**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-K**

**(Mark One)**

**x**                              ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe fiscal year ended December 31, 2004**

**OR**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe transition period from                        to                       **

**Commissionfile number: 0-17189**

**CALIFORNIA COASTAL COMMUNITIES, INC.**

(Exact name of registrantas specified in its charter)

| **Delaware**                                                     | **02-0426634**                        |
|------------------------------------------------------------------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) | (I.R.S. Employer  Identification No.) |
| **6 Executive Circle, Suite 250  Irvine, California**       | **92614**                             |
| (Address of  principal executive offices)                        | (Zip Code)                            |

 

Registrant’s telephonenumber, including area code:**(949) 250-7700**

Securities registeredpursuant to Section 12(b) of the Act:**NONE**

**Securities registered pursuant to Section 12(g) ofthe Act:**

**Common Stock, par value$.05 per share**

**(Title of Class)**

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.  YES x  NO o

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein,and will not be contained, to the best of registrant’s knowledge, in definitiveproxy or information statements incorporated by reference in Part III ofthis Form 10-K or any amendment to this Form 10-K.  YES x  NO o

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 12b-2 of the Act).  YES x  NO o

The aggregate market value of the voting stock held bynon-affiliates of the registrant as of March 1, 2005 was $158,225,281.

The number of shares of Common Stock outstanding as ofMarch 1, 2005 was 10,160,212.

**DOCUMENTSINCORPORATED BY REFERENCE**

Portionsof the registrant’s Proxy Statement for the 2005 Annual Meeting of Stockholdersare incorporated by reference into Part III of this Annual Report on Form 10-K.

 

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**PART I**

**Item 1.   Business**

**General**

California Coastal Communities, Inc. and itsconsolidated subsidiaries (the “Company”) is a residential land development andhomebuilding company with properties located primarily in southern California.The principal activities of the Company include: (i) obtaining zoning andother entitlements for land it owns or controls through purchase options andimproving the land for residential development; and (ii) designing,constructing and selling single-family residential homes in southernCalifornia. Once the residential land owned by the Company is entitled, theCompany may build homes, sell unimproved land to other developers orhomebuilders, sell improved land to homebuilders, or participate in jointventures with other developers, investors or homebuilders to finance andconstruct infrastructure and homes. During 2005, the Company will focus itsimmediate efforts to (i) obtain a Coastal Development Permit (“CDP”) fromthe California Coastal Commission (“Coastal Commission”) to build 349 homes onthe upper bench of the Bolsa Chica Mesa (“Upper Mesa”), as further describedbelow and in Note 3 to the Company’s Consolidated Financial Statements; and (ii) continueto expand its profitable homebuilding operations. However, the Company may alsoconsider other strategic and joint venture opportunities; and there can be noassurance that the Company will accomplish, in whole or in part, all or any ofthese strategic goals.

The Company’s executiveoffices are located at 6 Executive Circle, Suite 250, Irvine, California92614 (telephone: (949) 250-7700).

**PrincipalProperties**

The following sections describe the Company’sprincipal properties.

*Bolsa Chica.  *The BolsaChica Mesa is the principal property in the Company’s portfolio, representing62% of its assets as of December 31, 2004. The Bolsa Chica Mesa is one ofthe last large undeveloped coastal properties in southern California, and islocated in Orange County, approximately 35 miles south of downtown Los Angeles.Bolsa Chica is bordered on the north and east by residential development in theCity of Huntington Beach, to the south by open space and the Bolsa Chicawetlands, and to the west by Pacific Coast Highway, Bolsa Chica State Beach,and the Pacific Ocean. The Company owns approximately 351 acres of the 1,600acres of undeveloped land at Bolsa Chica. The Company’s holdings include 208acres on the Bolsa Chica Mesa, approximately 100 acres on, or adjacent to, theHuntington Mesa and 43 acres of lowlands.

In February 1997, the Company completed the saleof its approximately 880-acre Bolsa Chica lowlands, which had previouslybeen planned for the development of up to 900 homes and wetlands restoration,to the California State Lands Commission for $25 million. Under aninteragency agreement among various state and federal agencies, these agencieshave agreed to restore the Bolsa Chica wetlands habitat utilizing escrowedfunds from the Ports of Los Angeles and Long Beach. In January 2002, theCalifornia Coastal Commission and the State Lands Commission approved anapproximately $100 million wetlands restoration plan which is expected tosignificantly improve the views of many of the homes that the Company plans todevelop on the Bolsa Chica Mesa, as discussed below. Wetlands restorationconstruction is currently scheduled to commence in 2005.

The Company is currently pursuing approval of permitsfor development of 68 acres of its approximately 105-acre upper bench onthe Bolsa Chica Mesa (“Upper Mesa”). During 2002, the County of Orange approvedthe Company’s site plan and tentative tract map for development of 379single-family homes on 77 acres of the Upper Mesa. The Company submitted aCoastal Development Permit (“CDP”) application for the planned community, knownas “Brightwater”, to the Coastal Commission in November 2002. On October 13,2004, the Coastal Commission held a public hearing on the Company’s 

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CDP application. Followingcompletion of the public hearing, the Company withdrew its CDP application inorder to have additional time to work with Commissioners and their staff in aneffort to develop changes to the project which would be acceptable to theCommission.

In January 2005, the Company filed a newapplication with the Coastal Commission for a CDP consisting of 347 homes(subsequently amended to add two additional lots for a total of 349 homes) tobe built on 68 acres of the Upper Mesa. This new application reflectselimination of development in environmentally sensitive habitat areas andincreased buffers between the habitat areas and the proposed development. TheCompany made these substantial changes to its proposed development plan inresponse to issues raised with respect to the prior CDP application at theCoastal Commission’s October 13, 2004 hearing. These modificationsresulted in a nine-acre decrease in the proposed development area and acorresponding decrease of 30 homes in the plan. The Company expects that theCoastal Commission staff will issue their recommendation to the CoastalCommission in late March or early April 2005 and the Companycurrently expects that the Commission will hold a public hearing on the new CDPapplication in mid-April 2005. However, there can be no assurance thatfurther delays will not be encountered.

As a result of the modifications made to thedevelopment plans for the Upper Mesa and submitted to the Coastal Commission,further approval will be required by the County of Orange. In addition, theCompany expects that following any Coastal Commission approval of a developmentplan, there will be numerous specific conditions for planning items to becompleted prior to the issuance of a CDP. The Company currently expects that aCDP could be issued by the end of 2005, subject to satisfying the permitconditions. Ultimately, the Company does not believe that the CoastalCommission process will permanently prevent it from developing a plannedcommunity at Bolsa Chica; however, there can be no assurance in that regard, oras to (i) when development could commence, (ii) the number of acresor homes the Company will be permitted to develop, or (iii) the absence offurther litigation or administrative delay.

The Brightwater planned community is currentlyexpected to offer a broad mix of home choices, averaging 2,740 square feet andranging in size from 1,560 square feet to 4,000 square feet. The plan alsoincludes 37 acres of open space and conservation area on the 105-acreUpper Mesa. With only 349 homes on 68 acres of the Upper Mesa, the resultinglow-density plan equates to approximately 5 homes per acre, consistent andcompatible with the neighboring Huntington Beach communities. In addition, theCompany will offer to dedicate 51 acres of land on the Huntington Mesa to theCounty of Orange to complete the Harriett M. Wieder Linear Park, a 105-acreplanned regional park. The 1,200-acre Bolsa Chica Wetlands are fullypreserved and protected in accordance with previous agreements with the Stateof California and are not included in the Brightwater plan.

On August 12, 2004, an agreement to sell a 103-acreparcel of the Bolsa Chica Mesa known as the “Lower Bench” to the State’sWildlife Conservation Board (“WCB”) for $65 million was approved by the WCB. Thesale remains subject to shareholder approval and the terms of the agreementinclude an outside closing date of June 30, 2005. If the proposed sale iscompleted, WCB’s purchase of the property will be funded with bond proceedsauthorized by voter-approved Proposition 50, which was passed in November 2002.The Company has indicated that it will require Coastal Commission approval ofthe Brightwater development plan for the Upper Mesa prior to seekingshareholder approval and issuance of the CDP prior to closing the sale. Therefore,the Company has initiated discussions with the WCB to extend the outsideclosing date to December 31, 2005. However, there can be no assurancesthat the WCB agreement will be extended or that a sale transaction will ever becompleted.

If the Coastal Commission approves a CDP for the UpperMesa, the Company would then re-evaluate its projected profitability as itrelates to recorded deferred tax asset valuation allowance on net operatinglosses (“NOLs”) as required by SFAS No. 109. Such re-evaluation may resultin management concluding 

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that it is more likelythan not that the Company will realize its deferred tax assets, which wouldresult in a reversal of all or a portion of the related valuation allowance.

The Company’s valuation allowance on federal NOLs andother tax assets as of December 31, 2004 is approximately $43.2 million.Recognition of tax benefits from reductions in valuation allowancesattributable to any utilization or future potential utilization ofpre-Reorganization NOLs would be excluded from results of operations andcredited to capital in excess of par value. The portion of the valuationallowance attributable to federal pre-Reorganization NOLs is approximately$38.1 million as of December 31, 2004. Therefore, the Company would expectto reflect a tax benefit of $5.1 million in its statement of operations forreversal of valuation allowance on post-Reorganization NOLs and other taxassets and credit capital in excess of par value in the amount of $38.1 millionfor reversal of valuation allowance on pre-Reorganization NOLs if it concludesthat it is more likely than not that all the NOLs will ultimately be utilizedto offset operating income generated from the disposition of the Bolsa Chicaproperty. Preservation of the Company’s NOLs is dependent upon the enforcementof certain transfer restrictions on the Company’s common stock. Theserestrictions are set forth in the Company’s charter documents and stocktransfers are monitored for compliance purposes.

Upon completion of the Company’s recapitalization (the“Recapitalization”) in September 1997 as discussed in Note 1 to theConsolidated Financial Statements included in this Annual Report, the Companyapplied the accounting principles required by Fresh-Start Reporting and thecarrying value of land held for development (Bolsa Chica) was adjusted to fairvalue as of September 2, 1997. The fair value was determined in 1997 usingdiscounted estimated cash flows expected from the asset’s operations andeventual disposition. The Company updated its analysis at each year-end since1997, and has noted no indicators of impairment since that date.

In evaluating the recoverability of the carrying valueof Bolsa Chica, the Company considered the current status of developmentplanning for the Upper Mesa, including the likelihood of obtaining CoastalCommission approval for its CDP application, and the pending sale of the LowerBench in its probability-weighted approach to evaluating the recoverability ofthe carrying value of this asset under SFAS No. 144.

The Company’s application for a CDP from the CoastalCommission relates only to the Upper Mesa, where the Coastal Commission haspreviously approved residential development in four previous public hearings(1986, 1996, 1997 and 2000). Since the Coastal Commission, in its 2000 publichearing on Bolsa Chica, indicated that it would allow substantial developmenton the Upper Mesa and reiterated that some development was likely at its October 13,2004 public hearing, it appears likely that the Commission would allowreasonable development on the Upper Mesa in the future. A tentative tract mapand site plan for the Upper Mesa have been approved by the County of Orange. Changesmade to the plan since the County’s approval are anticipated to be acceptableto the County. Therefore, the Company believes that it will eventually bepermitted to reasonably develop the Upper Mesa; however there can be noassurance in that regard. Given that the Company has no debt which is securedby any of the Bolsa Chica property, and its current homebuilding operations areproviding cash flow, the Company expects to be able to continue pursuingreasonable development as long as necessary until it succeeds in obtainingpermits for development on the Upper Mesa. Alternatively, if the Company’s CDPis not approved, the Company expects to vigorously oppose any challenges toreasonable development of the Upper Mesa. Future costs incurred forcapitalizable development activities for the Bolsa Chica project will increasethe basis of the land. An estimate for these costs has been included in theCompany’s estimated undiscounted cash flow forecast used in its impairmentanalyses.

The following factsand assumptions were utilized by the Company in evaluating the potential valuewhich could be derived from development of the Bolsa Chica Upper Mesa:

·       TheUpper Mesa CDP application encompasses 349 homes aggregating approximately950,000 square feet.

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·       FollowingCoastal Commission approval, the Company expects it may take approximately sixto nine months to satisfy the Commission’s permit conditions which would be apre-requisite to issuance of a CDP.

·       Followingreceipt of a CDP, the Upper Mesa development is projected to take approximatelysix months for infrastructure and two to three years for home construction.

·       Newhome prices approximate $525 per square foot, including view and otherpremiums, in the local residential market (coastal Huntington Beach).

·       Thefinished lot component of home prices ranges from 60% to 65%.

·       Coststo improve the lots from their raw condition to finished lots approximate$120,000 per lot.

·       Homeprices in the coastal Huntington Beach area (as well as other Orange Countycoastal areas) appreciated approximately 20% during 2004. While demandcontinues to exceed the supply of housing, pressure for continued appreciationof home prices may be reduced by any significant increases in interest rates.

·       Generally,homebuilders expect to earn a gross profit of 8% of the sales price of homes.

Given the facts and assumptions described above, theCompany believes that the eventual development of the Upper Mesa will result inrealization of an amount that is substantially in excess of the $156.4 millionbook value presently reflected in the Company’s consolidated financial statements.From time to time, the Company has received outside appraisals on an “asdeveloped basis” which have supported the Company’s beliefs, although there canbe no assurance that those beliefs will be validated.

In accordance with the Company’s policy described inNote 2 to the Consolidated Financial Statements—Impairment of Long-LivedAssets, since the estimated undiscounted future cash flows from the proposedUpper Mesa development plan for 349 single-family homes and the proceeds whichwould be received if the pending sale of the Lower Bench to WCB is completedare expected to exceed its December 31, 2004 carrying value, the Companybelieves there has been no impairment.

The estimation processinvolved in the determination of value is inherently uncertain because itrequires estimates as to future events and market conditions. Such estimationprocess assumes the Company’s ability to complete development and dispositionof its real estate properties in the ordinary course of business based onmanagement’s present plans and intentions. Economic, market, environmental andpolitical conditions may affect management’s development and marketing plans.In addition, the implementation of such development and marketing plans couldbe affected by the availability of future financing for development andconstruction activities. The development of the Company’s Upper Mesa project isdependent upon various governmental approvals and economic factors.Accordingly, the amount ultimately realized from such project may differmaterially from current estimates and the project’s carrying value.

**Land Development—UnconsolidatedJoint Venture**

*Oxnard.  *In February 2003,the Company entered into two option contracts to acquire land adjacent to theCity of Oxnard in Ventura County, California aggregating approximately 168acres. The Company is in the process of developing a land plan for the area,which also includes an additional 149 acres owned by other landowners, with theintention of entitling the property for residential development and annexing itto the City of Oxnard. The Company currently expects that the residentialdevelopment plan will include approximately 880 single-family detached lots andapproximately 375 attached family residential units; however, these numbers aresubject to change during the course of the entitlement process. Approximately650 of the single-family lots and 250 of the attached units would be developedon the 168 acres of optioned land expected to be purchased by the Company. Theoption contracts allow for two years, plus up to three 

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additional years throughthe exercise of extensions, for the Company to complete these entitlementactivities in advance of consummating the purchase transactions. Theentitlement process is expected to be completed during the first quarter of2006; however, delays could be encountered. During January 2005, the firstsix-month option extensions were exercised. The option-holder has the right inits sole discretion to terminate the obligations under these option agreementsby forfeiting the cash deposits with no further financial responsibility.

During October 2003,the Company entered into a Limited Liability Company (“Oxnard LLC”) jointventure agreement with a major financial partner to pursue the Oxnarddevelopment opportunity. The Company assigned the land purchase optioncontracts to the Oxnard LLC. Hearthside Homes, Inc. (the Company’shomebuilding subsidiary) is the managing member of the Oxnard LLC, and hascontributed $500,000 to the venture. The non-managing member also made aninitial contribution of $500,000 to the venture. Capital contributions of up toan additional $4 million are to be made by the non-managing member. As of December 31,2004, the non-managing member had made an aggregate of approximately $2.6million of additional contributions. Under the Oxnard LLC operating agreement,if contributions in excess of $5 million are required and approved by themembers, the next $1 million would be contributed equally by the members. Totalcontributions of the non-managing member are generally limited to $5 million.After payment of a 10% preferred return on invested capital to each member,first tier profits are generally allocated 75% to the non-managing member and25% to the managing member and second tier profits and losses over $5 millionare generally allocated 50% to each member. The first $5 million of losses aregenerally allocated 80% to the non-managing member and 20% to the managingmember. While the Company exerts a large degree of influence over the venture,the non-managing member does have various participating rights such as approvalrights with regard to major business decisions. In addition, the Company is notthe primary beneficiary of the entity, therefore, the venture is notconsolidated.

**Homebuilding**

The Company’s homebuilding operations have increasedlot inventory during 2004, completing acquisitions of 265 single-familyresidential lots during the year, expanding into northern Los Angeles Countyand returning to the San Diego County market. The Company has also entered intoagreements to acquire an additional 357 lots in 2005. Although home prices inSouthern California have increased 20% to 30% annually over the last few years,the Company does not expect appreciation to continue at that rate, but ratherexpects modest increases of less than 10% over the next year. While the 135home deliveries for 2004 are less than the 154 homes delivered in 2003,homebuilding revenues and margins for 2004 exceeded 2003 results significantly.The Company’s active homebuilding projects are described below.

*Riverside*.   During 2003 and2004, the Company acquired 67 lots for a project known as “Jasper Ranch” nearthe city of Riverside, in Riverside County, in the master-planned communityknown as “Victoria Grove”. This well-established community is planned for atotal of 855 homes. The Company began construction of homes averaging 3,673square feet during the third quarter of 2003. The Company opened for sales onthese homes during June 2003. The Company delivered the first phase offive homes during the fourth quarter of 2003 at an average price ofapproximately $468,000, and an additional 38 homes during 2004, at an averageprice of approximately $612,000. The Company delivered six additional homesduring January and February 2005 and as of March 6, 2004, ninehomes are in escrow, four homes are available for sale and the remaining fivehomes are currently scheduled to be released for sale during the first half of2005.

*Chino.  *In May 2003,through a consolidated joint venture, the Company acquired 77 finished lots inChino, California in San Bernardino County. This infill site is part of a newcommunity known as “The Reserve”, encompassing 244 homes. Construction of homesaveraging approximately 3,320 square feet began during the fourth quarter of2003. The Company opened for home sales in February 2004, and delivered 65homes at an average price of $593,000 during 2004. As of March 6, 2005,three additional 

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homes have been delivered,one home is in escrow and the remaining eight homes are currently scheduled tobe released for sale during the first half of 2005.

During January 2004, the Company acquired 17additional finished lots in the City of Chino which are near, but not a part ofThe Reserve, and are not a part of the joint venture described above. TheCompany began construction of homes averaging 2,990 square feet during thefourth quarter of 2004. The Company opened for sales at this project during January 2005and 13 of the 17 homes are in escrow as of March 6, 2005.

*Rancho Santa Fe.  *In October 2003,the Company entered into an agreement to acquire 32 lots in a luxury golfcommunity known as Crosby Estates in the Rancho Santa Fe area of California inSan Diego County. The Company acquired eight of the lots during the fourthquarter of 2003, 18 additional lots during 2004 and expects to acquire thefinal six lots during March 2005. Two model homes are under constructionfor homes averaging approximately 3,370 square feet. The first phase of sixhomes was released for sale during February 2005 and as of March 6,2005, five homes are in escrow.

*Lancaster.  *The Companyacquired 104 lots in the city of Lancaster in northern Los Angeles Countyduring May 2004. The Company began construction of model homes averagingapproximately 2,800 square feet during the third quarter of 2004. The Companyopened for sales of the first phase in January 2005, and 10 homes are inescrow as of March 6, 2005. In 2004, the Company also purchased an optionto acquire an additional 70 lots in Lancaster, which is expected to occurduring the second quarter of 2005.

*Corona.  *The Companyacquired 83 lots in North Corona in May 2004. The Company expects to beginconstruction of homes averaging 3,250 square feet during the first quarter of2005.

*Joint Ventures.  *The Companyconducts its operations as either wholly-owned projects or through jointventures in which the joint venture partner typically provides more than amajority of the capital and/or financing required for the project. The Companyhas utilized joint ventures in order to increase access to sources of capital,financing and land. The Company expects to continue to utilize joint venturesin the future on a selective basis, taking into account other available sourcesof financing, project risk and the potential return to the Company. The use ofjoint ventures may vary in the future in order to enable the Company to controlan adequate supply of lots while minimizing capital commitments. The Companytypically is required to fund a small percentage of the capital requirements ofeach joint venture, which amount is included in other assets in the Company’sconsolidated balance sheets.

*Land Acquisition.  *TheCompany typically considers numerous factors when analyzing the suitability ofland for acquisition and development including, but not limited to, proximityto existing developed areas; population growth patterns; availability ofexisting community services (i.e., utilities, schools and transportation);employment growth rates; anticipated absorption rates for new housing; and theestimated cost of development. The Company tries to avoid speculative buildingby constraining project phase sizes, and entitlement risks by acquiringentitled land when practicable and acquiring lots through the use of options,development agreements and joint ventures with lot owners, when available onfavorable terms. Additionally, by forming joint ventures with various sourcesof capital, the Company has been able to obtain access to additional capitaland construction financing to expand the number of lots the Company controlsand to spread project risk.

*Product Design.  *The Companycontracts with a number of outside architects, designers, engineers,consultants and subcontractors. The Company believes that the use of thirdparties for the production of the final design, engineering and constructionreduces its costs, increases design innovation and quality, and reduces risks.The Company has a number of plans which it has used in various projects whichcan be re-used in new projects with appropriate modifications as necessary. TheCompany offers options and upgrades to provide its homebuyers withopportunities to customize their home to fit their lifestyle, the 

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extent of which variesdepending upon the project. However, structural and other changes which impactthe build time of the home are typically limited.

The Company creates architectural variety within itsprojects by offering numerous models, floor plans, and exterior styles in aneffort to enhance home values by creating diversified neighborhood appearanceswithin its projects. Generally, the Company selects the exterior finishes ofits homes subject to necessary architectural approvals. The Company offershomebuyers the opportunity to engage interior design consultants to personalizethe interior of their homes. Such services are offered at an additional cost tobuyers through third parties contracted with by the Company, or the servicesmay be provided through the homebuyer’s own consultants.

