under the Bankruptcy Code with respect to adequacy of disclosure regarding a plan of reorganization, soliciting and obtaining creditor acceptances of a plan, and fulfilling other statutory conditions for confirmation. We may not receive the requisite acceptances to confirm a plan of reorganization. Even if the requisite acceptances to a plan of reorganization are received, the Bankruptcy Court may not confirm the plan. In addition, even if a plan of reorganization is confirmed, we may not be able to consummate such plan.

 

If a plan of reorganization is not confirmed by the Bankruptcy Court, or if we are unable to successfully consummate a plan after confirmation, we may not be able to reorganize our businesses. If an alternative reorganization could not be agreed upon, we may have to liquidate our assets.

 

We have the exclusive right to file a Chapter 11 plan or plans prior to October 25, 2008 and the exclusive right to solicit acceptance thereof until December 24, 2008. Pursuant to Section 1121 of the Bankruptcy Code, the exclusivity periods may be expanded or reduced by the Bankruptcy Court, but in no event can the exclusivity periods to file and solicit acceptance of a plan or plans of reorganization be extended beyond 18 months and 20 months, respectively.

 

Transfers of our equity, or issuances of equity in connection with our restructuring, may impair our ability to utilize our federal income tax net operating loss carryforwards in the future.

 

Under federal income tax law, a corporation is generally permitted to deduct from taxable income in any year net operating losses carried forward from prior years. We have net operating loss carryforwards and built in losses (which are treated similarly to net operating losses) of approximately $83.5 million and $1.2 billion, respectively, as of December 31, 2007. In addition, we have alternative minimum tax credit carryforwards of $12.5 million. Our ability to deduct net operating loss carryforwards and recognize the benefits of the built in losses and the alternative minimum tax credit carryforwards could be subject to a significant limitation if we were to undergo an “ownership change” for purposes of Section 382 of the Internal Revenue Code of 1986, as amended, during or as a result of our Chapter 11 cases. During the pendency of the Chapter 11 cases, the Bankruptcy Court has entered an order that places certain limitations on trading in our common stock or certain securities, including options, convertible into our common stock. The Bankruptcy Court has also provided the potentially retroactive application of notice and sell-down procedures for trading in claims against the debtors’ estates (in the event that such procedures are approved in the future). These limitations, however, may not prevent an “ownership change” and our ability to utilize our net operating loss carryforwards and recognize the benefits of the built in losses and the alternative minimum tax credit carryforwards may be significantly limited as a result of our reorganization.

 

The Bankruptcy Code may limit our secured creditors’ ability to realize value from their collateral.

 

Upon the commencement of a case under Chapter 11 of the Bankruptcy Code, a secured creditor is prohibited from repossessing its security from a debtor in a Chapter 11 case, or from disposing of security repossessed from such debtor, without Bankruptcy Court approval. Moreover, the Bankruptcy Code generally permits the debtor to continue to retain and use collateral even though the debtor is in default under the applicable debt instruments, provided that the secured creditor is given “adequate protection.” The meaning of the term “adequate protection” may vary according to circumstances, but it is intended to protect the value of the secured creditor’s interest in the collateral and may include cash payments or the granting of additional security if and at such times as the Bankruptcy Court in its discretion determines that the value of the secured

creditor’s interest in the collateral is declining during the pendency of a Chapter 11 case. A Bankruptcy Court may determine that a secured creditor may not require compensation for a diminution in the value of its collateral if the value of the collateral exceeds the debt it secures.

 

In view of the lack of a precise definition of the term “adequate protection” and the broad discretionary power of a Bankruptcy Court, it is impossible to predict:

 

 

In addition, the instruments governing certain of our indebtedness provide that the secured creditors (or their applicable agents) may not object to a number of important matters following the filing of a bankruptcy petition. Accordingly, it is possible that the value of the collateral securing our indebtedness could materially deteriorate and secured creditors would be unable to raise an objection.

 

Furthermore, if the Bankruptcy Court determines that the value of the collateral is not sufficient to repay all amounts due on applicable secured indebtedness, the holders of such indebtedness would hold a secured claim only to the extent of the value of their collateral and would otherwise hold unsecured claims with respect to any shortfall. The Bankruptcy Code generally permits the payment and accrual of post-petition interest, costs and attorney’s fees to a secured creditor during a debtor’s Chapter 11 case, but only to the extent the value of its collateral is determined by a Bankruptcy Court to exceed the aggregate outstanding principal amount of the obligations secured by the collateral.

 

Our successful reorganization will depend on our ability to retain and motivate key employees.

 

Our success and the successful implementation of a business plan is largely dependent on the skills, experience and efforts of our people, particularly senior management. Our ability to attract, motivate and retain key and essential personnel is impacted by the Bankruptcy Code which limits our ability to implement a retention program or take other measures intended to motivate employees to remain with us. In addition, we must obtain U.S. Bankruptcy Court approval of employment contracts and other employee compensation programs. The process of obtaining such approvals, including negotiating with creditor committees (which may raise objections to or otherwise limit our ability to implement such contracts or programs), has resulted in delays and reduced potential compensation for many employees. Certain employees, including certain key members of senior management, have resigned following the filing of our Chapter 11 cases. The continued loss of such individuals or other key personnel could have a material adverse effect upon the implementation of a business plan and on our ability to reorganize successfully and emerge from bankruptcy.

 

Our financial results may be volatile and may not reflect historical trends.

 

While in Chapter 11, we expect our financial results to continue to be volatile as asset impairments, asset dispositions, restructuring activities, contract terminations and rejections and claims assessments may significantly impact our consolidated financial statements. As a result, our historical financial performance is likely not indicative of our financial performance during bankruptcy or post-bankruptcy. Upon emergence from Chapter 11, the amounts reported in our subsequent consolidated financial statements may materially change relative to our historical consolidated financial statements, including as a result of revisions to our operating plans pursuant to our plan of reorganization. In addition, as part of our successful emergence from Chapter 11, we expect that we will be required to adopt fresh start accounting. If fresh start accounting is applicable, our assets and liabilities will be recorded at fair value as of the fresh start reporting date. The fair value of our assets and liabilities may differ materially from the recorded values of assets and liabilities on our consolidated statements of financial condition. In addition, our financial results after the application of fresh start accounting may be different from historical trends.

Risks Related to Capital Resources; Liquidity

 

We have substantial liquidity needs and face liquidity pressure.

 

On February 5, 2008, pursuant to an interim order from the Bankruptcy Court dated January 31, 2008, we entered into the Senior Secured Super-Priority Debtor in Possession Credit and Security Agreement. The agreement provided for a first priority and priming secured revolving credit interim commitment of up to $134.6 million. The agreement was subsequently amended to extend it to June 19, 2008. No funds were drawn under the agreement. The agreement was subsequently terminated and we entered into an agreement with our secured lenders to use cash collateral on hand (cash generated by our operations, including the sale of excess inventory and the proceeds of our federal tax refund of $207.3 million received in April 2008). Under the Bankruptcy Court order dated June 20, 2008, we are authorized to use cash collateral of our first lien and second lien lenders (approximately $358.0 million at the time of the order) for a period of six months in a manner consistent with a budget negotiated by the parties. The order further provides for the paydown of $175.0 million to our first lien term loan facility secured lenders, subject to disgorgement provisions in the event that certain claims against the lenders are successful and repayment is required. The order also reserves our sole right to paydown an additional $15.0 million to our fist lien term loan facility secured lenders. We are permitted under the order to incur liens and enter into sale/leaseback transactions for model homes subject to certain limitations. As part of the order, we have granted the prepetition agents and the lenders various forms of protection, including liens and claims to protect against any diminution of the collateral value, payment of accrued, but unpaid interest on the first priority indebtedness at the non-default rate and the payment of reasonable fees and expenses of the agents under our secured facilities.

 

We continue to have substantial liquidity needs in the operation of our business and face liquidity challenges. Our business depends upon our ability to obtain financing for the acquisition of land, operating costs, development of our residential communities and to provide bonds to ensure the completion of our projects. Our ability to make payments on our indebtedness will depend on our ability to generate cash. This, to a large extent, is dependent upon industry conditions, as well as general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. The success of our Chapter 11 cases and implementation of our business plan will depend on our ability to achieve our budgeted operating results and access sufficient resources.

 

Our substantial indebtedness could adversely impact our financial health and limit our operations.

 

Our high level of indebtedness has important consequences, including:

 

 

We may be unable to obtain additional financing in the future.

 

Our ability to arrange financing (including any extension or refinancing) and the cost of the financing are dependent upon numerous factors, including:

 

 

 

Our cash collateral order imposes significant operating and financial restrictions on us; any failure to comply with these restrictions could have a material adverse effect on our liquidity and our operations.

 

These restrictions could adversely affect us by limiting our ability to plan for or react to market conditions or to meet our capital needs. These restrictions limit or prohibit our ability, subject to certain exceptions to, among other things:

 

 

Our ability to comply with these covenants depends in part on our ability to implement our restructuring program during the Chapter 11 cases. If we are unable to achieve the goals associated with our restructuring program and the other elements of our business plan, we may not be able to comply with these covenants.

 

We may incur significant damages and expenses due to the purported class action complaints filed against us and certain of our officers.

 

TOUSA, Inc. is a defendant in a class action lawsuit pending in the United States District Court for the Southern District of Florida. The name and case number of the class action suit is Durgin, et al., v. TOUSA, Inc., et al., No. 06-61844-CIV.

 

Beginning in December 2006, various stockholder plaintiffs brought lawsuits seeking class action status in the U.S. District Court for the Southern District of Florida. At a hearing held March 29, 2007, the Court consolidated the actions and heard arguments on the appointment of lead plaintiff and counsel. On September 7, 2007, the Court appointed Diamondback Capital Management, LLC as the lead plaintiff and approved Diamondback’s selection of counsel. Pursuant to a scheduling order, the lead plaintiff filed a Consolidated Complaint on November 2, 2007.

 

The Consolidated Complaint names TOUSA, all of TOUSA’s directors, David Keller, Randy Kotler, Beatriz Koltis, Lonnie Fedrick, Technical Olympic, S.A., UBS Securities, LLC, Citigroup Global Markets, Inc., Deutsche Bank Securities, Inc. and JMP Securities, LLC as defendants. The alleged class period is August 1, 2005 to March 19, 2007. The Consolidated Complaint alleges that TOUSA’s public filings and other public statements that described the financing for the Transeastern Joint Venture as non-recourse to TOUSA were false and misleading. The Consolidated Complaint also alleges that certain public filings and statements were misleading or suffered from material omissions in failing to disclose fully or describe the Completion and Carve-Out Guaranties that TOUSA executed in support of the Transeastern Joint Venture financing. The Consolidated Complaint asserts claims under Section 11 of the Securities Act against all defendants other than Ms. Koltis for strict liability and negligence regarding the registration statements and prospectus associated with the September 2005 offering of 4 million shares of stock. Plaintiffs contend that the registration

statements and prospectus contained material misrepresentations and suffered from material omissions in the description of the Transeastern Joint Venture financing and TOUSA’s related obligations. The Consolidated Complaint asserts related claims against Technical Olympic, S.A. and Messrs. Konstantinos Stengos, Antonio B. Mon, David Keller and Tommy L. McAden as controlling persons responsible for the statements in the registration statements and prospectus. The Consolidated Complaint also alleges claims under Section 10(b) of the Exchange Act for fraud with respect to various public statements about the non-recourse nature of the Transeastern debt and alleged omissions in disclosing or describing the Guaranties. These claims are alleged against TOUSA, Messrs. Mon, McAden, Keller and Kotler and Ms. Koltis. Finally, the Consolidated Complaint asserts related claims against Messrs. Mon, Keller, Kotler and McAden as controlling persons responsible for the various alleged false disclosures. Plaintiffs seek compensatory damages, plus fees and costs, on behalf of themselves and the putative class of purchasers of TOUSA common stock and purchasers and sellers of options on TOUSA common stock.

 

On January 30, 2008, TOUSA filed a Motion to Dismiss Plaintiffs’ Consolidated Complaint. TOUSA moved to dismiss plaintiffs’ claims on the grounds that plaintiffs: a) could not establish materially false or misleading statements or omissions; b) could not establish loss causation; c) failed to plead with particularity facts giving rise to a strong inference of scienter; and d) lacked standing to pursue a Section 11 claim. Many of the other defendants also filed motions to dismiss and/or signed on to TOUSA’s Motion to Dismiss.

 

On February 4, 2008, TOUSA filed a Notice of Suggestion of Bankruptcy notifying the Court that TOUSA filed for bankruptcy on January 29, 2008. On February 5, 2008, the Court entered an order staying the action as to TOUSA pursuant to Section 362 of the United States Bankruptcy Code. The action continues with respect to defendants other than TOUSA.

 

On April 30, 2008, lead plaintiff Diamondback Capital Management moved to withdraw as lead plaintiff. On May 22, 2008, the Court entered an order: granting Diamondback Capital Management’s motion to withdraw as lead plaintiff; establishing a procedure pursuant to which a new lead plaintiff would be appointed; extending the time for plaintiffs to respond to the motions to dismiss until a new lead plaintiff is selected; and acknowledging that the Court may need to set a time for the filing of an amended complaint, if requested by the new lead plaintiff.

 

On June 6, 2008, two prospective lead plaintiffs filed motions to be appointed the new lead plaintiff. On July 15, 2008, the Court entered an Order appointing the Bricklayers & Trowel Trades International Pension Fund as the new lead plaintiff. The Court further ordered that, within 15 days of the entry of the Order, the new plaintiff must either respond to the previously filed Motions to Dismiss, or file a notice of intent to file an amended complaint. On July 30, 2008, the new plaintiff filed a notice of intent to file an amended complaint. On July 31, 2008, following the notice of intent to file an amended complaint, the Court denied as moot, without prejudice, the defendants’ previously filed motion to dismiss the consolidated complaint. Under the current schedule set by the Court, the plaintiff must file its amended complaint by August 29, 2008.

