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EX-10.1 - AMENDED AND RESTATED LOAN AGREEMENT - WILLIAM LYON HOMESdex101.htm
EX-31.1 - CERTIFICATION OF CEO PURSUANT TO SECTION 302 - WILLIAM LYON HOMESdex311.htm
EX-32.1 - CERTIFICATION OF CEO PURSUANT TO SECTION 906 - WILLIAM LYON HOMESdex321.htm
EX-31.2 - CERTIFICATION OF CFO PURSUANT TO SECTION 302 - WILLIAM LYON HOMESdex312.htm
EX-32.2 - CERTIFICATION OF CFO PURSUANT TO SECTION 906 - WILLIAM LYON HOMESdex322.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2010

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 001-31625

 

 

WILLIAM LYON HOMES

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   33-0864902
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)
4490 Von Karman Avenue  
Newport Beach, California   92660
(Address of principal executive offices)   (Zip Code)

(949) 833-3600

(Registrant’s telephone number, including area code)

Not Applicable

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

 

 

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  ¨    NO  x

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every interactive data file required to be submitted and posted pursuant to Rule 405 of Regulation S-T (section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES  ¨    NO  ¨

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

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES  ¨    NO  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class of Common Stock

 

Outstanding at
August 3, 2010

Common stock, par value $.01   1,000

 

 

 


Table of Contents

WILLIAM LYON HOMES

INDEX

 

         Page
No.

PART I. FINANCIAL INFORMATION

  

Item 1.

  Financial Statements:   
 

Consolidated Balance Sheets — June 30, 2010 (unaudited) and December 31, 2009

   4
 

Consolidated Statements of Operations — Three and Six Months Ended June 30, 2010  and 2009 (unaudited)

   5
 

Consolidated Statement of Equity — Six Months Ended June 30, 2010 (unaudited)

   6
 

Consolidated Statements of Cash Flows — Six Months Ended June  30, 2010 and 2009 (unaudited)

   7
 

Notes to Consolidated Financial Statements

   8

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   36

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

   59

Item 4.

 

Controls and Procedures

   59

Item 4T.

 

Not Applicable

   59

PART II. OTHER INFORMATION

   60

Item 1.

 

Legal Proceedings

   60

Item 1A.

 

Risk Factors

   61

Item 2.

 

Not Applicable

   61

Item 3.

 

Not Applicable

   61

Item 4.

 

Not Applicable

   61

Item 5.

 

Not Applicable

   61

Item 6.

 

Exhibits

   61

SIGNATURES

   62

EXHIBIT INDEX

   63

 

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Table of Contents

NOTE ABOUT FORWARD-LOOKING STATEMENTS

Investors are cautioned that certain statements contained in this Quarterly Report on Form 10-Q, as well as some statements by the Company in periodic press releases and some oral statements by Company officials to securities analysts during presentations about the Company are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Act”). Statements which are predictive in nature, which depend upon or refer to future events or conditions, or which include words such as “expects”, “anticipates”, “intends”, “plans”, “believes”, “estimates”, “hopes”, and similar expressions constitute forward-looking statements. In addition, any statements concerning future financial performance (including future revenues, earnings or growth rates), ongoing business strategies or prospects, and possible future Company actions, which may be provided by management are also forward-looking statements as defined in the Act. Forward-looking statements are based upon expectations and projections about future events and are subject to assumptions, risks and uncertainties about, among other things, the Company, economic and market factors and the homebuilding industry.

Actual events and results may differ materially from those expressed or forecasted in the forward-looking statements due to a number of factors. The principal factors that could cause the Company’s actual performance and future events and actions to differ materially from such forward-looking statements include, but are not limited to, worsening in general economic conditions either nationally or in regions in which the Company operates, worsening in the markets for residential housing, further decline in real estate values resulting in further impairment of the Company’s real estate assets, volatility in the banking industry and credit markets, terrorism or other hostilities involving the United States, whether an ownership change occurred which could, under certain circumstances, have resulted in the limitation of the Company’s ability to offset prior years’ taxable income with net operating losses, expiration of income tax incentives for homebuyers, changes in home mortgage interest rates, changes in generally accepted accounting principles or interpretations of those principles, changes in prices of homebuilding materials, labor shortages, adverse weather conditions, the occurrence of events such as landslides, soil subsidence and earthquakes that are uninsurable, not economically insurable or not subject to effective indemnification agreements, changes in governmental laws and regulations, the Company’s ability to refinance the outstanding balances of its debt obligations at their maturity, the timing of receipt of regulatory approvals and the opening of projects and the availability and cost of land for future growth. These and other risks and uncertainties are more fully described in Item 1A. “Risk Factors” as contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009. While it is impossible to identify all such factors, factors which could cause actual results to differ materially from those estimated by the Company include, but are not limited to, those factors or conditions described under “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The Company’s past performance or past or present economic conditions in the Company’s housing markets are not indicative of future performance or conditions. Investors are urged not to place undue reliance on forward-looking statements. In addition, the Company undertakes no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of anticipated or unanticipated events or changes to projections over time unless required by federal securities law.

 

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Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements.

WILLIAM LYON HOMES

CONSOLIDATED BALANCE SHEETS

(in thousands except number of shares and par value per share)

 

     June 30,
2010
   December 31,
2009
     (unaudited)     
ASSETS      

Cash and cash equivalents — Note 6

   $ 110,519    $ 117,587

Restricted cash

     3,892      4,352

Receivables

     15,133      16,294

Income tax refunds receivable — Note 8

     —        106,989

Real estate inventories — Notes 2 and 4

     

Owned

     615,538      523,336

Not owned

     55,270      55,270

Investments in joint ventures

     2,295      1,703

Property & equipment, less accumulated depreciation of $6,622 and $8,195 at June 30, 2010 and December 31, 2009, respectively

     1,362      1,673

Deferred loan costs

     14,500      14,859

Other assets

     4,665      18,036
             
   $ 823,174    $ 860,099
             
LIABILITIES AND EQUITY      

Accounts payable

   $ 14,405    $ 11,046

Accrued expenses

     44,856      45,294

Liabilities from inventories not owned — Note 9

     55,270      55,270

Notes payable — Note 5

     34,551      64,227

Senior Secured Term Loan due October 20, 2014 — Note 5

     206,000      206,000

7 5/8 % Senior Notes due December 15, 2012 — Note 5

     67,204      67,204

10 3/4 % Senior Notes due April 1, 2013 — Note 5

     168,311      168,158

7 1/2 % Senior Notes due February 15, 2014 — Note 5

     84,701      84,701
             
     675,298      701,900

Commitments and contingencies — Note 9

     

Equity:

     

Stockholders’ equity

     

Common stock, par value $.01 per share; 3,000 shares authorized; 1,000 shares outstanding at June 30, 2010 and December 31, 2009, respectively

     —        —  

Additional paid-in capital

     48,867      48,867

Retained earnings

     88,711      101,733
             
     137,578      150,600

Noncontrolling interest — Note 2

     10,298      7,599
             
     147,876      158,199
             
   $ 823,174    $ 860,099
             

See accompanying notes.

 

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WILLIAM LYON HOMES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands)

(unaudited)

 

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2010     2009     2010     2009  

Operating revenue

        

Home sales

   $ 68,737      $ 67,408      $ 106,599      $ 123,956   

Lots, land and other sales

     17,204        883        17,204        7,415   

Construction services — Note 1

     751        9,116        6,052        15,375   
                                
     86,692        77,407        129,855        146,746   
                                

Operating costs

        

Cost of sales — homes

     (56,795     (58,198     (88,157 )     (109,060 )

Cost of sales — lots, land and other — Note 4

     (15,573     (2,303     (15,573     (46,565 )

Impairment loss on real estate assets — Notes 4 and 6

     (291     —          (291     (24,171 )

Construction services — Note 1

     (674     (7,842     (3,921 )     (13,611 )

Sales and marketing

     (5,815     (4,538     (9,402 )     (8,664 )

General and administrative

     (5,584     (4,523     (11,586     (10,553 )

Other

     (1,004     (687     (1,898     (2,547 )
                                
     (85,736     (78,091     (130,828     (215,171 )
                                

Equity in income (loss) of unconsolidated joint ventures

     761        413        1,173        (1,310 )
                                

Operating income (loss)

     1,717       

 

(271

 

 

    200        (69,735 )

Interest expense, net of amounts capitalized

     (6,213     (8,321     (13,307     (17,033 )

Gain on retirement of debt

     —          49,043        —          57,973   

Other loss, net

     (163     (775 )     (71 )     (722
                                

(Loss) income before benefit from income taxes

     (4,659     39,676       
(13,178

    (29,517 )
                                

Benefit from income taxes — Note 8

     —          —          65        22   
                                

Consolidated net (loss) income

     (4,659     39,676        (13,113     (29,495 )

Less: Net loss (income) — noncontrolling interest

     121        (289     91        (119
                                

Net (loss) income attributable to William Lyon Homes

   $ (4,538   $ 39,387      $ (13,022   $ (29,614 )
                                

See accompanying notes.

 

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Table of Contents

WILLIAM LYON HOMES

CONSOLIDATED STATEMENT OF EQUITY

Six Months Ended June 30, 2010

(in thousands)

(unaudited)

 

 

     Common Stock    Additional
Paid-In
Capital
   Retained
Earnings
    Non-
Controlling
Interest
    Total  
     Shares    Amount          

Balance — December 31, 2009

   1    $ —      $ 48,867    $ 101,733      $ 7,599      $ 158,199   

Net loss

   —        —        —        (13,022     (91     (13,113

Cash contributions from members of consolidated entities, net

   —        —        —        —          2,790        2,790   
                                           

Balance — June 30, 2010

   1    $ —      $ 48,867    $ 88,711      $ 10,298      $ 147,876   
                                           

See accompanying notes.

 

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WILLIAM LYON HOMES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

     Six Months Ended
June 30,
 
     2010     2009  

Operating activities

    

Consolidated net loss

   $ (13,113   $ (29,495

Adjustments to reconcile consolidated net loss to net cash provided by operating activities:

    

Depreciation and amortization

     229        986   

Impairment loss on real estate assets

     291        24,171   

Equity in (income) loss of unconsolidated joint ventures

     (1,173     1,310   

Loss on disposition of fixed asset

     122        —     

Gain on retirement of debt

     —          (57,973

Benefit from income taxes

     (65     (22

Net changes in operating assets and liabilities:

    

Restricted cash

     460        (79

Receivables

     1,161        22,171   

Income tax refunds receivable

     107,054        41,614   

Real estate inventories — owned

     (81,688     86,970   

Deferred loan costs

     1,731        819   

Other assets

     13,371        (335

Accounts payable

     3,359        (8,184

Accrued expenses

     (438     (15,409
                

Net cash provided by operating activities

     31,301        66,544   
                

Investing activities

    

Investments in and advances to unconsolidated joint ventures

     (194     (194

Distributions of income from unconsolidated joint ventures

     775        7   

Purchases of property and equipment, net

     (40     (15
                

Net cash provided by (used in) investing activities

     541        (202
                

Financing activities

    

Proceeds from borrowing on notes payable, net

     6,679        71,881   

Principal payments on notes payable

     (48,379     (108,958

Net cash paid for repurchase of Senior Notes

     —          (25,310

Noncontrolling interest contributions (distributions), net

     2,790        (5,148
                

Net cash used in financing activities

     (38,910     (67,535
                

Net decrease in cash and cash equivalents

     (7,068     (1,193

Cash and cash equivalents — beginning of period

     117,587        67,017   
                

Cash and cash equivalents — end of period

     110,519      $ 65,824   
                

Supplemental disclosures of non-cash items:

    

Decrease to net real estate inventories not owned and liabilities from inventories not owned

   $ —        $ 9,309   
                

Decrease to net real estate inventories not owned and noncontrolling interests

   $ —        $ 27,684   
                

Increase in real estate inventories owned and seller notes payable

   $ 10,652      $ —     
                

See accompanying notes

 

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WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Note 1 — Basis of Presentation and Significant Accounting Policies

William Lyon Homes, a Delaware corporation, and subsidiaries (the “Company”) are primarily engaged in designing, constructing and selling single family detached and attached homes in California, Arizona and Nevada.