*Construction and Development.  *TheCompany acts as the general contractor for the construction of its projects.All construction work for the Company is performed by subcontractors. TheCompany’s employees coordinate the construction of each project and theactivities of subcontractors and suppliers, and subject their work to qualityand cost controls and compliance with zoning and building codes. Subcontractorstypically are retained on a phase-by-phase basis to complete construction at afixed price. Agreements with the Company’s subcontractors are generally enteredinto after competitive bidding on a project-by-project basis. The Company hasestablished relationships with a large number of subcontractors and is notdependent to any material degree upon the services of any one subcontractor.Decreasing availability of insurance coverage for subcontractors as well as theeffects of increased worker’s compensation insurance rates may have an adverseeffect on the availability of qualified subcontractors.

The Company develops its residential projects inseveral phases generally averaging approximately 6 to 15 homes per phase. TheCompany determines the number of homes to be built in the first phase and theappropriate price range. The first phase of home construction is typicallyrelatively small to reduce risk while the Company measures consumer demand.Construction generally does not begin until some sales have occurred, exceptfor construction of model homes and in some cases the first few additionalhomes. Subsequent phases are generally not started until 90% to 100% of thehomes in the previous phase have been sold. Sales prices in the second phaseare then adjusted to reflect market demand as evidenced by sales experience inthe first phase. With each subsequent phase, the Company continues toaccumulate data which enables the Company to make decisions on the pricing,timing and size of subsequent phases. Although the time required to complete aphase varies from development to development depending on the factors above andthe build time which in turn varies generally with the size and complexity ofthe home, the Company typically completes construction of a phase within one ofits developments in approximately five to eight months. The Company iscontinuously developing and refining its production practices in order toreduce cycle time within the construction process.

*Sales and Marketing.  *TheCompany typically builds, furnishes and landscapes model homes for eachresidential project and maintains on-site sales offices, which are usually openseven days a week once a project fully opens. The Company generally sells allof its homes through Company sales representatives working from the salesoffices located at the model homes used in each subdivision. When appropriate,the Company also uses cooperative brokers to sell its homes. The Companyconducts preliminary research concerning the credit status of each potentialhomebuyer in order to “pre-qualify” the homebuyer. Once the prospectivehomebuyer has been “pre-qualified” and there is a strong indication that thehomebuyer will qualify for a mortgage (although final loan approval is stillpending), the homebuyer must submit an “earnest money deposit” usually rangingfrom $4,000 to $5,000 and complete a purchase contract for the purchase oftheir home. The Company attempts to keep its contract cancellation rate low byattempting to pre-qualify prospective homebuyers and by allowing homebuyers tocustomize their homes at an early point in the purchase process. When homepurchase contracts are canceled, the Company seeks to identify alternatehomebuyers.

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The Company makes extensive use of advertising andpromotional resources, including newspaper and magazine advertisements,brochures, direct mail and the placement of strategically located signs.Because the Company’s projects are often within a multi-builder community, itis able to participate in community-wide advertising that highlights all of theprojects within the same community. The Company provides flooring and otheramenities and upgrades to its homebuyers through various vendors contracted bythe Company.

*Backlog and Inventory.  *TheCompany typically pre-sells homes prior to and during construction through homepurchase contracts requiring earnest money deposits or through reservation documentsrequiring reservation deposits. Generally, reservation deposits are refundable,but home purchase contracts are not cancelable unless the customer is unable tosell their existing home, qualify for financing or under certain othercircumstances. A home sale is placed in backlog status upon execution of such acontract and receipt of an earnest money deposit and is removed when suchcontracts are canceled as described above, or the home purchase escrow isclosed.

*Competition.  *The homebuilding industry is highly competitive and fragmented. The Company does nothave a significant market presence in any of the geographic areas where it iscurrently building homes or where it expects to build homes in the future. Mostof the Company’s competitors have substantially greater financial resourcesthan those of the Company, and they have much larger staffs and marketingorganizations. However, the Company believes that it competes effectively inits existing markets as a result of its product design, development expertise,and its reputation as a producer of quality homes. The Company has seen thefinancial resources of its competitors increase as a result of the industryconsolidation experienced in the past few years. As the Company enters anduntil it develops a reputation in a new market area, the Company can expect toface even more significant competitive pressures.

*Regulation.  *The housing andland development industries are subject to increasing environmental, building,zoning and real estate sales regulations by various federal, state and localauthorities. Such regulations affect home building by specifying, among otherthings, the type and quality of building materials that must be used, certainaspects of land use and building design, as well as the manner in which theCompany conducts sales activities and otherwise deals with customers. Suchregulations affect development activities by directly affecting the viabilityand timing of projects.

The Company must obtain the approval of numerousgovernment authorities which regulate such matters as land use and level ofdensity, the installation of utility services, such as water and wastedisposal, and the dedication of acreage for open space, parks, schools andother community purposes. If such authorities determine that existing utilityservices will not adequately support proposed development (including possiblyin ongoing projects), building moratoria may be imposed. As a result, theCompany devotes an increasing amount of time to evaluating the impact ofgovernmental restrictions imposed upon a new residential development.Furthermore, as local circumstances or applicable laws change, the Company maybe required to obtain additional approvals or modifications of approvals previouslyobtained or even stop all work. Such increasing regulation may result in asignificant increase in time (and related carrying costs) between the Company’sinitial acquisition of land and the commencement and completion of itsdevelopments. In addition, the extent to which the Company participates in landdevelopment activities subjects it to greater exposure to regulatory risks.

*Raw Materials.  *Typically allthe raw materials and most of the components used in the Company’s business arereadily available in the United States. Most are standard items carried bymajor suppliers. However, a rapid increase in the number of homes started couldcause shortages in the availability of such materials or in the price ofservices, thereby leading to delays in the delivery of homes underconstruction. In addition, increases in the price of lumber and other materialshave a negative impact on margins. In the last six months, the Company hasexperienced some delays, shortages and price increases for many raw materialscomponents. Notably, lumber, concrete, insulation, and drywall products havebeen significantly 

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affected in both price andavailability. The Company has minimized the delays based on its long-termrelationships with subcontractors and suppliers.

*Homeowner Warranty and MortgageCompany Services.  *The Company provides homeowners witha limited warranty on the terms of which the Company will warrant, for alimited period, items listed in the homeowner warranty manual. The warrantydoes not, however, include items that are covered by manufacturer’s warranties(such as appliances and air conditioning) or items that are not installed byemployees or contractors of the Company (such as flooring installed by anoutside contractor employed by the homeowner). Statutory requirements inCalifornia may grant to homebuyers rights in addition to those provided by theCompany. The Company also offers mortgage broker services to certain of itsCalifornia homebuyers through its unconsolidated joint venture with anaffiliate of Wells Fargo Home Mortgage.

**Environmental andRegulatory Matters**

Before the Company can develop a property, it mustobtain a variety of discretionary approvals from local and state governments,as well as the federal government in certain circumstances, with respect tosuch matters as zoning, subdivision, grading, architecture and environmentalmatters. The entitlement approval process is often a lengthy and complexprocedure requiring, among other things, the submission of development plansand reports and presentations at public hearings. Because of the provisionalnature of these approvals and the concerns of various environmental and publicinterest groups, the approval process can be delayed by withdrawals ormodifications of preliminary approvals and by litigation and appealschallenging development rights. Accordingly, the ability of the Company todevelop properties and realize income from such projects could be delayed orprevented due to litigation challenging previously obtained governmentalapprovals. The Company may also be subject to periodic delays or may beprecluded entirely from developing in certain communities due to buildingmoratoriums or “slow-growth” or “no-growth” initiatives that could beimplemented in the future.

The Company is currently seeking a Coastal DevelopmentPermit from the Coastal Commission to build 349 homes on the Upper Mesa. TheCompany currently expects that the Coastal Commission will hold a publichearing on the Company’s permit application in mid-April 2005. Therefore,the regulatory approval process for the Bolsa Chica Mesa property remainssubject to further Coastal Commission approval, and there can be no assurancethat further delays will not result.

The Company has expended and will continue to expendsignificant financial and managerial resources to comply with environmentalregulations and local permitting requirements. Although the Company believesthat its operations are in general compliance with applicable environmentalregulations, certain risks of unknown costs and liabilities are inherent in developingand owning real estate. The Company does not believe that such costs will havea material adverse effect on its business, financial condition or results ofoperations, including the potential remediation expenditures proposed inconnection with certain indemnity obligations discussed below in CorporateIndemnification Matters and in Item 3. Legal Proceedings. However, thecurrently identifiable risks and uncertainties regarding the 43-acrelowlands property and other matters with recorded reserves are discussed inItem 3. Legal Proceedings and Note 6 to the Consolidated Financial Statementsincluded in this Annual Report.

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**CorporateIndemnification Matters**

The Company and its formeraffiliates have, through a variety of transactions effected since 1986,disposed of several assets and businesses, many of which are unrelated to theCompany’s current operations. By operation of law or contractual indemnityprovisions, the Company may have retained liabilities relating to certain ofthese assets and businesses. There is generally no maximum obligation or amountof indemnity provided for such liabilities. A portion of such liabilities issupported by insurance or by indemnities from certain of the Company’spreviously affiliated companies. The Company believes its balance sheetreflects adequate reserves for these matters. (See Item 3. Legal Proceedingsand Note 6 to the Consolidated Financial Statements regarding contingentindemnity and environmental obligations.)

**Employees**

As of March 1, 2005the Company and its subsidiaries had 48 employees.

**Safe Harbor, Statement Under the Private SecuritiesLitigation Reform Act of 1995**

Certain of the foregoinginformation and the information following this Item 1 contains forward-lookingstatements within the meaning of Section 21E of the Securities ExchangeAct of 1934, that relate to future events or the Company’s future financialperformance. In addition, other statements the Company may make from time totime, such as press releases, oral statements made by Company officials andother reports the Company files with the Securities and Exchange Commission,may also contain such forward-looking statements. Undue reliance should not beplaced on these statements, which involve known and unknown risks,uncertainties and other factors which may cause the Company’s actual results,performance or achievements to be materially different from any future results,performances or achievements expressed or implied by the forward-lookingstatements. In some cases, you can identify forward-looking statements byterminology such as “may”, “will”, “should”, “expects”, “plans”, “anticipates”,“believes”, “estimates”, “predicts”, “potential”, “continue”, or the negativeof such terms or other comparable terminology.

These forward-lookingstatements include, but are not limited to, (1) statements about theCompany’s strategies, plans, objectives, goals, expectations and intentions; (2) thenumber and types of homes and number of acres of land that the Company maydevelop and sell; (3) the timing and outcomes of litigation, regulatoryapproval processes or administrative proceedings, which may result in delays inthe land entitlement, development, construction, or the opening of new homecommunities (including, but not limited to ongoing administrative proceedingsrelated to the Company’s principal asset, the Bolsa Chica Mesa); (4) theCompany’s ability to realize the value of its net operating loss carryforwards; (5) the completion of the pending $65 million sale of the lowerbench of the Bolsa Chica Mesa to the State of California Wildlife ConservationBoard; (6) the Company’s ability to continue relationships with current orfuture partners; (7) the Company’s ability to expend resources to complywith environmental regulations and local permitting requirements; (8) theeffect of certain costs, contractual obligations and tax liabilities, both knownand unknown, on the Company’s business, results of operations and financialcondition; (9) the condition and adequacy of the Company’s properties; (10) theCompany’s ability to estimate cash flow projections due to uncertainties invaluing real property; (11) the Company’s ability to acquire residentiallots in order to continue homebuilding operations; (12) the adequacy ofcapital, financing and cash flow required to continue the Company’s operationsand land development activities; (13) the future condition of the realestate market in Southern California; (14) the ability to react toincreases or decreases in demand for housing and to rapidly take advantage oflocal market opportunities as they arise; (15) local and general economicand market conditions, including consumer confidence, employment rates,interest rates, the cost and availability of mortgage financing and stockmarket, home and land valuations; (16) competition; (17) theavailability and cost of raw materials used by the Company in its homebuildingoperations; (18) home building litigation and warranty claims; (19) shortagesand the cost of labor; (20) adverse weather and natural disaster relatedslowdowns; (21) slow growth and no growth initiatives or moratoria; (22) governmentalregulation, including the interpretation of tax, labor and 

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environmentallaws; (23) accounting changes including the expected impact of newaccounting pronouncements; (24) the effectiveness and adequacy of theCompany’s disclosure and internal controls; (25) the impact on economicconditions of terrorist attacks or the outbreak or escalation of armed conflictinvolving the United States; (26) other factors over which the Company haslittle or no control; and (27) other statements contained in thisForm 10-K that are not historical facts.

The Company assumes no,and hereby disclaims any, obligation to update any of the foregoing or anyother forward-looking statements. The Company nonetheless reserves the right tomake such updates from time to time by press release, periodic report or othermethod of public disclosure without the need for specific reference in thisForm 10-K or the 2004 Annual Report to Stockholders. No such update shallbe deemed to indicate that other statements not addressed by such update remaincorrect or create an obligation to provide any other updates.

**Item2.**                        Properties

The Company’s principalexecutive offices are located in Irvine, California. The Company and each ofits subsidiaries believe that their properties are generally well maintained,in good condition and adequate for their present and proposed uses. Theinability to renew any short-term real property lease would not beexpected to have a material adverse effect on the Company’s results ofoperations.

The principalproperties of the Company and its subsidiaries, which are owned in fee unlessotherwise indicated, are as follows:
| **Property**                            | ** ** | ** **           | ** ** | ** ** | **Location** | ** ** | ** **                       | ** ** | **Acres** | ** ** | ** ** | ** ** | **Present or Planned Use** | ** ** |
|-----------------------------------------|------------|----------------------|------------|------------|--------------|------------|----------------------------------|------------|-----------|------------|------------|------------|----------------------------|------------|
| Bolsa Chica—Upper Mesa             |       | Orange County, CA    |       | 105        |         |       | Ocean view residential community |
| Bolsa Chica—Lower Mesa             |       | Orange County, CA    |       | 103        |         |       | Pending sale to WCB              |
| Bolsa Chica-Huntington Mesa and lowland |       | Orange County, CA    |       | 143        |         |       | Raw land                         |
| Subtotal Bolsa Chica                    |       |                 |       | 351        |         |       |                             |
| Victoria Grove                          |       | Riverside County, CA |       | 5          |         |       | Residential community            |
| The Reserve                             |       | Chino, CA            |       | 1          |         |       | Residential community            |
| Crosby Estates                          |       | Rancho Santa Fe, CA  |       | 14         |         |       | Residential golf community       |
| Providence Ranch                        |       | Lancaster, CA        |       | 23         |         |       | Residential community            |
| Chandler Ranch                          |       | Corona, CA           |       | 15         |         |       | Residential community            |
| Irvine*                                 |       | Irvine,  CA          |       | —     |         |       | Headquarters                     |

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*                    Leased

**Item3.**                        LegalProceedings

In September 1997,the Company acquired 43 acres in the Bolsa Chica lowlands with the intent ofselling it to the State of California in connection with their plannedrestoration of 1,000 acres of adjacent wetlands. While the State is negotiatingto acquire this property from the Company, no such agreement has been reachedto date and there can be no assurances that any agreement will ever be reached.However, in anticipation of entering into a purchase agreement, the Stateperformed limited soils sampling on this property and notified the Company in1999 that it had discovered contamination from a group of chemicals calledPCBs. The source of the contamination is presently unknown; however, theCompany has never conducted any development, business or operations on thisproperty. In January 2002, the State’s Department of Toxic SubstancesControl (“DTSC”) became the regulatory agency responsible for overseeing theCompany’s efforts to remediate the contamination on this property. In July 2002,a subsidiary of the Company entered into a consent order with DTSC regardingremediation. The Company’s subsidiary prepared a Remedial Investigation (“RI”)Workplan, which was approved by DTSC in August 2003. During September andDecember 2003, the subsidiary performed soil sampling at the siteaccording to the RI Workplan to determine the nature and extent ofcontamination, and submitted an RI report to DTSC in February 2004. As of December 31,2004, the subsidiary has accrued approximately $800,000 for environmentaltesting and remediation of this property. While the accrual reflects the 

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estimatefor the minimum costs which are probable and estimable, such accrual may not beadequate to satisfy the full amount of remediation that may be required by theDTSC. A Remedial Action Workplan was approved by DTSC in December 2004.

In May 2004, theCompany’s subsidiary received an invoice from DTSC seeking reimbursement for$793,000 of oversight and remediation costs incurred by DTSC with respect toPCBs found on neighboring residential properties. Since receiving the originalinvoice, the Company’s subsidiary has received three similar invoices for anaggregate additional $78,000, including accrued interest. However, the Company’ssubsidiary contends, based upon advice of counsel, that it is not responsiblefor such costs because the Company did not develop or build the neighboringresidential properties, the Company did not generate the contamination, thecontamination did not emanate from the Company’s property and the 43-acresite should not be part of the same “site” as the residential properties.Furthermore, the Company’s subsidiary has also disputed such charges due to thefact that DTSC did not bill the Company’s subsidiary in accordance with therequirements of the applicable law. The Company’s subsidiary intends tovigorously defend itself in this matter. Therefore, the Company has not accruedfor any of DTSC’s $871,000 of claims related to these residential properties.

The Company’s consolidatedbalance sheet includes reserves for contingent indemnity obligations forcertain businesses disposed of by former affiliates and unrelated to theCompany’s current operations. In May 2002, Dresser Industries, Inc. (“Dresser”)filed litigation, captioned Dresser Industries, Inc. vs. CaliforniaCoastal Communities, Inc. and RESCO Holdings, Inc. (“RESCO”, a formeraffiliate), in the 58th Judicial District Court of Jefferson County,Texas. Dresser seeks a declaratory judgment regarding the rights andobligations of the parties under a January 1988 purchase agreement. Underthe agreement, Dresser acquired an engineering and construction business fromThe M.W. Kellogg Company (“Kellogg”), a corporation formerly affiliated withthe Company. Kellogg and its parent company, Wheelabrator Technologies, Inc.(“Wheelabrator”), agreed to indemnify Dresser against certain pre-closingclaims. In a subsequent transaction, Wheelabrator assigned certain assets andliabilities relating to the January 1988 purchase agreement to theCompany. Dresser also seeks unspecified damages for breach of the 1988 purchaseagreement, along with attorney’s fees and costs. Dresser’s indemnity claims relateto several hundred lawsuits encompassing approximately 5,900 contested asbestosclaims made by third parties in connection with work in facilities in which theDresser-acquired engineering and construction business was allegedly connected.

The Company denied Dresser’sallegations and vigorously defended itself in this case and related matters.The Company was not formed until September 1988 and, upon being spun offfrom Wheelabrator in December 1988, the Company agreed to indemnifyWheelabrator for its potential liabilities under the January 1988 purchaseagreement with Dresser, to the extent that any such liabilities are not coveredby insurance. However, the Company and RESCO contend that under the terms ofthe January 1988 purchase agreement, any contractual duty to indemnifyDresser for any third-party asbestos claims expired in March 1991.

In September 2004, RESCOand the Company reached an agreement in principle with Dresser to settle thislitigation, subject to negotiation of a definitive settlement agreement. TheCompany is continuing to negotiate with Dresser, RESCO and RESCO’s insurer inan effort to finalize the settlement agreement. The Company’s share of thesettlement is $1.33 million and is the amount of the Company’s litigationaccrual as of December 31, 2004. The Company and RESCO are not admittingfault or liability with respect to Dresser’s claims, but are negotiating tosettle the matter in order to avoid the continued cost and uncertainty oflitigation. However, in the event thatfinal settlement is not accomplished and the Company is required to provideindemnification to Dresser, defense costs and damage awards in asbestos casescan involve amounts that would have a material adverse effect on the Company’sbusiness, operations and financial condition.

**Item4.**                        Submissionof Matters to a Vote of Security Holders

None.

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**PART II**

**Item 5.**                        Marketfor Registrant’s Common Equity, Related Stockholder Matters and IssuerPurchases of Equity Securities

Thefollowing tables set forth information with respect to bid quotations for theCommon Stock of the Company for the periods indicated as reported on the NasdaqNational Market. These quotations are interdealer prices without retail markup,markdown or commission and may not necessarily represent actual transactions.
| ** **     | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------|------------|----------|------------|---------|------------|
| **2004**       |       |     |       |    |       |
| First Quarter  |       | $        | 18.70      |    | $          | 10.50 |   |
| Second Quarter |       | $        | 20.55      |    | $          | 14.00 |   |
| Third Quarter  |       | $        | 22.85      |    | $          | 17.50 |   |
| Fourth Quarter |       | $        | 24.50      |    | $          | 18.01 |   |
| **2003**       |       |     |       |    |       |
| First Quarter  |       | $        | 6.50       |    | $          | 5.26 |   |
| Second Quarter |       | $        | 6.69       |    | $          | 5.82 |   |
| Third Quarter  |       | $        | 8.91       |    | $          | 6.55 |   |
| Fourth Quarter |       | $        | 11.10      |    | $          | 8.70 |   |

 

The number of beneficialholders of the Company’s Common Stock as of March 1, 2005 wasapproximately 1,700. The Company has not paid any cash dividends on its CommonStock to date, nor does the Company currently intend to pay regular cashdividends on the Common Stock.

**Item 6.**                        SelectedFinancial Data

The Selected FinancialData with respect to the Company and its subsidiaries are set forth on page 24of this Annual Report.

**Item 7.**                        Management’sDiscussion and Analysis of Financial Condition and Results of Operations

Management’s Discussionand Analysis of Financial Condition and Results of Operations is set forthbeginning on page 24 of this Annual Report.

**Item 7A.**                Quantitativeand Qualitative Disclosures About Market Risk

The Company utilizesproject debt financing for acquisition, development and construction of homes.The interest rates on the Company’s project debt approximate the current ratesavailable for secured real estate financing with similar terms and maturities,and as a result, their carrying amounts approximate fair value. While changesin interest rates generally do not impact the fair market value of the debtinstrument, they do affect the Company’s earnings and cash flows. Holding theCompany’s variable rate debt balance constant as of December 31, 2004,each one point percentage increase in interest rates would result in anincrease in variable rate interest incurred for the coming year ofapproximately $230,000.