 

You may find it difficult to sell our common stock and debt securities.

 

Effective November 19, 2007, NYSE Regulation, Inc. suspended our common stock and debt securities from trading on the NYSE. We appealed the suspension. Following our suspension from the NYSE, we began trading on the Pink Sheet Electronic Quotation Service. On February 15, 2008, the NYSE denied our appeal and affirmed the decision to suspend trading in our common stock and debt securities on the NYSE and commenced delisting procedures. On March 3, 2008, the NYSE filed Forms 25, Notification of Removal of Listing and/or Registration under Section 12(b) of the Securities Exchange Act of 1934, with the SEC with respect to our listed securities. Our securities will be delisted 90 days thereafter.

 

The trading of our common stock over the counter negatively impacts the trading price of our common stock and the levels of liquidity available to our stockholders. In addition, the trading of our common stock over the counter materially adversely affects our access to the capital markets and our ability to raise capital through alternative financing sources on terms acceptable to us or at all. Securities that trade on the Pink Sheets are not eligible for margin loans and make our common stock subject to the provisions of Rule 15g-9 of the Securities Exchange Act of 1934, commonly referred to as the “penny stock rule.” The Securities and

Exchange Commission generally defines “penny stock” to be any equity security that has a market price less than $5.00 per share, subject to certain exceptions. If our common stock is deemed to be a penny stock, trading in the shares will be subject to additional sales practice requirements on broker-dealers who sell penny stocks to persons other than established customers and accredited investors. “Accredited investors” are persons with assets in excess of $1.0 million, or annual income exceeding $200,000, or $300,000 together with their spouse. For transactions covered by these rules, broker-dealers must make a special suitability determination for the purchase of such security and must have the purchaser’s written consent to the transaction prior to the purchase. Additionally, for any transaction involving a penny stock, unless exempt, the rules require the delivery, prior to the first transaction, of a risk disclosure document, prepared by the SEC, relating to the penny stock market. A broker-dealer also must disclose the commissions payable to both the broker-dealer and the registered representative, and current quotations for the securities. Finally, monthly statements must be sent disclosing recent price information for the penny stocks held in an account and information on the limited market in penny stocks. Consequently, these rules may restrict the ability of broker-dealers to trade and/or maintain a market in our common stock and may affect the ability of our shareholders to sell their shares. There are also other negative implications, including the potential loss of confidence by suppliers, existing and potential homebuyers and employees and the loss of institutional investor interest in our company.

 

Risks Related to Our Business

 

The homebuilding industry is experiencing a severe downturn that may continue for an indefinite period which may further adversely affect our business and results of operations compared to prior periods.

 

Since 2006, the homebuilding industry as a whole has experienced a significant and sustained decrease in demand for new homes, an oversupply of new and existing homes available for sale and a more restrictive mortgage lending environment. Although we operate in a number of markets, approximately 53% of our operations are concentrated in Florida and the West, based on 2007 deliveries, which suffered a particularly severe downturn in home buying activity. The rapid increase in new and existing home prices in these markets over the past several years reduced housing affordability and tempered buyer demand. In particular, investors and speculators reduced their purchasing activity and instead stepped up their efforts to sell the residential property they had earlier acquired. These trends, which were more pronounced in markets that had experienced the greatest levels of price appreciation, resulted in overall fewer home sales, greater cancellations of home purchase agreements by buyers, higher inventories of unsold homes and the increased use by homebuilders, speculators, investors and others of discounts, incentives, price concessions, broker commissions and advertising to close home sales compared to the past several years.

 

Reflecting these trends, we, like many other homebuilders, experienced the impact of severe liquidity challenges in the credit and mortgage markets, diminished consumer confidence, increased home inventories and foreclosures and downward pressure on home prices. Potential buyers have exhibited both a reduction in confidence as to the economy in general and a willingness to delay purchase decisions based on a perception that prices will continue to decline. Prospective homebuyers continue to be concerned about interest rates and the inability to sell their current homes or to obtain appraisals at sufficient amounts to secure mortgage financing as a result of the recent disruption in the mortgage markets and the tightening of credit standards. The homebuilding market may not improve in the near future, and is forecast to weaken further. Continued weakness in the homebuilding market would have an adverse effect on our business and our results of operations as compared to those of earlier periods.

 

Our strategies in responding to the adverse conditions in the homebuilding industry have had limited success and the continued implementation of these and other strategies may not be successful.

 

In 2007 we have experienced significantly reduced gross profit levels and have incurred significant asset impairment charges. These contributed to the net loss we recognized in 2007. Also, in 2007, notwithstanding our sales strategies, we continued to experience an elevated rate of sales contract cancellations. We believe that the elevated cancellation rate largely reflects a decrease in homebuyer confidence, with continued price declines and increases in the level of sales incentives for both new and existing homes prompting homebuyers to forgo or delay home purchases. A more restrictive mortgage lending environment and the inability of some

buyers to sell their existing homes have also led to cancellations. Many of the factors that affect new orders and cancellation rates are beyond our control. These factors include the level of employment, consumer confidence, consumer income, the availability of financing and interest rate levels. Continued reduced sales levels and the increased level of cancellations would continue to have an adverse effect on our business and our results of operations as compared to those of earlier periods.

 

Continued high cancellation rates may negatively impact our business.

 

Our backlog reflects the number and value of sold but undelivered homes. Generally we have the right to compel the customer to complete the purchase, however our only effective remedy may be the retention of the deposit. In some cases a customer may cancel the contract and receive a complete or partial refund of the deposit. If the current industry downturn continues, or if mortgage financing becomes less available, more homebuyers may cancel their contracts with us. Significant cancellations have had, and could have in the future, a material adverse effect on our business and results of operations. Contracts with a third-party that marketed homes in the United Kingdom included in backlog at December 31, 2007 were cancelled in 2008. These contracts were for 511 homes, representing $115.6 million in revenue.

 

Our revenues and profitability may be adversely affected by natural disasters or weather conditions.

 

Homebuilders are particularly subject to natural disasters and severe weather conditions as they can delay our ability to timely complete or deliver homes, damage partially complete or other unsold homes that are in our inventory, negatively impact the demand for homes, and/or negatively affect the price and availability of qualified labor and materials. Our operations are located in many areas that are especially subject to natural disasters; for example, we have significant operations in Florida and Texas which is especially at risk of hurricanes. To the extent that hurricanes, severe storms, floods, tornadoes or other natural disasters or similar weather events occur, our business may be adversely affected. To the extent our insurance is not adequate to cover business interruption or losses resulting from these events, our revenues and profitability may be adversely affected.

 

We are subject to substantial risks with respect to the land and home inventories we maintain, and fluctuations in market conditions may affect our ability to sell our land and home inventories at expected prices, if at all, which would reduce our profit margins.

 

As a homebuilder, we must constantly locate and acquire new tracts of land for development and developed homesites to support our homebuilding operations. There is a lag between the time we acquire land for development or developed homesites and the time that we can bring the communities to market and sell homes. Lag time varies on a project-by-project basis; however, historically, we have experienced a lag time of up to three years. As a result, we face the risk that demand for housing may decline or costs of labor or materials may increase during this period and that we will not be able to dispose of developed properties or undeveloped land or homesites acquired for development at expected prices or profit margins or within anticipated time frames or at all. The market value of home inventories, undeveloped land and developed homesites can fluctuate significantly because of changing market conditions. In addition, inventory carrying costs (including interest on funds used to acquire land or build homes) can be significant and can adversely affect our performance. The downturn in the housing market has caused the fair market value of certain of our inventory to fall, in some cases well below the purchase price. As a result, we were required to take substantial write-downs of the carrying value of our land inventory and we elected not to exercise options, even though that required us to forfeit deposits, write-off pre-acquisition land development costs and incur additional liabilities related to these contracts. Additionally, as a result of these market conditions, we recorded significant valuation adjustments relating to our investments in unconsolidated entities. If the current downturn in the housing market continues, we may need to take additional charges against our earnings for abandonments or inventory impairments, or both. Although impairments are non-cash charges, abandonments give the owner of the land the right to draw on letters of credit or cash deposits that may have an adverse impact on our liquidity. Additionally, any non-cash charges would have an adverse effect on our financial condition and results of operations.

Reduced home sales may impair our ability to recoup development costs or force us to absorb additional costs.

 

We incur many costs even before we begin to build homes in a community. Depending on the stage of development, these include costs of developing land and installing roads, sewage and other utilities, as well as taxes and other costs related to ownership of the land on which we plan to build homes. Reducing the rate at which we build homes extends the length of time it takes us to recover these costs. Also, we frequently acquire options to purchase land and make deposits that will be forfeited if we do not exercise the options within specified periods. Because of current market conditions, we have had to terminate some of these options, resulting in the forfeiture of deposits and unrecoverable development costs. Any such charges would have an adverse effect on our financial condition and results of operations, including our liquidity as a result of a lower borrowing base which reduces availability under our cash collateral order.

 

Market conditions in the mortgage lending and mortgage finance industries deteriorated significantly in 2007, adversely impacting us by increasing the supply of inventory housing, negatively impacting pricing conditions, as well as decreasing the demand for our homes, which adversely affected our revenues and profitability. Recent changes in mortgage lending requirements or further reduced mortgage liquidity could adversely affect the availability of credit for some purchasers of our homes and thereby reduce our sales.

 

Approximately 90% of our customers finance their purchases through mortgage financing obtained from us or other sources. Increases in interest rates or decreases in the availability of mortgage funds provided or sponsored by Fannie Mae, Freddie Mac, the Federal Housing Administration, or the Veteran’s Administration could cause a decline in the market for new homes as potential homebuyers may not be able to obtain affordable financing. In particular, because the availability of mortgage financing is an important factor in marketing many of our homes, any limitations or restrictions on the availability of those types of financing could reduce our home sales and the lending volume at our mortgage subsidiary.

 

In 2007, approximately 3% to 5% of the homebuyers that utilized our mortgage subsidiary obtained sub-prime loans. We define a sub-prime loan as one where the buyer’s FICO score is below 620 and is not an FHA or VA loan. At December 31, 2007, approximately 4% to 6% of our backlog that utilized our mortgage subsidiary included homebuyers seeking sub-prime financing. During 2007, the mortgage lending and mortgage finance industries experienced significant instability due to, among other things, defaults on subprime loans and a resulting decline in the market value of such loans. In light of these developments, lenders, investors, regulators and other third parties questioned the adequacy of lending standards and other credit requirements for several loan programs made available to borrowers in recent years. This has led to reduced investor demand for mortgage loans and mortgage-backed securities, tightened credit requirements, reduced liquidity, increased credit risk premiums and regulatory actions. Deterioration in credit quality among subprime and other nonconforming loans has caused most lenders to eliminate subprime mortgages and most other loan products that do not conform to Fannie Mae, Freddie Mac, the Federal Housing Administration, or the Veteran’s Administration standards. In general, these developments have resulted in a reduction in demand for the homes we sell and have delayed any general improvement in the housing market. Furthermore, they have resulted in a reduction in demand for the mortgage loans that we originate.

 

The Housing and Economic Recovery Act of 2008 was enacted into law on July 30, 2008. One provision of the Act eliminates down payment assistance programs for FHA loans approved after September 30, 2008. Down payment assistance programs were utilized for approximately 15% of our closings over the past year, but for over 50% of our Trophy Homes division closings.

 

We are dependent on the continued availability and satisfactory performance of our subcontractors, which, if unavailable, could have a material adverse effect on our business.

 

Subcontractors perform substantially all of our construction work. As a consequence, we depend on the continued availability of and satisfactory performance by these subcontractors for the construction of our

homes. There may not be sufficient availability of and satisfactory performance by these unaffiliated third-party subcontractors, which could have a material adverse effect on our business.

 

Supply risks and shortages relating to labor and materials can harm our business by delaying construction and increasing costs.

 

The homebuilding industry from time to time has experienced significant difficulties with respect to:

 

 

These difficulties can, and often do, cause unexpected short-term increases in construction costs and cause construction delays. In addition, to the extent our subcontractors incur increased costs associated with increases in insurance premiums and compliance with state and local regulations, these costs are passed on to us as homebuilders. We are generally unable to pass on any unexpected increases in construction costs to those customers who have already entered into sales contracts, as those contracts generally fix the price of the house at the time the contract is signed, which may be up to two years in advance of the delivery of the home. We have historically been able to offset sustained increases in the costs of materials with increases in the prices of our homes and through operating efficiencies. However, in the future, pricing competition, oversupply of new and existing homes and tightening mortgage qualifications, among other factors may restrict our ability to pass on any additional costs, and negatively impact our profit margins.

 

The competitive conditions in the homebuilding industry could increase our costs, reduce our revenues and otherwise adversely affect our results of operations.

 

The homebuilding industry is highly competitive and fragmented. We compete in each of our markets with numerous national, regional and local builders. Some of these builders have greater financial resources, more experience, more established market positions and better opportunities for land and homesite acquisitions than we do and have lower costs of capital, labor and material than us. Builders of new homes compete for homebuyers, as well as for desirable properties, raw materials and skilled subcontractors. The competitive conditions in the homebuilding industry could, among other things:

 

 

We also compete with resales of existing homes, available rental housing and, to a lesser extent, condominium resales. An oversupply of attractively priced resale or rental homes in the markets in which we operate could adversely affect our absorption rates and profitability. Foreclosures in the various markets as well as within our own communities creating enormous downward pressure on prices and consumer confidence.

 

Our financial services operations are also subject to competition from third party providers, many of which are substantially larger, may have a lower cost structure and may focus exclusively on providing such services.