The unaudited consolidated financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and in accordance with the rules and regulations of the Securities and Exchange Commission. The consolidated financial statements do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. The consolidated financial statements included herein should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.

The interim consolidated financial statements have been prepared in accordance with the Company’s customary accounting practices. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a presentation in accordance with U.S. generally accepted accounting principles have been included. Operating results for the three and six months ended June 30, 2010 are not necessarily indicative of the results that may be expected for the year ending December 31, 2010.

The preparation of the Company’s financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of the assets and liabilities as of June 30, 2010 and December 31, 2009 and revenues and expenses for the periods presented. Accordingly, actual results could differ from those estimates. The significant accounting policies using estimates include real estate inventories and cost of sales, impairment of real estate inventories, warranty reserves, loss contingencies, sales and profit recognition, income taxes, and accounting for variable interest entities. The current economic environment increases the uncertainty inherent in these estimates and assumptions.

The consolidated financial statements include the accounts of the Company and all majority-owned and controlled subsidiaries and joint ventures, and certain joint ventures and other entities which have been determined to be variable interest entities in which the Company is considered the primary beneficiary (see Note 2). Investments in joint ventures which have not been determined to be variable interest entities in which the Company is considered the primary beneficiary are accounted for using the equity method because the Company has a 50% or less voting or economic interest (and thus such joint ventures are not controlled by the Company). The accounting policies of the joint ventures are substantially the same as those of the Company. All significant intercompany accounts and transactions have been eliminated in consolidation.

The ability of the Company to meet its covenants and obligations on its indebtedness will depend to a large degree on its future performance which in turn will be subject, in part, to factors beyond its control, such as prevailing economic conditions, either nationally or in regions in which the Company operates, the outbreak of war or other hostilities involving the United States, mortgage and other interest rates, changes in prices of homebuilding materials, weather, the occurrence of events such as landslides, soil subsidence and earthquakes that are uninsurable, not economically insurable or not subject to effective indemnification agreements, availability of labor and homebuilding materials, changes in governmental laws and regulations, the timing of receipt of regulatory approvals and the opening of projects, and the availability and cost of land for future development. The Company cannot be certain that its cash flows will be sufficient to allow it to pay principal and interest on its debt, support its operations and meet its other obligations. If the Company is not able to meet those obligations, it may be required to refinance all or part of its existing debt, sell assets or borrow more money. The Company may not be able to do so on terms acceptable to it, if at all. In addition, the terms of existing or future indentures and credit or other agreements governing the Company’s Senior Secured Term Loan, Senior Note obligations and other indebtedness may restrict the Company from pursuing any of these alternatives.

The Company designs, constructs and sells a wide range of homes designed to meet the specific needs of each of its markets. The Company conducts its homebuilding operations through four reportable operating segments: Southern California, Northern California, Arizona and Nevada. See Note 3 for further discussion of the Company’s homebuilding segments.

 

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Table of Contents

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

The Company accounts for construction management agreements using the Percentage of Completion Method in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 605 Revenue Recognition (“ASC 605”). Under ASC 605, the Company records revenues and expenses as work on a contract progresses, and based on the percentage of costs incurred to date compared to the total estimated costs of the contract. Based on the provisions of ASC 605, the Company has recorded construction services revenues and expenses of $0.8 million and $0.7 million, respectively, for the three months ended June 30, 2010 and $9.1 million and $7.8 million, respectively for the three months ended June 30, 2009, in the accompanying consolidated statement of operations. In addition, the Company has recorded construction services revenues and expenses of $6.1 million and $3.9 million, respectively, for the six months ended June 30, 2010 and $15.4 million and $13.6 million, respectively for the six months ended June 30, 2009, in the accompanying consolidated statement of operations.

The Company entered into construction management agreements to build, sell and market homes in 3 separate communities. For such services, the Company receives fees (generally 5 percent of the sales price, as defined) and may, under certain circumstances, receive additional compensation if certain financial thresholds are achieved. In addition, in October 2008, the Company entered into a contract to build apartment units for a related party at a contract price of $13.5 million, which includes the Company’s contractor fee of $0.5 million. During the six months ended June 30, 2009, the Company recorded construction services revenue of $4.4 million and expenses of $4.2 million for this project, which was completed in 2009.

The Company evaluates performance and allocates resources primarily based on the operating income (loss) of individual homebuilding projects. Operating income (loss) is defined by the Company as operating revenue less operating costs plus equity in income (loss) of unconsolidated joint ventures. Accordingly, operating income (loss) excludes certain expenses included in the determination of net income (loss).

Restricted cash consists of $3.9 million in cash deposits held with the lenders of two of the Company’s revolving credit facilities, which is held as collateral for the use of letters of credit provided by such lenders. Under the terms of the senior secured term loan disclosed in Note 5, all of the Company’s standby letters of credit are secured by cash.

A provision for warranty costs relating to the Company’s limited warranty plans is included in cost of sales at the time the home sale is recorded. The Company generally reserves approximately one percent of the sales price of its homes against the possibility of future charges relating to its one-year limited warranty and similar potential claims. Factors that affect the Company’s warranty liability include the number of homes under warranty, historical and anticipated rates of warranty claims, and cost per claim. The Company periodically assesses the adequacy of its recorded warranty liability and adjusts the amounts as necessary. Changes in the Company’s warranty liability during the six months ended June 30 are as follows (in thousands):

 

     June 30  
     2010     2009  

Warranty liability, beginning of period

   $ 21,365      $ 26,394   

Warranty provision during period

     1,004        1,862   

Warranty payments during period

     (5,581     (5,033

Warranty charges related to pre-existing warranties during period

     832        (105
                

Warranty liability, end of period

   $ 17,620      $ 23,118   
                

The Company follows the guidance in ASC Topic 855 Subsequent Events (“ASC 855”), which provides guidance to establish general standards of accounting for and disclosures of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. ASC 855 sets forth (i) the period after the balance sheet date during which management of a reporting entity evaluates events or transactions that may occur for potential recognition or disclosure in the financial statements, (ii) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements, and (iii) the disclosures an entity should make about events or transactions that occurred after the balance sheet date.

 

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Table of Contents

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

In January 2010, the FASB issued Accounting Standards Update (“ASU”) 2010-06, Fair Value Measurements and Disclosures (Topic 820), which requires additional disclosures and clarifies some existing disclosure requirements about fair value measurement as set forth in ASC 820-10. ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The adoption in January 2010 of the additional disclosure portion of this guidance did not have a material effect on the Company’s consolidated financial statements, but resulted in additional disclosures. The Company does not expect the adoption of the later portion of this guidance to have a material effect on its consolidated financial statements.

In June 2009 and February 2010, the FASB updated certain provisions of ASC 810, Consolidation. These provisions amend the consolidation guidance applicable to variable interest entities and the definition of a variable interest entity, and require enhanced disclosures to provide more information about an enterprise’s involvement in a variable interest entity. ASC 810 also requires ongoing assessments of whether an enterprise is the primary beneficiary of a variable interest entity. These provisions under ASC 810 were effective for the Company on January 1, 2010. The adoption of this guidance did not have a material effect on the Company’s consolidated financial statements, but resulted in additional disclosures, which are reflected in Note 2 below.

Note 2 — Variable Interest Entities and Noncontrolling Interests

The FASB issued guidance now codified as ASC 810, Consolidation, which addresses the consolidation of variable interest entities (“VIEs”). Under this guidance, arrangements that are not controlled through voting or similar rights are accounted for as VIEs. An enterprise is required to consolidate a VIE if it is the primary beneficiary of the VIE. The primary beneficiary is an enterprise that has the power to direct the activities of the VIE that most significantly impacts its economic performance and the obligation to absorb losses or the right to receive benefits from the VIE that could be potentially significant to the VIE.

A VIE is created when (i) the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties or (ii) equity holders either (a) lack direct or indirect ability to make decisions about the entity through voting or similar rights, (b) are not obligated to absorb expected losses of the entity or (c) do not have the right to receive expected residual returns of the entity if they occur.

Based on the provisions of this guidance, the Company has concluded that under certain circumstances when the Company (i) enters into option agreements for the purchase of land or lots from an entity and pays a non-refundable deposit, (ii) enters into land banking arrangements or (iii) enters into arrangements with a financial partner for the formation of joint ventures which engage in homebuilding and land development activities, a VIE may be created under condition (ii) (b) or (c) of the previous paragraph. The Company may be deemed to have provided subordinated financial support, which refers to variable interests that will absorb some or all of an entity’s expected losses if they occur. For each VIE created, in order to determine if the Company is the primary beneficiary, the Company considers various factors including, but not limited to, voting rights, risks, involvement in the operations of the VIE, ability to make major decisions, contractual obligations including distributions of income and loss, and computations of expected losses and residual returns based on the probability of future cash flow. If the Company has been determined to be the primary beneficiary of the VIE, the assets, liabilities and operations of the VIE are consolidated with the Company’s financial statements.

 

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WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

Joint Ventures

Certain joint ventures have been determined to be VIEs under ASC 810 in which the Company is considered the primary beneficiary. Accordingly, the assets, liabilities and operations of these VIEs have been consolidated with the Company’s financial statements. The Company did not recognize any gain or loss on initial consolidation of the VIE since the joint ventures were previously accounted for on an unconsolidated basis using the equity method of accounting.

The joint ventures which have been determined to be VIEs are each engaged in homebuilding and land development activities. Certain of these joint ventures have not obtained construction financing from outside lenders, but are financing their activities through equity contributions from each of the joint venture partners. Creditors of these VIEs have no recourse against the general credit of the Company. The liabilities of each VIE are restricted to VIE assets. Additionally, the creditors of the Company have no access to the assets of the VIEs. Income allocations and cash distributions to the Company are based on predetermined formulas between the Company and their joint venture partners as specified in the applicable partnership or operating agreements. The Company generally receives, after partners’ priority returns and return of partners’ capital, approximately 50% of the profits and cash flows from the joint ventures.

As of June 30, 2010, the assets and liabilities of the consolidated VIEs totaled $15.9 million and $1.8 million, respectively. In addition, the Company’s interest in the consolidated VIEs is $3.8 million and the member’s interest in the consolidated VIEs is $10.3 million, which is reported as noncontrolling interest on the accompanying consolidated balance sheet.

As of December 31, 2009, the assets and liabilities of the consolidated VIEs totaled $13.5 million and $2.1 million, respectively. In addition, the Company’s interest in the consolidated VIEs was $3.7 million and the member’s interest in the consolidated VIEs was $7.6 million, which is reported as noncontrolling interest on the accompanying consolidated balance sheet.

Option Deposits

During the six months ended June 30, 2009, the Company abandoned its option deposit in three of its consolidated land banking arrangements in which land purchase commitments were required of $37.9 million, which was included in cost of sales-lots, land and other in the accompanying statement of operations. Management of the Company determined that the remaining purchase price of the lots in the arrangements were priced above market values at that time. In two of these arrangements, the Company reduced real estate inventories-not owned and the related noncontrolling interest $27.7 million for the remaining purchase price of the lots, which did not effect the Company’s operating income (loss) for the period. In the other arrangement, the Company reduced real estate inventories-not owned and liabilities from inventories-not owned $9.3 million for the remaining purchase price of 51 lots, which did not effect the Company’s operating income (loss) for the period. However, during the three month period ended December 31, 2009 the Company re-evaluated the purchase price of the 51 lots under option, and after the write-off of the $9.3 million deposit, the residual value became economically viable and the Company purchased the lots.