**Item 8.**                        FinancialStatements and Supplementary Data

Consolidated financialstatements, schedules and supplementary data of the Company and itssubsidiaries, listed under Item 15, are submitted as a separate section of thisAnnual Report, commencing on page F-2.

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**Item 9.**                        Changesin and Disagreements With Accountants on Accounting and Financial Disclosure

None

**Item 9A.**                Controlsand Procedures

The Company performed an evaluation under thesupervision and with the participation of the Company’s management, includingthe Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of theeffectiveness of the design and operation of the Company’s disclosure controlsand procedures, as defined in Rule 13a-15(e) under theSecurities Exchange Act of 1934 (“the Exchange Act”). Based on that evaluation,the Company’s CEO and CFO concluded that the Company’s disclosure controls andprocedures were effective as of December 31, 2004 to ensure thatinformation relating to the Company (including its consolidated subsidiaries)required to be disclosed in the Company’s reports filed or submitted by the Companyunder the Exchange Act is recorded, processed, summarized and reported withinthe time periods specified in the SEC’s rules and forms. As a result ofthis evaluation, there have been no significant changes in the Company’sinternal control over financial reporting during the three months ended December 31,2004 that have materially affected, or are reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.

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**MANAGEMENT’S REPORT**ONINTERNAL CONTROL OVER FINANCIAL REPORTING

The management, (“Management”) of California CoastalCommunities, Inc. and its subsidiaries (“the Company”) is responsible forestablishing and maintaining adequate internal control over financial reportingfor the Company. Internal control over financial reporting is a processdesigned by, or under the supervision of, the Company’s principal executive andprincipal financial officers, and effected by the Company’s board of directors,management and other personnel, to provide reasonable assurance regarding thereliability of financial reporting and the preparation of the Company’sfinancial statements for external purposes in accordance with generallyaccepted accounting principles.

The Company’s internal control over financialreporting includes those policies and procedures that (1) pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions of the company; (2) provide reasonable assurance thattransactions are recorded as necessary to permit preparation of financialstatements in accordance with generally accepted accounting principles, andthat receipts and expenditures of the Company are being made only in accordancewith authorizations of management and directors of the Company; and (3) providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use or disposition of the Company’s assets that could have amaterial effect on the financial statements.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Projectionsof any evaluation of effectiveness to future periods are subject to the riskthat controls may become inadequate because of changes in conditions, or thatthe degree of compliance with the policies or procedures may deteriorate.

Management assessed the effectiveness of the Company’sinternal control over financial reporting as of December 31, 2004. Inmaking this assessment, Management used the criteria set forth by the Committeeof Sponsoring Organizations of the Treadway Commission (COSO) in *Internal Control—Integrated Framework*. Based on itsassessment, Management has concluded that, as of December 31, 2004, theCompany’s system of internal control over financial reporting was effective.

TheCompany’s independent registered public accounting firm has audited Management’sassessment of the effectiveness of the Company’s internal control overfinancial reporting as of December 31, 2004, as stated in their report,appearing on the following page.
| /s/ RAYMOND  J. PACINI                              |   |
|-----------------------------------------------------|--------|
| Raymond J. Pacini                                   |
| *President and Chief Executive Officer*             |
| /s/ SANDRA G. SCIUTTO                               |   |
| Sandra G. Sciutto                                   |
| *Senior Vice President and Chief Financial Officer* |

 

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**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directors and Stockholders ofCalifornia Coastal Communities, Inc.

We have audited management’sassessment, included in the accompanying *Management’s Report onInternal Control over Financial Reporting*appearing in Item 9A, thatCalifornia Coastal Communities, Inc. and subsidiaries (the “Company”)maintained effective internal control over financial reporting as of December 31,2004, based on criteria established in *InternalControl—Integrated Framework*issued by the Committee of SponsoringOrganizations of the Treadway Commission. The Company’s management isresponsible for maintaining effective internal control over financial reportingand for its assessment of the effectiveness of internal control over financialreporting. Our responsibility is to express an opinion on management’sassessment and an opinion on the effectiveness of the Company’s internalcontrol over financial reporting based on our audit.

We conducted our audit inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether effective internal control overfinancial reporting was maintained in all material respects. Our audit includedobtaining an understanding of internal control over financial reporting,evaluating management’s assessment, testing and evaluating the design andoperating effectiveness of internal control, and performing such otherprocedures as we considered necessary in the circumstances. We believe that ouraudit provides a reasonable basis for our opinions.

A company’s internalcontrol over financial reporting is a process designed by, or under thesupervision of, the company’s principal executive and principal financialofficers, or persons performing similar functions, and effected by the company’sboard of directors, management, and other personnel to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with generallyaccepted accounting principles. A company’s internal control over financialreporting includes those policies and procedures that (1) pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (3) provide reasonable assurance regarding preventionor timely detection of unauthorized acquisition, use or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of the inherentlimitations of internal control over financial reporting, including thepossibility of collusion or improper management override of controls, materialmisstatements due to error or fraud may not be prevented or detected on atimely basis. Also, projections of any evaluation of the effectiveness of theinternal control over financial reporting to future periods are subject to therisk that the controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management’sassessment that the Company maintained effective internal control overfinancial reporting as of December 31, 2004, is fairly stated, in allmaterial respects, based on the criteria established in *Internal Control—Integrated Framework*issuedby the Committee of Sponsoring Organizations of the Treadway Commission. Alsoin our opinion, the Company maintained, in all material respects, effectiveinternal control over financial reporting as of December 31, 2004, basedon the criteria established in *InternalControl—Integrated Framework*issued by the Committee of SponsoringOrganizations of the Treadway Commission.

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We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the consolidated financial statements as of and for the yearended December 31, 2004 of the Company and our report dated March 7,2005 expressed an unqualified opinion on those financial statements.
| DELOITTE & TOUCHE LLP |
|--------------------------------|
| Costa Mesa, California         |
| March 7, 2005             |

 

**Item9B.**               Other Information

None

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**PART III**

**Item 10.**                 Directorsand Executive Officers of the Registrant

Information appearingunder the captions “Election of Directors” and “Executive Officers of theCompany” in the Company’s Proxy Statement for its 2005 Annual Meeting ofStockholders is for the limited purpose of providing the information necessaryto comply with this Item 10, incorporated herein by this reference.

**Item 11.**                 ExecutiveCompensation

Information appearingunder the caption “Compensation of Directors and Executive Officers” of theCompany’s Proxy Statement for its 2005 Annual Meeting of Stockholders and isfor the limited purpose of providing the information necessary to comply withthis Item 11, incorporated herein by this reference.

**Item 12.**                 SecurityOwnership of Certain Beneficial Owners and Management

Information appearingunder the captions “Voting Securities and Principal Holders Thereof”, “Electionof Directors” and “Compensation of Directors and Executive Officers” of theCompany’s Proxy Statement for its 2005 Annual Meeting of Stockholders, and isfor the limited purpose of providing the information necessary to comply withthis Item 12, incorporated herein by this reference.

**Item 13.**                 CertainRelationships and Related Transactions

Information appearingunder the captions “Certain Transactions” and “Compensation of Directors andExecutive Officers” of the Company’s Proxy Statement for its 2005 AnnualMeeting of Stockholders, and is for the limited purpose of providing theinformation necessary to comply with this Item 13, incorporated herein by thisreference.

**Item 14.**                 PrincipalAccounting Fees and Services

Information in answer to this Item appears in theCompany’s Proxy Statement for its 2005 Annual Meeting of Stockholders and is,for the limited purpose of providing the information necessary to comply withthis Item 14. incorporated herein by this reference.

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**PART IV**

**Item 15.**                 Exhibits,Financial Statement Schedules

(a)(1)  Consolidated Financial Statements:

The following consolidatedfinancial statements and supplementary data of the Company are included in aseparate section of this Annual Report on Form 10-K commencing onthe page numbers specified below: 
|                                                                                                                                   | ** ** | **Page** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|----------|
| Report of Independent  Registered Public Accounting Firm                                                                          |       | F-1      |   |
| Consolidated Balance Sheets as of December 31,  2004 and 2003                                                                |       | F-2      |   |
| Consolidated Statements of  Operations and Comprehensive Income (Loss) for the Years Ended December 31,  2004, 2003 and 2002 |       | F-3      |   |
| Consolidated Statements of  Cash Flows for the Years Ended December 31, 2004, 2003 and 2002                                  |       | F-4      |   |
| Consolidated Statements of  Changes in Stockholders’ Equity for the Years Ended December 31 2004,  2003 and 2002        |       | F-5      |   |
| Notes  to Consolidated Financial Statements                                                                                       |       | F-6      |   |

 

(2)   ConsolidatedFinancial Statement Schedules:

All schedules havebeen omitted since they are not applicable, not required, or the information isincluded in the consolidated financial statements or notes thereto.

(3)   Listing of Exhibits:
| 3.01(a)  |   | Amended and Restated Certificate of Incorporation of  the Registrant, incorporated by reference to Form 8-K filed October 14,  1999.                                                                                             |
|----------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.01(b)* |   | Certificate of Amendment  to Amended and Restated Certificate of Incorporation.                                                                                                                                                            |
| 3.02     |   | Amended By-Laws of  the Registrant, incorporated by reference to Exhibit 4.03 to the  Registrant’s Post-Effective Amendment No. 4 to Form S-4,  Registration Statement No. 333-29883, filed August 28, 1997. |
| 4.01(a)  |   | See Exhibit 3.01 (a).                                                                                                                                                                                                                      |
| 4.01(b)  |   | See Exhibit 3.01 (b).                                                                                                                                                                                                                      |
| 4.02     |   | See Exhibit 3.02.                                                                                                                                                                                                                          |
| 10.01*   |   | Amended and Restated  1993 Stock Option/Stock Issuance Plan.                                                                                                                                                                               |
| 10.02    |   | Deferred Compensation  Plan for Non-Employee Directors of the Registrant, incorporated by  reference to Exhibit 10.14 to the Registrant’s Registration Statement on  Form 10.                                               |
| 10.03    |   | Retirement Plan for Non-Employee  Directors of the Registrant, incorporated by reference to Exhibit 10.15  to the Registrant’s Registration Statement on Form 10.                                                           |

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| 10.04   |   | Retirement Plan  of the Registrant, incorporated by reference to Exhibit 10.16 to  Amendment No. 3 on Form 8 to the Registrant’s Registration  Statement on Form 10.                                                                                               |
|---------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.04A  |   | Amendment to  Retirement Plan of the Registrant dated December 8, 1993, incorporated  by reference to Exhibit 10.07A to the Registrant’s Annual Report on Form 10-K  for 1993.                                                                                          |
| 10.04B  |   | Amendment to Retirement Plan of the Registrant dated  effective January 1, 2000, incorporated by reference to Exhibit 10.08B  to Registrant’s Annual Report on Form 10-K for 1999.                                                                                      |
| 10.04C  |   | Amendment to Retirement  Plan of the Registrant dated December 19, 2001, incorporated by  reference to Exhibit 10.08C to Registrant’s Annual Report on Form 10-K  for 2001.                                                                                             |
| 10.04D  |   | Amendment to Retirement  Plan of the Registrant dated December 30, 2002, incorporated by  reference to Exhibit 10.04D to Registrant’s Annual Report on  Form 10-K for 2002.                                                                                             |
| 10.05   |   | California Coastal  Communities, Inc. 401(k) Plan and Trust Agreement dated effective January 1,  2000, incorporated by reference to Exhibit 10.10 to Registrant’s Annual  Report on Form 10-K for 1999.                                                      |
| 10.06   |   | Employment Agreement  between the Registrant and Mr. Raymond J. Pacini, dated as of May 1,  1998, incorporated by reference to Exhibit 10.1 to Registrant’s  Quarterly Report on Form 10-Q for the quarter ended March 31, 1998.                                   |
| 10.06A  |   | Extension and  Modification of Employment Agreement between the Registrant and Raymond J.  Pacini, dated as of December 7, 1999, incorporated by reference to Exhibit 10.11A  to Registrant’s Annual Report on Form 10-K for 1999.                                      |
| 10.06B  |   | Extension and  Modification of Employment Agreement between the Registrant and Mr. Raymond  J. Pacini, dated as of April 30, 2001, incorporated by reference to Exhibit 10.2  to Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31,  2001. |
| 10.06C  |   | Extension and  Modification of Employment Agreement between the Registrant and Mr. Raymond  J. Pacini, dated as of March 17, 2003, incorporated by reference to Exhibit 10.1  to Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31,  2003. |
| 10.06D* |   | Extension and  Modification of Employment Agreement between the Registrant and Mr. Raymond  J. Pacini, dated as of March 14, 2005.                                                                                                                                                |
| 10.07   |   | Employment Agreement  between the Registrant and Ms. Sandra G. Sciutto, dated as of May 1,  1998, incorporated by reference to Exhibit 10.2 to Registrant’s  Quarterly Report on Form 10-Q for the quarter ended March 31, 1998.                                   |
| 10.07A  |   | Extension and  Modification of Employment Agreement between the Registrant and Sandra G.  Sciutto, dated as of December 7, 1999, incorporated by reference to Exhibit 10.12A  to Registrant’s Annual Report on Form 10-K for 1999.                                      |
| 10.07B  |   | Extension and Modification  of Employment Agreement between the Registrant and Ms. Sandra G. Sciutto,  dated as of April 30, 2001, incorporated by reference to Exhibit 10.3  to Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31,  2001. |

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| 10.07C  |   | Extension and Modification of Employment Agreement  between the Registrant and Ms. Sandra G. Sciutto, dated as of March 17,  2003, incorporated by reference to Exhibit 10.2 to Registrant’s  Quarterly Report on Form 10-Q for the quarter ended March 31, 2003. |
|---------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.07D* |   | Extension and  Modification of Employment Agreement between the Registrant and Ms. Sandra  G. Sciutto, dated as of March 14, 2005.                                                                                                                                               |
| 10.08*  |   | Audit Committee Policy  for Pre-Approval of Auditor Services of the Registrant.                                                                                                                                                                                                            |
| 21.01*  |   | Subsidiaries of the  Registrant.                                                                                                                                                                                                                                                           |
| 31.1*   |   | Section 302  Certificate of Raymond J. Pacini, Chief Executive Officer of California  Coastal Communities, Inc.                                                                                                                                                                  |
| 31.2*   |   | Section 302  Certificate of Sandra G. Sciutto, Chief Financial Officer of California  Coastal Communities, Inc.                                                                                                                                                                  |
| 32.1*   |   | Section 906 Certificate  of Raymond J. Pacini, Chief Executive Officer of California Coastal  Communities, Inc.**                                                                                                                                                                |
| 32.2*   |   | Section 906  Certificate of Sandra G. Sciutto, Chief Financial Officer of California  Coastal Communities, Inc.**                                                                                                                                                                |

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*       Filedherewith.

**             These certificationsare being furnished solely to accompany this report pursuant to 18 U.S.C. Section 1350,and are not being filed for purposes of Section 18 of the SecuritiesExchange Act of 1934, as amended, and are not to be incorporated by referenceinto any filing of the Company, whether made before or after the date hereof,regardless of any general incorporation language in such filing.

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has caused this report to be signed on its behalfby the undersigned, thereunto duly authorized.
| Date: March 15, 2005 | CALIFORNIA COASTAL  COMMUNITIES, INC. |
|---------------------------|---------------------------------------|
|                      | By:                                   | /s/ SANDRA G. SCIUTTO |
|                      |                                  | Sandra G. Sciutto |
| * *                  | * *                              | *Senior Vice President and  Chief Financial Officer* |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the registrant and in thecapacities and on the date indicated.
|                              | **Signature** | ** **                                       | ** ** | ** **          | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|------------------------------|---------------|--------------------------------------------------|------------|---------------------|-----------|------------|------------|------------|----------|------------|
| /s/  GEOFFREY W. ARENS       |          | Director                                         |       | March 15, 2005 |
| (Geoffrey W.  Arens)         |          |                                             |       |                |
| /s/  PHILLIP R. BURNAMAN II  |          | Director                                         |       | March 15, 2005 |
| (Phillip R.  Burnaman II)    |          |                                             |       |                |
| /s/* *RAYMOND J. PACINI |          | President, Chief  Executive Officer and Director |       | March 15, 2005 |
| (Raymond J.  Pacini)         |          |                                             |       |                |
| /s/  THOMAS W. SABIN, JR.    |          | Director and Chairman of  the Board              |       | March 15, 2005 |
| (Thomas W. Sabin, Jr.)  |          |                                             |       |                |
| /s/  SANDRA G. SCIUTTO       |          | Senior Vice President  and                       |       | March 15, 2005 |
| (Sandra G.  Sciutto)         |          | Chief Financial Officer                          |       |                |

 

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**Item 6.**                        SelectedFinancial Data

Set forth below isselected financial data of the Company and its consolidated subsidiaries. Thefollowing information should be read in conjunction with the ConsolidatedFinancial Statements beginning on page F-2 of this Annual Report on Form 10-Kand Management’s Discussion and Analysis.
| ** **                                                      | ** ** | **Years Ended December 31,**                          | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                                                      | ** ** | **2004**                                                             | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                                      | ** ** | **(in millions, except per share amounts)** | ** ** |
| **Balance Sheet Data at period  end:**                          | ** ** | ** **                                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Unrestricted cash, cash equivalents and short-term  investments |       | $                                                                    | 9.0        | ** ** | $ | 14.7 |   | $ | 9.2 |   | $ | 16.2 |   | $ | 6.9 | ** ** |
| Total assets                                                    |       | 250.8                                                                | ** ** | 198.1 |   | 187.6 |   | 180.2 |   | 178.7 |   |
| Project debt                                                    |       | 22.6                                                                 | ** ** | 10.4 |   | 9.8 |   | 3.1 |   | 9.0 |   |
| Total stockholders’ equity                                 |       | $                                                                    | 178.9      | ** ** | $ | 164.6 |   | $ | 159.9 |   | $ | 159.0 |   | $ | 142.6 | ** ** |
| Shares outstanding at end of period                             |       | 10.1                                                                 | ** ** | 10.1 |   | 10.1 |   | 10.1 |   | 10.1 | ** ** |
| Book value per common share—basic                          |       | $                                                                    | 17.71      | ** ** | $ | 16.30 |   | $ | 15.83 |   | $ | 15.74 |   | $ | 14.12 |   |
| Book value per common share—diluted(a)                     |       | $                                                                    | 17.22      | ** ** | $ | 15.71 |   | $ | 15.56 |   | $ | 15.74 |   | $ | 14.12 |   |
| **Statement of Operations Data:**                               | ** ** | ** **                                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues                                                        |       | $                                                                    | 76.0       | ** ** | $ | 55.8 |   | $ | 32.8 |   | $ | 39.0 |   | $ | 23.0 | ** ** |
| Net income(b)                                                   |       | 4.8                                                                  | ** ** | 2.9 |   | 1.7 |   | 11.1 |   | 5.6 | ** ** |
| **Per common share—basic:**                                |       | ** **                                                           | ** ** |   |   |   |   |   |   |   | ** ** |
| Earnings                                                        |       | $                                                                    | .48        | ** ** | $ | .29 |   | $ | .17 |   | $ | 1.10 |   | $ | .55 |   |
| **Per common share—diluted:**                              |       | ** **                                                           | ** ** |   |   |   |   |   |   |   |   |
| Earnings                                                        |       | $                                                                    | .44        | ** ** | $ | .27 |   | $ | .16 |   | $ | 1.10 |   | $ | .55 |   |
| **Weighted-average shares  outstanding****—basic(c)**      |       | 10.1                                                                 | ** ** | 10.1 |   | 10.1 |   | 10.1 |   | 10.1 |   |
| **Weighted-average shares  outstanding—diluted(c)**        |       | 10.8                                                                 | ** ** | 10.8 |   | 10.8 |   | 10.1 |   | 10.1 |   |

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(a)           Book value per commonshare—diluted in 2002, 2003 and 2004 reflects cash proceeds to be realized uponthe exercise of options to purchase common stock and the related tax benefits.

(b)          In addition tohomebuilding operations, net income for the year ended December 31, 2001reflects other income from receipt of securities as demutualization proceedsfrom an insurance company in which the Company was a policy holder, and thesettlement or resolution of certain tax and other liabilities.

(c)           Theincrease in weighted-average shares outstanding at December 31, 2002reflects outstanding options with an exercise price below the average marketprice of the Company’s common stock.

**Item 7.**                        Management’sDiscussion and Analysis of Financial Condition and Results of Operations

The following discussionshould be read in conjunction with the following Consolidated FinancialStatements and Notes thereto which commence on page F-2.

**Overview**

The Company is a residential land development andhomebuilding company with properties located primarily in southern California.The principal activities of the Company and its consolidated subsidiariesinclude: (i) obtaining zoning and other entitlements for land it owns orcontrols through purchase options and improving the land for residentialdevelopment; and (ii) designing, constructing and selling single-familyresidential homes in southern California. Once the residential land owned bythe Company is entitled, the Company may build homes, sell unimproved land toother developers or homebuilders, sell improved land to homebuilders, orparticipate in joint ventures with other developers, investors or 

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homebuilders to financeand construct infrastructure and homes. During 2005, the Company will focus itsimmediate efforts to (i) obtain a Coastal Development Permit (“CDP”) fromthe California Coastal Commission (“Coastal Commission”) to build 349 homes onthe upper bench of the Bolsa Chica Mesa (“Upper Mesa”), as further described inNote 3 to the Company’s Consolidated Financial Statements; and (ii) continue toexpand its profitable homebuilding operations. However, the Company may alsoconsider other strategic and joint venture opportunities; and there can be noassurance that the Company will accomplish, in whole or in part, all or any ofthese strategic goals.