Future limitations on our ability to obtain bonds may adversely affect our homebuilding operations.

 

We are required under certain contracts to provide performance bonds. The market for performance bonds was severely impacted by certain corporate failures in recent years and continues to be impacted by general economic conditions. Consequently, less overall bonding capacity is available in the market than in the past, and surety bonds have become more expensive and restrictive. Additionally, in certain cases where we have stopped activities in a community, we may have failed to complete the infrastructure for which the performance bond was posted. In such cases, sureties for our performance bonds are required to fulfill our obligations and in the future, may be unwilling to issue performance bonds or may require additional collateral to issue or renew performance bonds. An inability to obtain new or renew existing performance bonds in a timely manner, on acceptable terms, or at all could result in limitations on our ability to enter into new contracts or fulfill existing contracts which could have a material adverse effect on our financial condition and results of operations.

 

We are subject to product liability and warranty claims arising in the ordinary course of business that could adversely affect our results of operations.

 

As a homebuilder, we are subject in the ordinary course of our business to liability and home warranty claims. We provide our homebuyers with a limited warranty that provides a one-year or two-year limited warranty covering workmanship and materials and a five to ten-year limited warranty covering major structural defects. Claims arising under these warranties and general liability claims are common in the homebuilding industry and can be costly. Although we maintain liability insurance, the coverage offered by, and availability of, liability insurance for construction defects is currently limited and, where coverage is available, it may be costly. We currently have liability insurance coverage which covers repair costs associated with warranty claims for structure and design defects related to homes sold by us during the policy period, subject to a significant self-insured retention per occurrence. However, our insurance coverage may contain limitations with respect to coverage; this insurance coverage may not be adequate to cover all liability and warranty claims for which we may be liable. In addition, coverage may be further restricted and become more costly. Although we generally seek to require our subcontractors and design professionals to indemnify us for liabilities arising from their work, we may be unable to enforce any such contractual indemnities. Uninsured and unindemnified liability and warranty claims, as well as the cost of insurance coverage, could adversely affect our results of operations.

 

Our business is subject to governmental regulations that may delay, increase the cost of, prohibit or severely restrict our development and homebuilding projects.

 

We are subject to extensive and complex laws and regulations that affect the land development and homebuilding process, including laws and regulations related to zoning, permitted land uses, levels of density, building design, elevation of properties, water and waste disposal, and use of open spaces. In addition, we and our subcontractors are subject to laws and regulations relating to workers health and safety. We also are subject to a variety of local, state and federal laws and regulations concerning the protection of health and the environment. In some of the markets in which we operate, we are required to pay environmental impact fees, use energy saving construction materials and give commitments to provide certain infrastructure such as roads and sewage systems. We must also obtain permits and approvals from local authorities to complete residential development or home construction. The laws and regulations under which we and our subcontractors operate, and our and their obligations to comply with them, may result in delays in construction and development, cause us to incur substantial compliance and other increased costs, and prohibit or severely restrict development and homebuilding activity in certain areas in which we operate.

 

Several states, cities and counties in which we operate have approved, and others in which we operate may approve, various “slow growth” or “no growth” initiatives and other ballot measures that could negatively impact the availability of land and building opportunities within those localities. Approval of slow or no growth measures would reduce our ability to build and sell homes in the affected markets and create additional costs and administration requirements, which in turn could have an adverse effect on our future revenues.

Our financial services operations are subject to numerous federal, state and local laws and regulations. Failure to comply with these requirements can lead to administrative enforcement actions, the suspension or loss of required licenses, and claims for monetary damages.

 

Our title insurance agency subsidiaries must comply with applicable insurance laws and regulations. Our mortgage financing subsidiary must comply with applicable real estate lending laws and regulations. In addition, to make it possible for purchasers of some of our homes to obtain FHA-insured or VA-guaranteed mortgages, we must construct those homes in compliance with regulations promulgated by those agencies.

 

The mortgage financing and title insurance subsidiaries are licensed in the states in which they do business and must comply with laws and regulations in those states regarding mortgage financing, homeowners’ insurance and title insurance agencies. These laws and regulations include provisions regarding capitalization, operating procedures, investments, forms of policies and premiums.

 

Forward-Looking Statements

 

This Annual Report on Form 10-K contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including in the material set forth in the sections entitled “Business” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” These statements concern expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts, and typically include the words “anticipate”, “believe”, “expect”, “estimate”, “project” and “future.” Specifically, this annual report contains forward-looking statements including with respect to:

 

 

We do not undertake any obligation to update any forward-looking statements.

 

These forward-looking statements reflect our current views about future events and are subject to risks, uncertainties and assumptions. As a result, actual results may differ significantly from those expressed in any forward-looking statement. The most important factors that could prevent us from achieving our goals, and cause the assumptions underlying forward-looking statements and the actual results to differ materially from

those expressed in or implied by those forward-looking statements include, but are not limited to, the following:

 

 

 

 

By letter dated May 19, 2006, the SEC provided us with comments relating to various registration statements filed by us in April 2006 and the Annual Report on Form 10-K for the year ended December 31, 2005 filed by us on March 10, 2006. We responded to the letter on July 21, 2006 and filed amendments to the registration statements. Through a series of letters with the SEC, responses were provided to additional comments on the filings noted above, the Quarterly Report on Form 10-Q for the quarter ended July 30, 2006 and the Annual Report on Form 10-K for the year ended December 31, 2006. We have not yet responded to comments from the SEC in a letter dated May 11, 2007. These comments relate principally to disclosures related to the operating results of the Transeastern JV. We believe that the disclosures were appropriate.

 

In the Matter of TOUSA, Inc. SEC Inquiry, File No. FL-3310. In June 2007, the Company was contacted by the Miami Regional Office of the SEC requesting the voluntary provision of documents, and other information from the Company, relating primarily to corporate and financial information and communications for the Transeastern JV to determine if there have been any violations of federal securities laws. The SEC has advised the Company that this inquiry should not be construed as an indication that any violations of law have occurred, nor should it be considered a reflection upon any person, entity, or security. The Company is cooperating with the inquiry.

 

 

We lease our executive offices located at 4000 Hollywood Blvd., Suite 500 N, Hollywood, Florida 33021. We lease substantially all of the office space required for our homebuilding and financial services operations and our corporate offices. We believe that our existing facilities exceed our current and planned levels of operations. We have cancelled a number of leases and are reviewing others with a view towards rejecting them as part of our bankruptcy proceedings. We do not believe that any single leased property is material to our current or planned operations.

 

 

Chapter 11

 

Chapter 11 Cases

 

On January 29, 2008, TOUSA, Inc. and certain of our subsidiaries (excluding our financial services subsidiaries and joint ventures) filed voluntary petitions for reorganization relief under the provisions of Chapter 11 of Title 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Southern District of Florida, Fort Lauderdale Division. The Chapter 11 cases have been consolidated solely on an administrative basis and are pending as Case No. 08-10928-JKO.

 

We continue to operate our businesses and manage our properties as debtors and debtors-in-possession under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court. As part of the “first day” relief, we sought from the Bankruptcy Court in the Chapter 11 cases, we obtained Bankruptcy Court approval to, among other things, continue to pay certain critical vendors and vendors with lien rights, meet our pre-petition payroll obligations, maintain our cash management systems, sell homes free and clear of liens, pay our taxes, continue to provide employee benefits and maintain our insurance programs. In addition, the Bankruptcy Court has approved certain trading notification and transfer procedures designed to allow us to restrict trading in our common stock (and related securities) and has also provided for potentially retroactive application of notice and sell-down procedures for trading in claims against the debtors’ estates (in the event that such procedures are approved in the future) which could negatively impact our accumulated net operating losses and other tax

attributes. The Bankruptcy Court has also entered orders to establish procedures for the purchase and disposition of real property by us subject to certain monetary limits without specific approval for each transaction.

 

On February 5, 2008, pursuant to an interim order from the Bankruptcy Court dated January 31, 2008, TOUSA, Inc. entered into the Senior Secured Super-Priority Debtor in Possession Credit and Security Agreement. The agreement provided for a first priority and priming secured revolving credit interim commitment of up to $134.6 million. The agreement was subsequently amended to extend it to June 19, 2008. No funds were drawn under the DIP Credit Agreement. The agreement was subsequently terminated and we entered into an agreement with our secured lenders to use cash collateral on hand (cash generated by our operations, including the sale of excess inventory and the proceeds of our federal tax refund of $207.3 million received in April 2008). Under the Bankruptcy Court order dated June 20, 2008, we are authorized to use cash collateral of our first lien and second lien lenders (approximately $358.0 million at the time of the order) for a period of six months in a manner consistent with a budget negotiated by the parties. The order further provides for the paydown of $175.0 million to our first lien term loan facility secured lenders, subject to disgorgement provisions in the event that certain claims against the lenders are successful and repayment is required. The order also reserves our sole right to paydown an additional $15.0 million to our fist lien term loan facility secured lenders. We are permitted under the order to incur liens and enter into sale/leaseback transactions for model homes subject to certain limitations. As part of the order, we have granted the prepetition agents and the lenders various forms of protection, including liens and claims to protect against any diminution of the collateral value, payment of accrued, but unpaid interest on the first priority indebtedness at the non-default rate and the payment of reasonable fees and expenses of the agents under our secured facilities.

 

We have the exclusive right to file a Chapter 11 plan or plans prior to October 25, 2008 and the exclusive right to solicit acceptance thereof until December 24, 2008. Pursuant to section 1121 of the Bankruptcy Code, the exclusivity periods may be expanded or reduced by the Bankruptcy Court, but in no event can the exclusivity periods to file and solicit acceptance of a plan or plans of reorganization be extended beyond 18 months and 20 months, respectively.

 

As a result of our Chapter 11 cases and other matters described herein, including uncertainties related to the fact that we have not yet had time to complete and obtain confirmation of a plan or plans of reorganization, there is substantial doubt about our ability to continue as a going concern. Our ability to continue as a going concern, including our ability to meet our ongoing operational obligations, is dependent upon, among other things:

 

 

These challenges are in addition to those operational and competitive challenges that we face in connection with our business. In conjunction with our advisors, we are implementing strategies to aid our liquidity and our ability to continue as a going concern. However, such efforts may not be successful.

 

We have taken and will continue to take aggressive actions to maximize cash receipts and minimize cash expenditures with the understanding that certain of these actions may make us less able to take advantage of future improvements in the homebuilding market. We continue to take steps to reduce our general and administrative expenses by streamlining activities and increasing efficiencies, which have led and will continue to lead to major reductions in the workforce. However, much of our efforts to reduce general and administrative expenses are being offset by professional and consulting fees associated with our Chapter 11 cases. In addition, we are working with our existing suppliers and seeking new suppliers, through competitive bid processes, to reduce construction material and labor costs. We have and will continue to analyze each

community based on anticipated sales absorption rates, net cash flows and financial returns taking into consideration current market factors in the homebuilding industry such as the oversupply of homes available for sale in most of our markets, less demand, decreased consumer confidence, tighter mortgage loan underwriting criteria and higher foreclosures. In order to generate cash and to reduce our inventory to levels consistent with our business plan, we have taken and will continue to take the following actions, to the extent possible given the limitations resulting from our Chapter 11 cases:

 

 

The foregoing discussion provides general background information regarding our Chapter 11 Cases, and is not intended to be an exhaustive description. Additional information regarding our Chapter 11 Cases, including access to court documents and other general information about the Chapter 11 Cases, is available at www.kccllc.net/tousa. Financial information on the website is prepared according to requirements of federal bankruptcy law and the local Bankruptcy Court. While such financial information accurately reflects information required under federal bankruptcy law, such information may be unconsolidated, unaudited and prepared in a format different than that used in our consolidated financial statements prepared in accordance with generally accepted accounting principles in the United States and filed under the securities laws. Moreover, the materials filed with the Bankruptcy Court are not prepared for the purpose of providing a basis for investment decisions relating to our stock or debt or for comparison with other financial information filed with the Securities and Exchange Commission.

 

These challenges are in addition to those operational and competitive challenges that we face in connection with our business. In conjunction with our advisors, we are implementing strategies to aid our liquidity and our ability to continue as a going concern. However, such efforts may not be successful.

 

Class Action Lawsuit

 

TOUSA, Inc. is a defendant in a class action lawsuit pending in the United States District Court for the Southern District of Florida. The name and case number of the class action suit is Durgin, et al., v. TOUSA, Inc., et al., No. 06-61844-CIV.

 

Beginning in December 2006, various stockholder plaintiffs brought lawsuits seeking class action status in the U.S. District Court for the Southern District of Florida. At a hearing held March 29, 2007, the Court consolidated the actions and heard arguments on the appointment of lead plaintiff and counsel. On September 7, 2007, the Court appointed Diamondback Capital Management, LLC as the lead plaintiff and approved Diamondback’s selection of counsel. Pursuant to a scheduling order, the lead plaintiff filed a Consolidated Complaint on November 2, 2007.