 

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Table of Contents

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

Note 3 — Segment Information

The Company operates one principal homebuilding business. In accordance with FASB ASC Topic 280, Segment Reporting (“ASC 280”), the Company has determined that each of its operating divisions is an operating segment. Corporate is a non-operating segment.

The Company’s homebuilding operations design, construct and sell a wide range of homes designed to meet the specific needs in each of it markets. In accordance with the aggregation criteria defined by ASC 280, the Company’s homebuilding operating segments have been grouped into four reportable segments: Southern California, consisting of an operating division with operations in Orange, Los Angeles, San Bernardino and San Diego counties; Northern California, consisting of an operating division with operations in Contra Costa, Sacramento, San Joaquin, Santa Clara, Solano and Placer counties; Arizona, consisting of operations in the Phoenix, Arizona metropolitan area; and Nevada, consisting of operations in the Las Vegas, Nevada metropolitan area.

Corporate is a non-operating segment that develops and implements strategic initiatives and supports the Company’s operating divisions by centralizing key administrative functions such as finance and treasury, information technology, risk management and litigation and human resources.

Segment financial information relating to the Company’s homebuilding operations was as follows:

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2010     2009     2010     2009  
     (in thousands)     (in thousands)  

Homebuilding revenues:

        

Southern California

   $ 53,640      $ 39,788      $ 75,021      $ 68,171   

Northern California

     3,319        12,693        11,266        24,551   

Arizona

     6,025        7,417        10,124        14,647   

Nevada

     5,753        7,510        10,188        16,587   
                                

Total homebuilding revenues

   $ 68,737      $ 67,408      $ 106,599      $ 123,956   
                                
     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2010     2009     2010     2009  
     (in thousands)     (in thousands)  

Homebuilding (loss) income before benefit from income taxes:

        

Southern California

   $ (1,212   $ (1,841   $ (5,876 )   $ (19,073 )

Northern California

     1,912        218        2,623        (36,689 )

Arizona

     (1,439     (3,103     (2,461 )     (4,543 )

Nevada

     (921     (1,488     (1,931 )     (21,784 )

Corporate

     (2,999     45,890        (5,533 )     52,572   
                                

Total homebuilding (loss) income before benefit from income taxes

   $ (4,659   $ 39,676      $ (13,178 )   $ (29,517 )
                                

 

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WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

Homebuilding pretax (loss) income includes the following pretax inventory impairment charges recorded in the following segments:

 

     Three Months Ended
June 30,
   Six Months Ended
June 30,
     2010    2009           2010           2009
     (in thousands)    (in thousands)

Inventory impairments

           

Southern California

   $ —        —      $ —      $ 450

Northern California

     —        —        —        6,144

Arizona

     291      —        291      —  

Nevada

     —        —        —        17,577
                           

Total inventory impairments

   $ 291    $ —      $ 291    $ 24,171
                           

Homebuilding pretax income (loss) includes the following pretax income (loss) on sales of lots, land and other recorded in the following segments (in thousands):

 

     Three Months Ended June 30, 2010  
     Southern
California
    Northern
California
    Arizona    Nevada     Total  

(Loss) Gain on sales of lots, land and other

           

Operating revenue

   $ —        $ 17,204      $ —      $ —        $ 17,204   

Operating costs

     (1,188     (14,320     —        (65     (15,573
                                       

(Loss) Gain on sales of lots, land and other

   $ (1,188   $ 2,884      $ —      $ (65   $ 1,631   
                                       

 

     Three Months Ended June 30, 2009  
     Southern
California
   Northern
California
   Arizona     Nevada    Total  

(Loss) Gain on sales of lots, land and other

             

Operating revenue

   $ —      $ —      $ 883      $ —      $ 883   

Operating costs

     —        —        (2,303     —        (2,303 )
                                     

(Loss) Gain on sales of lots, land and other

   $ —      $ —      $ (1,420   $ —      $ (1,420 )
                                     

 

     Six Months Ended June 30, 2009  
     Southern
California
    Northern
California
    Arizona     Nevada    Total  

(Loss) Gain on sales of lots, land and other

           

Operating revenue

   $ —        $ —        $ 7,415      $ —      $ 7,415   

Operating costs

     (9,316 )     (28,568 )     (8,681     —        (46,565 )
                                       

(Loss) Gain on sales of lots, land and other

   $ (9,316 )   $ (28,568 )   $ (1,266   $ —      $ (39,150 )
                                       

 

     June 30,
2010
   December 31,
2009
     (in thousands)

Homebuilding assets:

     

Southern California

   $ 365,240    $ 324,728

Northern California

     64,534      38,383

Arizona

     186,009      172,518

Nevada

     65,545      60,764

Corporate (1)

     141,846      263,706
             

Total homebuilding assets

   $   823,174    $ 860,099
             

 

(1) Comprised primarily of cash, receivables and other assets.

 

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WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

Note 4 — Real Estate Inventories

Real estate inventories consist of the following (in thousands):

 

     June 30,
2010
   December  31,
2009

Inventories owned: (1)

     

Deposits

   $ 32,937    $ 33,582

Land and land under development

     338,680      334,877

Homes completed and under construction

     186,868      100,795

Model homes

     57,053      54,082
             

Total

   $ 615,538    $ 523,336
             

Inventories not owned: (2)

     

Other land options contracts - land banking arrangement

   $ 55,270    $ 55,270
             

 

(1) The Company temporarily suspended development, sales and marketing activities at certain of its projects from 2006 to 2008 which were in various stages of development. Management of the Company determined that this strategy was necessary under the market conditions at that time and would allow the Company to market the properties at some future time when market conditions may have improved. As market conditions continue to improve into 2010, management of the Company has released for sale or restarted development certain of these held projects. At June 30, 2010, the Company has incurred costs related to the remaining suspended projects of $110.3 million, of which $45.1 million is included in Land and land under development, $41.2 million is included in Homes completed and under construction and $24.0 million is included in Model homes. At December 31, 2009, the Company has incurred costs related to these certain projects of $261.9 million, of which $165.3 million is included in Land and land under development, $61.3 million is included in Homes completed and under construction and $35.3 million is included in model homes.
(2) Includes the consolidation of a land banking arrangement recorded as a product financing arrangement (See Note 9). Amounts are net of deposits.

The Company accounts for its real estate inventories (including land, construction in progress, completed inventory, including models, and inventories not owned) under FASB ASC 360 Property, Plant, & Equipment (“ASC 360”).

ASC 360 requires impairment losses to be recorded on real estate inventories when indicators of impairment are present and the undiscounted cash flows estimated to be generated by real estate inventories are less than the carrying amount of such assets. Indicators of impairment include a decrease in demand for housing due to softening market conditions, competitive pricing pressures which reduce the average sales prices of homes including an increase in sales incentives offered to buyers, slowing sales absorption rates, decreases in home values in the markets in which the Company operates, significant decreases in gross margins and a decrease in project cash flows for a particular project.

For land, construction in progress, completed inventory, including model homes, and inventories not owned, the Company estimates expected cash flows at the project level by maintaining current budgets using recent historical information and current market assumptions. The Company updates project budgets and cash flows of each real estate project on a quarterly basis to determine whether the estimated remaining undiscounted future cash flows of the project are more or less than the carrying amount (net book value) of the asset. If the undiscounted cash flows are more than the net book value of the project, then there is no impairment. If the undiscounted cash flows are less than the net book value of the asset, then the asset is deemed to be impaired and is written-down to its fair value.

 

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Table of Contents

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

Fair value represents the amount at which an asset could be bought or sold in a current transaction between willing parties (i.e., other than a forced liquidation sale). Management determines the estimated fair value of each project by determining the present value of estimated future cash flows at discount rates that are commensurate with the risk of each project. The estimation process involved in determining if assets have been impaired and in the determination of fair value is inherently uncertain because it requires estimates of future revenues and costs, as well as future events and conditions. Estimates of revenues and costs are supported by the Company’s budgeting process, and are based on recent sales in backlog, pricing required to get the desired pace of sales, pricing of competitive projects, incentives offered by competitors and current estimates of costs of development and construction.

Under the provisions of ASC 360, the Company is required to make certain assumptions to estimate undiscounted future cash flows of a project, which include: (i) estimated sales prices, including sales incentives, (ii) anticipated sales absorption rates and sales volume, (iii) project costs incurred to date and the estimated future costs of the project based on the project budget, (iv) the carrying costs related to the time a project is actively selling until it closes the final unit in the project, and (v) alternative strategies including selling the land to a third party or temporarily suspending development of the project. Each project has different assumptions and is based on management’s assessment of the current market conditions that exist in each project location. The Company’s assumptions include moderate absorption increases in certain projects beginning in 2011. In addition, the Company has assumed some moderate reduction in sales incentives in certain projects.

The assumptions and judgments used by the Company in the estimation process to determine the future undiscounted cash flows of a project and its fair value are inherently uncertain and require a substantial degree of judgment. The realization of the Company’s real estate inventories is dependent upon future uncertain events and market conditions. Due to the subjective nature of the estimates and assumptions used in determining the future cash flows of a project, the uncertainty in the current housing market, the uncertainty in the banking and credit markets, actual results could differ materially from current estimates.

Management assesses land deposits for impairment when estimated land values are deemed to be less than the agreed upon contract price. The Company considers changes in market conditions, the timing of land purchases, the ability to renegotiate with land sellers the terms of the land option contracts in question, the availability and best use of capital, and other factors. The Company records abandoned land deposits and related pre-acquisition costs in cost of sales-lots, land and other in the consolidated statements of operations in the period that it is abandoned. During the three and six months ended June 30, 2010, the Company recorded $1.2 million related to abandoned land deposits (not under land banking arrangements) and related pre-acquisition costs. During the six months ended June 30, 2009, the Company recorded $37.9 million related to abandoned land deposits and related pre-acquisition costs.

The following table summarizes inventory impairments recorded during the three and six months ended June 30, 2010 and 2009:

 

     Three Months Ended
June 30,
   Six Months Ended
June 30,
     2010    2009    2010    2009
     (Dollars in thousands)          

Inventory impairments related to:

           

Land under development and homes completed and under construction

   $ 291    $ —      $ 291    $ 10,818

Land held for sale or sold

     —        —        —        13,353
                           

Total inventory impairments

   $ 291      —      $ 291    $ 24,171
                           

Number of projects impaired during the period

     1      0      1      11
                           

Number of projects assessed for impairment during the period

     62      62      68      70
                           

These charges were included in impairment loss on real estate assets in the accompanying consolidated statements of operations (See Note 3 for a detail of impairment by segment). The impairment charges recorded during the period noted above stemmed from lower home prices which were driven by increased incentives and discounts resulting from weakened demand experienced from 2006 through 2009. The Company may incur impairment on real estate inventories in the future, if the homebuilding industry experiences deteriorating market condition described above.

 

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Table of Contents

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

Note 5 — Senior Notes and Secured Indebtedness

As of June 30, 2010, the Company had the following outstanding Senior Secured Term Loan due 2014, 7 5/8% Senior Notes due 2012, 10 3/4% Senior Notes due 2013 and 7 1/2% Senior Notes due 2014 (in thousands):

 

Senior Secured Term Loan due October 20, 2014

   $ 206,000

7 5/8 % Senior Notes due December 15, 2012

     67,204

10 3/4 % Senior Notes due April 1, 2013

     168,311

7 1/2 % Senior Notes due February 15, 2014

     84,701
      
   $ 526,216
      

Senior Secured Term Loan

William Lyon Homes, Inc., a California corporation (“California Lyon”) and wholly-owned subsidiary of William Lyon Homes is a party to a Senior Secured Term Loan Agreement (the “Term Loan Agreement”), dated October 20, 2009, with COLFIN WLH Funding, LLC, as Administrative Agent (“Admin Agent”), COLFIN WLH Funding, LLC, as Initial Lender and Lead Arranger (“COLFIN”) and the other Lenders who may become assignees of COLFIN (collectively, with COLFIN, the “Lenders”).