The Company currently has on-going southern Californiaprojects in Riverside County near the cities of North Corona and Riverside, inthe city of Chino in San Bernardino County, in the city of Lancaster innorthern Los Angeles County, and in the Rancho Santa Fe area in San Diego County.These homebuilding projects are expected to generate cash flows and grossoperating margins through 2007. However, the Company’s inventory of entitledland available for homebuilding projects is still limited. Given this limitedinventory of buildable lots, the Company is continuing to pursue residentiallot acquisition opportunities throughout Southern California. Due to delays inapprovals for homebuilding at Bolsa Chica, continuation of homebuildingoperations beyond 2007 is dependent upon acquisition of suitable, entitledresidential lots within the southern California area or Coastal Commissionapproval of the Company’s development plan for 349 homes on the Upper Mesa.

Bolsa Chica is the Company’s principal asset,representing 62% of total assets at December 31, 2004. It has required andcontinues to require significant investments for entitlement and landdevelopment activities.

The Company is currently pursuing approval of permitsfor development of 68 acres of its approximately 105-acre upper bench onthe Bolsa Chica Mesa (“Upper Mesa”). During 2002, the County of Orange approvedthe Company’s site plan and tentative tract map for development of 379single-family homes on 77 acres of the Upper Mesa. The Company submitted aCoastal Development Permit (“CDP”) application for the planned community, knownas “Brightwater”, to the Coastal Commission in November 2002. On October 13,2004, the Coastal Commission held a public hearing on the Company’s CDPapplication. Following completion of the public hearing, the Company withdrewits CDP application in order to have additional time to work with Commissionersand their staff in an effort to develop changes to the project which would beacceptable to the Commission.

In January 2005, the Company filed a newapplication with the Coastal Commission for a CDP consisting of 347 homes(subsequently amended to add two additional lots for a total of 349 homes) tobe built on 68 acres of the Upper Mesa. This new application reflectselimination of development in environmentally sensitive habitat areas andincreased buffers between the habitat areas and the proposed development. TheCompany made these substantial changes to its proposed development plan inresponse to issues raised with respect to the prior CDP application at theCoastal Commission’s October 13, 2004 hearing. These modificationsresulted in a nine-acre decrease in the proposed development area and acorresponding decrease of 30 homes in the plan. The Company expects that theCoastal Commission staff will issue their recommendation to the CoastalCommission in late March or early April 2005 and the Companycurrently expects that the Commission will hold a public hearing on the new CDPapplication in mid-April 2005. However, there can be no assurance thatfurther delays will not be encountered.

As a result of the modifications made to thedevelopment plans for the Upper Mesa and submitted to the Coastal Commission,further approval will be required by the County of Orange. In addition, theCompany expects that following any Coastal Commission approval of a developmentplan, there will be numerous specific conditions for planning items to becompleted prior to the issuance of a CDP. The Company currently expects that aCDP could be issued by the end of 2005, subject to satisfying the permitconditions. Ultimately, the Company does not believe that the CoastalCommission process will permanently prevent it from developing a plannedcommunity at Bolsa Chica; however, there can be no 

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assurance in that regard, oras to (i) when development could commence, (ii) the number of acresor homes the Company will be permitted to develop, or (iii) the absence offurther litigation or administrative delay.

The Brightwater planned community is currentlyexpected to offer a broad mix of home choices averaging 2,740 square feet andranging in size from 1,560 square feet to 4,000 square feet. The plan alsoincludes 37 acres of open space and conservation area on the 105-acreUpper Mesa. With only 349 homes on 68 acres of the Upper Mesa, the resultinglow-density plan equates to approximately 5 homes per acre, consistent andcompatible with the neighboring Huntington Beach communities. In addition, theCompany will offer to dedicate 51 acres of land on the Huntington Mesa to theCounty of Orange to complete the Harriett M. Wieder Linear Park, a 105-acreplanned regional park. The 1,200-acre Bolsa Chica Wetlands are fullypreserved and protected in accordance with previous agreements with the Stateof California and are not included in the Brightwater plan.

On August 12, 2004, an agreement to sell a 103-acreparcel of the Bolsa Chica Mesa known as the “Lower Bench” to the State’sWildlife Conservation Board (“WCB”) for $65 million was approved by the WCB. Thesale remains subject to shareholder approval and the terms of the agreementinclude an outside closing date of June 30, 2005. If the proposed sale iscompleted, WCB’s purchase of the property will be funded with bond proceedsauthorized by voter-approved Proposition 50, which was passed in November 2002.The Company has indicated that it will require Coastal Commission approval ofthe Brightwater development plan for the Upper Mesa prior to seekingshareholder approval and issuance of the CDP prior to closing the sale. Therefore,the Company has initiated discussions with the WCB to extend the outsideclosing date to December 31, 2005. However, there can be no assurancesthat the WCB agreement will be extended or that a sale transaction will ever becompleted.

Given the facts and circumstances described above, theCompany believes that the eventual development of the Upper Mesa and thepending sale of the Lower Bench will result in realization of an amount that issubstantially in excess of the $156.4 million book value presently reflected inthe Company’s consolidated financial statements. From time to time, the Companyhas received outside appraisals on an “as developed basis” which have supportedthe Company’s beliefs, although there can be no assurance that those beliefswill be validated .

Real estate held forcurrent development or sale and land held for future development (real estateproperties) are carried at fair value as of September 2, 1997, followingadoption of Fresh-Start Reporting as discussed in Notes 1 and 2 to theConsolidated Financial Statements, as adjusted by subsequent activity. TheCompany’s real estate properties are subject to a number of uncertainties whichcan affect the values of those assets. These uncertainties include litigationor appeals of regulatory approvals (as discussed above) and availability ofadequate capital, financing and cash flow. In addition, future values may beadversely affected by increases in property taxes, increases in the costs oflabor and materials and other development risks, changes in general economicconditions, including higher mortgage interest rates, and other real estaterisks such as the general demand for housing and the supply of competitiveproducts. Real estate properties do not constitute liquid assets and, at anygiven time, it may be difficult to sell a particular property for anappropriate price.

**Impact ofInflation; Changing Prices and Economic Conditions**

Real estate and residential housing prices areaffected by inflation, which can cause increases in the price of land, rawmaterials and subcontracted labor. Unless these increased costs are recoveredthrough higher sales prices, gross margin from home sales would decrease. Ifinterest rates increase, construction and financing costs would also increase,which can also result in lower gross margin from home sales. The volatility ofinterest rates could have an adverse effect on the Company’s future operationsand liquidity. 

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Among other things, theseconditions may affect adversely the demand for housing and the availability ofmortgage financing and may reduce the credit facilities offered to the Company.

There can be no assurance regarding the continuedhealth of the southern California residential real estate market. Inparticular, (i) the state of the national economy and the level ofemployment growth, (ii) the State of California’s budget deficit, and (iii) thevolatility in the stock market, collectively may exert recessionary pressureson the California economy and may have a negative impact on the southernCalifornia housing market.

While low mortgage rates have sustained housing demandto date, any significant future increase in mortgage rates or significant lossof jobs in southern California would most likely slow demand for new homes.Increases in home mortgage interest rates make it more difficult for theCompany’s customers to qualify for home mortgage loans, potentially decreasinghome sales volume and prices. The tight supply of new homes in southernCalifornia has resulted in significant home price increases over the last fiveyears. As a result, the affordability of new homes has been declining and couldfurther jeopardize future demand.

Most of the Company’sactive homebuilding projects are located in the “Inland Empire” area ofsouthern California, which includes Riverside and San Bernardino counties. Noneof the Company’s projects experienced any direct impact from the southernCalifornia fires during late 2003 or from landslides in early 2005. The InlandEmpire has experienced significant population and job growth in the pastdecade. While continued growth is expected, partially due to the limited supplyof affordably priced housing in coastal areas such as Orange County, there canbe no assurance that economic, demographic or other factors will not slow,diminish or cause such growth to discontinue. The Company is continuing topursue land development and lot acquisition opportunities throughout southernCalifornia.

**Critical AccountingPolicies**

In the preparation of theConsolidated Financial Statements, the Company applies accounting principlesgenerally accepted in the United States. The application of generally acceptedaccounting principles may require management to make estimates and assumptionsthat affect the amounts reported in the financial statements and accompanyingresults. Listed below are those policies that the Company believes are criticaland require the use of complex judgment in their application. In particular,the Company’s critical accounting policies include the evaluation of theimpairment of long-lived assets and the evaluation of the probability of beingable to realize the future benefits indicated by its significant federal taxnet operating losses, as discussed further in Note 2 to the ConsolidatedFinancial Statements.

*Impairment ofLong-Lived Assets*

The Company assesses the impairment of land held forfuture development (the Bolsa Chica project) and real estate held for currentdevelopment or sale including long-lived assets in accordance with Statement ofFinancial Accounting Standards (“SFAS”) No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets”. These assets are carried at cost,unless the carrying amount of the parcel or subdivision is determined not to befully recoverable, in which case the impaired real estate is written down tofair value. Given the significance of the carrying value of land held forfuture development, the application of SFAS No. 144 in evaluating anypotential impairment is critical to the Company’s consolidated financial statements,as discussed further in Note 2 to the Consolidated Financial Statements.

In accordance with SFAS No. 144,in developing estimated future cash flows for impairment testing, the Companyhas incorporated its own assumptions regarding the entitlement prospects ofland held for future development and its own market assumptions including thoseregarding home prices, infrastructure and home-building costs regarding bothland held for future development and real estate held for current developmentor sale. Additionally, as appropriate, the Company identifies alternativecourses of action to 

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recoverthe carrying value of its long-lived assets and evaluates all likelyalternatives under a probability-weighted approach as described in SFAS No. 144.

*Basis of Consolidation*

Certain wholly-ownedsubsidiaries of the Company are members in joint ventures involved in thedevelopment and sale of residential projects and residential loan production.The consolidated statements of the Company include the accounts of the Companyand all majority-owned and controlled subsidiaries and joint ventures. Thefinancial statements of joint ventures in which the Company generally has acontrolling or majority economic interest (and thus are controlled by theCompany) are consolidated with the Company’s financial statements. Minorityinterest represents the equity interest of the Company’s joint venture partnerfor one consolidated venture and is further described in Note 8 to theConsolidated Financial Statements. The Company’s investments in unconsolidatedjoint ventures are accounted for using the equity method when the Company doesnot have voting or economic control of the venture operations, as furtherdiscussed in Note 4 to the Consolidated Financial Statements.

*Income Taxes*

The Company accounts forincome taxes on the liability method. Deferred income taxes are determinedbased on the difference between the financial statement and tax bases of assetsand liabilities. The liability method requires an evaluation of the probabilityof being able to realize the future benefits indicated by deferred tax assets,such as tax net operating losses (“NOLs”). A valuation allowance related to thedeferred tax asset is recorded when it is more likely than not that someportion or all of the deferred tax asset will not be realized. Given thesignificance of the Company’s historical federal tax NOLs, as discussed in Note7 to the Consolidated Financial Statements, the application of the Company’spolicy in evaluating the expected future benefit of NOLs is critical. Inapplying those policies, estimates and judgments affect the amounts at whichcertain assets and liabilities are recorded. The Company applies its accountingpolicies on a consistent basis. As circumstances change, they are considered inour estimates and judgments, and future changes in circumstances could resultin changes in amounts at which assets and liabilities are recorded.

*Homebuilding Revenues and Cost of Sales*

The Company’s homebuildingoperation generates revenues from the sale of homes to homebuyers. The majorityof these homes are designed to appeal to move-up homebuyers and the homes aregenerally offered for sale in advance of their construction. Sales contractsare usually subject to certain contingencies such as the buyer’s ability toqualify for financing. Revenue from the sale of homes is recognized at closingwhen title passes to the buyer, and the earnings process is complete. As aresult, the Company’s revenue recognition process does not involve significantjudgments or estimates. However, the Company does rely on certain projectionsand estimates to determine the related construction costs and resulting grossmargins associated with revenues recognized. The cost of sales is recordedbased upon total estimated costs within a subdivision and allocated using therelative sales value method. The Company’s construction costs are comprised ofdirect and allocated costs, including estimated costs for future warranties andindemnities. The Company’s estimates are based on historical results, adjustedfor current factors.

*Litigation Reserves*

The Company and certain of its subsidiaries have beennamed as defendants in various cases arising in the normal course of businessand regarding disposed assets and businesses of the Company or formeraffiliates (see Notes 6 and 9 to the Consolidated Financial Statements). TheCompany has reserved for costs expected to be incurred with respect to thesecases based upon information provided by its legal counsel. There can be noassurance that total litigation costs actually incurred will not exceed theamount of such reserve.

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*Stock-BasedCompensation*

The Company uses a fair value based method ofaccounting for share-based compensation provided to employees in accordancewith SFAS No. 123 “Accounting for Stock-Based Compensation” (“SFAS 123”). Stockoptions are valued based upon an option-pricing model and this fair value isrecognized as an expense over the period in which the options vest. Prior tothe second quarter of 2003, the Company accounted for its stock-based employeecompensation plan using the recognition and measurement principles (intrinsicvalue method) of Accounting Principles Board (“APB”) Opinion No. 25, “Accountingfor Stock Issued to Employees,” and the related Financial Accounting StandardsBoard (“FASB”) Interpretation No. 44 “Accounting for Certain TransactionsInvolving Stock Compensation” (“FIN 44”). As a result of the May 2001repricing of outstanding stock options, the Company accounted for the optionsas variable awards and recorded non-cash stock-based compensation expense on acumulative basis as the difference between the option exercise price and thequoted market price of the Company’s common stock. From May 2001 throughthe first quarter of 2003, non-cash compensation expense was reflected forstock price changes pursuant to variable accounting for repriced options.

During the second quarterof 2003, the Company adopted the fair value recognition provisions of SFAS No. 123,“Accounting for Stock-Based Compensation” (“SFAS 123”). For this change inaccounting, the Company selected the “modified prospective method” under theprovisions of SFAS No. 148 “Accounting for Stock-Based Compensation—Transitionand Disclosure—an Amendment of FASB Statement No. 123” (“SFAS 148”). Underthis method, the change was retroactive to January 1, 2003, andcompensation cost recognized for 2003 was the same as that which would havebeen recognized had the recognition provisions of SFAS 123 been applied fromits original effective date. In accordance with SFAS 148, results forprior years have not been restated. SFAS 123 states that the adoption of thefair value based method is a change to a preferable method of accounting.Management believes that use of the fair value based method to record employeestock-based compensation expense is consistent with the accounting for allother forms of compensation. The adoption of SFAS 123 may have a significantimpact on the Company’s future consolidated results of operations, due to theelimination of the potential future effects of variable accounting for repricedstock options. During 2004, options for 20,000 shares were issued to a directorand vesting was accelerated to make the options currently exercisable. Pursuantto SFAS 123, the Company recorded $271,000 of compensation expense, which isreflected in capital in excess of par value.

**Recent AccountingPronouncements**

In December 2004, the Financial AccountingStandards Board (“FASB”) issued SFAS No. 123 (revised 2004), “Share-BasedPayment”. This Statement replaces SFAS 123, “Accounting for Stock-BasedCompensation” and supersedes Accounting Principles Board (“APB”) Opinion No. 25.“Accounting for Stock Issued to Employees.” SFAS No. 123R addresses theaccounting for share-based payment transactions in which an enterprise receivesemployee services in exchange for (a) equity instruments of the enterpriseor (b) liabilities that are based on the fair value of the enterprise’sequity instruments or that may be settled by the issuance of such equityinstruments. SFAS No. 123R eliminates the ability to account forshare-based compensation transactions using the intrinsic value method underAPB No. 25, and generally would require instead that such transactions beaccounted for using a fair-value-based method. The Company is currentlyevaluating SFAS No. 123R to determine which fair-value-based model andtransitional provision it will follow upon adoption. SFAS No. 123R will beeffective for the Company beginning in the third quarter of 2005. The Companyis evaluating the impact application of SFAS No. 123R will have on theCompany’s results of operations.

In December 2004, theFASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets—An amendment ofAPB 29, Accounting for Nonmonetary Transactions” (“SFAS 153”). Thisstatement amends APB 29 to eliminate the exception for nonmonetary exchanges ofsimilar productive assets and 

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replacesit with a general exception for exchanges of nonmonetary assets that do nothave commercial substance. A nonmonetary exchange has commercial substance ifthe future cash flows of the entity are expected to change significantly as aresult of the exchange. The Company will evaluate the effect, if any, inadopting SFAS 153.

**Liquidity andCapital Resources**

The principal assets in the Company’s portfolio areresidential land which must be held over an extended period of time in order tobe developed to a condition that, in management’s opinion, will ultimatelymaximize the return to the Company. Consequently, the Company requiressignificant capital to finance its real estate development and homebuildingoperations. Historically, sources of capital have included bank lines ofcredit, specific property financings, asset sales and available internal funds.The Company is utilizing internally generated cash to fund its Bolsa Chica landdevelopment project. The Company is utilizing internally generated cash, andproject debt to fund construction of its homebuilding projects, and jointventure contributions to fund the Oxnard land development project. The Company’scurrent and pending homebuilding projects, which are primarily in the “InlandEmpire” area of southern California (Riverside and San Bernardino counties) arecurrently expected to generate approximately $39.0 million of positive cashflows, after net investments in new projects to acquire 357 lots during thenext 24 months, based on present economic conditions and market assumptions.The Company’s unrestricted cash and cash equivalents as of December 31,2004 were approximately $9.0 million. The Company believes that its cash andcash equivalents, future real estate sales proceeds, and funds available underits credit agreements will be sufficient to meet anticipated operating andcapital investment requirements, primarily project development costs forhomebuilding projects, and the Oxnard and Bolsa Chica land developmentprojects, along with general and administrative expenses, for the next 12months.

The Company is subject to the usual obligationsassociated with entering into contracts for the purchase of land and improvedhomesites. The purchase of properties under these contracts is generallycontingent upon satisfaction of certain requirements by the sellers, includingobtaining applicable property entitlements. The Company also utilizes optioncontracts with third-party land sellers and financial entities as a method ofacquiring land in staged takedowns and minimizing the use of funds from othercorporate financing sources. These option contracts also help to manage thefinancial and market risk associated with land holdings. Purchase and optioncontracts generally require the payment of a non-refundable cash deposit of 5%to 20% of the purchase price for the right to acquire lots over a specifiedperiod of time (usually one to two years) at predetermined prices. The Companyhas the right at its discretion to terminate its obligations under these landpurchase and option agreements by forfeiting the cash deposit with no furtherfinancial responsibility.

Summary informationregarding the Company’s land option deposits is as follows as of December 31,2004:
| Total number of  projects                                                      |   | 5   |   |
|--------------------------------------------------------------------------------|--------|-----|--------|
| Total number of lots                                                           |   | 357 |   |
| Total forfeited deposits if lots are not purchased  (included in other assets) |   | $   | 4.9    |   |
| Total remaining  purchase price                                                |   | $   | 41.8   |   |

 

The Company may enter into land development andhomebuilding joint ventures from time to time as a means of expanding itsmarket opportunities, establishing strategic alliances, managing its riskprofile and leveraging the Company’s capital base. These joint ventures mayobtain secured acquisition, development and construction financing, whichminimizes the use of funds from other corporate financing sources.

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**Financial Condition**

*December 31,2004 Compared With December 31, 2003*

Cash flows from homebuilding operations for 2004primarily reflect sales proceeds of $75.9 million from deliveries of 135 homesand cash flows from financing activities reflect net borrowing under projectdebt financing of $12.2 million. These sources of funds were used primarily forinvestments in real estate and construction costs of $79.7 million, includingthe acquisition of an aggregate of 265 lots. Lots acquired were throughoutSouthern California and include 104 in Lancaster, 83 in Corona, 43 nearRiverside, 17 in Chino and 18 lots in the Rancho Santa Fe, California area.Other significant uses of cash include joint venture (minority interest)distributions for the Chino project of $7.6 million, approximately $2.8 millionfor investment in the Bolsa Chica Mesa project, primarily for consultantsengaged in the entitlement process, and selling, general and administrativeexpenses paid of approximately $5.5 million. These items, as well as otheractivity presented in the Statements of Cash Flows, resulted in the $5.7million decrease in cash and cash equivalents.

The $22.4 million increase in real estate held forcurrent development or sale reflects the purchase of 265 lots described aboveand project construction, partially offset by reductions recorded upon sale ofhomes.

The $7.4 million increase in other assets primarilyreflects deposits for purchases of entitled land in Southern California and netdeferred tax assets, reflected as of December 31, 2003 as a net liability.

Accounts payable and accrued liabilities increased by$8.7 million, to a balance of $15.0 million as of December 31, 2004,primarily reflecting accruals of $6.3 million for estimated payments due toland sellers for participation in homebuilding profits from certain projects,an increased level of monthly accounts payable for project construction and anincreased accrual for incentive bonuses related to the Company’s homebuildingoperation.

The $3.6 million decrease in other liabilitiesprimarily reflects the reversal of valuation reserves on pre-reorganizationNOLs described below. The resulting net deferred tax balance is reflected as anasset as of December 31, 2004.

The $9.7 million increasein capital in excess of par value primarily reflects the reversal of $9.1million of valuation reserves on pre-Reorganization federal NOLs utilizedduring 2004 and anticipated to be utilized in the future. Additional increasesof approximately $300,000 for recognition of non-cash compensation expense forstock options and $300,000 for issuance of common stock pursuant to optionexercises and the related state tax effect are also reflected.

**Results ofOperations**

The nature of the Company’sbusiness, including its limited inventory of buildable lots, is such that thestatus of each project often causes significant fluctuations in operatingresults from quarter-to-quarter and year-to-year.

*2004 Compared with2003*

The Company reported revenues of $76.0 million andgross operating profit of $18.4 million for 2004, compared with $55.8 millionin revenues and gross operating profit of $10.3 million for 2003. Revenues for2004 reflect deliveries of 135 homes, including 65 at the Chino Reserveproject, 32 at the Providence Ranch project and 38 homes at the Company’sRiverside (Jasper Ranch) project and a $100,000 land sale. The results for theprior year reflect deliveries of an aggregate of 154 homes at the Riverside,North Corona and Yucaipa projects. The homebuilding gross margin for 2004 of24.1% is higher than the prior year’s homebuilding gross margin of 17.0% due tohome price appreciation experienced over the past year 

31

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and higher profitability ofthe Riverside (Jasper Ranch), Chino and North Corona homes delivered during2004 as compared with the North Corona and Riverside (Harvest) homes deliveredduring 2003.