 

The Consolidated Complaint names TOUSA, all of TOUSA’s directors, David Keller, Randy Kotler, Beatriz Koltis, Lonnie Fedrick, Technical Olympic, S.A., UBS Securities LLC, Citigroup Global Markets Inc., Deutsche Bank Securities Inc. and JMP Securities LLC as defendants. The alleged class period is August 1, 2005 to March 19, 2007. The Consolidated Complaint alleges that TOUSA’s public filings and other public statements that described the financing for the Transeastern Joint Venture as non-recourse to TOUSA were false and misleading. The Consolidated Complaint also alleges that certain public filings and statements were

misleading or suffered from material omissions in failing to fully disclose or describe the Completion and Carve-Out Guaranties that TOUSA executed in support of the Transeastern Joint Venture financing. The Consolidated Complaint asserts claims under Section 11 of the Securities Act against all defendants other than Ms. Koltis for strict liability and negligence regarding the registration statements and prospectus associated with the September 2005 offering of 4 million shares of stock. Plaintiffs contend that the registration statements and prospectus contained material misrepresentations and suffered from material omissions in the description of the Transeastern Joint Venture financing and TOUSA’s related obligations. The Consolidated Complaint asserts related claims against Technical Olympic, S.A. and Messrs. Konstantinos Stengos, Antonio B. Mon, David Keller and Tommy L. McAden as controlling persons responsible for the statements in the registration statements and prospectus. The Consolidated Complaint also alleges claims under Section 10(b) of the Exchange Act for fraud with respect to various public statements about the non-recourse nature of the Transeastern debt and alleged omissions in disclosing or describing the Guaranties. These claims are alleged against TOUSA, Messrs. Mon, McAden, Keller and Kotler and Ms. Koltis. Finally, the Consolidated Complaint asserts related claims against Messrs. Mon, Keller, Kotler and McAden as controlling persons responsible for the various alleged false disclosures. Plaintiffs seek compensatory damages, plus fees and costs, on behalf of themselves and the putative class of purchasers of TOUSA common stock and purchasers and sellers of options on TOUSA common stock.

 

On January 30, 2008, TOUSA filed a Motion to Dismiss Plaintiffs’ Consolidated Complaint. TOUSA moved to dismiss plaintiffs’ claims on the grounds that plaintiffs: a) could not establish materially false or misleading statements or omissions; b) could not establish loss causation; c) failed to plead with particularity facts giving rise to a strong inference of scienter; and d) lacked standing to pursue a Section 11 claim. Many of the other defendants also filed motions to dismiss and/or signed on to TOUSA’s Motion to Dismiss.

 

On February 4, 2008, TOUSA filed a Notice of Suggestion of Bankruptcy notifying the Court that TOUSA filed for bankruptcy on January 29, 2008. On February 5, 2008 the Court entered an order staying the action as to TOUSA pursuant to Section 362 of the United States Bankruptcy Code. The action continues with respect to defendants other than TOUSA.

 

On April 30, 2008, lead plaintiff Diamondback Capital Management moved to withdraw as lead plaintiff. On May 22, 2008, the Court entered an order: granting Diamondback Capital Management’s motion to withdraw as lead plaintiff; establishing a procedure pursuant to which a new lead plaintiff would be appointed; extending the time for plaintiffs to respond to the motions to dismiss until a new lead plaintiff is selected; and acknowledging that the Court may need to set a time for the filing of an amended complaint, if requested by the new lead plaintiff.

 

On June 6, 2008, two prospective lead plaintiffs filed motions to be appointed the new lead plaintiff. On July 15, 2008, the Court entered an Order appointing the Bricklayers & Trowel Trades International Pension Fund as the new lead plaintiff. The Court further ordered that, within 15 days of the entry of the Order, the new plaintiff must either respond to the previously filed Motions to Dismiss, or file a notice of intent to file an amended complaint. On July 30, 2008, the new plaintiff filed a notice of intent to file an amended complaint. On July 31, 2008, following the notice of intent to file an amended complaint, the Court denied as moot, without prejudice, the defendants’ previously filed motion to dismiss the consolidated complaint. Under the current schedule set by the Court, the plaintiff must file its amended complaint by August 29, 2008.

 

Proceeding by Official Committee of Unsecured Creditors

 

In re TOUSA, Inc., Docket No. 08-10928-JKO; Adv. Pro No. 08-1435-JKO. TOUSA and certain of our subsidiaries are non-parties in an adversary proceeding brought as part of our Chapter 11 proceedings. This adversary proceeding was brought by the Official Committee of Unsecured Creditors of TOUSA, Inc. on behalf of our bankruptcy estates. The adversary proceeding seeks to avoid certain allegedly fraudulent and preferential pre-petition transfers of up to $800.0 million made in connection with the settlement of litigation related to the Transeastern Joint Venture (the “Transeastern Settlement”), and further seeks to avoid as a preferential transfer any security interest that may have been granted to certain lenders in a tax refund of approximately $210.0 million that the Debtors received in June 2008. The Committee’s complaint names over

60 defendants including the lenders under the credit agreements funding the Transeastern Joint Venture as well as the original lenders (and their successors and assigns) and administrators under the credit agreements entered into as a result of the Transeastern Settlement. We are not defendants in the adversary proceeding.

 

The complaint alleges that, in order to resolve certain prepetition litigation regarding the Transeastern Joint Venture, the parties to that litigation entered into a series of settlement agreements releasing all claims relating to the Transeastern acquisition. The complaint alleges that, as part of these settlement agreements, certain TOUSA entities agreed to pay over $420.0 million to the administrator of the Transeastern loans and to issue approximately $135.0 million in notes and warrants. The complaint further alleges that to fund these payments, TOUSA, TOUSA Homes, LP and certain of their subsidiaries (the “Conveying Subsidiaries”) entered into the three new credit agreements. According to the complaint, the loans issued under these new credit agreements were secured by liens on the property and assets of all of the debtors, including the Conveying Subsidiaries. The complaint alleges that the Conveying Subsidiaries were not defendants in the prepetition Transeastern litigation and were not obligated on the Transeastern debt that was released in connection with the Transeastern Settlement. Therefore, the complaint alleges, the Conveying Subsidiaries did not receive reasonably equivalent value for the secured debt obligations that they incurred. The complaint also alleges that the Conveying Subsidiaries were either insolvent at the time of the Transeastern Settlement or became insolvent as a result of it, and that the Conveying Subsidiaries were left with unreasonably small capital as a result of the new credit agreements. Based on these allegations, the Committee seeks to have the liens established under the new credit agreements voided and all amounts already repaid under the new credit agreements returned. The Committee also seeks to have the security interest granted on the Debtors’ tax refund voided and the new lenders’ claims seeking allowance of the full amount of the new loans disallowed in their entirety or reduced.

 

Proofs of Claims

 

The Bankruptcy Court established May 19, 2008 as the bar date for filing proofs of claim against the Debtors relating to obligations arising before January 29, 2008. To date, approximately 4,130 claims have been filed against us totaling approximately $7.0 billion in asserted liabilities. These claims are comprised of approximately $1.0 million in administrative claims, $182.0 million in secured claims, $73.0 million in priority claims and $6.7 billion in unsecured claims. There are many claims (at least 1,418) that have been asserted in “unliquidated” amounts or that contain an unliquidated component. Notably, among the unliquidated claims are the claims of our secured first and second lien lenders. In addition, the indenture trustees under the approximately $1.1 billion of our unsecured debentures each filed an unliquidated claim with respect to such obligations.

 

Vista Lakes

 

Plaintiffs, purchasers of homes in the Vista Lakes community near Orlando, filed a class action complaint alleging that their homes were built on the site of a former bombing range. The plaintiffs seek recovery under theories of fraud, breach of contract, strict liability, negligence, and civil conspiracy. Because the plaintiffs named debtor defendants Tousa, Inc., Tousa Homes, Inc., d/b/a Engle Homes Orlando and Tousa Homes, LP as defendants in this action, the action was removed to federal court. The plaintiffs then agreed to dismiss the debtor defendants and the parties entered into a stipulation for remand. The state court case has been re-opened and the parties still remaining as defendants include Tousa Financial Services (which has not been served) and Universal Land Title, Inc.

 

Plaintiffs have granted an extension on the response to the complaint and the discovery requests up to and including August 18, 2008 in order to re-evaluate their claims against the defendants and amend their complaint.

 

Other Litigation

 

We are also involved in various other claims and legal actions arising in the ordinary course of business. We do not believe that the ultimate resolution of these other matters will have a material adverse effect on our

financial condition or results of operations. As of the date of the Chapter 11 filing, then pending litigation was generally stayed, and absent further order of the Bankruptcy Court, most parties may not take any action to recover on prepetition claims against us.

 

 

None.

 

 

Our common stock traded on the New York Stock Exchange (“NYSE”) under the symbol “TOA” until November 19, 2007 when the NYSE Regulation, Inc. suspended our common stock and debt securities from trading on the NYSE. We appealed the suspension. Following our suspension from the NYSE, we began trading on the Pink Sheet Electronic Quotation Service under the symbol “TOUS”. On February 15, 2008, the NYSE denied our appeal and affirmed the decision to suspend trading in our common stock and debt securities on the NYSE and commenced delisting procedures. On March 3, 2008, the NYSE filed Forms 25, Notification of Removal of Listing and/or Registration under Section 12(b) of the Securities Exchange Act of 1934, with the SEC of its intention to remove our common stock, 9% Senior Notes due July 1, 2010, 9% Senior Notes due July 1, 2010, 71/2% Senior Subordinated Notes due March 15, 2011, 71/2% Senior Subordinated Notes due January 15, 2015 and the 103/8% Senior Subordinated Notes due July 1, 2012 at the opening of business May 13, 2008.

 

The table below sets forth the high and low sales price for our common stock as reported by the Pink Sheet Electronic Quotation Service or the New York Stock Exchange as applicable for the periods indicated.

 

 

 

As of August 6, 2008, there were 34 record holders of our common stock. The closing sale price of our common stock on August 6, 2008 was $0.09 per share.

 

During the year ended December 31, 2007, we did not declare any common stock dividends. During the year ended December 31, 2006, we declared a cash dividend of $0.015 per share of common stock in each of February 2006, May 2006, August 2006 and November 2006. Our cash collateral order prohibits the payment of dividends and issuance of common stock.

 

On May 19, 2006, our stockholders approved an amendment to our Annual and Long Term Incentive Plan increasing the maximum number of shares that may be granted from 7,500,000 to 8,250,000.

PERFORMANCE GRAPH

 

The following graph and table compare the cumulative total stockholder return on our common stock from December 31, 2002 through December 31, 2007 with the performance of: (i) the Standard & Poor’s 500 Stock Index and (ii) the Standard & Poor’s 600 Homebuilding Index. The comparisons reflected in the graph and table below are not intended to forecast the future performance of our stock and may not be indicative of future performance. The graph and table assume investments of $100 in our stock and each index on December 31, 2002.

 

Comparison of Cumulative Five Year Total Return

 

 

 

The following Selected Financial Data should be read in conjunction with the consolidated financial statements and notes thereto in Item 8 of this report and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of this report.

 

 

 

 

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this report.

 

As used in this Form 10-K, “consolidated” information refers only to information relating to our continuing operations which are consolidated in our financial statements and exclude the results of our Dallas/Fort Worth division which we have classified as a discontinued operation; and “combined” information includes consolidated information and information relating to our unconsolidated joint ventures. Unless otherwise noted, the information contained herein is shown on a consolidated basis. Our consolidated financial statements are presented on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business.

 

On July 31, 2007, we consummated transactions to settle the disputes regarding the Transeastern JV with the lenders to the Transeastern JV, its land bankers and our joint venture partner in the Transeastern JV. Pursuant to the settlement, among other things, the Transeastern JV became a wholly-owned subsidiary of ours by merger into one of our subsidiaries. The acquisition of the Transeastern JV (the “TE Acquisition”) was accounted for using the purchase method of accounting. The results of operations of the Transeastern JV have been included in our consolidated results beginning on July 31, 2007. Results of operations prior to July 31, 2007 are included in the results for the unconsolidated joint ventures.

 

Executive Summary

 

We generate revenues from our homebuilding operations (“Homebuilding”) and financial services operations (“Financial Services”), which comprise our two principal business segments. Through our Homebuilding operations we design, build and market high-quality detached single-family residences, town homes and condominiums in various metropolitan markets in nine states located in four major geographic regions, which are also our reportable segments: Florida, the Mid-Atlantic, Texas and the West.

 

 

We conduct our Homebuilding operations through our consolidated subsidiaries and through various unconsolidated joint ventures that additionally build and market homes.

 

Since 2006, the homebuilding industry as a whole has experienced a significant and sustained decrease in demand for new homes, an oversupply of new and existing homes available for sale and a more restrictive mortgage lending environment. Although we operate in a number of markets, approximately 53% of our operations are concentrated in Florida and the West, based on 2007 deliveries, which suffered particularly severe downturns in home buying activity. The rapid increase in new and existing home prices in these markets over the past several years reduced housing affordability and tempered buyer demand. In particular, investors and speculators reduced their purchasing activity and instead stepped up their efforts to sell the residential property they had earlier acquired. These trends, which were more pronounced in markets that had experienced the greatest levels of price appreciation, resulted in overall fewer home sales, greater cancellations of home purchase agreements by buyers, higher inventories of unsold homes and the increased use by homebuilders, speculators, investors and others of discounts, incentives, price concessions, broker commissions and advertising to close home sales compared to the past several years.

 

Reflecting these trends, we, like many other homebuilders, experienced severe liquidity challenges in the credit and mortgage markets, diminished consumer confidence, increased home inventories and foreclosures and downward pressure on home prices. Potential buyers have exhibited both a reduction in confidence as to the economy in general and a willingness to delay purchase decisions based on a perception that prices will

continue to decline. Prospective homebuyers continue to be concerned about interest rates and the inability to sell their current homes or to obtain appraisals at sufficient amounts to secure mortgage financing as a result of the recent disruption in the mortgage markets and the tightening of credit standards.

 

As a result of deteriorating market conditions and liquidity constraints, we did not exercise certain homesite option contracts and reviewed our inventories, goodwill, investments in joint ventures and other assets for possible impairment charges. As a result, we recognized charges totaling $1.3 billion for the year ended December 31, 2007 related to inventory impairments, abandonment costs, joint venture impairments, goodwill impairments and the settlement of a loss contingency compared to $586.7 million for the year ended December 31, 2006.