The Term Loan Agreement provides for a first lien secured loan of $206.0 million (the “Term Loan”), secured by substantially all of the assets of California Lyon, the Company, as defined in the agreement, (excluding stock in California Lyon) and certain wholly-owned subsidiaries. The Term Loan is guaranteed by the Company.

California Lyon received the first installment of $131.0 million, which funded in October 2009, and its second installment of $75.0 million, which funded in December 2009. Under the Term Loan Agreement, California Lyon will be restricted from future borrowings, and, if necessary, will be required to repay existing borrowings, in order to maintain required loan to value ratios such that: (i) the aggregate amount of outstanding loans under the Term Loan Agreement may not exceed 60% of the aggregate value of the properties securing the facility, with valuation based on the lower of appraised value (if any) and discounted net present value of the cash flows, plus unrestricted cash, and (ii) the aggregate amount of secured debt may not exceed 60% of the aggregate value of the properties owned by California Lyon and its subsidiaries, with valuation based on the lower of appraised value (if any) and discounted net present value of the cash flows. California Lyon is currently in compliance with the above requirements following each drawdown. The net proceeds to the Company from the first installment of the term loan, after giving effect to attorney fees, loan fees and other miscellaneous costs associated with the loan transaction, and repayment of the revolving credit facilities and purchase of the senior notes was $34.6 million. A portion of the $75.0 million proceeds from the second installment were used to fund the Company’s opportunistic land acquisitions in 2010.

The Term Loan bears interest at a rate of 14.0%. However, California Lyon has also agreed that, upon any repayment of any portion of the principal amount under the Term Loan (whether or not at maturity), California Lyon will also pay an exit fee equal to the difference (if positive) between (x) the interest that would have been accrued and been then payable on the repaid portion if the interest rate under the Loan Agreement were 15.625% and (y) the internal rate of return realized by the Lenders on such repaid portion, taking into account all cash amounts actually received by the Lenders with respect thereto other than any make whole payments described below.

Based on the current outstanding balance of the Term Loan, interest payments are $28.8 million annually.

On any voluntary prepayment of any portion of the Term Loan, California Lyon will be required to make a “make whole payment” equal to an amount, if positive, of the present value of all future payments of interest which would become due with respect to such prepaid amount from the date of prepayment thereof through and including the maturity date, discounted at a rate of 14%.

The Term Loan will mature on October 20, 2014; however, in the event that any portion of the outstanding principal amounts (the “Repaid Senior Note Principal”) of the Senior Notes is repaid (whether or not at maturity), the Lenders may elect to require California Lyon to repay that portion of the outstanding Loan as bears the same ratio to the entire Loan outstanding (excluding any obligation of California Lyon with respect to the Exit fee or Make-Whole Payment) as the Repaid Senior Note Principal bears to the entire amounts then outstanding under all of the indentures. All or a portion of the Term Loan may also be accelerated upon certain other events described in the Loan Agreement. The lenders waived the requirement for such repayment in connection with the Senior Note repurchases described in Note 10 and in Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

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Table of Contents

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

The Term Loan Agreement contains covenants that limit the ability of California Lyon and the Company to, among other things: (i) incur liens; (ii) incur additional indebtedness; (iii) transfer or dispose of assets; (iv) merge, consolidate or alter their line of business; (v) guarantee obligations; (vi) engage in affiliated party transactions; (vii) declare or pay dividends or make other distributions or repurchase stock; (viii) make advances, loans or investments; (ix) repurchase debt (including under the Senior Note indentures) and (x) engage in change of control transactions.

The Term loan Agreement contains customary events of default, including, without limitation, failure to pay when due amounts in respect of the loan or otherwise under the Term Loan Agreement; failure to comply with certain agreements or covenants contained in the Term Loan Agreement for a period of 10 days (or, in some cases, 30 days) after the administrative agent’s notice of such non-compliance; acceleration of more than $10.0 million of certain other indebtedness; and certain insolvency and bankruptcy events.

In addition, under the Term Loan, the Company is required to comply with a number of covenants, the most restrictive of which require the Company to maintain:

 

   

A tangible net worth, as defined, of not less than $75.0 million;

 

   

A minimum borrowing base such that the indebtedness under the Term Loan does not exceed 60% of the Borrowing Base, with the “Borrowing Base” being calculated as (1) the discounted cash flows of each project securing the loan (collateral value), plus (2) restricted cash and (3) escrow proceeds receivable, as defined;

 

   

Total secured indebtedness (including the indebtedness under the Term Loan and under all other Construction Notes payable) less than or equal to the Maximum Permitted Secured Indebtedness under the Term Loan Agreement (which is generally 60% of the total secured debt collateral value as calculated under the Term Loan Agreement, which value generally does not include cash assets); and

 

   

Excluded Assets of no more than $20.0 million, with “Excluded Assets” being defined generally as the sum total of certain deposit accounts, payroll accounts, unrestricted cash accounts, and the Company’s total investment in joint ventures.

The Company’s covenant compliance for the Term Loan at June 30, 2010 is detailed in the table set forth below:

 

Covenant and Other Requirements

   Actual at
June 30,
2010
    Covenant
Requirements  at
June 30,
2010

Tangible Net Worth (1)

   $ 133.4      ³$75.0

Borrowing Base

     40.9   £60%

Maximum Permitted Secured Indebtedness

     50.9   £60%

Excluded Assets

   $ 13.6      £$20.0

 

(1) Tangible Net Worth was calculated based on the stated amount of equity less intangible assets of $14.5 million as of June 30, 2010.

As of and for the period ending June 30, 2010, the Company is in compliance with the covenants under this loan.

 

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Table of Contents

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

If market conditions deteriorate, the Company’s compliance with the financial covenants contained in the Company’s Term Loan could be negatively impacted. Under these circumstances, the lenders under the Term Loan would need to provide the Company with additional covenant relief if the Company is to avoid future noncompliance with these financial covenants. If the Company is unable to obtain requested covenant relief or is unable to obtain a waiver for any covenant non-compliance, the Company’s obligation to repay indebtedness under the Term Loan and the Senior Notes could be accelerated. The Company can give no assurance that in such an event, the Company would have, or be able to obtain, sufficient funds to pay all debt that the Company would be required to repay.

7  5/8% Senior Notes

On November 22, 2004, California Lyon issued $150.0 million principal amount of 7 5/8% Senior Notes due 2012 (the “7 5/8% Senior Notes”), resulting in net proceeds to the Company of approximately $148.5 million. Of the initial $150.0 million, $67.2 million in aggregate principal amount remained as of June 30, 2010 and December 31, 2009.

Interest on the 7 5 /8% Senior Notes is payable semi-annually on December 15 and June 15 of each year. Based on the current outstanding principal amount of the 7 5/8% Senior Notes, the Company’s semi-annual interest payments are $2.6 million.

The 7 5/8% Senior Notes are redeemable at the option of California Lyon, in whole or in part, at a redemption price equal to 100% of the principal amount plus a premium declining ratably to par, plus accrued and unpaid interest, if any.

10  3/4% Senior Notes

On March 17, 2003 California Lyon issued $250.0 million of 10 3/4% Senior Notes due 2013 (the “10 3/4% Senior Notes”) at a price of 98.493% to the public, resulting in net proceeds to the Company of approximately $246.2 million. The purchase price reflected a discount to yield 11% under the effective interest method and the notes have been reflected net of the unaccreted discount in the consolidated balance sheet. Of the initial $250.0 million, $168.3 million and $168.2 million aggregate principal amount remained outstanding as of June 30, 2010 and December 31, 2009, respectively. In July 2010, the Company repurchased, in a privately negotiated transaction, $10.5 million principal amount of its outstanding 10 3/4 % Senior Notes at a cost of $9.0 million plus accrued interest.

Interest on the 10 3 /4% Senior Notes is payable on April 1 and October 1 of each year. Based on the current outstanding principal amount of the 10 3/4% Senior Notes, the Company’s semi-annual interest payments $9.0 million.

The 10 3/4% Senior Notes are redeemable at the option of California Lyon, in whole or in part, at a redemption price equal to 100% of the principal amount plus a premium declining ratably to par, plus accrued and unpaid interest, if any.

7  1/2% Senior Notes

On February 6, 2004, California Lyon issued $150.0 million principal amount of 7 1/2% Senior Notes due 2014 (the “7 1/2% Senior Notes”), resulting in net proceeds to the Company of approximately $147.6 million. Of the initial $150.0 million, $84.7 million aggregate principal amount remained outstanding as of June 30, 2010 and December 31, 2009.

Interest on the 7 1 /2% Senior Notes is payable on February 15 and August 15 of each year. Based on the current outstanding principal amount of 7 1/2% Senior Notes the Company’s semi-annual interest payments are $3.2 million.

The 7 1/2% Senior Notes are redeemable at the option of California Lyon, in whole or in part, at a redemption price equal to 100% of the principal amount plus a premium declining ratably to par, plus accrued and unpaid interest, if any.

 

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WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

General Terms of the Senior Notes

The 7 5/8% Senior Notes, the 10 3/4% Senior Notes and the 7 1/2% Senior Notes (collectively, the “Senior Notes”) are senior unsecured obligations of California Lyon and are unconditionally guaranteed on a senior unsecured basis by William Lyon Homes, a Delaware corporation (“Delaware Lyon”), which is the parent company of California Lyon, and all of Delaware Lyon’s existing and certain of its future restricted subsidiaries. The Senior Notes and the guarantees rank senior to all of the Company’s and the guarantors’ debt that is expressly subordinated to the Senior Notes and the guarantees, but are effectively subordinated to all of the Company’s and the guarantors’ senior secured indebtedness to the extent of the value of the assets securing that indebtedness.

Upon a change of control as described in the respective Indentures governing the Senior Notes (the “Senior Notes Indentures”), California Lyon will be required to offer to purchase the Senior Notes at a purchase price equal to 101% of the principal amount, plus accrued and unpaid interest, if any.

If the Company’s consolidated tangible net worth falls below $75.0 million for any two consecutive fiscal quarters, California Lyon will be required to make an offer to purchase up to 10% of each class of Senior Notes originally issued at a purchase price equal to 100% of the principal amount, plus accrued and unpaid interest, if any.

California Lyon is 100% owned by Delaware Lyon. Each subsidiary guarantor is 100% owned by California Lyon or Delaware Lyon. All guarantees of the Senior Notes are full and unconditional and all guarantees are joint and several. There are no significant restrictions on the ability of Delaware Lyon or any guarantor to obtain funds from subsidiaries by dividend or loan.

The Senior Notes Indentures contain covenants that limit the ability of Delaware Lyon and its restricted subsidiaries to, among other things: (i) incur additional indebtedness; (ii) pay dividends or make other distributions or repurchase its stock; (iii) make investments; (iv) sell assets; (v) incur liens; (vi) enter into agreements restricting the ability of Delaware Lyon’s restricted subsidiaries (other than California Lyon) to pay dividends; (vii) enter into transactions with affiliates; and (viii) consolidate, merge or sell all or substantially all of Delaware Lyon’s and California Lyon’s assets. These covenants are subject to a number of important exceptions and qualifications as described in the Senior Notes Indentures.

As of and for the period ending June 30, 2010, the Company was in compliance with these covenants.

The foregoing summary is not a complete description of the Senior Notes and is qualified in its entirety by reference to the Senior Notes Indentures.