The $1.4 million increase in selling, general andadministrative expenses to $5.8 million in 2004 compared with $4.4 million in2003, primarily reflects an increase in accrued incentive compensation for theCompany’s homebuilding business of $1.0 million, and $300,000 for non-cashcompensation expense as a result of the issuance and vesting of stock optionsin 2004.

The $1.1 million of other expense, net for 2004primarily reflects increases in litigation and environmental accruals,including a $500,000 accrual for the Dresser litigation settlement (see Note 6).The $1.1 million of other expense, net in 2003 includes accruals ofapproximately $700,000 for estimated environmental remediation costs for the 43-acreBolsa Chica lowland remediation and $300,000 for contingent indemnityobligations related to asbestos claims (see Note 6), partially offset by incomeof approximately $400,000 from recovery of the value of water rightscertificates, related to a completed project, which had been reserved.

The effective income taxrate for the year ended December 31, 2004 is 38%, as compared with an effectiveincome tax rate of 43% during 2003. The decrease in the effective rateprimarily reflects a tax benefit of $400,000 for the reversal of valuationallowances on post-Reorganization state NOLs. In addition, during each of 2004and 2003, the Company recorded a tax benefit of approximately $100,000 inconnection with the resolution of outstanding tax matters in two and eightstates, respectively.

*2003 Compared with2002*

The Company reported homebuilding revenues of $54.7million and gross operating profit from homebuilding of approximately $9.3million for 2003, compared with $32.8 million in revenues and gross operatingprofit of $4.5 million for 2002. This represents a $21.9 million or 67%increase in homebuilding revenues and a $4.8 million increase in grossoperating profit from homebuilding. Revenues during 2003 reflect deliveries of154 homes, including 65 homes at the Company’s Riverside projects, 86 homes atthe North Corona projects and the final three homes at the Yucaipa project.Revenues during 2002 reflect deliveries of an aggregate of 117 homes at theYucaipa and North Corona projects. The increase in the average price of homessold from $280,000 in 2002 to $355,000 in 2003, and the improved gross marginfrom homebuilding from 13.7% for 2002 to 17.0% in 2003 reflect home priceappreciation experienced from 2002 to 2003 and higher profitability of theRiverside project as compared with the Yucaipa project.

In addition, during 2003, the Company reported revenuefrom a non-residential land sale of $1.1 million, resulting in a grossoperating profit of approximately $1.0 million, or approximately 90.9%, whichwhen combined with the homebuilding gross margin, resulted in the overall grossmargin of 18.5%.

The $200,000 increase in selling, general andadministrative expenses to $4.4 million in 2003 as compared with $4.2 millionin 2002, reflects an increase in accrued incentive compensation for the Company’shomebuilding business, largely offset by the absence in 2003 of approximately$778,000 of compensation expense recorded in 2002 pursuant to variableaccounting for repriced options in accordance with APB 25.

The $400,000 decrease in income from unconsolidatedjoint ventures from approximately $900,000 for 2002 to approximately $500,000for 2003 reflects reduced income from the Fairbanks Highlands project, due tothe completion of home deliveries during the first quarter of 2002.

The $1.1 million of other expense, net for 2003 ascompared with $100,000 of expense in 2002, primarily reflects additionalaccruals of approximately $700,000 for estimated environmental remediationcosts, and $300,000 for contingent indemnity obligations related to asbestosclaims in the 2003 period. Other expense also includes recurring pension andreal estate holding period costs, which were largely offset by recovery of$400,000 of water rights certificates related to a completed project, the valueof which 

32

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had been charged to costof sales in prior years. The increase in expense also reflects the absence in2003 of $1.2 million in gains on sales of short-term investments, which wererealized during the second quarter of 2002. These gains in the 2002 period werepartially offset by increased non-recurring period costs related to land heldfor future development.

During 2003, the Company’stax provision was partially offset by a tax benefit of approximately $100,000in connection with the reduction in reserves for contingent tax liabilitiesrecorded in conjunction with periodic reviews of the adequacy of such reserves.During 2002, the Company recorded an income tax benefit of $800,000. Thisbenefit included a provision for income taxes of $600,000 which was more thanoffset by tax benefits equivalent to reductions of reserves for state taxliabilities of $1.4 million. The reductions in tax reserves in 2003 and 2002were due to expiration of statutes of limitations or settlements in eightstates, and one state, respectively, which reduced the Company’s exposure.

*Payments UnderContractual Obligations*

The Company has entered intocertain contractual obligations to make future payments for items such asproject debt and lease agreements. A summary of the payments due underspecified contractual obligations, aggregated by category of contractualobligation, for specified time periods is presented below as of December 31,2004 (in millions):
| ** **       | ** ** | **Payments due by period** | ** ** |
|------------------|------------|-------------------------------------------|------------|
| ** **       | ** ** | ** **                                | ** ** | **Less** | ** ** | ** ** | ** ** | ** ** | ** ** | **More** | ** ** |
| ** **       | ** ** | ** **                                | ** ** | **than 1** | ** ** | **1-3** | ** ** | **3-5** | ** ** | **than 5** | ** ** |
| ** **       | ** ** | **Total**                                 | ** ** | **year** | ** ** | **years** | ** ** | **years** | ** ** | **years** | ** ** |
| Project debt     |       | $                                         | 22.6       |   | $ | 22.6 |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Operating leases |       | .3                                        |       | .1 |   |   | .2 |   |   |   | — |   |   |   | — |   |   |
| Total            |       | $                                         | 22.9       |   | $ | 22.7 |   |   | .2 |   |   |   | — |   |   |   | — |   |   |

 

The Company’s purchasecontracts which are made in the normal course of its homebuilding business forland acquisition and construction subcontracts are generally cancelable atwill. Other contractual obligations including the Company’s other taxliabilities, accrued benefit liability for a frozen retirement plan and otheraccrued pensions, home warranty reserves and contingent indemnity andenvironmental obligations are estimated based on various factors. Payments arenot due as of a given date, but rather are dependent upon the incurrence ofprofessional services, the lives of annuitants and other factors. Theestimation process involved in the determination of carrying values of theseobligations is inherently uncertain since it requires estimates as to futureevents and contingencies. The Company has provided additional disclosure inItem 3. Legal Proceedings and in its Consolidated Financial Statements inNote 6—Other Liabilities.

**Forward Looking Statements**

Certain of the foregoing information and theinformation following this Item 7 contains forward-looking statements withinthe meaning of Section 21E of the Securities Exchange Act of 1934, thatrelate to future events or the Company’s future financial performance. Inaddition, other statements the Company may make from time to time, such aspress releases, oral statements made by Company officials and other reports theCompany files with the Securities and Exchange Commission, may also containsuch forward-looking statements. Undue reliance should not be placed on thesestatements, which involve known and unknown risks, uncertainties and otherfactors which may cause the Company’s actual results, performance orachievements to be materially different from any future results, performancesor achievements expressed or implied by the forward-looking statements. In somecases, you can identify forward-looking statements by terminology such as “may”,“will”, “should”, “expects”, “plans”, 

33

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“anticipates”, “believes”,“estimates”, “predicts”, “potential”, “continue”, or the negative of such termsor other comparable terminology. 

These forward-looking statements include, but are notlimited to, (1) statements about the Company’s strategies, plans,objectives, goals, expectations and intentions; (2) the number and typesof homes and number of acres of land that the Company may develop and sell; (3) thetiming and outcomes of litigation, regulatory approval processes oradministrative proceedings, which may result in delays in the land entitlement,development, construction, or the opening of new home communities (including,but not limited to ongoing administrative proceedings related to the Company’sprincipal asset, the Bolsa Chica Mesa); (4) the Company’s ability torealize the value of its net operating loss carry forwards; (5) thecompletion of the pending $65 million sale of the lower bench of the BolsaChica Mesa to the State of California’s Wildlife Conservation Board; (6) theCompany’s ability to continue relationships with current or future partners; (7) theCompany’s ability to expend resources to comply with environmental regulationsand local permitting requirements; (8) the effect of certain costs,contractual obligations and tax liabilities, both known and unknown, on theCompany’s business, results of operations and financial condition; (9) thecondition and adequacy of the Company’s properties; (10) the Company’sability to estimate cash flow projections due to uncertainties in valuing realproperty; (11) the Company’s ability to acquire residential lots in orderto continue homebuilding operations; (12) the adequacy of capital, financingand cash flow required to continue the Company’s operations and landdevelopment activities; (13) the future condition of the real estate market inSouthern California; (14) the ability to react to increases or decreasesin demand for housing and to rapidly take advantage of local marketopportunities as they arise; (15) local and general economic and marketconditions, including consumer confidence, employment rates, interest rates,the cost and availability of mortgage financing and stock market, home and landvaluations; (16) competition; (17) the availability and cost of raw materialsused by the Company in its homebuilding operations; (18) home buildinglitigation and warranty claims; (19) shortages and the cost of labor; (20) adverseweather and natural disaster related slowdowns; (21) slow growth and no growthinitiatives or moratoria; (22) governmental regulation, including theinterpretation of tax, labor and environmental laws; (23) accounting changesincluding the expected impact of new accounting pronouncements; (24) theeffectiveness and adequacy of the Company’s disclosure and internal controls;(25) the impact on economic conditions of terrorist attacks or theoutbreak or escalation of armed conflict involving the United States; (26)other factors over which the Company has little or no control; and (27) otherstatements contained in this Form 10-K that are not historical facts.

The Company assumes no, and hereby disclaims any,obligation to update any of the foregoing or any other forward-lookingstatements. The Company nonetheless reserves the right to make such updatesfrom time to time by press release, periodic report or other method of publicdisclosure without the need for specific reference in this Form 10-K orthe 2004 Annual Report to Stockholders. No such update shall be deemed to indicatethat other statements not addressed by such update remain correct or create anobligation to provide any other updates.

34

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**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To The Board of Directors and Stockholdersof California Coastal Communities, Inc.:

We have audited the accompanying consolidated balancesheets of California Coastal Communities, Inc. and its subsidiaries (the “Company”)as of December 31, 2004 and 2003 and the related consolidated statementsof operations and comprehensive income (loss), cash flows, and changes instockholders’ equity for each of the years ended December 31, 2004, 2003and 2002. These financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statementspresent fairly, in all material respects, the financial position of CaliforniaCoastal Communities, Inc. and its subsidiaries as of December 31,2004 and 2003 and the results of their operations and their cash flows for theyears ended December 31, 2004, 2003 and 2002, in conformity withaccounting principles generally accepted in the United States of America.

We have also audited, in accordance with the standardsof the Public Company Accounting Oversight Board (United States), theeffectiveness of the Company’s internal control over financial reporting as of December 31,2004, based on the criteria established in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission and our report dated March 7, 2005 expressed anunqualified opinion on management’s assessment of the effectiveness of theCompany’s internal control over financial reporting and an unqualified opinionon the effectiveness of the Company’s internal control over financialreporting.

As discussed in Note 2 to the consolidated financialstatements, in 2004, the Company adopted Financial Accounting Standards BoardInterpretation No. 46, “Consolidation of Variable Interest Entities—aninterpretation of ARB No. 51.”

As discussed in Note 2, the Company carries its landheld for future development at cost, with write-downs to fair value inthe event that costs cannot be recovered from estimated undiscounted futurecash flows. The value and future cash flow estimation process is inherentlyuncertain and relies to a considerable extent on future events and marketconditions. As discussed in Note 3, the development of the Company’s BolsaChica project is dependent upon various governmental approvals and economic factors.Accordingly, the amount ultimately realized from such project may differmaterially from current estimates as well as the project’s carrying value.

Deloitte & Touche LLP

Costa Mesa, California

March 7, 2005

F-1

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**CALIFORNIA COASTAL COMMUNITIES, INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS**
| ** **                                                                                                                              | ** ** | **December 31** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                                                                              | ** ** | **2004**             | ** ** | **2003** | ** ** |
| ** **                                                                                                                              | ** ** | **(in millions)**    | ** ** |
| **ASSETS**                                                                                                                              |       |                 |       |   |   |   |   |
| Cash and cash equivalents                                                                                                               |       |                 | $          | 9.0 |   |   | $ | 14.7 |   |
| Restricted cash                                                                                                                         |       |                 | 1.1        |   |   | — |   |
| Real estate held  for current development or sale                                                                                       |       |                 | 49.9       |   |   | 27.5 |   |
| Consolidated real  estate to be held for current development—not owned                                                             |       |                 | 24.7       |   |   | — |   |
| Land held for  future development                                                                                                       |       |                 | 156.4      |   |   | 153.6 |   |
| Other assets                                                                                                                            |       |                 | 9.7        |   |   | 2.3 |   |
|                                                                                                                                    |       |                 | $          | 250.8 |   |   | $ | 198.1 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                           | ** ** |                 |       |   | ** ** | ** ** | ** ** |
| Liabilities:                                                                                                                            |       |                 |       |   |   |   |   |
| Accounts payable and accrued liabilities                                                                                                |       |                 | $          | 15.0 |   |   | $ | 6.3 |   |
| Project debt                                                                                                                            |       |                 | 22.6       |   |   | 10.4 |   |
| Consolidated obligations related to real estate—not  owned                                                                         |       |                 | 24.7       |   |   | — |   |
| Other liabilities                                                                                                                       |       |                 | 9.3        |   |   | 12.9 |   |
| Total liabilities                                                                                                                       |       |                 | 71.6       |   |   | 29.6 |   |
| Minority interest                                                                                                                       |       |                 | .3         |   |   | 3.9 |   |
| Commitments and  contingencies                                                                                                          |       |                 |       |   |   |   |   |
| Stockholders’  equity:                                                                                                             |       |                 |       |   |   |   |   |
| Common Stock—$.05  par value; 13,500,000 shares authorized; 10,130,212 and 10,075,212 shares  issued and outstanding, respectively |       |                 | .5         |   |   | .5 |   |
| Excess Stock—$.05  par value; 13,500,000 shares authorized; no shares outstanding                                                  |       |                 | —     |   |   | — |   |
| Capital in excess  of par value                                                                                                         |       |                 | 152.8      |   |   | 143.1 |   |
| Retained earnings                                                                                                                       |       |                 | 28.2       |   |   | 23.4 |   |
| Accumulated other  comprehensive loss                                                                                                   |       |                 | (2.6       | ) |   | (2.4 | ) |
| Total stockholders’ equity                                                                                                         |       |                 | 178.9      |   |   | 164.6 |   |
|                                                                                                                                    |       |                 | $          | 250.8 |   |   | $ | 198.1 |   |

 

See accompanying notes to consolidated financial statements.

F-2

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**CALIFORNIACOASTAL COMMUNITIES, INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**AND COMPREHENSIVE INCOME (LOSS)
| ** **                                                 | ** ** | **For the Years EndedDecember 31,**         | ** ** |
|------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                                 | ** ** | **2004**                                                        | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                 | ** ** | **(in millions  except per share amounts)** | ** ** |
| Revenues:                                                  |       |                                                            |       |   |   |   |   |
| Homebuilding                                               |       | $                                                               | 75.9       |   | $ | 54.7 |   | $ | 32.8 |   |
| Non-residential land                                       |       | .1                                                              |       | 1.1 |   | — |   |
|                                                       |       | 76.0                                                            |       | 55.8 |   | 32.8 |   |
| Cost of sales:                                             |       |                                                            |       |   |   |   |   |
| Homebuilding                                               |       | 57.6                                                            |       | 45.4 |   | 28.3 |   |
| Non-residential land                                       |       | —                                                          |       | .1 |   | — |   |
|                                                       |       | 57.6                                                            |       | 45.5 |   | 28.3 |   |
| Gross operating profit                                     |       | 18.4                                                            |       | 10.3 |   | 4.5 |   |
| Selling, general and administrative expenses               |       | 5.8                                                             |       | 4.4 |   | 4.2 |   |
| Interest expense                                           |       | .2                                                              |       | .2 |   | .2 |   |
| Income from  unconsolidated joint ventures                 |       | (.4                                                             | )          | (.5 | ) | (.9 | ) |
| Other expense,  net                                        |       | 1.1                                                             |       | 1.1 |   | .1 |   |
| Income before income taxes                                 |       | 11.7                                                            |       | 5.1 |   | .9 |   |
| Provision (benefit) for income taxes                       |       | 4.5                                                             |       | 2.2 |   | (.8 | ) |
| Minority interest  in income of consolidated joint venture |       | 2.4                                                             |       | — |   | — |   |
| Net income                                                 |       | $                                                               | 4.8        |   | $ | 2.9 |   | $ | 1.7 |   |
| Other  comprehensive loss, net of income taxes:            |       |                                                            |       |   |   |   |   |
| Realized gain on short-term investments                    |       | —                                                          |       | — |   | (1.3 | ) |
| Minimum pension liability adjustment                       |       | (.2                                                             | )          | — |   | (1.0 | ) |
|                                                       |       | —                                                          |       | — |   | (2.3 | ) |
| Comprehensive income (loss)                                |       | $                                                               | 4.6        |   | $ | 2.9 |   | $ | (.6 | ) |
| Net earnings per common share—basic                   |       | $                                                               | .48        |   | $ | .29 |   | $ | .17 |   |
| Net earnings per  common share—diluted                |       | $                                                               | .44        |   | $ | .27 |   | $ | .16 |   |
| Common equivalent  shares:                                 |       |                                                            |       |   |   |   |   |
| Basic                                                      |       | 10.1                                                            |       | 10.1 |   | 10.1 |   |
| Diluted                                                    |       | 10.8                                                            |       | 10.8 |   | 10.8 |   |

 

See accompanying notes to consolidated financial statements.

F-3

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**CALIFORNIA COASTAL COMMUNITIES, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OFCASH FLOWS**
| ** **                                                                                                                                     | ** ** | **For the Years EndedDecember 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                                                                                     | ** ** | **2004**                                           | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                                                                                     | ** ** | **(in millions)**                             | ** ** |
| Cash flows from  operating activities:                                                                                                         |       |                                               |       |   |   |   |   |
| Net income                                                                                                                                     |       | $                                                  | 4.8        |   | $ | 2.9 |   | $ | 1.7 |   |
| Adjustments to  reconcile net income to cash provided by (used in) operating activities:                                                       |       |                                               |       |   |   |   |   |
| Non-cash interest expense                                                                                                                      |       | .2                                                 |       | .2 |   | .2 |   |
| Non-cash compensation expense                                                                                                                  |       | .3                                                 |       | — |   | .8 |   |
| Minority interest in income of consolidated joint  venture                                                                                     |       | 2.4                                                |       | — |   | — |   |
| Gains on sales of short-term investments                                                                                                       |       | —                                             |       | — |   | (1.2 | ) |
| Gains on sales of real estate held for current  development or sale                                                                            |       | (18.4                                              | )          | (10.2 | ) | (4.5 | ) |
| Proceeds from real estate sales, net                                                                                                           |       | 75.7                                               |       | 55.7 |   | 32.4 |   |
| Investments in real estate held for current  development or sale                                                                               |       | (79.7                                              | )          | (48.0 | ) | (38.9 | ) |
| Changes in assets  and liabilities:                                                                                                            |       |                                               |       |   |   |   |   |
| Investment in land held for future development                                                                                                 |       | (2.8                                               | )          | (1.7 | ) | (4.8 | ) |
| Increase in other assets                                                                                                                       |       | (.2                                                | )          | (.8 | ) | (.1 | ) |
| Increase (decrease) in accounts payable, accrued and  other liabilities                                                                        |       | 8.3                                                |       | 2.8 |   | (.7 | ) |
| Cash provided by (used in) operating activities                                                                                                |       | (9.4                                               | )          | .9 |   | (15.1 | ) |
| Cash flows from  investing activities:                                                                                                         |       |                                               |       |   |   |   |   |
| Proceeds from sales of short-term investments                                                                                                  |       | —                                             |       | — |   | 7.4 |   |
| Cash provided by investing activities                                                                                                          |       | —                                             |       | — |   | 7.4 |   |
| Cash flows from  financing activities:                                                                                                         |       |                                               |       |   |   |   |   |
| Borrowings of project debt                                                                                                                     |       | 49.3                                               |       | 23.6 |   | 15.7 |   |
| Repayments of project debt                                                                                                                     |       | (37.1                                              | )          | (23.0 | ) | (9.0 | ) |
| Proceeds from exercise of warrants and stock options                                                                                           |       | .2                                                 |       | .1 |   | — |   |
| Increase in restricted cash                                                                                                                    |       | (1.1                                               | )          | — |   | — |   |
| Release of restricted cash                                                                                                                     |       | —                                             |       | — |   | 1.5 |   |
| Minority interest contributions (distributions)                                                                                                |       | (7.6                                               | )          | 3.9 |   | — |   |
| Cash provided by financing activities                                                                                                          |       | 3.7                                                |       | 4.6 |   | 8.2 |   |
| Net increase  (decrease) in cash and cash equivalents                                                                                          |       | (5.7                                               | )          | 5.5 |   | .5 |   |
| Cash and cash  equivalents—beginning of year                                                                                              |       | 14.7                                               |       | 9.2 |   | 8.7 |   |
| Cash and cash  equivalents—end of year                                                                                                    |       | $                                                  | 9.0        |   | $ | 14.7 |   | $ | 9.2 |   |
| Supplemental  disclosures of cash flow information:                                                                                            |       |                                               |       |   |   |   |   |
| Cash paid during the period for income taxes, net of  refunds received                                                                         |       | $                                                  | (.5        | ) | $ | (.7 | ) | $ | (.9 | ) |
| Supplemental disclosures  of non-cash investing and financing activities:                                                                      |       |                                               |       |   |   |   |   |
| Reclassification adjustment for realized gains  included in net income                                                                         |       | —                                             |       | — |   | (1.3 | ) |
| Minimum pension  liability adjustment recorded as other comprehensive loss, net of income tax  benefit of $0, $0 and $.2 million, respectively |       | (.2                                                | )          | — |   | (1.0 | ) |

 

See accompanying notes to consolidated financial statements.