 

For the year ended December 31, 2007, we had a loss from continuing operations, net of taxes, of $1.3 billion compared to $200.8 million for the year ended December 31, 2006. Home deliveries from continuing operations decreased 9%, Homebuilding revenues decreased 12%, and net sales orders from continuing operations decreased 21% for the year ended December 31, 2007 as compared to the year ended December 31, 2006. During the year ended December 31, 2007, our unconsolidated joint ventures had a decrease in deliveries of 58% and an increase in net sales orders of 79% as compared to the year ended December 31, 2006. The increase in net sales orders was due to high cancellation rates experienced during the third quarter of last year by the Transeastern JV. Sales orders at our other joint ventures declined 15%, as compared to prior year, due to worsening market conditions, decreased demand and higher cancellation rates in the current year.

 

Recent Developments

 

Chapter 11 Cases

 

On January 29, 2008, TOUSA, Inc. and certain of our subsidiaries (excluding our financial services subsidiaries and joint ventures) filed voluntary petitions for reorganization relief under the provisions of Chapter 11 of Title 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Southern District of Florida, Fort Lauderdale Division. The Chapter 11 cases have been consolidated solely on an administrative basis and are pending as Case No. 08-10928-JKO.

 

We continue to operate our businesses and manage our properties as debtors and debtors-in-possession under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court. As part of the “first day” relief, we sought from the Bankruptcy Court in the Chapter 11 cases, we obtained Bankruptcy Court approval to, among other things, continue to pay certain critical vendors and vendors with lien rights, meet our pre-petition payroll obligations, maintain our cash management systems, sell homes free and clear of liens, pay our taxes, continue to provide employee benefits and maintain our insurance programs. In addition, the Bankruptcy Court has approved certain trading notification and transfer procedures designed to allow us to restrict trading in our common stock (and related securities) and has also provided for potentially retroactive application of notice and sell-down procedures for trading in claims against the debtors’ estates (in the event that such procedures are approved in the future) which could negatively impact our accumulated net operating losses and other tax attributes. The Bankruptcy Court has also entered orders to establish procedures for the purchase and disposition of real property by us subject to certain monetary limits without specific approval for each transaction.

 

On February 5, 2008, pursuant to an interim order from the Bankruptcy Court dated January 31, 2008, we entered into the Senior Secured Super-Priority Debtor in Possession Credit and Security Agreement. The agreement provided for a first priority and priming secured revolving credit interim commitment of up to $134.6 million. The agreement was subsequently amended to extend it to June 19, 2008. No funds were drawn under the agreement. The agreement was subsequently terminated and we entered into an agreement with our secured lenders to use cash collateral on hand (cash generated by our operations, including the sale of excess inventory and the proceeds of our federal tax refund of $207.3 million received in April 2008). Under the Bankruptcy Court order dated June 20, 2008, we are authorized to use cash collateral of our first lien and second lien lenders (approximately $358.0 million at the time of the order) for a period of six months in a

manner consistent with a budget negotiated by the parties. The order further provides for the paydown of $175.0 million to our first lien term loan facility secured lenders, subject to disgorgement provisions in the event that certain claims against the lenders are successful and repayment is required. The order also reserves our sole right to paydown an additional $15.0 million to our fist lien term loan facility secured lenders. We are permitted under the order to incur liens and enter into sale/leaseback transactions for model homes subject to certain limitations. As part of the order, we have granted the prepetition agents and the lenders various forms of protection, including liens and claims to protect against any diminution of the collateral value, payment of accrued, but unpaid interest on the first priority indebtedness at the non-default rate and the payment of reasonable fees and expenses of the agents under our secured facilities.

 

We have the exclusive right to file a Chapter 11 plan or plans prior to October 25, 2008 and the exclusive right to solicit acceptance thereof until December 24, 2008. Pursuant to section 1121 of the Bankruptcy Code, the exclusivity periods may be expanded or reduced by the Bankruptcy Court, but in no event can the exclusivity periods to file and solicit acceptance of a plan or plans of reorganization be extended beyond 18 months and 20 months, respectively.

 

As a result of our Chapter 11 cases and other matters described herein, including uncertainties related to the fact that we have not yet had time to complete and obtain confirmation of a plan or plans of reorganization, there is substantial doubt about our ability to continue as a going concern. Our ability to continue as a going concern, including our ability to meet our ongoing operational obligations, is dependent upon, among other things:

 

 

These challenges are in addition to those operational and competitive challenges that we face in connection with our business. In conjunction with our advisors, we are implementing strategies to aid our liquidity and our ability to continue as a going concern. However, such efforts may not be successful.

 

We have taken and will continue to take aggressive actions to maximize cash receipts and minimize cash expenditures with the understanding that certain of these actions may make us less able to take advantage of future improvements in the homebuilding market. We continue to take steps to reduce our general and administrative expenses by streamlining activities and increasing efficiencies, which have led and will continue to lead to major reductions in the workforce. However, much of our efforts to reduce general and administrative expenses are being offset by professional and consulting fees associated with our Chapter 11 cases. In addition, we are working with our existing suppliers and seeking new suppliers, through competitive bid processes, to reduce construction material and labor costs. We have and will continue to analyze each community based on anticipated sales absorption rates, net cash flows and financial returns taking into consideration current market factors in the homebuilding industry such as the oversupply of homes available for sale in most of our markets, less demand, decreased consumer confidence, tighter mortgage loan underwriting criteria and higher foreclosures. In order to generate cash and to reduce our inventory to levels consistent with our business plan, we have taken and will continue to take the following actions, to the extent possible given the limitations resulting from our Chapter 11 cases:

 

 

 

The foregoing discussion provides general background information regarding our Chapter 11 Cases, and is not intended to be an exhaustive description. Additional information regarding our Chapter 11 Cases, including access to court documents and other general information about the Chapter 11 Cases, is available at www.kccllc.net/tousa. Financial information on the website is prepared according to requirements of federal bankruptcy law and the local Bankruptcy Court. While such financial information accurately reflects information required under federal bankruptcy law, such information may be unconsolidated, unaudited and prepared in a format different than that used in our consolidated financial statements prepared in accordance with generally accepted accounting principles in the United States and filed under the securities laws. Moreover, the materials filed with the Bankruptcy Court are not prepared for the purpose of providing a basis for investment decisions relating to our stock or debt or for comparison with other financial information filed with the Securities and Exchange Commission.

 

Mortgage Joint Venture

 

On January 28, 2008, Preferred Home Mortgage Company, our wholly-owned residential mortgage lending subsidiary, entered into an Amended and Restated Agreement of Limited Liability Company with Wells Fargo Ventures, LLC. The limited liability company is known as PHMCWF, LLC but does business as “Preferred Home Mortgage Company, an affiliate of Wells Fargo.” Preferred Home Mortgage Company owns 49.9% of the venture with the balance owned by Wells Fargo. Effective April 1, 2008, the venture began to carry on the mortgage business of Preferred Home Mortgage Company. The venture is managed by a committee composed of six members, three from Preferred Home Mortgage Company and three from Wells Fargo. The venture entered into a revolving credit agreement with Wells Fargo Bank, N.A. providing for advances of up to $20.0 million. Wells Fargo Home Mortgage provides the general and administrative support (as well as all loan related processing, underwriting, closing functions), and is the end investor for the majority of the loans closed through the joint venture. Prior to the joint venture, Preferred Home Mortgage Company had a centralized operations center that provided those support functions. The majority of these support functions ceased in June 2008.

 

Transeastern JV Settlement

 

On July 31, 2007, we consummated transactions to settle the disputes regarding the Transeastern JV with the lenders to the Transeastern JV, its land bankers and our joint venture partner in the Transeastern JV. Pursuant to the settlement, among other things,

 

 

 

To effect the settlement of the Transeastern JV dispute, on July 31, 2007, we also entered into:

 

 

The proceeds from the first lien and second lien term loans were used to satisfy claims of the senior secured lenders against the Transeastern JV, and to pay related expenses. Our existing $800.0 million revolving loan facility was amended and restated to reduce the revolving commitments thereunder by $100.0 million and permit the incurrence of the first and second lien term loan facilities (and make other conforming changes relating to the facilities). Net proceeds from these financings at closing were $470.6 million which is net of a 1% discount and transaction costs.

 

In connection with the Transeastern JV settlement, we recognized a loss of $426.6 million, of which $151.6 million was recognized during the year ended December 31, 2007, and $275.0 million was recognized during the year ended December 31, 2006.

 

We also paid:

 

 

NYSE Delisting

 

Effective November 19, 2007, NYSE Regulation, Inc. suspended our common stock and debt securities from trading on the NYSE. We appealed the suspension. Following our suspension from the NYSE, we began trading on the Pink Sheet Electronic Quotation Service. On February 15, 2008, the NYSE denied our appeal and affirmed the decision to suspend trading in our common stock and debt securities on the NYSE and commenced delisting procedures. On March 3, 2008, the NYSE filed Forms 25, Notification of Removal of Listing and/or Registration under Section 12(b) of the Securities Exchange Act of 1934, with the SEC of its intention to remove our common stock, 9% Senior Notes due July 1, 2010, 9% Senior Notes due July 1, 2010, 71/2% Senior Subordinated Notes due March 15, 2011, 71/2% Senior Subordinated Notes due January 15, 2015 and the 103/8% Senior Subordinated Notes due July 1, 2012 at the opening of business May 13, 2008.

 

Sale of Dallas/Fort Worth Operations

 

On June 6, 2007, we sold substantially all of our Dallas/Fort Worth division to an unrelated third party for $56.5 million and realized a pre-tax loss on disposal of $13.6 million. Results of our Dallas/Fort Worth operations have been classified as discontinued operations and prior periods have been restated.

Bulk Sale of Homesites in the Mid-Atlantic (excluding Nashville) and Virginia Divisions

 

As part of our asset management initiatives, on September 25, 2007, we sold 317 homesites to an unrelated homebuilder. Additionally, as part of the transaction, in the fourth quarter of 2007, the unrelated homebuilder purchased an option interest to acquire 250 homesites as well as 34 owned homesites. The total purchase price for these transactions was $31.3 million and we realized a pre-tax loss of $12.5 million. In July 2008, we received a letter of intent from a party interested in purchasing our remaining assets in our Pennsylvania, Maryland, Delaware and Virginia divisions. The letter of intent is subject to a number of conditions.

 

SEC Inquiry

 

In the Matter of TOUSA, Inc. SEC Inquiry, File No. FL-3310. In June of 2007, we were contacted by the Miami Regional Office of the SEC requesting the voluntary provision of documents, and other information from the Company, relating primarily to corporate and financial information and communications related to the Transeastern Joint Venture. The SEC has advised us that this inquiry should not be construed as an indication that any violations of law have occurred, nor should it be considered a reflection upon any person, entity, or security. We are cooperating with the inquiry.

 

Total Controlled Homesites by our Homebuilding Operations (Including Joint Ventures)

 

The following is a summary of our controlled homesites:

 

 

 

 

The following is a summary breakdown of our owned homesites:

 

 

 

 

We use option contracts in addition to land joint ventures in order to acquire land whenever feasible. Option contracts allow us to control large homesite positions with reduced capital investment.

 

From time to time we acquired and developed larger land parcels that we believed could yield homesites exceeding the requirements of our homebuilding activities over the next 3 to 5 years. These additional homesites are typically sold to other homebuilders. At December 31, 2007, of the 21,400 owned homesites from our continuing operations, 6,300 homesites are part of this strategy. At December 31, 2007, of the 10,800 homesites controlled through option contracts from our continuing operations, 4,700 homesites are also part of this strategy. At December 31, 2007, deposits related to these controlling homesites under option approximated $14.9 million. We plan to continue reducing our positions in these large land transactions in connection with our asset management activities.

 

Controlled homesites represent homesites either owned or under option by our consolidated subsidiaries or by our unconsolidated joint ventures that build and market homes. We do not include as controlled homesites those homesites which are included in land development joint ventures where we do not intend to build homes. These joint ventures will acquire and develop land to be sold to us for use in our homebuilding operations or sold to others. As of December 31, 2007 and 2006, these joint ventures owned 3,000 and 3,100 homesites, respectively. We had options to acquire 500 homesites, which are included in our consolidated homesites under option at December 31, 2006. We did not have any remaining options to acquire homesites from these joint ventures at December 31, 2007. Any profits generated from the purchase of homesites from these joint ventures are deferred until the ultimate sale to an unrelated third party. The number of homesites controlled by our unconsolidated joint ventures, decreased by 17,100 homesites, or 83%, from December 31, 2006, primarily due to the settlement and purchase of the Transeastern JV. See additional discussion regarding our joint ventures located in “Liquidity and Capital Resources” section.

 

Due to worsening market conditions impacting the new home industry, we have applied increasingly conservative standards to our land retention and option exercise decisions. We have analyzed each of our communities to determine if they are aligned with our immediate and mid term goals which are focused on our ability to monetize assets within a relatively short period of time. As part of the analysis we have reviewed our construction processes including our bid procedures, bid templates and engineering designs in an attempt

to reduce costs from home construction. Preacquisition costs, development costs and the number of home starts and speculative homes have also been reduced in light of the new challenges facing the market.

 

At December 31, 2007, the number of homesites controlled by our consolidated continuing operations has decreased by 28,400, or 47%, as compared to December 31, 2006. The decrease in controlled homesites is a result of our asset management initiatives including the sale of our Dallas/Fort Worth division, the bulk sale of homesites in our Mid-Atlantic (excluding Nashville) and Virginia divisions, other land sales and the abandonment of rights under certain option contracts. In connection with our asset management efforts, as well as in part to our liquidity constraints, during the year ended December 31, 2007, we did not exercise certain option contracts which resulted in a reduction of 21,100 optioned homesites. In addition, the sale of our Dallas/Fort Worth division and the bulk sale of homesites in our Mid-Atlantic (excluding Nashville) and Virginia divisions reduced the number of controlled homesites by approximately 3,700 homesites. This decrease, however, was partially offset by an increase in the number of homesites acquired as part of the TE Acquisition as reflected in the table above. In connection with the abandonment of our rights under these option contracts, we forfeited cash deposits of $82.5 million and had letters of credit of $98.5 million drawn at December 31, 2007, which increased our outstanding borrowings. Through June 30, 2008 an additional $72.8 million of letters of credit have been drawn related to the abandonment of option contracts.