Supplemental consolidating financial information of the Company, specifically including information for California Lyon, the issuer of the Senior Notes, and Delaware Lyon and the guarantor subsidiaries is presented below. Investments in subsidiaries are presented using the equity method of accounting. Separate financial statements of California Lyon and the guarantor subsidiaries are not provided, as the consolidating financial information contained herein provides a more meaningful disclosure to allow investors to determine the nature of assets held and the operations of the combined groups.

Construction Notes Payable

At June 30, 2010, the Company had two construction notes payable totalling $23.9 million. One of the notes matures in July 2011 and bears interest at rates based on either LIBOR or prime with an interest rate floor of 6.5% and an outstanding principal balance of $13.9 million. Interest is calculated on the average daily balance and is paid following the end of each month.

The other construction note had a remaining balance at June 30, 2010 of $10.0 million, after giving effect to a partial prepayment of the note in the amount of $28.1 million that was made in May 2010. This note was previously due to mature in July 2010; however, in conjunction with the partial prepayment, the Company and the lender entered into a new loan agreement for the remaining outstanding principal of $10.0 million, which matures July 2015. The new loan pays interest monthly at a fixed rate of 12.5%, with quarterly principal payments of $0.5 million beginning in July 2010. The interest rate decreases to 10.0% when the principal balance is reduced to $7.5 million.

 

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WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

Seller Financing

At June 30, 2010, the Company had $10.7 million of notes payable outstanding related to a land acquisition for which seller financing was provided, which is included in notes payable in the accompanying consolidated balance sheet. The seller financing note is due at various dates through 2012 and bear interest at 7.0%. Interest is calculated on the principal balance outstanding and is accrued and paid to the seller at the time each residential unit is closed. In addition, the Company makes an annual interest payment on the outstanding principal balance related to any remaining residential units.

 

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Table of Contents

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

CONSOLIDATING BALANCE SHEET

June 30, 2010

(in thousands)

 

     Unconsolidated           
     Delaware
Lyon
   California
Lyon
    Guarantor
Subsidiaries
   Non-Guarantor
Subsidiaries
   Eliminating
Entries
    Consolidated
Company

ASSETS

Cash and cash equivalents

   $ —      $ 107,936      $ 133    $ 2,450    $ —        $ 110,519

Restricted cash

     —        3,892        —        —        —          3,892

Receivables

     —        11,361        318      3,454      —          15,133

Income tax refund receivable

     —        —          —        —        —          —  

Real estate inventories

               

Owned

     —        605,257        —        10,281      —          615,538

Not owned

     —        55,270        —        —        —          55,270

Investments in and advances to unconsolidated joint ventures

     —        2,295        —        —        —          2,295

Property and equipment, net

     —        1,362        —        —        —          1,362

Deferred loan costs

     —        14,500        —        —        —          14,500

Other assets

     —        4,462        203      —        —          4,665

Investments in subsidiaries

     137,578      4,002        —        —        (141,580     —  

Intercompany receivables

     —        —          204,082      11      (204,093     —  
                                           
   $ 137,578    $ 810,337      $ 204,736    $ 16,196    $ (345,673   $ 823,174
                                           

LIABILITIES AND EQUITY

Accounts payable

   $ —      $ 12,780      $ 27    $ 1,598    $ —        $ 14,405

Accrued expenses

     —        44,528        245      83      —          44,856

Liabilities from inventories not owned

     —        55,270        —        —        —          55,270

Notes payable

     —        34,551        —        —        —          34,551

Senior Secured Term Loan

     —        206,000        —        —        —          206,000

7 5/8 % Senior Notes

     —        67,204        —        —        —          67,204

10 3/4 % Senior Notes

     —        168,311        —        —        —          168,311

7 1/2 % Senior Notes

     —        84,701        —        —        —          84,701

Intercompany payables

     —        203,878        —        215      (204,093     —  
                                           

Total liabilities

     —        877,223        272      1,896      (204,093     675,298

Equity

               

Noncontrolling interest

     —        —          —        —        10,298        10,298

Stockholders’ equity (deficit)

     137,578      (66,886     204,464      14,300      (151,878     137,578
                                           
   $ 137,578    $ 810,337      $ 204,736    $ 16,196    $ (345,673   $ 823,174
                                           

 

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Table of Contents

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

CONSOLIDATING BALANCE SHEET

December 31, 2009

(in thousands)

 

     Unconsolidated           
     Delaware
Lyon
   California
Lyon
    Guarantor
Subsidiaries
   Non-Guarantor
Subsidiaries
   Eliminating
Entries
    Consolidated
Company
ASSETS

Cash and cash equivalents

   $ —      $ 115,247      $ 111    $ 2,229    $ —        $ 117,587

Restricted cash

     —        4,352        —        —        —          4,352

Receivables

     —        12,599        320      3,375      —          16,294

Income tax refunds receivable

     —        106,989        —        —        —          106,989

Real estate inventories

               

Owned

     —        515,102        —        8,234      —          523,336

Not owned

     —        55,270        —        —        —          55,270

Investments in and advances to unconsolidated joint ventures

     —        1,703        —        —        —          1,703

Property and equipment, net

     —        1,624        49      —        —          1,673

Deferred loan costs

     —        14,859        —        —        —          14,859

Other assets

     —        17,819        217      —        —          18,036

Investments in subsidiaries

     150,600      3,978        —        —        (154,578     —  

Intercompany receivables

     —        —          204,917      —        (204,917     —  
                                           
   $ 150,600    $ 849,542      $ 205,614    $ 13,838    $ (359,495   $ 860,099
                                           

LIABILITIES AND EQUITY

Accounts payable

   $ —      $ 8,914      $ 42    $ 2,090    $ —        $ 11,046

Accrued expenses

     —        44,814        397      83      —          45,294

Liabilities from inventories not owned

     —        55,270        —        —        —          55,270

Notes payable

     —        64,227        —        —        —          64,227

Senior Secured Term Loan

     —        206,000        —        —        —          206,000

7 5/8 % Senior Notes

     —        67,204        —        —        —          67,204

10 3/4 % Senior Notes

     —        168,158        —        —        —          168,158

7 1/2 % Senior Notes

     —        84,701        —        —        —          84,701

Intercompany payables

     —        204,829        —        88      (204,917     —  
                                           

Total liabilities

     —        904,117        439      2,261      (204,917     701,900

Equity

               

Noncontrolling interest

     —        —          —        —        7,599        7,599

Stockholders’ equity (deficit)

     150,600      (54,575     205,175      11,577      (162,177     150,600
                                           
   $ 150,600    $ 849,542      $ 205,614    $ 13,838    $ (359,495   $ 860,099
                                           

 

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Table of Contents

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

CONSOLIDATING STATEMENT OF OPERATIONS

Three Months Ended June 30, 2010

(in thousands)

 

     Unconsolidated             
     Delaware
Lyon
    California
Lyon
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminating
Entries
   Consolidated
Company
 

Operating revenue

             

Sales

   $ —        $ 79,916      $ 6,025      $ —        $ —      $ 85,941   

Construction services

     —          751        —          —          —        751   
                                               
     —          80,667        6,025        —          —        86,692   
                                               

Operating costs

             

Cost of sales

     —          (66,390     (5,991     13        —        (72,368 )

Impairment loss on real estate assets

     —          (291     —          —          —        (291

Construction services

     —          (674     —          —          —        (674 )

Sales and marketing

     —          (5,315     (424     (76     —        (5,815 )

General and administrative

     —          (5,483     (89     (12     —        (5,584 )

Other

     —          (1,004     —          —          —        (1,004 )
                                               
     —          (79,157     (6,504     (75     —        (85,736 )
                                               

Equity in income of unconsolidated joint ventures

     —          761        —          —          —        761   
                                               

(Loss) income from subsidiaries

     (4,538     (484     14        —          5,008      —     
                                               

Operating loss

     (4,538     (1,787     (465     (75     5,008      1,717   

Interest expense, net of amounts capitalized

     —          (6,213     —          —          —        (6,213 )

Other loss, net

     —          (41     (85     (37     —        (163 )
                                               

Loss before benefit from income taxes

     (4,538     (4,467     (550     (112     5,008      (4,659 )

Benefit from income taxes

     —          —          —          —          —        —     
                                               

Consolidated net loss

     (4,538     (4,467     (550     (112     5,008      (4,659 )

Less: Net loss—non-controlling interest

     —          —          —          —          121      121   
                                               

Net loss attributable to William Lyon Homes

   $ (4,538   $ (4,467   $ (550   $ (112   $ 5,129    $ (4,538 )
                                               

 

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Table of Contents

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

CONSOLIDATING STATEMENT OF OPERATIONS

Three Months Ended June 30, 2009

(in thousands)

 

     Unconsolidated     Eliminating
Entries
    Consolidated
Company
 
     Delaware
Lyon
   California
Lyon
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
     

Operating revenue

             

Sales

   $ —      $ 57,795      $ 7,417      $ 3,079      $ —        $ 68,291   

Construction services

     —        9,116        —          —          —          9,116   

Management fees

     —        144        —          —          (144     —     
                                               
     —        67,055        7,417        3,079        (144     77,407   
                                               

Operating costs

             

Cost of sales

     —        (50,727     (7,261     (2,657 )     144        (60,501

Loss on impairment of real estate assets

     —        —          —          —          —          —     

Construction services

     —        (7,842     —          —         —          (7,842

Sales and marketing

     —        (3,857     (474     (207 )     —          (4,538

General and administrative

     —        (4,479     (47     3       —          (4,523

Other

     —        (687     —          —         —          (687
                                               
     —        (67,592     (7,782     (2,861 )     144        (78,091
                                               

Equity in income of unconsolidated joint ventures

     —        413        —          —          —          413   
                                               

Income (loss) from subsidiaries

     39,676      (693     —          —          (38,983     —     
                                               

Operating (loss) income

     39,676      (817     (365     218       (38,983     (271

Interest expense, net of amounts capitalized

     —        (8,321     —          —         —          (8,321

Gain on retirement of debt

     —        49,043        —          —          —          49,043   

Other income (loss), net

     —        19        (867     73       —          (775
                                               

Income (loss) before benefit from income taxes

     39,676      39,924        (1,232     291        (38,983     39,676   

Benefit from income taxes

     —        —          —          —          —          —     
                                               

Consolidated net income (loss)

     39,676      39,924        (1,232     291        (38,983     39,676   

Less: Net loss—non-controlling interest

     —        —          —          —         (289     (289
                                               

Net income (loss) attributable to William Lyon Homes

   $ 39,676    $ 39,924      $ (1,232   $ 291      $ (39,272   $ 39,387   
                                               

 

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Table of Contents

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

CONSOLIDATING STATEMENT OF OPERATIONS

Six Months Ended June 30, 2010

(in thousands)

 

     Unconsolidated             
     Delaware
Lyon
    California
Lyon
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminating
Entries
   Consolidated
Company
 

Operating revenue

             

Sales

   $ —        $ 113,679      $ 10,124      $ —        $ —      $ 123,803   

Construction services

     —          6,052        —          —          —        6,052   
                                               
     —          119,731        10,124        —          —        129,855   
                                               

Operating costs

             

Cost of sales

     —          (93,899     (9,871     40        —        (103,730 )

Impairment loss on real estate assets

     —          (291     —          —          —        (291

Construction services

     —          (3,921     —          —          —        (3,921 )

Sales and marketing

     —          (8,652     (653     (97     —        (9,402 )

General and administrative

     —          (11,402     (163     (21     —        (11,586 )

Other

     —          (1,898     —          —          —        (1,898 )
                                               
     —          (120,063     (10,687     (78     —        (130,828 )
                                               