F-4

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**CALIFORNIA COASTAL COMMUNITIES, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OFCHANGES IN STOCKHOLDERS’ EQUITY**
| ** **                                              | ** ** | ** **             | ** ** | ** **          | ** ** | ** **   | ** ** | **Accumulated**        | ** ** | ** ** | ** ** |
|---------------------------------------------------------|------------|------------------------|------------|---------------------|------------|--------------|------------|------------------------|------------|------------|------------|
| ** **                                              | ** ** | ** **             | ** ** | **Capital in** | ** ** | ** **   | ** ** | **Other**              | ** ** | ** ** | ** ** |
| ** **                                              | ** ** | **Common**             | ** ** | **Excess of**  | ** ** | **Retained** | ** ** | **Comprehensive**      | ** ** | ** ** | ** ** |
| ** **                                              | ** ** | **Stock**              | ** ** | **Par Value**  | ** ** | **Earnings** | ** ** | **Income (Loss)** | ** ** | **Total**  | ** ** |
| ** **                                              | ** ** | **(in millions)** | ** ** |
| Balance at  January 1, 2002                        |       |                   | $          | .5                  |       |         |       | $                      | 139.8      |       |       |   | $ | 18.8 |   |   |   | $ | (.1 | ) |   | $ | 159.0 |   |
| Net income                                              |       |                   | —     |                |       |         | —     |                   |       |       | 1.7        |   |   |   | — |   |   | 1.7 |   |
| Other comprehensive loss, net of income taxes      |       |                   | —     |                |       |         | —     |                   |       |       | —     |   |   |   | (2.3 | ) |   | (2.3 | ) |
| Non-cash compensation expense—stock options        |       |                   | —     |                |       |         | .8         |                   |       |       | —     |   |   |   | — |   |   | .8 |   |
| Utilization of pre-reorganization net operating  losses |       |                   | —     |                |       |         | .7         |                   |       |       | —     |   |   |   | — |   |   | .7 |   |
| Balance at  December 31, 2002                      |       |                   | .5         |                |       |         | 141.3      |                   |       |       | 20.5       |   |   |   | (2.4 | ) |   | 159.9 |   |
| Net income                                              |       |                   | —     |                |       |         | —     |                   |       |       | 2.9        |   |   |   | — |   |   | 2.9 |   |
| Exercise of warrants                                    |       |                   | —     |                |       |         | .1         |                   |       |       | —     |   |   |   | — |   |   | .1 |   |
| Utilization of pre-reorganization net operating  losses |       |                   | —     |                |       |         | 1.7        |                   |       |       | —     |   |   |   | — |   |   | 1.7 |   |
| Balance at  December 31, 2003                      |       |                   | .5         |                |       |         | 143.1      |                   |       |       | 23.4       |   |   |   | (2.4 | ) |   | 164.6 |   |
| Net income                                              |       |                   | —     |                |       |         | —     |                   |       |       | 4.8        |   |   |   | — |   |   | 4.8 |   |
| Other comprehensive loss, net of income taxes      |       |                   | —     |                |       |         | —     |                   |       |       | —     |   |   |   | (.2 | ) |   | (.2 | ) |
| Non-cash compensation expense—stock options        |       |                   | —     |                |       |         | .3         |                   |       |       | —     |   |   |   | — |   |   | .3 |   |
| Exercise of stock options and related state taxes       |       |                   | —     |                |       |         | .3         |                   |       |       | —     |   |   |   | — |   |   | .3 |   |
| Utilization of pre-reorganization net operating losses  |       |                   | —     |                |       |         | 9.1        |                   |       |       | —     |   |   |   | — |   |   | 9.1 |   |
| Balance at  December 31, 2004                      |       |                   | $          | .5                  |       |         |       | $                      | 152.8      |       |       |   | $ | 28.2 |   |   |   | $ | (2.6 | ) |   | $ | 178.9 |   |

 

See accompanying notes to consolidated financial statements.

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**CALIFORNIA COASTAL COMMUNITIES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**Note 1—Formationand Basis of Presentation**

California Coastal Communities, Inc. including itsconsolidated subsidiaries (the “Company”) was formerly known as Koll RealEstate Group, Inc. (October 1993—April 1998), The Bolsa ChicaCompany (July 1992—September 1993), Henley Properties Inc. (December 1989—July 1992)and The Henley Group, Inc. (December 1988—December 1989). Theprincipal activities of the Company currently include: (i) obtainingzoning and other entitlements for land it owns or controls through purchaseoptions and improving the land for residential development; and (ii) designing,constructing and selling single-family residential homes in SouthernCalifornia. Once the residential land owned by the Company is entitled, theCompany may build homes; sell unimproved land to other developers orhomebuilders; sell improved land to homebuilders; or participate in jointventures with other developers, investors or homebuilders to finance andconstruct infrastructure and homes.

On December 31, 1989, The Henley Group, Inc.separated its business into two public companies through a distribution to itscommon stockholders of all of the common stock of a newly formed Delawarecorporation to which The Henley Group, Inc. had contributed its non-realestate development operations, certain assets and related and unrelatedliabilities. The new company was named The Henley Group, Inc. (“HenleyGroup”) immediately following the distribution. The remaining company wasrenamed Henley Properties Inc. (“Henley Properties”) and consisted of the realestate development business and assets of Henley Group, including its principalsubsidiary Signal Landmark.

On July 16, 1992, a subsidiary of HenleyProperties merged with and into Henley Group (the “Merger”) and Henley Groupbecame a wholly owned subsidiary of Henley Properties. In the Merger, HenleyProperties, through its Henley Group subsidiary, received net assets having abook value as of July 16, 1992 of approximately $45.3 million. Inconnection with the Merger, Henley Properties was renamed The Bolsa ChicaCompany.

On September 30, 1993, a subsidiary of The BolsaChica Company acquired the domestic real estate development business andrelated assets of The Koll Company. In connection with this acquisition, TheBolsa Chica Company was renamed Koll Real Estate Group, Inc.

On September 2, 1997, the Company completed arecapitalization (“Recapitalization”). The Recapitalization, which waseffective pursuant to a prepackaged plan of reorganization that was confirmedby the U.S. Bankruptcy Court, resulted in the exchange of all the then existingDebentures, Series A Preferred Stock and Class A Common Stock intonew Common Stock. The prepackaged plan was filed by the Company, excluding allof its subsidiaries and affiliates, contemporaneously with a voluntary petitionfor relief under Chapter 11 of the bankruptcy code in July 1997. Upon theRecapitalization, the Company adopted the provisions of Statement of Position (“SOP”)No. 90-7, “Financial Reporting by Entities in Reorganization Underthe Bankruptcy Code” (“Fresh-Start Reporting”). Accordingly, all assets andliabilities were revalued to reflect their reorganization value, approximatingtheir fair value at the effective date of the Recapitalization. In addition,the accumulated deficit of the Company was eliminated and its capital structurerecast in conformity with the Recapitalization and, as such, the Company hasrecorded the effects of the Recapitalization and Fresh-Start Reporting as ofthe effective date.

On April 30, 1998, the Company sold itscommercial development business. Immediately following the sale, Koll RealEstate Group, Inc. was renamed California Coastal Communities, Inc.

The accompanyingconsolidated financial statements have been prepared in accordance withaccounting principles generally accepted in the United States of America andinclude the accounts of the 

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Companyand its wholly-owned subsidiaries. Intercompany accounts and transactionshave been eliminated.

**Note 2—SignificantAccounting Policies**

*Cash and CashEquivalents and Restricted Cash*

The Company considers allhighly liquid instruments with a maturity of three months or less whenpurchased to be cash equivalents. The Company’s restricted cash of $1.1 millionas of December 31, 2004 represents cash held as security for a standbyletter of credit and a bond for a homebuilding project under development.

*Real Estate*

Real estate held for current development or sale iscarried at the lower of cost, or fair value, less costs to sell. Land held forfuture development is carried at cost, with write-downs to fair value only inthe event that costs cannot be recovered from estimated undiscounted futurecash flows, as described under “Impairment of Long-Lived Assets.” Theestimation process involved in the determination of fair value is inherentlyuncertain since it requires estimates as to future events and marketconditions. Such estimation process assumes the Company’s ability to completedevelopment and dispose of its real estate properties in the ordinary course ofbusiness based on management’s present plans and intentions. Economic, market,environmental and political conditions may affect management’s development andmarketing plans. In addition, the implementation of such development andmarketing plans could be affected by the availability of future financing fordevelopment and construction activities. Accordingly, the ultimate values ofthe Company’s real estate properties are dependent upon future economic andmarket conditions, the availability of financing, and the resolution ofpolitical, environmental and other related issues.

The cost of sales of multi-unitprojects is generally computed using the relative sales value method. Interestcost is capitalized to real estate projects during their development andconstruction period.

*Impairment ofLong-Lived Assets*

The Company assesses the impairment of land held forfuture development and other long-lived assets in accordance with Statement ofFinancial Accounting Standards (“SFAS”) No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets”, which requires that animpaired asset, for which costs cannot be recovered from estimated undiscountedfuture cash flows, be written down to fair value. Long-lived assets arereviewed for impairment whenever events or changes in circumstances indicatethat the carrying amount of an asset may not be recoverable. As provided bySFAS No. 144, impairment is evaluated by comparing an asset’s carryingvalue to the undiscounted estimated cash flows expected from the asset’soperations and eventual disposition. If the sum of the undiscounted estimatedfuture cash flows is less than the carrying value of the asset, an impairmentloss is recognized based on the fair value of the asset. If an impairmentoccurs, the fair value of an asset for purposes of SFAS No. 144 isdeemed to be the amount a willing buyer would pay a willing seller for suchasset in a current transaction. On September 2, 1997, the Companycompleted its Recapitalization pursuant to court confirmation of a PrepackagedPlan of Reorganization, and the Company applied the principles required by theAmerican Institute of Certified Public Accountants Statement of Position (“SOP”)90-7, “Financial Reporting by Entities in Reorganization Under theBankruptcy Code” (“Fresh-Start Reporting”), and the carrying value of realestate properties was adjusted to fair value (see Note 1). Following theCalifornia Coastal Commission’s November 2000 approval of suggestedmodifications to the Bolsa Chica Local Coastal Program, which would limitdevelopment to only the upper bench of the Company’s 208-acre mesaproperty (“Bolsa Chica Mesa”) (see Note 3), the Company evaluated this asset’scarrying value. The Company has updated its 

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analysis at each year-endsince December 31, 2000. Since the undiscounted estimated future cashflows from the upper bench of the Bolsa Chica Mesa (the “Upper Mesa”) and theCompany’s pending sale of its 103-acre Lower Bench at Bolsa Chica exceedits carrying value, there has been no impairment.

In accordance with SFAS No. 144,in developing estimated future cash flows for impairment testing, the Companyhas incorporated its own assumptions regarding the entitlement prospects ofland held for future development and its own market assumptions including thoseregarding home prices, infrastructure and home-building costs regarding bothland held for future development and real estate held for current developmentor sale. Additionally, as appropriate, the Company identifies alternativecourses of action to recover the carrying value of its long-lived assets andevaluates all likely alternatives under a probability-weighted approach asdescribed in SFAS No. 144.

*Change inAccounting Principle—Consolidation of Variable Interest Entities*

In January 2003, the FASB issued FinancialInterpretation FIN No. 46, “Consolidation of Variable Interest Entities—aninterpretation of ARB No. 51.” (“FIN 46”) A Variable Interest Entity(“VIE”) is created when (i) the equity investment at risk is notsufficient to permit the entity from financing its activities withoutadditional subordinated financial support from other parties or (ii) equityholders either (a) lack direct or indirect ability to make decisions aboutthe entity, (b) are not obligated to absorb expected losses of the entityor (c) do not have the right to receive expected residual returns of theentity if they occur. If an entity is deemed to be a VIE, pursuant to FIN 46,an enterprise that has the majority of the variability in gains and losses ofthe VIE is considered to be the primary beneficiary and must consolidate theVIE. FIN 46 was effective immediately for VIEs created after January 31,2003. Pursuant to the FASB’s revision to FIN 46 (“FIN 46-R”), issued in December 2003,the Company was required to apply the provisions of FIN 46 to any interest heldin a VIE or potential VIE beginning the quarter ended March 31, 2004 forVIEs created before February 1, 2003. In accordance with FIN 46-R,the Company implemented FIN 46-R as of March 31, 2004.

Based on the provisions of FIN 46, the Company hasconcluded that whenever it options land or lots from an entity and pays anon-refundable deposit, a VIE may be created under condition (ii)(b) and (c) ofthe previous paragraph. The Company may be deemed to have provided subordinatedfinancial support, which refers to variable interests that will absorb some orall of an entity’s expected theoretical losses if they occur. For each VIEcreated with a significant nonrefundable option fee, the Company will computeexpected losses and residual returns based on the probability of future cashflows as outlined in FIN 46. If the Company is deemed to be the primarybeneficiary of the VIE, the VIE will be consolidated on the Company’s balancesheet. The fair value of the VIE’s real estate will be reported as consolidatedreal estate to be held for current development—not owned and the related theoreticalliability will be reported as consolidated obligations related to real estate—notowned.

The Company’s exposure to loss as the result of apurchase contract with a VIE is limited to the amount of the non-refundable optiondeposit, which is typically 10% or less of the purchase price, not total assetson the balance sheet of the VIE. Therefore, the Company believes thatconsolidating the VIE does not reflect the economic realities or risks ofowning and developing land. The Company has no material third party guaranteesrelated to these contracts. Creditors of these VIEs, if any, have no recourseagainst the Company.

During November 2004,the Company entered into an agreement to purchase land from a third partyentity deemed to be a VIE, with the Company as the primary beneficiary of theentity. Because the Company does not have access to the financial informationof the VIE, the fair value of the optioned property less the cash deposit andconsolidated obligations related to consolidated real estate - not owned of$24.7 million is reflected on the Company’s balance sheet as of December 31,2004. Not all of the Company’s deposits are with VIEs. See Note 9—Real EstateMatters.

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*Basis ofConsolidation*

Certain wholly-ownedsubsidiaries of the Company are members in joint ventures involved in thedevelopment and sale of residential projects and residential loan production.The consolidated statements of the Company include the accounts of the Companyand all majority-owned and controlled subsidiaries and joint ventures. Thefinancial statements of joint ventures in which the Company generally has acontrolling or majority economic interest (and thus are controlled by theCompany) are consolidated with the Company’s financial statements. Minorityinterest represents the equity interest of the Company’s joint venture partnerfor one consolidated venture and is further described in Note 8. The Company’sinvestments in unconsolidated joint ventures are accounted for using the equitymethod, when the Company does not have voting or economic control of theventure operations, as further described in Note 4.

*Income Taxes*

The Company accounts forincome taxes on the liability method. Deferred income taxes are determinedbased on the difference between the financial statement and tax bases of assetsand liabilities, using enacted tax rates in effect in the years in which thesedifferences are expected to reverse. The liability method requires anevaluation of the probability of being able to realize the future benefitsindicated by deferred tax assets. A valuation allowance related to the deferredtax asset is recorded when it is more likely than not that some portion or allof the deferred tax asset will not be realized.

*HomebuildingRevenues and Cost of Sales*

The Company’s homebuildingoperation generates revenues from the sale of homes to homebuyers. The majorityof these homes are designed to appeal to move-up homebuyers and are generallyoffered for sale in advance of their construction. Sales contracts are usuallysubject to certain contingencies such as the buyer’s ability to qualify forfinancing. Revenue from the sale of homes is recognized at closing when titlepasses to the buyer and the earnings process is complete. As a result, theCompany’s revenue recognition process does not involve significant judgments orestimates. However, the Company does rely on certain estimates to determine therelated construction costs and resulting gross margins associated with revenuesrecognized. The cost of sales is recorded based upon total estimated costswithin a subdivision and allocated using the relative sales value method. TheCompany’s construction costs are comprised of direct and allocated costs,including estimated costs for future warranties and indemnities. The Company’sestimates are based on historical results, adjusted for current factors.

*Warranty Costs*

Warranty reserves areestablished as homes close escrow on a per-unit basis in an amount estimated tobe adequate to cover expected warranty-related costs for materials and outsidelabor to be incurred during the warranty period. Reserves are determined basedupon historical data with respect to similar product types and geographicalareas.

*Litigation Reserves*

The Company and certain ofits subsidiaries have been named as defendants in various cases arising in thenormal course of business and regarding disposed assets and businesses of theCompany or former affiliates. The Company has reserved for costs expected to beincurred with respect to these cases based upon information provided by itslegal counsel.

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*Earnings Per CommonShare*

The weighted-averagenumber of common shares outstanding was 10.1 million for each of the yearsended December 31, 2004, 2003 and 2002. Earnings per share, assumingdilution, is computed using the weighted-average number of common sharesoutstanding and the dilutive effect of potential common shares outstanding. Forthe years ended December 31, 2004, 2003 and 2002, the average market priceof the Company’s common stock exceeded the exercise price of outstanding stockoptions. Therefore, the dilutive effect of the weighted average number ofcommon shares from potential exercise of .7 million options is reflected in the10.8 million weighted-average common shares assuming dilution, in the relatedconsolidated statements of operations for 2004, 2003 and 2002. For the yearended December 31, 2003, the average market price of the Company’s commonstock exceeded the exercise price of the 48,000 outstanding warrants, whichwere exercised or expired in December 2003. For the year ended December 31,2002, the average market price of the Company’s common stock did not exceed theexercise price of outstanding warrants. Therefore, the dilutive effect ofoutstanding warrants is reflected in the weighted-average common sharesassuming dilution for 2003, but not for 2002.

*Stock-BasedCompensation*

The Company uses a fair value based method ofaccounting for share-based compensation provided to employees in accordancewith SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”).Stock options are valued based upon an option-pricing model and the fair valueis recognized as an expense over the period in which the options vest. Duringthe second quarter of 2003, the Company adopted the fair value recognitionprovisions of SFAS 123. For this change in accounting, the Companyselected the “modified prospective method” under the provisions of SFAS No. 148,“Accounting for Stock-Based Compensation—Transition and Disclosure—an Amendmentof FASB Statement No. 123” (“SFAS 148”). Under this method, the change wasretroactive to January 1, 2003 and compensation cost recognized during2003 is zero, the same as that which would have been recognized had therecognition provisions of SFAS 123 been applied from its original effectivedate. In accordance with SFAS 148, results for prior years have not beenrestated.

Until the second quarterof 2003, the Company applied Accounting Principles Board (“APB”) Opinion No. 25,“Accounting for Stock Issued to Employees” (“APB 25”), and relatedinterpretations in accounting for its plan. Accordingly, no compensationexpense was recognized through 2002 for its stock-based compensation plansother than for variable accounting for repriced stock options as described above.

*Other ComprehensiveIncome (Loss)*

Other comprehensive income(loss) items under SFAS No. 130, “Reporting Comprehensive Income”, aretransactions recorded in stockholders’ equity during the year, excluding netincome (loss) and transactions with stockholders. The components of othercomprehensive income (loss) are disclosed in the consolidated statements ofoperations net of tax.

*Recent AccountingPronouncements*

In December 2004, the Financial AccountingStandards Board (“FASB”) issued SFAS No. 123 (revised 2004), “Share-BasedPayment”. This Statement replaces SFAS 123, “Accounting for Stock-BasedCompensation” and supersedes APB 25. “Accounting for Stock Issued toEmployees.” SFAS No. 123R addresses the accounting for share-based paymenttransactions in which an enterprise receives employee services in exchange for (a) equityinstruments of the enterprise or (b) liabilities that are based on thefair value of the enterprise’s equity instruments or that may be settled by theissuance of such equity instruments. SFAS No. 123R eliminates the abilityto account for share-based compensation transactions using the intrinsic valuemethod under APB 25, and generally would require instead that suchtransactions 

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be accounted for using afair-value-based method. The Company is currently evaluating SFAS No. 123Rto determine which fair-value-based model and transitional provision it willfollow upon adoption. SFAS No. 123R will be effective for the Companybeginning in the third quarter of 2005. The Company is evaluating the impactapplication of SFAS No. 123R will have on the Company’s results ofoperations.

In December 2004, theFASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets—An amendment ofAPB 29, Accounting for Nonmonetary Transactions”. This statement amends APB 29to eliminate the exception for nonmonetary exchanges of similar productiveassets and replaces it with a general exception for exchanges of nonmonetaryassets that do not have commercial substance. A nonmonetary exchange hascommercial substance if the future cash flows of the entity are expected tochange significantly as a result of the exchange. The Company will evaluate theeffect, if any, of adopting SFAS 153.

*Use of Estimates*

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period. Actual results could differ from those estimates.

**Note 3—Land Heldfor Future Development**

The Company owns approximately 351 acres located inOrange County, California overlooking the Pacific Ocean and the Bolsa Chicawetlands (which were sold by the Company to the State of California in 1997),surrounded by the City of Huntington Beach and approximately 35 miles south ofdowntown Los Angeles. The Company’s holdings include 208 acres on a mesa northof the Bolsa Chica wetlands (“Bolsa Chica Mesa”), approximately 100 acres on,or adjacent to, the Huntington Mesa and 43 acres of lowlands which wereacquired by the Company in September 1997.

The Company is currently pursuing approval of permitsfor development of 68 acres of its approximately 105-acre upper bench onthe Bolsa Chica Mesa (“Upper Mesa”). During 2002, the County of Orange approvedthe Company’s site plan and tentative tract map for development of 379single-family homes on 77 acres of the Upper Mesa. The Company submitted aCoastal Development Permit (“CDP”) application for the planned community, knownas “Brightwater”, to the Coastal Commission in November 2002. On October 13,2004, the Coastal Commission held a public hearing on the Company’s CDPapplication. Following completion of the public hearing, the Company withdrewits CDP application in order to have additional time to work with Commissionersand their staff in an effort to develop changes to the project which would beacceptable to the Commission.

In January 2005, the Company filed a newapplication with the Coastal Commission for a CDP consisting of 347 homes(subsequently amended to add two additional lots for a total of 349 homes) tobe built on 68 acres of the Upper Mesa. This new application reflectselimination of development in environmentally sensitive habitat areas andincreased buffers between the habitat areas and the proposed development. TheCompany made these substantial changes to its proposed development plan inresponse to issues raised with respect to the prior CDP application at theCoastal Commission’s October 13, 2004 hearing. These modificationsresulted in a nine-acre decrease in the proposed development area and acorresponding decrease of 30 homes in the plan. The Company expects that theCoastal Commission staff will issue their recommendation to the CoastalCommission in late March or early April 2005 and the Company currentlyexpects that the Commission will hold a public hearing on the new CDPapplication in mid-April 2005. However, there can be no assurance thatfurther delays will not be encountered.