 

Homebuilding Operations

 

For the year ended December 31, 2007 total consolidated home deliveries from continuing operations decreased 9%, consolidated Homebuilding revenues decreased 12%, and consolidated net sales orders from continuing operations decreased 21% as compared to the year ended December 31, 2006. We had a net loss from continuing operations of $1.3 billion for the year ended December 31, 2007 as compared to a net loss from continuing operations of $200.8 million for the year ended December 31, 2006. For the year ended December 31, 2007, our unconsolidated joint ventures had an increase in net sales orders of 79% and a decrease in deliveries of 58% as compared to the year ended December 31, 2006.

 

Compared to December 31, 2006, consolidated sales value in backlog from continuing operations at December 31, 2007 decreased 47% to $736.3 million. Contracts with a third-party that marketed homes in the United Kingdom included in backlog at December 31, 2007 were cancelled in 2008. These contracts were for 511 homes, representing $115.6 million in revenue. Our unconsolidated joint ventures had an additional $24.7 million in sales value in backlog at December 31, 2007. Our sales orders cancellation rate was approximately 38% for the year ended December 31, 2007 as compared to 32% for the year ended December 31, 2006. Cancellation rates continue to be affected by worsening market conditions.

 

We build homes for inventory (speculative homes) and on a pre-sold basis. At December 31, 2007, we had 2,900 homes completed or under construction compared to 3,800 homes at December 31, 2006. Approximately 42% of these homes were unsold at December 31, 2007, an increase from 35% at December 31, 2006. At December 31, 2007, we had 532 completed unsold homes in our inventory, up 91% from 279 homes at December 31, 2006. Approximately 70% of our completed, unsold homes at December 31, 2007 had been completed for more than 90 days. As part of our asset management strategy, we are focusing our efforts on diligently managing the number and geographic allocation of our speculative homes, addressing our inventory levels and timing our construction starts, together with other actions, to strengthen our balance sheet.

 

Once a sales contract with a buyer has been approved, we classify the transaction as a “new sales order” and include the home in “backlog.” Such sales orders are usually subject to certain contingencies such as the buyer’s ability to qualify for financing and ability to sell their existing home. At closing, title passes to the buyer and a home is considered to be “delivered” and is removed from backlog. Revenues, which are net of buyer incentives and cost of sales, are recognized upon the delivery of the home, land or homesite when title is transferred to the buyer. We estimate that the average period between the execution of a sales contract for a home and closing is approximately four months to over a year for pre-sold homes; however, this varies by market. The principal expenses of our Homebuilding operations are cost of sales and selling, general and administrative (“SG&A”) expenses. Costs of home sales include land and land development costs, home construction costs, previously capitalized indirect costs, capitalized interest and estimated warranty costs.

SG&A expenses for our Homebuilding operations include administrative costs, advertising expenses, on-site marketing expenses, sales commission costs and closing costs. Sales commissions are included in selling, general and administrative costs when the related revenue is recognized. As used herein, “Homebuilding” includes results of home and land sales. “Home sales” includes results related only to the sale of homes.

 

Financial Services Operations

 

To provide homebuyers with a seamless home purchasing experience, we have a financial services business which provides mortgage financing and settlement services and offers title, homeowners’ and other insurance products to our homebuyers and others. Our mortgage financing operation derives most of its revenues from buyers of our homes, although it also offers its services to existing homeowners refinancing their mortgages. Our title and settlement services and our insurance agency operations are used by our homebuyers and a broad range of other clients purchasing or refinancing residential or commercial real estate. Our mortgage financing operations’ revenues consist primarily of origination and premium fee income, interest income and the gain on the sale of mortgages which is recognized when the loans and related servicing rights are sold to third party investors. Our title operations’ revenues consist primarily of fees and premiums from title insurance and settlement services. The principal expenses of our Financial Services operations are SG&A expenses, which consist primarily of compensation and interest expense on our warehouse lines of credit.

 

During the year ended December 31, 2007, approximately 3% to 5% of the homebuyers, including those in our unconsolidated joint ventures, that utilized our mortgage subsidiary obtained sub-prime loans. We define a sub-prime loan as one where the buyer’s FICO score is below 620 and is not an FHA or VA loan. At December 31, 2007, approximately 4% to 6% of our backlog that utilized our mortgage subsidiary included homebuyers seeking sub-prime financing. During the year ended December 31, 2007, the mortgage markets experienced a significant disruption, which commenced with increasing rates of default on “sub-prime” loans and declines in the market value of those loans. These events led to an unprecedented combination of reduced investor demand for mortgage loans and mortgage-backed securities, tighter credit underwriting standards, reduced mortgage loan liquidity and increased credit risk premiums, all of which affected the availability of nonconforming mortgage products. The tightening of credit standards in the sub-prime market had an impact on the Alt-A and prime loans and further negatively impacted current homebuilding market conditions.

 

On January 28, 2008, Preferred Home Mortgage Company, our wholly-owned residential mortgage lending subsidiary, entered into an Amended and Restated Agreement of Limited Liability Company with Wells Fargo Ventures, LLC. The limited liability company is known as PHMCWF, LLC but does business as “Preferred Home Mortgage Company, an affiliate of Wells Fargo.” Preferred Home Mortgage Company owns 49.9% of the venture with the balance owned by Wells Fargo. Effective April 1, 2008, the venture began to carry on the mortgage business of Preferred Home Mortgage Company. The venture is managed by a committee composed of six members, three from Preferred Home Mortgage Company and three from Wells Fargo. The venture entered into a revolving credit agreement with Wells Fargo Bank, N.A. providing for advances of up to $20.0 million. Wells Fargo Home Mortgage provides the general and administrative support (as well as all loan related processing, underwriting, closing functions), and is the end investor for the majority of the loans closed through the joint venture. Prior to the joint venture, Preferred Home Mortgage Company had a centralized operations center that provided those support functions. The majority of these support functions ceased in June 2008.

 

Critical Accounting Policies

 

In the preparation of our consolidated financial statements, we apply accounting principles generally accepted in the United States. The application of generally accepted accounting principles may require management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying results. Listed below are those policies that we believe are critical or require the use of complex judgment in their application.

Homebuilding Revenues and Cost of Sales

 

Revenue from the sale of homes and the sale of land and homesites is recognized at closing when title passes to the buyer and all of the following conditions are met: (1) a sale is consummated; (2) a significant down payment is received; (3) the earnings process is complete; and (4) the collection of any remaining receivables is reasonably assured. As a result, our revenue recognition process does not involve significant judgments or estimates. However, we do rely on certain estimates to determine the related construction and land costs and resulting gross profit associated with revenues recognized. Our construction and land costs are comprised of direct and allocated costs, including interest, indirect construction costs and estimated costs for future warranties and indemnities. Our estimates are based on historical results, adjusted for current factors. Land, land improvements and other common costs are generally allocated on a relative fair value basis to units within a parcel or community. Land and land development costs generally include related interest and property taxes incurred until construction is substantially completed. We believe that the accounting policy related to revenue recognition is a critical accounting policy because of the significance of revenue.

 

Financial Services Revenues and Expenses

 

Our Financial Services operations generate revenues from mortgage financing, title insurance and settlement services and property and casualty insurance agency operations. Our mortgage financing operations’ revenues consist primarily of origination and premium fee income, interest income and the gain on the sale of the mortgages. Revenue from our mortgage financing operations is recognized when the mortgage loans and related servicing rights are sold to third-party investors. Substantially all of our mortgages are sold to private investors within 30 days of closing. Title operations revenues consist primarily of title insurance policy commissions and settlement services fees, which are recognized at the time of settlement. Our property and casualty insurance revenues are recognized when commissions are received from third-party insurers. As a result, our revenue recognition process does not involve significant judgments or estimates. We believe that the accounting policy related to revenue recognition is a critical accounting policy because of the significance of revenue.

 

Impairment of Long-Lived Assets

 

Housing communities and land/homesites under development are stated at the lower of cost or net realizable value. Property and equipment is carried at cost less accumulated depreciation. We assess these assets for impairment in accordance with the provisions of SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets is measured by comparing the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. We believe that the accounting for impairment of long-lived assets is a critical accounting policy because of the assumptions inherent in the evaluations and the impact of recognizing impairments would be material to our consolidated financial statements. These evaluations for impairment are significantly impacted by estimates of future revenues, costs and expenses and other factors involving some amount of uncertainty. Therefore, due to uncertainties in the estimation process, actual results could differ from such estimates. If an asset is considered to be impaired, the impairment loss to be recognized is measured by the amount by which the carrying amount of the asset exceeds the fair value of the asset. During the year ended December 31, 2007, we recorded impairment losses of $180.8 million on active communities, including $3.9 million of inventory impairments recognized on assets consolidated under SFAS 66 for which we do not have title to the underlying asset.

 

Investments in Unconsolidated Joint Ventures

 

We evaluate our investments in and receivables from our unconsolidated joint ventures in accordance with the provisions of Accounting Principles Board Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock, Statement of Position 78-9, Accounting for Investments in Real Estate Ventures, and Statement of Financial Accounting Standards No. 114, Accounting by Creditors for Impairment of a Loan. Recoverability of our investments in and receivables from unconsolidated joint ventures are measured by

comparing the carrying amount of the assets to future undiscounted net cash flows expected to be generated by the assets. We believe that the accounting for the impairments of our investments in and receivables from our unconsolidated joint ventures is a critical accounting policy because of the assumptions inherent in the evaluations and the impact of recognizing these impairments would be material to our consolidated financial statements. These evaluations for impairment are significantly impacted by estimates of future revenues, costs and expenses and other factors involving some amount of uncertainty. Therefore, due to uncertainties in the estimation process, actual results could differ from such estimates.

 

In some instances, we are liable under the joint venture credit agreements, we have agreed to: complete certain property development commitments in the event the joint ventures default; pay an amount necessary to decrease the principal balance of the joint ventures’ loans to achieve a certain loan to value ratio; and, to indemnify the lenders for losses resulting from fraud, misappropriation and similar acts. We evaluate our obligations related to these commitments under Statement of Financial Accounting Standards No. 5, Accounting for Contingencies. Because of the high degree of judgment required in determining these estimated obligations, actual amounts could differ from our current estimates.

 

Goodwill

 

Goodwill is accounted for in accordance with the provisions of SFAS No. 142, Goodwill and Other Intangible Assets. Pursuant to SFAS No. 142, goodwill is not subject to amortization. Goodwill is subject to at least an annual assessment for impairment by applying a fair-value based test. For purposes of the impairment test, we consider each division a reporting unit. Our impairment test is based on discounted cash flows derived from internal projections. This process requires us to make assumptions on future revenues, costs and timing of expected cash flows. Due to the degree of judgment required and uncertainties surrounding such estimates, actual results could differ from such estimates. To the extent additional information arises or our strategies change, it is possible that our conclusion regarding goodwill impairment could change, which could have a material effect on our financial position and results of operations. For these reasons, we consider the accounting estimate related to goodwill impairment to be a critical accounting estimate. We performed impairment tests during the year ended December 31, 2007 and determined that the goodwill recorded in each of our Homebuilding regions was impaired; accordingly, we wrote off $89.7 million of goodwill. Additionally, during the year ended December 31, 2007, we wrote off $3.9 million of Finance Services goodwill and $3.1 million of goodwill related to Dallas/Fort Worth, which has been accounted for as a discontinued operation.

 

Homesite Option Contracts and Consolidation of Variable Interest Entities

 

We enter into option contracts to purchase homesites and land held for development in the ordinary course of business. Option contracts allow us to control significant homesite positions with minimal capital investment. Our liability for nonperformance under such contracts is generally limited to forfeiture of the related deposits. However, in some cases we are obligated to complete construction of certain improvements notwithstanding the cancellation of the option. Although we are typically compensated for this work, in certain cases we are responsible for any cost overruns. At December 31, 2007, we had option contracts from continuing operations on 10,800 homesites. At December 31, 2007 and December 31, 2006, we had non-refundable deposits aggregating $56.9 million and $216.6 million, respectively, included in inventory. In addition, at December 31, 2007 and December 31, 2006, we had issued $44.9 million and $257.8 million, respectively, in letters of credit under option contracts.

 

We enter into option contracts with land sellers and third-party financial entities as a method of acquiring developed homesites. From time to time to leverage our ability to acquire and finance the development of these homesites, we transfer our option right to third parties. Option contracts generally require the payment of a non-refundable cash deposit or the issuance of a letter of credit for the right to acquire homesites over a specified period of time at predetermined prices. Typically, our deposits or letters of credit are less than 20% of the underlying purchase price. We generally have the right at our discretion to terminate our obligations under these option agreements by forfeiting our cash deposit or repaying amounts drawn under the letter of credit with no further financial responsibility. In some cases, these contracts give the other party the right to

require us to purchase homesites or guarantee minimum returns. (see Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Financial Condition, Liquidity and Capital Resources — Off-Balance Sheet Arrangements”). We do not have legal title to these assets. Additionally, we do not have an investment in the third-party acquirer and do not guarantee their liabilities. However, if certain conditions are met, including the deposit and/or letters of credit exceeding certain significance levels as compared to the remaining homesites under the option contract, we will include the homesites in inventory with a corresponding liability in obligations for inventory not owned.