Equity in income of unconsolidated joint ventures

     —          1,173        —          —          —        1,173   
                                               

(Loss) income from subsidiaries

     (13,022     (546     12        —          13,556      —     
                                               

Operating (loss) income

     (13,022     295        (551     (78     13,556      200   

Interest expense, net of amounts capitalized

     —          (13,307     —          —          —        (13,307 )

Other income (loss), net

     —          58        (145     16        —        (71 )
                                               

Loss before benefit from income taxes

     (13,022     (12,954     (696     (62     13,556      (13,178 )

Benefit from income taxes

     —          65        —          —          —        65   
                                               

Consolidated net loss

     (13,022     (12,889     (696     (62     13,556      (13,113 )

Less: Net loss—non-controlling interest

     —          —          —          —          91      91   
                                               

Net loss attributable to William Lyon Homes

   $ (13,022   $ (12,889   $ (696   $ (62   $ 13,647    $ (13,022 )
                                               

 

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Table of Contents

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

CONSOLIDATING STATEMENT OF OPERATIONS

Six Months Ended June 30, 2009

(in thousands)

 

     Unconsolidated     Eliminating
Entries
    Consolidated
Company
 
     Delaware
Lyon
    California
Lyon
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
     

Operating revenue

            

Sales

   $ —        $ 111,785      $ 14,647      $ 4,939      $ —        $ 131,371   

Construction services

     —          15,375        —          —          —          15,375   

Management fees

     —          234        —          —          (234     —     
                                                
     —          127,394        14,647        4,939        (234     146,746   
                                                

Operating costs

            

Cost of sales

     —          (137,670     (14,079     (4,110 )     234        (155,625

Impairment loss on real estate assets

     —          (24,171     —          —          —          (24,171

Construction services

     —          (13,611     —          —          —          (13,611

Sales and marketing

     —          (7,286     (966     (412 )     —          (8,664

General and administrative

     —          (10,391     (144     (18 )     —          (10,553

Other

     —          (2,547     —          —          —          (2,547
                                                
     —          (195,676     (15,189     (4,540 )     234        (215,171
                                                

Equity in loss of unconsolidated joint ventures

     —          (1,310     —          —          —          (1,310
                                                

Loss from subsidiaries

     (29,614     (1,018     —          —          30,632        —     
                                                

Operating (loss) income

     (29,614     (70,610     (542     399       30,632        (69,735

Interest expense, net of amounts capitalized

     —          (17,033     —          —          —          (17,033

Gain on retirement of debt

     —          57,973        —          —          —          57,973   

Other income, loss net

     —          443        (1,119     (46 )     —          (722
                                                

(Loss) income before benefit from income taxes

     (29,614     (29,227     (1,661     353       30,632        (29,517

Benefit from income taxes

     —          22        —          —          —          22   
                                                

Consolidated net (loss) income

     (29,614     (229,205     (1,661     353       30,632        (29,495

Less: Net (loss) income—non-controlling interest

     —          —          —          —          (119     (119
                                                

Net (loss) income attributable to William Lyon Homes

   $ (29,614   $ (29,205   $ (1,661   $ 353     $ 30,513      $ (29,614
                                                

 

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Table of Contents

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

CONSOLIDATING STATEMENT OF CASH FLOWS

Six Months Ended June 30, 2010

(in thousands)

     Unconsolidated              
     Delaware
Lyon
    California
Lyon
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminating
Entries
    Consolidated
Company
 

Operating activities

            

Net loss

   $ (13,022   $ (12,889   $ (696   $ (62   $ 13,556      $ (13,113

Adjustments to reconcile net loss to net cash provided by (used in) operating activities:

            

Depreciation and amortization

     —          166        63        —          —          229   

Impairment loss on real estate assets

     —          291        —          —          —          291   

Equity in income of unconsolidated joint ventures

     —          (1,173     —          —          —          (1,173

Loss on disposition of fixed asset

     —                 122        —          —          122   

Equity in earnings of subsidiaries

     13,022        546        (12     —          (13,556     —     

Benefit from income taxes

     —          (65     —          —          —          (65

Net changes in operating assets and liabilities:

            

Restricted cash

     —          460        —          —          —          460   

Receivables

     —          1,238        2        (79     —          1,161   

Income tax refund receivable

     —          107,054        —          —          —          107,054   

Real estate inventories—owned

     —          (79,641     —          (2,047     —          (81,688

Deferred loan costs

     —          1,731        —          —          —          1,731   

Other assets

     —          13,357        14        —          —          13,371   

Accounts payable

     —          3,866        (15     (492     —          3,359   

Accrued expenses

     —          (286     (152     —          —          (438 )
                                                

Net cash provided (used in) by operating activities

     —          34,655        (674     (2,680     —          31,301   
                                                

Investing activities

            

Net change in investment in and advances to unconsolidated joint ventures

     —          581        —          —          —          581   

Purchases of property and equipment

     —          96        (136     —          —          (40

Investments in subsidiaries

     —          (570     12        —          558        —     
                                                

Net cash provided by (used in) investing activities

     —          107        (124     —          558        541   
                                                

Financing activities

            

Proceeds from borrowings on notes payable

     —          6,679        —          —          —          6,679   

Principal payments on notes payable

     —          (48,379     —          —          —          (48,379

Non-controlling interest contributions, net

     —          —          —          —          2,790        2,790   

Advances to affiliates

     —          —          (15     2,785        (2,770     —     

Intercompany receivables/payables

     —          (373     835        116        (578     —     
                                                

Net cash (used in) provided by financing activities

     —          (42,073     820        2,901        (558     (38,910
                                                

Net (decrease) increase in cash and cash equivalents

     —          (7,311     22        221        —          (7,068 )

Cash and cash equivalents at beginning of period

     —          115,247        111        2,229        —          117,587   
                                                

Cash and cash equivalents at end of period

   $ —        $ 107,936      $ 133      $ 2,450      $ —        $ 110,519   
                                                

 

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Table of Contents

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

CONSOLIDATING STATEMENT OF CASH FLOWS

Six Months Ended June 30, 2009

(in thousands)

 

     Unconsolidated              
     Delaware
Lyon
    California
Lyon
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries 
    Eliminating
Entries
    Consolidated
Company
 

Operating activities

            

Net (loss) income

   $ (29,614   $ (29,205   $ (1,661   $ 353      $ 30,632      $ (29,495

Adjustments to reconcile net income to net cash provided by operating activities:

            

Depreciation and amortization

     —          313        673        —          —          986   

Impairment loss on real estate assets

     —          24,171        —          —          —          24,171   

Equity in loss of unconsolidated joint ventures

     —          1,310        —          —          —          1,310   

Gain on retirement of debt

     —          (57,973     —          —          —          (57,973

Equity in earnings of subsidiaries

     29,614        1,018        —          —          (30,632     —     

Benefit from income taxes

     —          (22     —          —          —          (22

Net changes in operating assets and liabilities:

            

Restricted cash

     —          (79     —          —          —          (79

Receivables

     —          8,228        6,640        7,303        —          22,171   

Income tax refund receivable

     —          41,614        —          —          —          41,614   

Real estate inventories—owned

     —          84,132        —          2,838        —          86,970   

Deferred loan costs

     —          819        —          —          —          819   

Other assets

     —          (437     102        —          —          (335

Accounts payable

     —          (5,219     (31     (2,934     —          (8,184

Accrued expenses

     —          (15,051     (358     —          —          (15,409
                                                

Net cash provided by operating activities

     —          53,619        5,365        7,560        —          66,544   
                                                

Investing activities

            

Net change in investment in and advances to unconsolidated joint ventures

     —          (187     —          —          —          (187

Purchases of property and equipment

     —          62        (77     —          —          (15

Investments in subsidiaries

     —          2,785        —          —          (2,785     —     

Advances to affiliates

     —          (25,918     —          —          25,918        —     
                                                

Net cash used in investing activities

     —          (23,258     (77     —          23,133        (202
                                                

Financing activities

            

Proceeds from borrowings on notes payable

     —          60,529        11.352        —          —          71,881   

Principal payments on notes payable

     —          (91,337     (17,621     —          —          (108,958

Net cash paid for retirement of senior notes

     —          (25,310     —          —          —          (25,310

Minority interest contributions, net

     —          —          —          —          (5,148     (5,148

Advances to affiliates

     —          —          (514     (9,185     9,699        —     

Intercompany receivables/payables

     —          29,412        (1,170     (558     (27,684     —     
                                                

Net cash used in financing activities

     —          (26,706     (7,953     (9,743     (23,133     (67,535
                                                

Net increase (decrease) in cash and cash equivalents

     —          3,655        (2,665     (2,183     —          (1,193

Cash and cash equivalents at beginning of period

     —          59,285        2,898        4,834        —          67,017   
                                                

Cash and cash equivalents at end of period

   $ —        $ 62,940      $ 233      $ 2,651      $ —        $ 65,824   
                                                

 

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Table of Contents

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

Note 6 — Fair Value of Financial Instruments

In accordance with FASB ASC Topic 820, Fair Value Measurements and Disclosures (“ASC 820”), the Company is required to disclose the estimated fair value of financial instruments. As of June 30, 2010, the Company used the following assumptions to estimate the fair value of each type of financial instrument for which it is practicable to estimate:

 

   

Cash and Cash Equivalents — The carrying amount is a reasonable estimate of fair value. The Company’s cash balances primarily consist of short-term liquid investments and demand deposits.

 

   

Construction Notes Payable — On certain notes, the carrying amount is a reasonable estimate of fair value because the maturities occur within one year or the loan was renegotiated during the period. On certain other notes, the Company used Level 3 unobservable inputs, as defined below, to estimate fair value.

 

   

Seller Financing — The carrying amount is a reasonable estimate of fair value. The notes originated during the three months ended March 31, 2010.

 

   

Senior Secured Term Loan — The carrying amount is a reasonable estimate of fair value. The loan originated in October 2009 and due to the short time frame since the loan was funded, management of the Company believes a new loan of this type would have similar pricing, using level 3 inputs.

 

   

Senior Notes Payable — The senior notes are traded over the counter and their fair values were based upon quotes from industry sources except for the 10 3/4% Senior Notes due 2010, which is based on the price of a repurchase that occurred in July, 2010.

The estimated fair values of financial instruments are as follows (in thousands):

 

     June 30, 2010    December 31, 2009
     Carrying
Amount
   Fair
Value
   Carrying
Amount
   Fair
Value

Financial assets:

           

Cash and cash equivalents

   $ 110,519    $ 110,519    $ 117,587    $ 117,587

Financial liabilities:

           

Construction notes payable

   $ 23,899    $ 23,461    $ 64,227    $ 42,149

Seller financing

   $ 10,652    $ 10,652    $ —      $ —  

Senior Secured Term Loan due 2014

   $ 206,000    $ 206,000    $ 206,000    $ 206,000

7 5/8 % Senior Notes due 2012

   $ 67,204    $ 55,225    $ 67,204    $ 42,943

10 3/4 % Senior Notes due 2013

   $ 168,311    $ 144,310    $ 168,158    $ 120,233

7 1/2 % Senior Notes due 2014

   $ 84,701    $ 63,949    $ 84,701    $ 59,291

The Company has implemented the requirements of ASC 820 for the Company’s financial assets and liabilities. ASC 820 establishes a framework for measuring fair value, expands disclosures regarding fair value measurements, and defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820 requires the Company to maximize the use of observable market inputs, minimize the use of unobservable market inputs and disclose in the form of an outlined hierarchy the details of such fair value measurements. ASC 820 specifies a hierarchy of valuation techniques based on whether the inputs to a fair value measurement are considered to be observable or unobservable in a marketplace. The three levels of the hierarchy are as follows:

 

   

Level 1 — quoted prices for identical assets or liabilities in active markets;

 

   

Level 2 — quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; and model-derived valuations in which significant inputs and significant value drivers are observable in active markets; and

 

   

Level 3 — valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.