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As a result of the modifications made to thedevelopment plans for the Upper Mesa and submitted to the Coastal Commission,further approval will be required by the County of Orange. In addition, theCompany expects that following any Coastal Commission approval of a developmentplan, there will be numerous specific conditions for planning items to becompleted prior to the issuance of a CDP. The Company currently expects that aCDP could be issued by the end of 2005, subject to satisfying the permitconditions. Ultimately, the Company does not believe that the Coastal Commissionprocess will permanently prevent it from developing a planned community atBolsa Chica; however, there can be no assurance in that regard, or as to (i) whendevelopment could commence, (ii) the number of acres or homes the Companywill be permitted to develop, or (iii) the absence of further litigationor administrative delay.

The Brightwater planned community is currentlyexpected to offer a broad mix of home choices, averaging 2,740 square feet andranging in size from 1,560 square feet to 4,000 square feet. The plan alsoincludes 37 acres of open space and conservation area on the 105-acreUpper Mesa. With only 349 homes on 68 acres of the Upper Mesa, the resultinglow-density plan equates to approximately 5 homes per acre, consistent andcompatible with the neighboring Huntington Beach communities. In addition, theCompany will offer to dedicate 51 acres of land on the Huntington Mesa to theCounty of Orange to complete the Harriett M. Wieder Linear Park, a 105-acreplanned regional park. The 1,200-acre Bolsa Chica Wetlands are fullypreserved and protected in accordance with previous agreements with the Stateof California and are not included in the Brightwater plan.

On August 12, 2004, an agreement to sell a 103-acreparcel of the Bolsa Chica Mesa known as the “Lower Bench” to the State’sWildlife Conservation Board (“WCB”) for $65 million was approved by the WCB. Thesale remains subject to shareholder approval and the terms of the agreementinclude an outside closing date of June 30, 2005. If the proposed sale iscompleted, WCB’s purchase of the property will be funded with bond proceedsauthorized by voter-approved Proposition 50, which was passed in November 2002.The Company has indicated that it will require Coastal Commission approval of theBrightwater development plan for the Upper Mesa prior to seeking shareholderapproval and issuance of the CDP prior to closing the sale. Therefore, theCompany has initiated discussions with the WCB to extend the outside closingdate to December 31, 2005. However, there can be no assurances that theWCB agreement will be extended or that a sale transaction will ever becompleted.

Upon completion of the Company’s Recapitalization asdiscussed in Note 1, the Company applied the accounting principles required byFresh-Start Reporting and the carrying value of land held for development(Bolsa Chica) was adjusted to fair value as of September 2, 1997. The fairvalue was determined in 1997 using discounted estimated cash flows expectedfrom the asset’s operations and eventual disposition. The Company has updatedits analysis at each year-end since 1997, and has noted no indicators ofimpairment since that date. Future costs incurred for capitalizable developmentactivities for the Bolsa Chica project will increase the basis of the land. Anestimate for these costs has been included in the Company’s estimatedundiscounted cash flow forecast used in its impairment analyses. In accordancewith the Company’s policy described in Note 2—Impairment of Long-Lived Assets,since the estimated undiscounted future cash flows from the proposed Upper Mesadevelopment plan for 349 single-family homes and the pending sale of the LowerBench to WCB are expected to exceed its December 31, 2004 carrying value,the Company believes there has been no impairment.

The estimation processinvolved in the determination of value is inherently uncertain since itrequires estimates as to future events and market conditions. Such estimationprocess assumes the Company’s ability to complete development and dispositionof its real estate properties in the ordinary course of business based onmanagement’s present plans and intentions. Economic, market, environmental andpolitical conditions may affect management’s development and marketing plans. Inaddition, the implementation of such development and marketing plans could beaffected by the availability of future financing for development andconstruction activities. The development of the Company’s Upper Mesa 

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projectis dependent upon various governmental approvals and economic factors.Accordingly, the amount ultimately realized from such project may differmaterially from current estimates and the project’s carrying value.

**Note 4—Investmentsin Unconsolidated Joint Ventures**

TheCompany’s investments in unconsolidated joint ventures are 50% or less owned,not substantially controlled by the Company, and accordingly, are accounted forusing the equity method and are not consolidated with the Company’sconsolidated financial statements. Investments are included in the Company’sbalance sheet in other assets. Condensed combined financial informationregarding the Company’s investments in: (i) the 93-home FairbanksHighlands joint venture (San Diego, California), (ii) a residential loanproduction partnership with a major commercial bank and (iii) the Oxnardland development joint venture (described below) are summarized as follows (inmillions, except home closings):
| ** **                    | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Balance Sheet  Data:          |       |     |       |     |       |     |       |
| Total assets                  |       | $        | 5.4        |     | $          | 3.6      |       |   |   |
| Total liabilities             |       | (1.5     | )          | (.9      | )          |     |       |
| Venturers’  capital      |       | $        | 3.9        |     | $          | 2.7      |       |   |   |
| Statement of Operations Data: |       |     |       |     |       |     |       |
| Revenues                      |       | $        | 1.4        |     | $          | 1.6      |       | $ | 6.4 |   |
| Expenses                      |       | (.7      | )          | (.4      | )          | (4.1     | )          |
| Net income                    |       | $        | .7         |     | $          | 1.2      |       | $ | 2.3 |   |
| Home closings                 |       | —   |       | —   |       | 4        |       |

 

During 2004, 2003 and 2002, the Company received $.1million, $.1 million and $1.4 million, respectively, in aggregate cashdistributions from the Fairbanks Highlands joint venture and $.4 million, $.3million and $.2 million in 2004, 2003 and 2002, respectively, from the residentialloan production partnership.

In February 2003, the Company entered into twooption contracts to acquire land adjacent to the City of Oxnard in VenturaCounty, California aggregating approximately 168 acres. The Company is in theprocess of developing a land plan for the area, which also includes anadditional 149 acres owned by other landowners, with the intention of entitlingthe property for residential development and annexing it to the City of Oxnard.The Company currently expects that the residential development plan willinclude approximately 880 single-family detached lots and approximately 375attached family residential units; however, these numbers are subject to changeduring the course of the entitlement process. Approximately 650 of the singlefamily lots and 250 of the attached units would be developed on the 168 acresof optioned land expected to be purchased by the Company. The option contractsallow for two years, plus up to three additional years through the exercise ofextensions, for the Company to complete these entitlement activities in advanceof consummating the purchase transactions. The entitlement process is expectedto be completed during the first quarter of 2006; however, delays could beencountered. During January 2005, the first six-month option extensionswere exercised. The option-holder has the right in its sole discretion toterminate the obligations under these option agreements by forfeiting the cashdeposits with no further financial responsibility.

During October 2003,the Company entered into a Limited Liability Company (“Oxnard LLC”) jointventure agreement with a major financial partner to pursue the Oxnarddevelopment opportunity. The Company assigned the land purchase option contractsto the Oxnard LLC. Hearthside Homes, Inc. (the 

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Company’shomebuilding subsidiary) is the managing member of the Oxnard LLC, and hascontributed $500,000 to the venture. The non-managing member also made aninitial contribution of $500,000 to the venture. Capital contributions of up toan additional $4 million are to be made by the non-managing member. As of December 31,2004, the non-managing member had made an aggregate of approximately $2.6million of additional contributions. Under the Oxnard LLC operating agreement,if contributions in excess of $5 million are required and approved by themembers, the next $1 million would be contributed equally by the members. Totalcontributions of the non-managing member are generally limited to $5 million. Afterpayment of a 10% preferred return on invested capital to each member, firsttier profits are generally allocated 75% to the non-managing member and 25% tothe managing member and second tier profits and losses over $5 million aregenerally allocated 50% to each member. The first $5 million of losses aregenerally allocated 80% to the non-managing member and 20% to the managingmember. While the Company exerts a large degree of influence over the venture,the non-managing member does have various participating rights such as approvalrights with regard to major business decisions. In addition, the Company is notthe primary beneficiary of the entity, therefore, the venture is notconsolidated.

**Note 5—Project Debt**

In conjunction with theacquisition of single-family residential lots, the Company’s homebuildingsubsidiary, Hearthside Homes, Inc. and its subsidiaries, enter intoconstruction loan agreements with a commercial bank. These loan facilitiesfinance a portion of the land acquisition and the majority of the constructionof infrastructure and homes. The loans are secured by deeds of trust onindividual projects and require principal repayments upon the delivery of homes.The loans bear an interest rate of prime plus three-fourths percent (6.0% at December 31,2004). During the year ended December 31, 2004, Hearthside Homes, Inc.entered into nine new loan facilities aggregating $76.0 million in conjunctionwith the acquisitions and development of a total of 265 single familyresidential lots. Two of these loans were repaid during 2004. The followingamounts were available and outstanding under these loan facilities as of December 31,2004 and 2003 ($ in millions):
| ** **      | ** ** | ** **           | ** ** | ** **       | ** ** | ** **   | ** ** | **Outstanding at** | ** ** |
|-----------------|------------|----------------------|------------|------------------|------------|--------------|------------|-------------------------|------------|
| ** **      | ** ** | **Amount**           | ** ** | **Number**       | ** ** | **Maturity** | ** ** | **December 31,**   | ** ** |
| ** **      | ** ** | **of Facility** | ** ** | **of Lots** | ** ** | **Date**     | ** ** | **2004**                | ** ** | **2003** | ** ** |
| Chino           |       |                 | $          | 15.4             |       |         |       | —                  |       |   | 11/29/04 |   | $ | — |   | $ | 10.4 |   |
| Riverside       |       |                 | 2.3        |             |       |         | 13         |                    |       | 5/10/05 |   | 2.3 |   | — |   |
| Chino II        |       |                 | 6.3        |             |       |         | 17         |                    |       | 5/11/05 |   | 1.7 |   | — |   |
| Rancho Santa Fe |       |                 | 5.2        |             |       |         | 8          |                    |       | 5/19/05 |   | 1.6 |   | — |   |
| Lancaster       |       |                 | 10.7       |             |       |         | 104        |                    |       | 5/23/05 |   | 4.0 |   | — |   |
| Corona          |       |                 | 21.1       |             |       |         | 83         |                    |       | 5/24/05 |   | 11.4 |   | — |   |
| Rancho Santa Fe |       |                 | 3.9        |             |       |         | 6          |                    |       | 6/13/05 |   | 1.1 |   | — |   |
| Chino           |       |                 | 9.6        |             |       |         | 11         |                    |       | 7/29/05 | * * | .5 | * * | *—* | * * |
|            |       |                 |       |             |       |         |       |                    |       |   |   | $ | 22.6 |   | $ | 10.4 |   |

 

For the years ended December 31,2004, 2003 and 2002, approximately $1.4 million, $.8 million and $.6 million,respectively, of interest incurred was capitalized to projects in theconstruction stage.

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**Note 6—Other Liabilities**

Other liabilities were comprised of the following asof December 31 (in millions):
| ** **                                          | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------------------------|------------|----------|------------|----------|------------|
| Net deferred  taxes and other tax liabilities       |       | $        | —     |     | $          | 3.6 |   |
| Accrued pensions  and benefits                      |       | 4.9      |       | 4.9      |       |
| Home warranty  reserves                             |       | 1.6      |       | 1.2      |       |
| Contingent  indemnity and environmental obligations |       | 3.5      |       | 4.1      |       |
| Unamortized  discount                               |       | (.7      | )          | (.9      | )          |
|                                                |       | $        | 9.3        |     | $          | 12.9 |   |

 

Thedecrease in net deferred taxes and other tax liabilities primarily reflects thereversal of reserves on federal NOLs of $9.1 million, which caused the deferredtax account to be a net asset as of December 31, 2004. See Note 7. Contingentindemnity and environmental obligations primarily reflect (i) reservesbefore related discount (recorded pursuant to Fresh-Start Reporting) forcontingent indemnity obligations for businesses disposed of by formeraffiliates and unrelated to the Company’s current operations, and (ii) thecontingent liability of a subsidiary of the Company for PCB contamination onits 43-acre Bolsa Chica lowlands property as further described below.

*Dresser Litigation*

In May 2002, Dresser Industries, Inc. (“Dresser”)filed litigation, captioned Dresser Industries, Inc. vs. CaliforniaCoastal Communities, Inc. and RESCO Holdings, Inc. (“RESCO”, a formeraffiliate), in the 58th Judicial District Court of Jefferson County,Texas. Dresser seeks a declaratory judgment regarding the rights andobligations of the parties under a January 1988 purchase agreement. Underthe agreement, Dresser acquired an engineering and construction business fromThe M.W. Kellogg Company (“Kellogg”), a corporation formerly affiliated withthe Company. Kellogg and its parent company, Wheelabrator Technologies, Inc.(“Wheelabrator”, a former affiliate of the Company), agreed to indemnifyDresser against certain pre-closing claims. In a subsequent transaction,Wheelabrator assigned certain assets and liabilities relating to the January 1988purchase agreement to the Company. Dresser also seeks unspecified damages forbreach of the 1988 purchase agreement, along with attorney’s fees and costs.Dresser’s indemnity claims relate to several hundred lawsuits encompassingapproximately 5,900 contested asbestos claims made by third parties inconnection with work in facilities in which the Dresser-acquired engineeringand construction business was allegedly connected.

The Company denied Dresser’s allegations andvigorously defended itself in this case and related matters. The Company wasnot formed until September 1988 and, when it was spun-off fromWheelabrator in December 1988, the Company agreed to indemnifyWheelabrator for its potential liabilities under the January 1988 purchaseagreement with Dresser, to the extent that any such liabilities are not coveredby insurance. However, the Company and RESCO contended that under the terms ofthe January 1988 purchase agreement, any contractual duty to indemnifyDresser for any third-party asbestos claims expired in March 1991.

In September 2004, RESCO and the Company reachedan agreement in principle with Dresser to settle this litigation subject tonegotiation of a definitive settlement agreement. The Company is continuing tonegotiate with Dresser, RESCO and RESCO’s insurer in an effort to finalize thesettlement agreement. The Company’s share of the settlement is $1.33 millionand is the amount of the Company’s litigation accrual as of December 31,2004. The Company recorded an increase in the accrual of approximately $500,000during 2004. The Company and RESCO are not admitting fault or liability withrespect to Dresser’s claims, but are negotiating to settle the matter in orderto avoid the continued cost and uncertainty of litigation. However, in the event that final settlement isnot accomplished and the Company is required to provide indemnification toDresser, defense costs and damage awards in asbestos cases can involve amountsthat would have a material adverse effect on the Company’s business, operationsand financial condition.

F-15

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*Lowland Remediation*

In September 1997, the Company acquired 43 acresin the Bolsa Chica lowlands with the intent of selling it to the State ofCalifornia in connection with their planned restoration of 1,000 acres ofadjacent wetlands. While the State is negotiating to acquire this property fromthe Company, no such agreement has been reached to date and there can be noassurances that any agreement will ever be reached. However, in anticipation ofentering into a purchase agreement, the State performed limited soils samplingon this property and notified the Company in 1999 that it had discoveredcontamination from a group of chemicals called PCBs. The source of thecontamination is presently unknown; however, the Company has never conductedany development, business or operations on this property. In January 2002,the State’s Department of Toxic Substances Control (“DTSC”) became theregulatory agency responsible for overseeing the Company’s efforts to remediatethe contamination on this property. In July 2002, a subsidiary of theCompany entered into a consent order with DTSC regarding remediation. TheCompany’s subsidiary prepared a Remedial Investigation (“RI”) Workplan, whichwas approved by DTSC in August 2003. During 2003, the subsidiary performedsoil sampling at the site according to the RI Workplan to determine the natureand extent of contamination, and submitted an RI Report to DTSC in February 2004.As of December 31, 2004, the subsidiary has accrued approximately $800,000for environmental testing and remediation of this property. While the accrualreflects the estimate for the minimum costs which are probable and estimable,such accrual may not be adequate to satisfy the full amount of remediation thatmay be required by the DTSC. A Remedial Action Workplan (“RAW”) was approved byDTSC in December 2004.

In May 2004, theCompany’s subsidiary received an invoice from DTSC seeking reimbursement for$793,000 of oversight and remediation costs incurred by DTSC with respect toPCBs found on neighboring residential properties. Since receiving the originalinvoice, the Company’s subsidiary has received three similar invoices for anaggregate additional $78,000 including accrued interest. However, the Company’ssubsidiary contends, based upon advice of counsel, that it is not responsiblefor such costs because the Company did not develop or build the neighboringresidential properties, the Company did not generate the contamination, thecontamination did not emanate from the Company’s property and the 43-acresite should not be part of the same “site” as the residential properties.Furthermore, the Company’s subsidiary has also disputed such charges due to thefact that DTSC did not bill the Company’s subsidiary in accordance with therequirements of the applicable law. The Company’s subsidiary intends tovigorously defend itself in this matter. Therefore, the Company has not accruedfor any of DTSC’s $871,000 of claims related to these residential properties.

*Home WarrantyReserve*

TheCompany provides a home warranty reserve to reflect its contingent obligationfor product liability. The Company generally records a provision as homes aredelivered, based upon historical and industry experience, subject to certainminimums. The home warranty reserve activity is presented below for the yearsended December 31 (in millions):
| ** **                      | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------|------------|----------|------------|----------|------------|
| Balance at  beginning of period |       | $        | 1.2        |     | $          | 1.2 |   |
| Provision                       |       | .6       |       | .1       |       |
| Payments                        |       | (.2      | )          | (.1      | )          |
| Balance at end of period        |       | $        | 1.6        |     | $          | 1.2 |   |

 

**Note 7—Income Taxes**

Upon completion of the 1997 Recapitalization, theCompany experienced an “ownership change” under Section 382 of theInternal Revenue Code (the “Code”) as a result of the increase in thepercentage 

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of the Company’s stock byvalue held by certain persons (including creditors who exchanged debt forstock) of more than 50 percentage points at any time during a three-yearperiod. Subsequent to an ownership change, the Company’s annual use of its netoperating losses (“NOLs”) is generally limited to the value of the Company’sequity immediately before the ownership change multiplied by the long-termtax-exempt rate. However, Section 382(l)(5) of the Code, the “bankruptcyexception,” provides that if the ownership change occurs through a bankruptcy,such as the Company’s Recapitalization which utilized a prepackaged plan, andif the continuing shareholders and “qualifying creditors” before the ownershipchange own at least 50% of the Company’s stock after the ownership change, thegeneral limitations of Section 382 will not apply. “Qualifying creditors”generally must have held their debt at least 18 months before the prepackagedplan was filed on July 14, 1997, or the debt must have arisen in theordinary course of the Company’s business.

The Company believes that it qualifies for the “bankruptcyexception” of Section 382(l)(5). Under this exception, the Company wasrequired to reduce its NOLs by (i) the amount of interest accrued on anydebt exchanged for stock in the bankruptcy proceeding during the year of theproceeding and the three prior taxable years and (ii) an additional amountrequired to make the total reduction equal to the amount of cancelation ofindebtedness income realized. Accordingly, the Company’s NOLs of approximately$271 million as of September 2, 1997 were reduced by approximately $79million. As reduced, the Company’s NOL carryovers are fully deductible againstpost-reorganization income, subject to the general rules regarding changeof ownership as discussed below, and expiration of NOLs. The federal NOLsavailable as of December 31, 2004 are approximately $164 million,including pre-Reorganization NOLs of approximately $151 million, afterreflecting activity subsequent to September 2, 1997 and the 1998settlement with the Internal Revenue Service (“IRS”) discussed below. Theamount of NOLs which expire if not utilized is zero, $10 million, $8 million,$19 million, $11 million and $116 million for 2005, 2006, 2007, 2008, 2009 andthereafter, respectively.

The Company remains subject to the general rules regardinga change of ownership under Section 382 of the Code, which limit theavailability of NOLs if an ownership change (defined as more than a 50% changein ownership) occurs within any three-year period. If the Company was toexperience another ownership change, the use of all remaining NOLs wouldgenerally be subject to an annual limitation equal to the value of the Company’sequity before the ownership change, multiplied by the long-term tax-exemptrate. The Company estimates that after giving effect to various transactions bystockholders who hold a 5% or greater interest in the Company, as of February 25,2005, it has experienced a three-year cumulative ownership shift ofapproximately 40%, as computed in accordance with Section 382.

In response to an unsolicited written consent from amajority of its stockholders, the Company amended its certificate ofincorporation on October 14, 1999 in order to preserve the ability of theCompany to utilize its tax loss carryforwards. Since the Company’s use of itsNOLs would be severely restricted if it experiences an ownership change of 50%or more, the Company’s majority stockholders requested that the Board ofDirectors enact the amendments, which have been determined to be in the bestinterest of the Company and its stockholders. The amendments prohibit futurepurchases of the Company’s common stock by persons who would become new 5%holders, and also prohibit current holders of over 5% from increasing theirpositions, except in certain permissible circumstances which would notjeopardize the Company’s ability to use its NOLs. While these amendmentsreduced the Company’s risk of an ownership change occurring due to theacquisition of shares by 5% stockholders, the risk remains that an ownershipchange could result from the sale of shares by existing 5% stockholders. TheCompany’s Board of Directors evaluates requests to purchase any amounts inexcess of 5% of the Company’s common stock and authorizes such transactionswhich are not expected to jeopardize the Company’s ability to use its NOLs. DuringAugust 2004, the Company announced that it would not approve furtherpurchases in the foreseeable future. However, since the calculation of thecumulative 

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ownership shift is basedon a rolling three years, the Company’s Board of Directors will re-evaluatesuch requests in the future.