 

Homebuilders may enter into option contracts for the purchase of land or homesites with land sellers and third-party financial entities, some of which qualify as Variable Interest Entities (“VIEs”) under Financial Accounting Standards Board (“FASB”) Interpretation No. 46 (Revised), Consolidation of Variable Interest Entities (“FIN 46(R)” ). FIN 46(R) addresses consolidation by business enterprises of VIEs in which an entity absorbs a majority of the expected losses, receives a majority of the entity’s expected residual returns, or both, as a result of ownership, contractual or other financial interests in the entity, which have one or both of the following characteristics: (1) the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated support from other parties, which is provided through other interests that will absorb some or all of the expected losses of the entity; or (2) the equity investors lack one or more of the following essential characteristics of a controlling financial interest: (a) the direct or indirect ability to make decisions about the entity’s activities through voting rights or similar rights; or (b) the obligation to absorb the expected losses of the entity if they occur, which makes it possible for the entity to finance its activities; or (c) the right to receive the expected residual returns of the entity if they occur, which is the compensation for the risk of absorbing the expected losses.

 

In applying FIN 46(R) to our homesite option contracts and other transactions with VIEs, we make estimates regarding cash flows and other assumptions. We believe that our critical assumptions underlying these estimates are reasonable based on historical evidence and industry practice. Based on our analysis of transactions entered into with VIEs, we determined that we are the primary beneficiary of certain of these homesite option contracts. Consequently, FIN 46(R) requires us to consolidate the assets (homesites) at their fair value, although (1) we have no legal title to the assets, (2) our maximum exposure to loss is generally limited to the deposits or letters of credits placed with these entities, and (3) creditors, if any, of these entities have no recourse against us. We classify these assets as “inventory not owned” with a corresponding liability in “obligations for inventory not owned” in the accompanying consolidated statement of financial condition. Additionally, we have entered into arrangements with VIEs to acquire homesites in which our variable interest is insignificant and, therefore, we have determined that we are not the primary beneficiary and are not required to consolidate the assets of such VIEs.

 

In addition to land options recorded pursuant to FIN 46(R), we evaluate land options in accordance with the provisions of SFAS No. 49, Product Financing Arrangements. When our deposits and pre-acquisition development costs exceed certain thresholds, or we have determined that we are compelled to exercise our option, we record the remaining purchase price of the land in the consolidated statements of financial condition under “obligations for inventory not owned”.

 

Stock-Based Compensation

 

Effective January 1, 2006, we adopted SFAS No. 123(R), Share-Based Payment, (“SFAS 123R”) using the modified prospective method. SFAS No. 123R generally requires entities to recognize the cost of employee services in exchange for awards of equity instruments based on the grant-date fair value of those awards. That cost, based on the estimated number of awards that are expected to vest, will be recognized over the period during which the employee is required to provide the service in exchange for the award. No compensation cost is recognized for awards for which employees do not render the requisite service. The grant-date fair value of employee share options and similar instruments was estimated using the Black-Scholes valuation model.

 

The Black-Scholes valuation model requires the input of subjective assumptions, including the expected life of the stock-based award and stock price volatility. The assumptions used are management’s best estimates,

but the estimates involve inherent uncertainties and the application of management judgment. As a result, if other assumptions had been used, the recorded and pro forma stock-based compensation expense could have been materially different from that depicted in the consolidated financial statements.

 

Warranty Reserves

 

In the normal course of business we will incur warranty related costs associated with homes that have been delivered to the homebuyers. Warranty reserves are established by charging cost of sales and recognizing a liability for the estimated warranty costs for each home that is delivered. We monitor this reserve on a regular basis by evaluating the historical warranty experience in each market in which we operate and the reserve is adjusted as appropriate for current quantitative and qualitative factors. Actual future warranty costs could differ from our currently estimated amounts.

 

Insurance and Litigation Reserves

 

Insurance and litigation reserves have been established for estimated amounts based on an analysis of historical claims. We have, and require the majority of our subcontractors to have, general liability insurance that protects us against a portion of our risk of loss from construction-related claims. We reserve for costs to cover our self-insured retentions and deductible amounts under these policies and for any costs in excess of our coverage limits. Because of the high degree of judgment required in determining these estimated reserve amounts, actual future claim costs could differ from our currently estimated amounts.

 

Income Taxes

 

We calculate a provision for income taxes using the asset and liability method, under which deferred tax assets and liabilities are recognized by identifying the temporary differences arising from the different treatment of items for tax and accounting purposes. We assess the realization of our deferred tax assets to determine whether an income tax valuation allowance is required. Based on all available evidence, both positive and negative, and the weight of that evidence to the extent such evidence can be objectively verified, we determine whether it is more likely than not that all or a portion of the deferred tax assets will be realized. In determining the future tax consequences of events that have been recognized in our consolidated financial statements or tax returns, judgment is required. Differences between the anticipated and actual outcomes of these future tax consequences could have a material impact on our consolidated results of operations or financial position.

 

In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an interpretation of SFAS 109, (“FIN 48”). FIN 48 clarifies the accounting for income taxes, by prescribing a minimum recognition threshold a tax position is required to meet before it is recognized in the consolidated financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. We adopted FIN 48 effective January 1, 2007, and recognized a $1.3 million increase in the liability for unrecognized tax benefits, which was accounted for as a reduction to the retained earnings balance at January 1, 2007. In accordance with the transition requirements of FIN 48, results of prior periods have not been restated.

 

Results of Operations — Consolidated

 

Fiscal Year 2007 compared to Fiscal Year 2006

 

Total revenues decreased 12% to $2.2 billion for the year ended December 31, 2007, from $2.5 billion for the year ended December 31, 2006. This decrease is primarily attributable to a decrease in Homebuilding revenues of 12%.

 

For the year ended December 31, 2007, we had a loss from continuing operations before benefit for income taxes of $1.4 billion as compared to a loss from continuing operations before benefit for income taxes of $243.6 million for the year ended December 31, 2006. Results for 2007 and 2006 include charges totaling

$1.3 billion and $586.7 million, respectively, related to inventory impairments, abandonment costs, joint venture impairments, goodwill impairments and the provision for settlement of loss contingency.

 

Our effective tax rate was 2.5% and 17.6% for the years ended December 31, 2007 and 2006, respectively. The 2007 effective tax rate was primarily impacted by a valuation allowance on our deferred tax asset. The 2006 effective tax rate was primarily impacted by a valuation allowance on certain deferred tax assets and the non-deductible state portion of the impairment of our investment in unconsolidated joint ventures, and the provision of the settlement of a loss contingency in connection with the Transeastern JV.

 

For the year ended December 31, 2007, we had a loss from continuing operations, net of taxes, of $1.3 billion (or a loss of $22.22 per diluted share) compared to a loss from continuing operations, net of taxes, of $200.8 million (or a loss of $3.37 per diluted share) for the year ended December 31, 2006. For the year ended December 31, 2007, we had a net loss of $1.3 billion (or a loss of $22.60 per diluted share) compared to a net loss of $201.2 million (or a loss of $3.38 per diluted share) for the year ended December 31, 2006.

 

Homebuilding

 

Homebuilding revenues decreased 12% to $2.2 billion for the year ended December 31, 2007, from $2.4 billion for the year ended December 31, 2006. This decrease is primarily due to a decrease in revenue from home sales to $2.0 billion for the year ended December 31, 2007 from $2.3 billion for the year ended December 31, 2006. The decrease in revenue from home sales, which is net of buyer incentives, was due to a 9% decrease in the number of deliveries from continuing operations to 6,580 for the year ended December 31, 2007 from 7,260 for the year ended December 31, 2006. The average price of homes delivered from continuing operations fell slightly, decreasing to $311,000 for the year ended December 31, 2007, from $318,000 for the year ended December 31, 2006. We expect our home sales revenues to continue to decrease in 2008 as the number of home deliveries declines and the average price of homes delivered continues to be impacted by increased incentives as a result of severe market conditions in the new and existing home industry combined with diminished consumer confidence, the oversupply of new and existing homes available for sale, increased foreclosures and downward pressure on home prices.

 

For the year ended December 31, 2007, we had a homebuilding gross loss of $507.4 million as compared to a gross profit of $417.9 million for the year ended December 31, 2006. This decrease is primarily due to an increase in inventory impairments and abandonment costs during the year ended December 31, 2007 in addition to the decrease in the number of deliveries coupled with higher incentives on homes delivered in response to challenging homebuilding market conditions. Inventory impairments and abandonment costs were $852.7 million for the year ended December 31, 2007 compared to $153.2 million for the year ended December 31, 2006. For the year ended December 31, 2007, our incentives from continuing operations increased to $43,900 per home delivered from $21,200 per home delivered for the year ended December 31, 2006. We expect gross margins to continue to decline in 2008 due to our expected continued use of higher incentives to drive our sales rates and downward pressure on home prices in response to challenging market conditions.

 

SG&A expenses increased to $362.7 million for the year ended December 31, 2007, from $358.3 million for the year ended December 31, 2006. This increase in expenses is due to: (i) an increase of $22.6 million in professional and consultant fees related to the Transeastern JV settlement and professional services obtained in connection with the development of a long term business plan and the evaluation of our restructuring options; and (ii) an increase of $9.3 million in selling and marketing expenses. The increase in SG&A expenses was partially offset by a reduction in overhead and related expenses.

 

SG&A expenses as a percentage of revenues from home sales for the year ended December 31, 2007 increased to 18%, as compared to 16% for the year ended December 31, 2006. The increase in SG&A expenses as a percentage of home sales revenues is due to the factors discussed above. We expect our selling expenses as a percentage of our revenue from home sales to continue to increase in 2008 due to the competition for homebuyers.

For the year ended December 31, 2007, we had a loss from unconsolidated joint ventures of $14.9 million compared to income from unconsolidated joint ventures of $104.7 million for the year ended December 31, 2006. The decrease in our earnings from unconsolidated joint ventures is primarily due to: (i) reduced earnings in the joint ventures as our joint ventures are experiencing similar severe market conditions as our consolidated operations and (ii) a reduction in the number of joint ventures. In addition, during the year ended December 31, 2007 and 2006, we recorded impairment losses of $194.1 million and $152.8 million, respectively, related to unconsolidated joint ventures. For the year ended December 31, 2007, our unconsolidated joint ventures delivered 1,666 homes as compared to 3,951 homes delivered during the comparable period in the prior year.

 

Net Sales Orders and Homes in Backlog (Consolidated)

 

For the year ended December 31, 2007, net sales orders from continuing operations decreased by 21% to 4,836 as compared to 6,085 for the year ended December 31, 2006. The decrease in net sales orders is due to decreased demand for new homes and higher cancellation rates. We expect these factors to continue to negatively impact our net sales orders until the markets normalize.

 

Our cancellation rate increased to 38% for the year ended December 31, 2007 from 32% for the year ended December 31, 2006. Except for our West region, all of our regions experienced increases in cancellation rates for the year ended December 31, 2007 when compared with the same period in 2006. Our Florida region had the largest increase in cancellation rate to 47% for the year ended December 31, 2007 from 33% for the year ended December 31, 2006. Our Texas region also experienced a large increase in cancellation rate to 35% for the year ended December 31, 2007 from 28% for the year ended December 31, 2006. The cancellation rate for our Mid-Atlantic region was 33% for the year ended December 31, 2007, which represents an 8% increase over the comparative period in the prior year. The cancellation rate for our West region was 36% for the year ended December 31, 2007, which represents an 8% decrease over the comparative period in the prior year.

 

We had 2,379 homes in backlog from continuing operations as of December 31, 2007, as compared to 3,869 homes in backlog as of December 31, 2006. The 39% decrease in backlog units is primarily due to a decline in sales orders and an increase in cancellation rates as a result of decreased demand. The sales value of backlog from continuing operations decreased 47% to $736.3 million at December 31, 2007, from $1.4 billion at December 31, 2006, due to the decrease in the number of homes in backlog in addition to a decrease in the average selling price of homes in backlog to $310,000 from $361,000 from period to period. The decrease in the average selling price of homes in backlog was primarily due to increased incentives and a change in product mix. Contracts with a third-party that marketed homes in the United Kingdom included in backlog at December 31, 2007 were cancelled in 2008. These contracts were for 511 homes, representing $115.6 million in revenue. At June 30, 2008, our consolidated continuing operations had 1,580 homes in backlog representing $479.3 million in revenue. We expect the average selling price of homes in backlog to decrease in the future as cancellations remain higher than historical levels and higher incentives are offered to move home inventory.

 

Net Sales Orders and Homes in Backlog (Unconsolidated Joint Ventures)

 

For the year ended December 31, 2007, net sales orders increased by 79% as compared to the year ended December 31, 2006. The increase in net sales orders was due to high cancellation rates experienced during the third quarter of last year by the Transeastern JV. Sales orders at our other joint ventures declined 15% due to worsening market conditions, decreased demand and higher cancellation rates in the current year. We expect these factors to continue to negatively impact our combined net sales orders until the markets strengthen. The decrease in net sales orders at our joint ventures other than the Transeastern JV was also due to a decline in the number of active communities. We intend to limit the use of joint ventures that build and sell homes.

 

We had 94 homes in backlog as of December 31, 2007, as compared to 1,199 homes in backlog as of December 31, 2006. The 92% decrease in backlog is primarily due to a decline in net sales orders due to the factors described above. Additionally, the results of operations of the Transeastern JV, which were previously included in the results for the unconsolidated joint ventures, have been included in our consolidated results beginning on July 31, 2007.

Joint venture revenues are not included in our consolidated financial statements. At December 31, 2007, the sales value of our joint ventures’ homes in backlog was $24.7 million compared to $365.6 million at December 31, 2006. This decrease is due to the decrease in the number of homes in backlog and the decrease in the average selling price of homes in backlog to $263,000 from $305,000 from year to year.