 

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Table of Contents

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

Non-financial Instruments

The Company adopted ASC 820 in 2008, however, disclosure of certain non-financial portions of the statement were deferred until the 2009 reporting period. These non-financial homebuilding assets are those assets for which the Company recorded valuation adjustments during the first half of 2009 on a nonrecurring basis. See Note 4, “Real Estate Inventories” for further discussion of the valuation of real estate inventories and within “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

The following table summarizes the fair-value measurements of its non-financial assets for the three and six months ended June 30, 2010:

 

      Fair Value
Hierarchy
   Fair  Value
at
Measurement
Date(1)
   Impairment
Charges
for the Three
and Six

Months Ended
June 30,

2010(1)
     (in thousands)

Land under development and homes completed and under construction(2)

   Level 3    $ 574    $ 291

 

(1) Amounts represent the aggregate fair values for communities where the Company recognized noncash inventory impairment charges during the period, as of June 30, 2010, the date that the fair value measurements were made. The carrying value for these communities may have subsequently increased or decreased from the fair value reflected due to activity that has occurred since the measurement date.
(2) In accordance with ASC 360, inventory under this caption with a carrying value of $0.9 million was written down to its fair value of $0.6 million at June 30, 2010, resulting in total impairments of $0.3 million for the period.

The following table summarizes the fair-value measurements of its non-financial assets for the six months ended June 30, 2009:

 

      Fair Value
Hierarchy
   Fair  Value
at
Measurement
Date(1)
   Impairment
Charges
for the  Six

Months Ended
June 30,

2009(1)
     (in thousands)

Land under development and homes completed and under construction(2)

   Level 3    $ 12,241    $ 10,818

Inventory held-for-sale(3)

   Level 3      7,822      13,353

 

(1) Amounts represent the aggregate fair values for communities where the Company recognized noncash inventory impairment charges during the period, as of March 31, 2009, the date that the fair value measurements were made. The carrying value for these communities may have subsequently increased or decreased from the fair value reflected due to activity that has occurred since the measurement date.
(2) In accordance with ASC 360, inventory under this caption with a carrying value of $23.1 million was written down to its fair value of $12.3 million at March 31, 2009, resulting in total impairments of $10.8 million for the period.
(3) In accordance with ASC 360, inventory under this caption with a carrying value of $21.2 million was written down to its fair value of $7.8 million at March 31, 2009, resulting in total impairments of $13.4 million.

Fair values determined to be level 3 include the use of internal assumptions, estimates and financial forecasts. Valuations of these items are therefore sensitive to the assumptions used. Fair values represent the Company’s best estimates as of the measurement date, based on conditions existing and information available at the date of issuance of the March 31, 2009 consolidated financial statements. Subsequent changes in conditions or information available may change assumptions and estimates, as outlined in more detail within “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Fair values determined using Level 3 inputs, were primarily based on the estimated future cash flows discounted for inherent risk associated with each asset. These discounted cash flows are impacted by: the risk-free rate of return; expected risk premium based on estimated land development; construction and delivery timelines; market risk from potential future price erosion; cost uncertainty due to development or construction cost increases; and other risks specific to the asset or conditions in the market in which the asset is located at the time the assessment is made. These factors are specific to each community and may vary among communities.

Note 7 — Related Party Transactions

On December 27, 2007, the Company sold certain land in San Diego County, California for $12.0 million in cash to a limited liability company owned indirectly by Frank T. Suryan, Jr. as Trustee for the Suryan Family Trust. Mr. Suryan is Chairman and Chief Executive Officer of Lyon Capital Ventures, a company wholly-owned by Frank T. Suryan, Jr., General William Lyon, Chairman and Chief Executive Officer of the Company, and a trust whose sole beneficiary is William H. Lyon, President and Chief Operating Officer of the Company. The Company received a report from a third-party valuation and financial advisory services firm as to the reasonableness of the sales price in the transaction. Further, the transaction was unanimously approved by all independent members of the Board of Directors. Prior to the sale, the net book value of this land (as reflected on the Company’s financial statements) was approximately $18.7 million resulting in a loss on the transaction of $6.7 million. In October 2008, in a separately negotiated transaction from the sale of the land to the Company owned indirectly by the Suryan Family Trust (the “Owner”), the Company was contracted by and for the Owner to build apartment units for a contract price of $13.5 million, which includes the Company’s contractor fee of $0.5 million. As described in Note 1, the Company accounts for this transaction based on the percentage of completion method, and recorded construction services revenue of $4.4 million and construction services costs of $4.2 million during the three months ended March 31, 2009, respectively. This project was completed during 2009 and therefore there are no comparable amounts during the three or six months ended June 30, 2010.

 

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Table of Contents

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

For the three and six months ended June 30, 2010, the Company incurred reimbursable on-site labor costs of $57,000 and $119,000, respectively, and for the three and six months ended June 30, 2009, the Company incurred reimbursable on-site labor-costs of $44,000 and $112,000, respectively, for providing customer service to real estate projects developed by entities controlled by William Lyon and William H. Lyon. At June 30, 2010 and December 31, 2009, $104,000 and $58,000, respectively, was due to the Company for reimbursable on-site labor costs.

The Company earned fees of $89,000 and $244,000, respectively, during the three and six months ended June 30, 2010 with no comparable amounts in 2009, related to a Human Resources and Payroll Services contract between the Company and an entity controlled by General William Lyon and William H. Lyon of which $88,000 was due to the Company at June 30, 2010.

For the three and six months ended June 30, 2010, the Company incurred charges of $197,000 and $393,000, respectively, related to rent on its corporate office, from a trust of which William H. Lyon is the sole beneficiary. For the three and six months ended June 30, 2009, the Company incurred charges of $197,000 and $393,000, respectively.

On September 3, 2009, Presley CMR, Inc., a California corporation (“Presley CMR”) and wholly owned subsidiary of California Lyon, entered into an Aircraft Purchase and Sale Agreement (“PSA”) with an affiliate of General William Lyon to sell the aircraft described above. The PSA provided for an aggregate purchase price for the Aircraft of $8.3 million, (which value was the appraised fair market value of the Aircraft), which consists of: (i) cash in the amount of $2.1 million to be paid at closing and (ii) a promissory note from the affiliate in the amount of $6.2 million, which is included in receivables in the accompanying consolidated balance sheet at June 30, 2010 and December 31, 2009. The closing of this sale occurred on September 9, 2009. The Company recorded a loss on the sale of the Aircraft totaling $3.0 million in 2009.

In 2004, the Company entered into an aircraft consulting and management agreement with an affiliate (the “Affiliate”) of William Lyon to operate and manage the Company’s aircraft. The terms of the agreement provided that the Affiliate shall consult and render its advice and management services to the Company with respect to all functions necessary to the operation, maintenance and administration of the aircraft. The Company’s business plan for the aircraft included (i) use by Company executives for traveling on Company business to the Company’s divisional offices and other destinations, (ii) charter service to outside third parties and (iii) charter service to William Lyon personally. Charter services for outside third parties are contracted for at market rates. As compensation to the Affiliate for its management and consulting services under the agreement, the Company pays the Affiliate a fee equal to (i) the amount equal to 107% of compensation paid by the affiliate for the pilots supplied pursuant to the agreement, (ii) $50 per operating hour for the aircraft and (iii) $9,000 per month for hangar rent. In addition, all maintenance work, inspections and repairs performed by the

 

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Table of Contents

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

Affiliate on the aircraft are charged to the Company at the Affiliate’s published rates for maintenance, inspections and repairs in effect at the time such work is completed. The total compensation paid to the Affiliate under the agreement amounted to $345,000 and $575,000, for the three and six months ended June 30, 2009, respectively.

Effective July 1, 2006, General William Lyon entered into a time sharing agreement (“the Agreement”) with the Company pertaining to his personal use of the aircraft. The agreement calls for General Lyon to reimburse the company for all costs incurred by the Company during his personal flights plus a surcharge on fuel consumption of two times the cost. Pursuant to the agreement, the Company had earned revenue of $39,000 and $53,000 for charter services provided to William Lyon personally, during the three and six months ended June 30, 2009, respectively.

Note 8 — Income Taxes

Effective January 1, 2008, the Company and its shareholders made a revocation of the “S” corporation election. As a result of this revocation, the Company was taxed as a “C” corporation. The shareholders will not be able to elect “S” corporation status until 2013. The revocation of the “S” corporation election allowed taxable losses generated in 2008 to be carried back to the 2006 “C” corporation year. As a result of the change in tax status, the Company recorded a deferred tax asset and related income tax benefit of $41.6 million as of January 1, 2008. In January 2009, the Company received the tax refund for the amount of the deferred tax asset.

On November 6, 2009, an expanded carry back election was signed into law as part of the Worker, Homeownership, and Business Assistance Act of 2009. As a result of this legislation, the Company elected to carry back for five years the taxable losses generated in 2009. As of December 31, 2009, the Company recorded an income tax refund receivable and the related income tax benefit of $101.8 million. As of March 31, 2010, the Company received the tax refund.

The Company accounts for income taxes in accordance with FASB ASC Topic 740, Income Taxes (“ASC 740”). ASC 740 prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be considered “more-likely-than-not” to be sustained upon examination by taxing authorities. The Company has taken positions in certain taxing jurisdictions for which it is more likely than not that previously unrecognized tax benefits will be recognized. In addition, the Company has elected to recognize interest and penalties related to uncertain tax positions in the income tax provision. In accordance with the provisions of ASC 740, effective January 1, 2007, the Company recorded an income tax refund receivable of $5.7 million and recognized the associated tax benefit as an increase in additional paid-in capital. In connection therewith, the Company recorded interest receivable of $1.1 million and recognized the associated tax benefit as an increase in retained earnings. Since recording the income tax refund, the Company has received refunds and accrued additional interest, leaving approximately $5.2 million of income tax refunds and interest receivable on the consolidated balance sheet at December 31, 2009. The Company received the balance of the refunds and interest, totaling $5.2 million in the first quarter of 2010. At December 31, 2009 and June 30, 2010, the Company has no unrecognized tax benefits.

In compliance with the Company’s election to recognize interest income (expense) and penalties related to uncertain tax positions in the income tax provision, $75,000 of interest income related to the income tax refund received, recorded under the provisions of ASC 740, is included in the benefit from income taxes of $65,000 for the six months ended June 30, 2010.

As of January 1, 2010, the Company has gross federal and state net operating loss carry forwards totaling approximately $39.2 million and $329.8 million respectively. Federal net operating loss carry forwards will expire after 2028; state net operating loss carry forwards begin to expire after 2013.

Due to the “change of ownership” provision of the Tax Reform Act of 1986, utilization of the Company’s net operating loss carry forwards may be subject to an annual limitation against taxable income in future periods. As a result of the annual limitation, a portion of these carry forwards may expire before ultimately becoming available to reduce future income tax liabilities.

 

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Table of Contents

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

The Company has federal alternative minimum tax credit carry forward of $2.7 million which do not expire.

In addition, as of January 1, 2010, the Company has unused built-in losses of $19.4 million which are available to offset future income and expire between 2010 and 2011. The utilization of these losses is limited to $3.9 million of taxable income per year; however, any unused losses in any year may be carried forward for utilization in future years through 2010 and 2011. The maximum cumulative unused built-in loss that may be carried forward through 2010 and 2011 is $11.5 million and $7.9 million, respectively. The Company’s ability to utilize the foregoing tax benefits will depend upon the amount of its future taxable income and may be limited under certain circumstances.

The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various state jurisdictions. The Company is subject to U.S. federal income tax examination for calendar tax years ending 2006 through 2009. The Company is subject to various state income tax examinations for calendar tax years ending 2005 through 2009.