Thetax effects of items that gave rise to significant portions of the deferred taxaccounts for the years ended December 31 (in millions) are as follows:
| ** **                                                                                                                                                   | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| Deferred tax assets:                                                                                                                                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Accruals/reserves not deductible until paid                                                                                                                  |       | $          | 7.0        |       | $          | 4.5 |   |
| Net operating loss and alternative minimum tax  credit carryforwards                                                                                         |       | 57.9       |       | 62.4       |       |
| State income tax provisions deductible when paid for  federal tax purposes                                                                                   |       | 1.1        |       | 1.2        |       |
| Valuation allowance                                                                                                                                          |       | (43.3      | )          | (52.6      | )          |
|                                                                                                                                                         |       | 22.7       |       | 15.5       |       |
| Deferred tax  liabilities:                                                                                                                                   |       |       |       |       |       |
| Land held for future development (principally due to  accounting for a prior business combination, partially offset by asset  revaluations in 1995 and 1997) |       | 19.0       |       | 19.0       |       |
| Net deferred tax assets  (liabilities)                                                                                                                       |       | $          | 3.7        |       | $          | (3.5 | ) |

 

The net deferred tax balance at December 31, 2004is primarily composed of federal NOL and is included in other assets. Thedeferred tax balance at December 31, 2003 is primarily comprised of statenet deferred tax liabilities and is included in other liabilities. The Companyhas established a valuation allowance related to the potential utilization ofits deferred tax assets due to uncertainties that preclude it from determiningthat it is “more likely than not” that the Company will be able to generatesufficient taxable income to realize such assets. Such uncertainties includethe availability of real estate for development at economically viable prices,government approvals, results of litigation and economic factors affecting theCompany’s operations. The Company monitors these, as well as other positive andnegative factors that may arise in the future, as it assesses the need for avaluation allowance against its deferred tax assets. Recognition of taxbenefits from future potential reductions in valuation allowances attributableto any utilization of pre-Reorganization NOLs are excluded from results ofoperations and credited to capital in excess of par value. The portion of thevaluation allowance allocated to federal pre-Reorganization NOLs isapproximately $38.1 million as of December 31, 2004.

Thefollowing is a summary of the income tax provision (benefit) applicable toincome before income taxes for the years ended December 31 (in millions):
| ** **                               | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Current taxes                            |       | $        | 1.5        |     | $          | .5       |       | $ | .6 |   |
| Deferred taxes                           |       | 3.1      |       | 1.8      |       | —   |       |
| Reduction in  contingent tax liabilities |       | (.1      | )          | (.1      | )          | (1.4     | )          |
|                                     |       | $        | 4.5        |     | $          | 2.2      |       | $ | (.8 | ) |

 

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Theprincipal items accounting for the difference in taxes on income computed atthe statutory rate and as recorded, are as follows for the years ended December 31(in millions):
| ** **                                    | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Provision for  income taxes at statutory rate |       | $        | 4.1        |     | $          | 1.8      |       | $ | .3 |   |
| State income  taxes, net                      |       | .4       |       | .4       |       | .5       |       |
| Change in federal  tax law                    |       | —   |       | —   |       | (.3      | )          |
| Reduction in  contingent tax liabilities      |       | (.1      | )          | (.1      | )          | (1.4     | )          |
| All other items,  net                         |       | .1       |       | .1       |       | .1       |       |
|                                          |       | $        | 4.5        |     | $          | 2.2      |       | $ | (.8 | ) |

The tax provision for theyear ended December 31, 2004 reflects a $400,000 benefit for a reductionin valuation allowance on post-Reorganization state NOLs. During the yearsended 2004, 2003 and 2002, reductions in valuation allowance on federalpre-Reorganization NOLs, of $9.1 million, $1.7 million and $.7 million,respectively, were recorded, as the Company determined that the utilization ofthese NOLs is “more likely than not” based on forecasted earnings. Pursuant toFresh-Start Reporting, the reductions in valuation allowance related topre-Reorganization NOLs were reflected by increasing the Company’s capital inexcess of par value.

*Tax ComplianceMatters*

In 1998, the Company andthe IRS settled a significant dispute with respect to the tax returns of theCompany and its consolidated subsidiaries, including formerly affiliatedentities, for the years ended December 31, 1989, 1990 and 1991. All of thestate jurisdictions in which the Company filed amended returns for these yearshave accepted such returns, thereby eliminating the Company’s exposure topotential claims. In conjunction with periodic reviews of the adequacy ofreserves for estimated state income tax exposure related to the 1998 IRS taxsettlement, the Company reduced its reserves by approximately $100,000,$100,000 and $1.4 million in 2004, 2003 and 2002, respectively. Each reductionin contingent tax liabilities is reflected as a benefit in the income taxprovision.

**Note 8—MinorityInterest**

In April 2003, theCompany entered into a Limited Liability Company (“Chino LLC”) joint ventureagreement for the purpose of designing, constructing and selling 77 homes inChino, California. The Chino LLC acquired the 77 lots in May 2003 and iscurrently constructing and selling homes. Hearthside Homes, Inc. (one ofthe Company’s principal subsidiaries) is the managing member of the Chino LLC,manages its operations and contributed capital of approximately $400,000(approximately 10%) to the venture. Minority interest represents thenon-managing member’s equity interest in the venture including a capitalcontribution of approximately $4.0 million (approximately 90%), net ofdistributions and as adjusted for the member’s allocation of profits andlosses. Profits and losses are generally allocated 50% to each member, after a10% preferred return on invested capital. During the year ended December 31,2004, capital distributions of approximately $7.6 million were made to thenon-managing member, repaying all of its initial capital contribution, plus all$600,000 of accumulated preferred return and $3.1 million in profitdistributions, in conjunction with the delivery of the first 65 homes. During theyear ended December 31, 2004, the Company recorded minority interest inincome of consolidated joint venture of $2.4 million, net of income tax benefitof $1.6 million.

**Note 9—Commitmentsand Contingencies**

*Real Estate Matters*

The Company is subject tothe usual obligations associated with entering into contracts for the purchaseof land and improved homesites. The purchase of properties under thesecontracts is generally 

F-19

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contingentupon satisfaction of certain requirements by the sellers, including obtainingapplicable property entitlements. The Company also utilizes option contractswith third-party land sellers and financial entities as a method of acquiringland in staged takedowns and minimizing the use of funds from other corporatefinancing sources. These option contracts also help to manage the financial andmarket risk associated with land holdings. Option contracts generally requirethe payment of a non-refundable cash deposit of 5% to 20% of the purchase pricefor the right to acquire lots over a specified period of time (usually one totwo years) at predetermined prices. The Company has the right at its discretionto terminate its obligations under these land purchase and option agreements byforfeiting the cash deposit with no further financial responsibility. Summaryinformation regarding the Company’s land option deposits is as follows as of December 31,2004:
| Total number of  projects                                                      |   | 5   |   |
|--------------------------------------------------------------------------------|--------|-----|--------|
| Total number of lots                                                           |   | 357 |   |
| Total forfeited deposits if lots are not purchased  (included in other assets) |   | $   | 4.9    |   |
| Total remaining  purchase price                                                |   | $   | 41.8   |   |

 

The Company had outstanding performance and suretybonds, for the benefit of city and county jurisdictions, related principally toits obligations for site improvements at various projects at December 31,2004. The Company does not believe that draws upon these bonds, if any, willhave a material effect on the Company’s financial position, results ofoperations or cash flows.

*Legal Proceedings*

See Note 6 for a discussion of pending litigation filedagainst the Company by Dresser.

There are various other lawsuits and claims pendingagainst the Company and certain subsidiaries. In the opinion of the Company’smanagement, ultimate liability, if any, will not have a material adverse effecton the Company’s financial condition or results of operations.

See Notes 3 and 6 for adiscussion of other contingencies.

*Lease Obligations*

For the years ended December 31,2004, 2003 and 2002, the Company incurred rents for corporate facilities ofapproximately $166,000, $131,000 and $131,000, respectively. Future minimumnoncancelable operating lease payments for the years ending December 31,2005 and 2006 are approximately $162,000 and $168,000, respectively. Thereaftersuch amounts are zero.

*Corporate IndemnificationMatters*

The Company and its formeraffiliates have, through a variety of transactions effected since 1986,disposed of several assets and businesses, many of which are unrelated to theCompany’s current operations. By operation of law or contractual indemnityprovisions, the Company may have retained liabilities relating to certain ofthese assets and businesses. There is generally no maximum obligation or amountof indemnity provided for such liabilities. A portion of such liabilities issupported by insurance or by indemnities from certain of the Company’spreviously affiliated companies. The Company believes its consolidated balancesheet reflects adequate reserves for these matters.

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**Note 10—RetirementPlans**

The Company adopted a retirement savings planeffective January 1, 2000 pursuant to Section 401(k) of theCode, and participants may contribute a portion of their compensation to theirrespective retirement accounts, in an amount not to exceed the maximum allowedunder the Code. Prior to January 1, 2000, the Company participated in asimilar plan sponsored by a former affiliate. All participants in the previousplan were allowed to transfer their balances to the Company sponsored planeffective January 1, 2000. The new plan provides for certain matchingcontributions paid in cash by the Company to non-highly compensated employees,as defined in the Internal Revenue Code. Plan participants are immediatelyvested in their own contributions.

TheCompany has a noncontributory defined benefit retirement plan which coveredsubstantially all employees of the Company prior to September 30, 1993 whohad completed one year of continuous employment. The benefit accrual for allparticipants was terminated on December 31, 1993. Net periodic pensioncost was as follows for the years ended December 31 (in millions):
| ** **                     | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|--------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Service cost                   |       | $        | —     |     | $          | —   |       | $ | — |   |
| Interest cost                  |       | .4       |       | .3       |       | .3       |       |
| Expected return  on assets     |       | (.3      | )          | (.2      | )          | (.3      | )          |
| Net amortization  and deferral |       | .1       |       | .1       |       | .1       |       |
| Net periodic pension  expense  |       | $        | .2         |     | $          | .2       |       | $ | .1 |   |

 

The development of theprojected benefit obligation for the plan at December 31, 2004 and 2003 isbased on the following assumptions: a discount rate of 5.5% and 6% for 2004 and2003, respectively, and an expected long-term rate of return on assets of8% and 7% for 2004 and 2003, respectively. Assets of the plan are investedprimarily in stocks, bonds, short-term securities and cash equivalents asshown below.

**Plan asset information:**
| ** **        | ** ** | **Target  Allocation  2005** | ** ** | **Allocation  2004** | ** ** | **Allocation  2003** | ** ** |
|-------------------|------------|------------------------------|------------|----------------------|------------|----------------------|------------|
| Equity securities |       |                         | 80         | %                    |       |                 | 84         | % |   |   | 93 | % |   |
| Debt securities   |       |                         | 20         | %                    |       |                 | 16         | % |   |   | 6 | % |   |
| Cash              |       |                         | 0          | %                    |       |                 | 0          | % |   |   | 0 | % |   |

 

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Thefunded status and accrued pension cost at December 31, 2004 and 2003 forthe defined benefit retirement plan were as follows (in millions):
| ** **                                                        | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------------------------------|------------|----------|------------|----------|------------|
| **Benefit obligation:**                                           |       |     |       |     |       |
| Benefit  obligation at beginning of year                          |       | $        | 6.4        |     | $          | 5.7 |   |
| Service cost                                                      |       | —   |       | —   |       |
| Interest cost                                                     |       | .4       |       | .3       |       |
| Actuarial loss                                                    |       | .5       |       | .9       |       |
| Change in assumptions                                             |       | —   |       | —   |       |
| Benefits paid                                                     |       | (.5      | )          | (.5      | )          |
| Administrative  expenses paid                                     |       | (.1      | )          | —   |       |
| Benefit  obligation at end of year                                |       | $        | 6.7        |     | $          | 6.4 |   |
| **Plan  assets:**                                                 |       |     |       |     |       |
| Fair value of  plan assets at end of prior year                   |       | $        | 4.4        |     | $          | 3.9 |   |
| Net return on  plan assets                                        |       | .5       |       | 1.0      |       |
| Assets  contributed to plan                                       |       | .2       |       | —   |       |
| Benefits paid                                                     |       | (.5      | )          | (.5      | )          |
| Administrative  expenses paid                                     |       | (.1      | )          | —   |       |
| Fair value of  plan assets at end of year                         |       | $        | 4.5        |     | $          | 4.4 |   |
| Funded status                                                     |       | $        | (2.2       | )        | $          | (2.0 | ) |
| Unrecognized net  actuarial loss                                  |       | 2.9      |       | 2.6      |       |
| Prepaid benefit  cost                                             |       | .7       |       | .6       |       |
| Additional  minimum liability charged to other comprehensive loss |       | (2.9     | )          | (2.6     | )          |
| Accrued benefit  liability                                        |       | $        | (2.2       | )        | $          | (2.0 | ) |

 

The $2.6 million and $2.4million balance of accumulated other comprehensive loss as of December 31,2004 and 2003, respectively, reflects the additional minimum liability of $2.9million and $2.6 million, respectively, net of a minimal tax effect due tooffset from the Company’s federal tax NOLs. The amount of the accrued benefitliability is reflected in other liabilities.

**Note 11—CapitalStock**

*Common Stock*

During October 1999, pursuant to an unsolicitedwritten consent from a majority of the Company’s stockholders, the Companyadopted certain amendments to its certificate of incorporation. The amendmentsauthorized 18,000,000 shares of a second class of stock, (“Excess Stock”) to beissued under certain circumstances. The effect of the amendments is to prohibitthe acquisition of the Company’s Common Stock by anyone who would become a 5%stockholder or by existing 5% stockholders, except in certain permissiblecircumstances which would not significantly increase the risk of an OwnershipChange (as defined by the Internal Revenue Code of 1986, as amended) and wouldnot, therefore, jeopardize the Company’s ability to use its $164 million ofNOLs (see Note 7). While these amendments reduced the Company’s risk of anOwnership Change occurring due to the acquisition of shares by 5% stockholders,the risk remains that an Ownership Change could result from the sale of sharesby existing 5% stockholders. The Company’s Board of Directors evaluatesrequests to purchase any amounts in excess of 5% of the Company’s common stockand authorizes such transactions which are not expected to jeopardize theCompany’s ability to use its NOLs. During August 2004, the Companyannounced that it would not approve further purchases in the foreseeable future.However, since the calculation of the cumulative 

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ownership shift is basedon a rolling three years, the Company’s Board of Directors will re-evaluatesuch requests in the future.

At the May 2000Annual Meeting, the Company’s shareholders approved a reduction in authorizedshares of both Common Stock and Excess Stock from 18,000,000 shares to11,000,000 shares. At the May 2004 Annual Meeting, the Company’sshareholders approved an increase in authorized shares of both Common andExcess Stock from 11,000,000 shares to 13,500,000 shares.

*Warrants*

During December 2003,the Company issued 18,000 common shares upon the exercise of a warrantpreviously received by a consultant in partial compensation for its services in1999. The warrant was issued with its exercise price at a then current marketprice of $7.00 per share, and vested after one year. The Company received$126,000 in cash in connection with the exercise of this warrant. As of December 31,2004 and 2003, there are no warrants outstanding.

**Note 12—Stock Plans**

*1993 StockOption/Stock Issuance Plan*

The 1993 Stock Option/Stock Issuance Plan (“1993 Plan”)was approved at the 1994 Annual Meeting of Stockholders, reserving 7.5 millionshares each of Series A Preferred Stock and Class A Common Stock forissuance to officers, key employees and consultants of the Company and itssubsidiaries and the non-employee members of the Board of Directors (the “Board”).On April 28, 1997, in connection withthe Recapitalization, the Compensation Committee of the Board authorized thegrant of stock options for 759,984 shares, equivalent at that time to 6% of theCompany’s fully diluted equity, for certain directors and officers. At the May 2004stockholder meeting, the stockholders of the Company authorized an additional150,000 stock options for the 1993 Plan.

In 1998, options for 569,988 shares were terminated inconnection with the Company’s sale of its commercial development business andnew options for 295,000 shares were granted. During 1999, options aggregating270,000 shares were issued to certain officers and directors of the Company andits subsidiaries. These options have a term of 10 years and vested 50% afterone year and the remaining 50% after two years. During 2004, options for 20,000shares were issued to a Director at an exercise price of $10.90 and vesting wasaccelerated to make the options currently exercisable. Pursuant to SFAS 123,the Company recorded $271,000 of compensation expense, which is reflected incapital in excess of par value.

Asummary of the status of the Company’s stock option plan as of December 31,2003 and for the year ended December 31, 2004 follows (there was noactivity in the plan from January 1, 2002 to December 31, 2003):
| **Options  Outstanding**                                        | ** ** | ** ** | ** ** | **Number  of Options** | ** ** | **Weighted-Average  Exercise Price** | ** ** | **Weighted-Average  Remaining Life** | ** ** |
|-----------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|
| Options fully  vested and exercisable at December 31, 2003 |       | 754,996    |       |                        | $          | 4.50                                      |       |                                      |       |   |   |   |
| Options granted  and vested                                     |       | 20,000     |       |                        | $          | 10.90                                     |       |                                      |       |   |   |   |
| Options exercised                                               |       | (55,000    | )          |                        | $          | 4.50                                      |       |                                      |       |   |   |   |
| Options fully  vested and exercisable at December 31, 2004 |       | 719,996    |       |                        | $          | 4.87                                      |       |                                      |       | 3.5 years |   |   |
| Options available for  future grants at December 31, 2004  |       | 134,988    |       |                        |       |                                      |       |                                      |       |   |   |

 

F-23

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As of December 31, 2004, there were 699,996options outstanding with a weighted-average exercise price of $4.50 and aweighted-average remaining life of 3.6 years and 20,000 options outstandingwith a weighted-average exercise price of $10.90 and a weighted-averageremaining life of six and a half months. In February 2005, options for 20,000shares at $10.90 per share and options for 10,000 shares at $4.50 per sharewere exercised.

In May 2001, all outstanding options to purchasean aggregate of 754,996 shares of the Company’s common stock were re-priced to$4.50 per share, which represented a premium of approximately 11.1% above theaverage closing price over the previous 30 trading days. The options, whichwere granted to certain directors and officers, carried previous exerciseprices of $9.25 per share on 484,996 options granted in 1997 and 1998, and$7.00 per share on 270,000 options granted in 1999. In accordance with FIN 44,“Accounting for Certain Transactions Involving Stock Compensation”, themodification of the options required that they be accounted for as variableawards, which measures compensation expense as the difference between theoption price and the quoted market price of the Company shares. Based on themarket price of $5.53 per share at December 31, 2002, compensation expenseof $778,000 was recorded during 2002.

During the second quarter of 2003, the Company adoptedthe fair value recognition provisions of SFAS 123. For this change inaccounting, the Company selected the “modified prospective method” under theprovisions of SFAS 148. Under this method, the change is retroactive to January 1,2003 and compensation cost recognized during 2003 is zero, the same as thatwhich would have been recognized had the recognition provisions of SFAS 123been applied from its original effective date. In accordance with SFAS 148,results for prior years have not been restated. SFAS 123 states that theadoption of the fair value based method is a change to a preferable method ofaccounting. Management believes that use of the fair value based method torecord employee stock-based compensation expense is consistent with theaccounting for all other forms of compensation.

Until the second quarterof 2003, the Company applied APB 25 and related interpretations inaccounting for its plan. Accordingly, no compensation expense was recognizedthrough 2002 for its stock-based compensation plans other than for variableaccounting for repriced stock options as described above.

F-24

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**Note 13—UnauditedQuarterly Financial Information**

Thefollowing is a summary of quarterly financial information for 2004 and 2003 (inmillions, except per share amounts):
| ** **                                  | ** ** | **First** | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** | **Full  Year** | ** ** |
|---------------------------------------------|------------|-----------|------------|------------|------------|-----------|------------|------------|------------|----------------|------------|
| **2004**                                    |       |      |       |       |       |      |       |       |       |           |       |
| Revenues(a)                                 |       | $         | 5.6        |       | $          | 3.2       |       | $          | 28.4       |           | $          | 38.8 |   | $ | 76.0 |   |
| Cost of sales                               |       | 4.3       |       | 2.1        |       | 22.4      |       | 28.8       |       | 57.6           |       |
| Gross operating profit                      |       | 1.3       |       | 1.1        |       | 6.0       |       | 10.0       |       | 18.4           |       |
| Net income                                  |       | .3        |       | .2         |       | 1.3       |       | 3.0        |       | 4.8            |       |
| Other comprehensive  loss(b)                |       | —    |       | —     |       | —    |       | (.2        | )          | (.2            | )          |
| Earnings per common  share—diluted     |       | $         | .03        |       | $          | .02       |       | $          | .12        |           | $          | .28 |   | $ | .44 |   |
| Weighted-average common shares outstanding: |       |      |       |       |       |      |       |       |       |           |       |
| Basic                                       |       | 10.1      |       | 10.1       |       | 10.1      |       | 10.1       |       | 10.1           |       |
| Diluted                                     |       | 10.8      |       | 10.8       |       | 10.9      |       | 10.9       |       | 10.8           |       |

 
| ** **                                     | ** ** | **First** | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** | **Full  Year** | ** ** |
|------------------------------------------------|------------|-----------|------------|------------|------------|-----------|------------|------------|------------|----------------|------------|
| **2003**                                       |       |      |       |       |       |      |       |       |       |           |       |
| Revenues(a)                                    |       | $         | 3.9        |       | $          | 9.2       |       | $          | 8.4        |           | $          | 34.3 |   | $ | 55.8 |   |
| Cost of sales                                  |       | 3.3       |       | 7.6        |       | 6.8       |       | 27.8       |       | 45.5           |       |
| Gross operating  profit                        |       | .6        |       | 1.6        |       | 1.6       |       | 6.5        |       | 10.3           |       |
| Net income (loss)                              |       | (.2       | )          | .3         |       | .5        |       | 2.3        |       | 2.9            |       |
| Earnings (loss)  per common share—diluted |       | $         | (.02       | )          | $          | .03       |       | $          | .05        |           | $          | .21 |   | $ | .27 |   |
| Weighted-average common  shares outstanding:   |       |      |       |       |       |      |       |       |       |           |       |
| Basic                                          |       | 10.1      |       | 10.1       |       | 10.1      |       | 10.1       |       | 10.1           |       |
| Diluted                                        |       | 10.8      |       | 10.8       |       | 10.8      |       | 10.8       |       | 10.8           |       |

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(a)           The Company recordedrevenues from the delivery of 135 and 154 homes, respectively, in 2004 and2003.

(b)          Other comprehensive lossreflects a minimum pension liability adjustment of $200,000 reflected in thefourth quarter of 2004.

F-25

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