 

In some cases our Chapter 11 filings have constituted an event of default under the joint venture lender agreements which have resulted in the joint venture’s debt becoming immediately due and payable, limiting the joint ventures’ access to future capital. See additional discussion regarding our joint ventures located in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Financial Condition, Liquidity and Capital Resources.”

 

Financial Services

 

Financial Services revenues decreased to $36.5 million for the year ended December 31, 2007, from $63.3 million for the year ended December 31, 2006. This 42% decrease is due primarily to a decrease in the number of closings at our title operations. For the year ended December 31, 2007, our mix of mortgage originations was 6% adjustable rate mortgages (of which approximately 91% were interest only) and 94% fixed rate mortgages, which is a shift from 19% adjustable rate mortgages (of which approximately 89% were interest only) and 81% fixed rate mortgages in the comparable period of the prior year. The average FICO score of our homebuyers during the year ended December 31, 2007 was 731, and the average loan-to-value ratio on first mortgages was 79%. For the years ended December 31, 2007 and 2006, approximately 10% of our homebuyers paid in cash. Our combined mortgage operations capture ratio for non-cash homebuyers increased to 70% for the year ended December 31, 2007 from 69% for the year ended December 31, 2006. The number of closings at our mortgage operations decreased to 5,192 for the year ended December 31, 2007, from 6,276 for the year ended December 31, 2006. Our combined title operations capture ratio was 97% for the year ended December 31, 2007, down slightly from the comparative prior period’s 98% capture ratio. The number of closings at our title operations decreased to 13,792 for the year ended December 31, 2007, from 23,248 for the same period in 2006 as a result of deteriorating market conditions. Non-affiliated customers accounted for approximately 41% of our title company revenues for the year ended December 31, 2007.

 

Financial Services expenses decreased to $36.3 million for the year ended December 31, 2007, from $41.8 million for the year ended December 31, 2006. This 13% decrease is a result of reduced staff levels in 2007 versus 2006 in response to a more challenging housing market.

 

Discontinued Operations

 

On June 6, 2007, we sold substantially all of our Dallas/Fort Worth division to an independent third-party for $56.5 million and realized a pre-tax loss on disposal of $13.6 million.

 

In accordance with SFAS 144, results of our Dallas/Fort Worth division have been classified as discontinued operations, and prior periods have been restated to be consistent with the December 31, 2007 presentation. Discontinued operations include Dallas/Fort Worth division revenues of $47.9 million and $132.7 million for the year ended December 31, 2007 and 2006, respectively. The Dallas/Fort Worth division had a net loss of $22.8 million for the year ended December 31, 2007 as compared to a net loss of $0.4 million for the year ended December 31, 2006.

 

Fiscal Year 2006 Compared to Fiscal Year 2005

 

Total revenues from continuing operations increased 4% to $2.5 billion for the year ended December 31, 2006, from $2.4 billion for the year ended December 31, 2005. This increase was attributable to an increase in Homebuilding revenues of 3%, and an increase in Financial Services revenues of 33%.

 

For the year ended December 31, 2006, we had a loss from continuing operations before benefit for income taxes of $243.6 million as compared to income from continuing operations before benefit for income taxes of $344.6 million for the year ended December 31, 2005. This decrease is due primarily to (1) $153.2 million in inventory impairments and write-offs of land deposits and related abandonment costs, (2) $152.8 million in

impairments related to our unconsolidated joint ventures, (3) a $275.0 million increase in the estimated loss contingency related to the settlement of the Transeastern JV litigation, and (4) goodwill impairments totaling $5.7 million.

 

Our effective tax rate was 17.6% and 36.7% for the year ended December 31, 2006 and 2005, respectively. The 2006 effective tax rate was primarily impacted by a valuation allowance on certain deferred tax assets and the non-deductible state portion of the impairment of our investment in unconsolidated joint ventures, and the provision of the settlement of a loss contingency in connection with the Transeastern JV.

 

For the year ended December 31, 2006, we had a loss from continuing operations, net of taxes, of $200.8 million (or a loss of $3.37 per diluted share) compared to net income from continuing operations, net of taxes, of $218.1 million (or $3.82 per diluted share) for the year ended December 31, 2005. For the year ended December 31, 2006, we had a net loss of $201.2 million (or a loss of $3.38 per diluted share) compared to net income of $218.3 million (or $3.68 per diluted share) for the year ended December 31, 2005.

 

Homebuilding

 

Homebuilding revenues increased 3% to $2.4 billion for the year ended December 31, 2006 compared to the comparable period in the prior year. This increase was due to a 6% increase in revenue from home sales to $2.3 billion for the year ended December 31, 2006 from $2.2 billion for the year ended December 31, 2005, partially offset by a 29% decrease in revenue from land sales to $131.9 million for the year ended December 31, 2006 from $186.1 million for the comparable period in 2005. The increase in revenue from home sales, which is net of buyer incentives, was due to a 7% increase in the average price of homes delivered to $318,000 for the year ended December 31, 2006, from $297,000 for the year ended December 31, 2005. The increase in the average price of homes delivered is due to increased demand in many of our markets in 2005 which allowed us to increase prices, and to a lesser degree to changes in product mix. The decrease in revenue from land sales was due to the sale of various large tracts of land, particularly in the Phoenix market, during the year ended December 31, 2005.

 

For the year ended December 31, 2006, we had a homebuilding gross profit of $417.9 million as compared to a gross profit of $591.0 million for the year ended December 31, 2005. This decrease is primarily due to an increase in inventory impairments and abandonment costs to $153.2 million for the year ended December 31, 2006 in addition to the decrease in the number of deliveries and higher incentives on homes delivered in response to softening demand. For the year ended December 31, 2006, our incentives increased to $21,200 per home delivered from $8,800 per home delivered for the year ended December 31, 2005.

 

SG&A expenses increased to $358.3 million for the year ended December 31, 2006, from $309.1 million for the year ended December 31, 2005. The increase in SG&A expenses is due primarily to: (1) an increase of $38.8 million in direct selling and advertising expenses, which include commissions, closing costs, advertising and sales associates compensation, as a result of the more challenging housing market; (2) an increase of $10.1 million in severance expenses resulting from employee termination benefits and contract termination costs relating to certain consulting contracts for which we did not expect to receive economic benefit during the remaining terms; (3) an increase of $5.0 in stock-based compensation expense; and (4) $3.5 million in professional fees related to the Transeastern JV.

 

SG&A expenses as a percentage of revenues from home sales for the year ended December 31, 2006 increased to 16%, as compared to 14% for the year ended December 31, 2005. The increase in SG&A expenses as a percentage of home sales revenues is due to the factors discussed above. Our ratio of SG&A expenses as a percentage of revenues from home sales is also affected by the fact that our consolidated revenues from home sales do not include revenues recognized by our unconsolidated joint ventures; however, the compensation and other expenses capitalized by us in connection with certain of these joint ventures are included in our consolidated SG&A expenses.

 

For the year ended December 31, 2006, we had income from unconsolidated joint ventures of $104.7 million compared to income of $45.7 million for the year ended December 31, 2005. This increase is the result of an increase in deliveries to 3,951 for the year ended December 31, 2006 from 1,666 deliveries for

the year ended December 31, 2005. Impairments on unconsolidated joint ventures totaled $152.8 million for the year ended December 31, 2006 and consist of (1) $145.1 million related to our investment in the Transeastern JV and (2) $7.7 million from a joint venture in Southwest Florida.

 

Net Sales Orders and Homes in Backlog (Consolidated)

 

For the year ended December 31, 2006, net sales orders from continuing operations decreased by 24% to 6,085 as compared to 8,042 for the year ended December 31, 2006. The decrease in net sales orders is due to decreased demand for new homes and higher cancellation rates, especially during the second half of 2006.

 

Our cancellation rate increased to 32% for the year ended December 31, 2006 from 17% for the year ended December 31, 2005. All of our regions experienced increases in cancellation rates for the year ended December 31, 2006 when compared with the same period in 2005. Our West region had the largest increase in cancellation rate to 44% for the year ended December 31, 2006 from 18% for the year ended December 31, 2005. Our Florida region also experienced a large increase in cancellation rate to 33% for the year ended December 31, 2006 from 11% for the year ended December 31, 2005. The cancellation rate for our Mid-Atlantic region was 25% for the year ended December 31, 2006, which represents a 6% increase over the comparative period in the prior year. The cancellation rate for our Texas region was 28% for the year ended December 31, 2006, which represents a 5% decrease over the comparative period in the prior year.

 

We had 3,869 homes in backlog at December 31, 2006, as compared to 4,984 homes in backlog at December 31, 2005. The 22% decrease in backlog is primarily due to a decline in sales orders and an increase in cancellation rates as a result of decreased demand. The sales value of backlog decreased 17% to $1.4 billion at December 31, 2006, from $1.7 billion at December 31, 2005, due to the decrease in the number of homes in backlog. The decrease in the sales value of backlog was partially offset by a 6% increase in average sales price to $361,000 from $339,000 for the same periods.

 

Net Sales Orders and Homes in Backlog (Unconsolidated Joint Ventures)

 

For the year ended December 31, 2006, unconsolidated joint ventures net sales orders decreased by 77% to 456 as compared to 2,009 for the year ended December 31, 2006 due to challenging market conditions, decreased demand and higher cancellation rates especially in the Transeastern JV. The decrease in net sales orders was also due to a decline in the number of active communities as we limit the use of joint ventures that build and sell homes.

 

We had 1,199 homes in backlog as of December 31, 2006, as compared to 4,749 homes in backlog as of December 31, 2005. The 75% decrease in backlog primarily is due to a decline in net sales orders due to the factors described above.

 

Joint venture revenues are not included in our consolidated financial statements. At December 31, 2006, the sales value of our joint ventures’ homes in backlog was $365.6 million compared to $1.5 billion at December 31, 2005. This decrease is due primarily to the decrease in the number of homes in backlog. In addition, the average selling price of homes in backlog decreased to $305,000 from $318,000 from period to period.

 

Financial Services

 

Financial Services revenues increased to $63.3 million for the year ended December 31, 2006, from $47.5 million for the year ended December 31, 2005. This 33% increase was due primarily to an increase in the number of closings at our mortgage and title operations and increased revenue per loan at our mortgage operations due to a shift toward more fixed rate mortgages. For the year ended December 31, 2006, our mix of mortgage originations was 19% adjustable rate mortgages (of which approximately 89% were interest only) and 81% fixed rate mortgages, which is a shift from 34% adjustable rate mortgages and 66% fixed rate mortgages in the comparable period in 2005. The average FICO score of our homebuyers during the year ended December 31, 2006 was 728, and the average loan to value ratio on first mortgages was 77%. For the year ended December 31, 2006, approximately 10% of our homebuyers paid in cash as compared to 11%

during the year ended December 31, 2005. Our combined mortgage operations capture ratio for non-cash homebuyers (excluding the Transeastern JV) increased to 69% for the year ended December 31, 2006 from 65% for the year ended December 31, 2005. The number of closings at our mortgage operations decreased to 5,192 for the year ended December 31, 2006, from 5,455 for the year ended December 31, 2005. Our combined title operations capture ratio (excluding the Transeastern JV) increased to 98% of our homebuyers for the year ended December 31, 2006, from 91% for the comparable period in 2005. The capture ratio for the year ended December 31, 2005 was affected by an organizational change in our Phoenix operations causing a loss of closings during the period. The number of closings at our title operations decreased slightly to 23,248 for the year ended December 31, 2006, from 23,530 for the same period in 2005. Non-affiliated customers accounted for approximately 66% of our title company revenues for the year ended December 31, 2006.

 

Financial Services expenses increased to $41.8 million for the year ended December 31, 2006, from $39.0 million for the year ended December 31, 2005. This 7% increase is a result of increased compensation and slightly higher staff levels in 2006 compared to 2005.

 

Discontinued Operations

 

On June 6, 2007, we sold substantially all of our Dallas/Fort Worth division to Wall Homes Texas LLC for $56.5 million and realized a pre-tax loss on disposal of $13.6 million.

 

In accordance with SFAS 144, results of our Dallas/Fort Worth division have been classified as discontinued operations, and prior periods have been restated to be consistent with the December 31, 2007 presentation. Discontinued operations include Dallas/Fort Worth division revenues of $132.7 million and $101.0 million for the year ended December 31, 2006 and 2005, respectively. The Dallas/Fort Worth division had a net loss of $0.4 million for the year ended December 31, 2006 as compared to net income of $0.2 million for the year ended December 31, 2005.

 

Reportable Segments

 

Our operating segments are aggregated into reportable segments in accordance with Statement of Financial Accounting Standards No. 131, Disclosures About Segments of an Enterprise and Related Information, based primarily upon similar economic characteristics, product type, geographic area, and information used by the chief operating decision maker to allocate resources and assess performance. Our reportable segments consist of our four major Homebuilding geographic regions (Florida, Mid-Atlantic, Texas and the West) and our Financial Services operations.

 

Homebuilding Operations

 

The reportable segments for our Homebuilding operations are as follows:

 

Florida:  Central Florida, Jacksonville, Southeast Florida, Southwest Florida, Tampa/St. Petersburg

 

Mid-Atlantic:  Baltimore/Southern Pennsylvania, Nashville, Northern Virginia (on September 25, 2007 we sold in bulk, home sites in our Mid-Atlantic (excluding Nashville) and Virginia divisions)

 

Texas:  Austin, Houston, San Antonio (on June 6, 2007, we sold substantially all of our Dallas/Fort Worth division)

 

West:  Colorado, Las Vegas, Phoenix

Selected Homebuilding Operations and Financial Data

 

The following tables set forth selected operational and financial data for our Homebuilding operations for the periods indicated (dollars in millions, except average price in thousands):