Note 9 — Commitments and Contingencies

The Company’s commitments and contingent liabilities include the usual obligations incurred by real estate developers in the normal course of business. In the opinion of management, these matters will not have a material effect on the Company’s consolidated financial position, results of operations or cash flows.

 

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Table of Contents

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

The Company is a defendant in various lawsuits related to its normal business activities. In the opinion of management, disposition of the various lawsuits will have no material effect on the consolidated financial statements of the Company.

In some jurisdictions in which the Company develops and constructs property, assessment district bonds are issued by municipalities to finance major infrastructure improvements. As a land owner benefited by these improvements, the Company is responsible for the assessments on its land. When properties are sold, the assessments are either prepaid or the buyers assume the responsibility for the related assessments. Assessment district bonds issued after May 21, 1992 are accounted for under the provisions of 91-10, “Accounting for Special Assessment and Tax Increment Financing Entities” issued by the Emerging Issues Task Force of the Financial Accounting Standards Board on May 21, 1992, now codified as FASB ASC Topic 970-470, Real Estate – Debt, and recorded as liabilities in the Company’s consolidated balance sheet, if the amounts are fixed and determinable.

As of June 30, 2010, the Company had $3.9 million of outstanding irrevocable standby letters of credit to guarantee the Company’s financial obligations under certain land banking arrangements and other contractual arrangements in the normal course of business. The standby letters of credit were secured by cash as reflected by restricted cash on the accompanying consolidated balance sheet. The beneficiary may draw upon these letters of credit in the event of a contractual default by the Company relating to each respective obligation. These letters of credit generally have a stated term of 12 months and have varying maturities throughout 2010 and 2011, at which time the Company may be required to renew to coincide with the term of the respective arrangement.

The Company also had outstanding performance and surety bonds of $96.2 million at June 30, 2010 related principally to its obligations for site improvements at various projects. The Company does not believe that draws upon these bonds, if any, will have a material effect on the Company’s financial position, results of operations or cash flows.

The Company has provided unsecured environmental indemnities to certain lenders, joint venture partners and land sellers. In each case, the Company has performed due diligence on the potential environmental risks including obtaining an independent environmental review from outside environmental consultants. These indemnities obligate the Company to reimburse the guaranteed parties for damages related to environmental matters. There is no term or damage limitation on these indemnities; however, if an environmental matter arises, the Company could have recourse against other previous owners.

See Note 5 for additional information relating to the Company’s guarantee arrangements.

 

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Table of Contents

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

Land Banking Agreements

The Company enters into purchase agreements with various land sellers. In some instances, and as a method of acquiring land in staged takedowns, thereby minimizing the use of funds from the Company’s corporate financing sources and limiting the Company’s risk, the Company transfers its right in such purchase agreements to entities owned by third parties (land banking arrangements). These entities use equity contributions and/or incur debt to finance the acquisition and development of the lots. The entities grant the Company an option to acquire lots in staged takedowns. In consideration for this option, the Company makes a non-refundable deposit of 15% to 25% of the total purchase price. The Company is under no obligation to purchase the balance of the lots, but would forfeit remaining deposits and be subject to penalties if the lots were not purchased. The Company does not have legal title to these entities or their assets and has not guaranteed their liabilities. These land banking arrangements help the Company manage the financial and market risk associated with land holdings. ASC 810 requires the consolidation of the assets, liabilities and operations of the Company’s land banking arrangements that are VIEs, of which none existed at June 30, 2010 and December 31, 2009.

The Company participates in one land banking arrangement, which is not a VIE in accordance with ASC 810, but is consolidated in accordance with FASB ASC Topic 470, Debt (“ASC 470”). Under the provisions of ASC 470, the Company has determined it is economically compelled, based on certain factors, to purchase the land in the land banking arrangement, and therefore, must record the remaining purchase price of the land which is included in real estate inventories not owned and liabilities from inventories not owned in the accompanying balance sheet.

Consolidated real estate inventories-owned include land deposits under option agreements or land banking arrangements of $55.3 million at June 30, 2010 and December 31, 2009, respectively.

Summary information with respect to the Company’s consolidated land banking arrangements is as follows as of June 30, 2010 (dollars in thousands):

 

Total number of land banking projects

     1
      

Total number of lots

     625
      

Total purchase price

   $ 161,465
      

Balance of lots still under option and not purchased:

  

Number of lots

     248
      

Purchase price

   $ 55,270
      

Forfeited deposits if lots are not purchased

   $ 25,234
      

Note 10 — Subsequent Events

In July 2010, the Company repurchased, in a privately negotiated transaction $10.5 million principal amount of its outstanding 10 3/4% Senior Notes at a cost of $9.0 million plus accrued interest. The Lenders of the Term Loan have permitted this repurchase and have waived their right to require any prepayment of the Term Loan in connection therewith. The net gain resulting from this purchase, after giving effect to amortization of related deferred loan costs and other fees, was approximately $1.5 million.

 

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Table of Contents
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

WILLIAM LYON HOMES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

The following discussion of results of operations and financial condition should be read in conjunction with the consolidated financial statements and notes thereto included in Item 1, as well as the information presented in the Annual Report on Form 10-K for the year ended December 31, 2009.

Results of Operations

Beginning in 2006 and continuing into the beginning of 2009, the homebuilding industry experienced decreased demand for housing and declining sales prices. These conditions were the result of an erosion of homebuyer confidence which was driven by increases in unemployment, limited availability of mortgage financing due to stress in the mortgage and credit markets, price instability, increasing foreclosures and increased levels of housing inventory in the market. In the latter part of 2009 and into 2010, in certain of the Company’s markets, the Company has experienced steadying sales absorption rates, a decrease in sales incentives and an increase in base pricing, while homebuilding costs continue to decrease. However, in certain of the Company’s projects, the Company experienced slower absorption rates than anticipated during the three months ended June 30, 2010. Management of the Company will continue to monitor these projects and may decrease base pricing or increase sales incentives to stimulate homebuyer demand and improve sales absorption at these projects. The Company’s number of net new home orders per average sales location overall decreased to 10.1 for the three months ended June 30, 2010 compared to 10.3 for the three months ended June 30, 2009. In Southern California, net new home orders per average sales location decreased to 14.6 during the three months ended June 30, 2010 from 14.8 for the same period in 2009. In Arizona, net new home orders per average sales location decreased to 9.7 in the 2010 period from 14.0 for the same period in 2009. The Company’s cancellation rate increased slightly to 18% in the three months ended June 30, 2010, compared to 17% in the 2009 period, particularly impacted by Southern California of 19% in the 2010 period compared to 17% in the 2009 period. In addition, the Company is experiencing increased homebuilding gross margin percentages of 17.4% in the three months ended June 30, 2010, compared to 13.7% in the 2009 period particularly impacted by Southern California gross margins of 18.2% in the 2010 period compared to 14.7% in the 2009 period, Northern California gross margins of 26.0% in the 2010 period compared to 12.5% in the 2009 period and Nevada of 17.5% in the 2010 period compared to 18.5% in the 2009 period.

Comparisons of Three Months Ended June 30, 2010 to June 30, 2009

On a consolidated basis, the number of net new home orders for the three months ended June 30, 2010 decreased 29% to 192 homes from 269 homes for the three months ended June 30, 2009. The number of homes closed on a consolidated basis for the three months ended June 30, 2010, increased 15% to 233 homes from 202 homes for the three months ended June 30, 2009. On a consolidated basis, the backlog of homes sold but not closed as of June 30, 2010 was 202, down 33% from 301 homes a year earlier.

Homes in backlog are generally closed within three to six months. The dollar amount of backlog of homes sold but not closed on a consolidated basis as of June 30, 2010 was $83.5 million, up 13% from $74.2 million as of June 30, 2009. The cancellation rate of buyers who contracted to buy a home but did not close escrow at the Company’s projects was approximately 18% during the three months ended June 30, 2010 compared to 17% during the three months ended June 30, 2009. The inventory of completed and unsold homes was 83 homes as of June 30, 2010, up from 35 homes at June 30, 2009.

The average number of sales locations during the quarter ended June 30, 2010 was 19, down 27% from 26 in the comparable period a year ago.

The Company’s number of new home orders per average sales location overall decreased 2% to 10.1 for the three months ended June 30, 2010 as compared to 10.3 for the three months ended June 30, 2009. This was attributable to Southern California new home orders per average sales location which decreased from 14.8 per location at June 30, 2009 to 14.6 per location at June 30, 2010, Northern California, which decreased from 8.5 per location at June 30, 2009 to 5.2 per location at June 30, 2010, and Arizona for which the number of new home orders per average sales location decreased from 14.0 per location at June 30, 2009 to 9.7 per location at June 30, 2010 and by Nevada which increased to 6.7 per location during the 2010 period compared to 4.0 per location in the 2009 period.

 

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Table of Contents
     Three Months Ended
June 30,
    Increase (Decrease)  
     2010     2009     Amount     %  

Number of Net New Home Orders

        

Southern California

   117      133      (16   (12 )% 

Northern California

   26      34      (8   (24 )% 

Arizona

   29      70      (41   (59 )% 

Nevada

   20      32      (12   (38 )% 
                    

Total

   192      269      (77   (29 )% 
                    

Cancellation Rate

   18   17   (1 )%   
                    

Net new home orders in each segment decreased period over period. Many of the Company’s Southern California markets have seen a reduction in sales incentives, an increase in base pricing and an increase in weekly absorption. In Arizona, net new home orders decreased 59% from 70 in the 2009 period to 29 in the 2010 period. Arizona experienced a significant increase in homebuyer demand in 2009 with the introduction of the new home buyer federal tax credit. In addition, in the 2010 period, the Company’s Arizona projects are experiencing competition from the large number of bank foreclosures and short sales in the marketplace.

Cancellation rates increased to 18% for the three month period ended June 30, 2010 from 17% for the three month period ended June 30, 2009. The change includes an increase in the cancellation rate in Southern California to 19% in the 2010 period from 17% in the 2009 period, a decrease in Northern California to 13% in the 2010 period from 21% in the 2009 period, an increase in Arizona to 15% in the 2010 period from 5% in the 2009 period and a decrease in Nevada to 17% in the 2010 period from 32% in the 2009 period.

 

     Three Months Ended
June 30,
   Increase (Decrease)  
     2010    2009    Amount     %  

Average Number of Sales Locations

          

Southern California

   8    9    (1   (11 )% 

Northern California

   5    4    1      25

Arizona

   3    5    (2   (40 )% 

Nevada

   3    8    (5   (63 )% 
                  

Total

   19    26    (7   (27 )% 
                  

The average number of sales locations decreased in each homebuilding segment except Northern California during the 2010 period primarily due to (i) final deliveries in a project and (ii) management’s efforts to manage cash outflows by limiting the purchase of new lots in 2008 and 2009. However, in the last half of 2009 and into 2010, the Company has purchased additional lots for new projects, some of which are open sales locations.

 

     June 30,    Increase (Decrease)  
     2010    2009    Amount     %  

Backlog (units)

          

Southern California

   159    191    (32   (17 )% 

Northern California

   26    35    (9   (26 )% 

Arizona

   11    57    (46   (81 )% 

Nevada

   6    18    (12   (67 )% 
                  

Total

   202    301    (99   (33 )% 
                  

The Company’s backlog at June 30, 2010 decreased 33% from levels at June 30, 2009, primarily resulting from a decrease in average sales locations and an increase in homes closed during the period. The decrease in backlog at quarter end reflects a decrease in total net new order activity of 29% to 192 homes in the 2010 period from 269 homes in the 2009 period. The decrease in backlog also reflects the increase in the number of homes closed by 15% to 233 in the 2010 period from 202 in the 2009 period.

 

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     June 30    Increase (Decrease)  
     2010