This Form 10-Qconsists of 19 sequentially numbered pages.

 

 

**FORM 10-Q**

 

**SECURITIES AND EXCHANGE COMMISSION**

 

**WASHINGTON,D.C. 20549**

 

**QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)OF THESECURITIES EXCHANGE ACT OF 1934**

 

**Forthe quarterly period ended September 30, 2002**

 

**Commissionfile number 0-17189**

 

| **CALIFORNIA COASTAL COMMUNITIES, INC.**                         |
|------------------------------------------------------------------|
| (Exact name of  registrant as 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 telephone number, including area code:  **(949)250-7700**

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filing requirementsfor the past 90 days:

 

Yes ý    No o

 

Thenumber of shares of Common Stock outstanding at October 31, 2002 was10,058,589.

 

 

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CALIFORNIA COASTAL COMMUNITIES,INC.

 

FORM 10-Q

 

FOR THE QUARTER ENDED SEPTEMBER30, 2002

 

I N D E X

 
| Part I  - | Financial  Information:                    |
|----------------|--------------------------------------------|
|           |                                       |   |
|           | Item  1 -                                  | Consolidated  Financial Statements |
|           |                                       |   |
|           |                                       | Consolidated Balance Sheets  -  December 31, 2001 and September 30, 2002 (unaudited) |
|           |                                       |   |
|           |                                       | Consolidated  Statements of Operations -  Three and Nine Months Ended September 30, 2001 and 2002 (unaudited) |
|           |                                       |   |
|           |                                       | Consolidated  Statements of Cash Flows -  Nine Months Ended September 30, 2001 and 2002 (unaudited) |
|           |                                       |   |
|           |                                       | Notes to  Consolidated Financial Statements |
|           |                                       |   |
|           | Item 2 -                                   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
|           |                                       |   |
|           | Item 3 -                                   | Quantitative  and Qualitative Disclosures About Market Risk |
|           |                                       |   |
|           | Item 4 -                                   | Evaluation  of Disclosure Controls and Procedures |
|           |                                       |   |
| Part II - | Other Information:                         |
|           |                                       |   |
|           | Item  1 - Legal Proceedings                |
|           |                                       |   |
|           | Item  6 - Exhibits and Reports on Form 8-K |
|           |                                       |   |
| SIGNATURE      |
|           |                                       |   |
| CERTIFICATIONS |
|                |                                            |  |  |  |

 

2

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CALIFORNIA COASTAL COMMUNITIES, INC.

 

CONSOLIDATED BALANCESHEETS

 

(in millions)

 

(unaudited)

 
|                                             |   | **December 31,  2001** |   | **September 30, 2002** |   |
|--------------------------------------------------|--------|-----------------------------|--------|------------------------|--------|
|                                             |   |                        |   |                   |   |
| ASSETS                                           |   |                        |   |                   |   |
|                                             |   |                        |   |                   |   |
| Cash and cash equivalents                        |   | $                           | 8.7    |                   | $      | 7.6 |   |
| Short-term investments – available for sale |   | 7.5                         |   | —                 |   |
| Restricted cash equivalents                      |   | 1.5                         |   | —                 |   |
| Real estate held for current development or sale |   | 14.0                        |   | 21.4                   |   |
| Land held for future development                 |   | 147.3                       |   | 151.3                  |   |
| Other assets                                     |   | 1.4                         |   | 1.4                    |   |
|                                             |   |                        |   |                   |   |
|                                             |   | $                           | 180.4  |                   | $      | 181.7 |   |
|                                             |   |                        |   |                   |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY        |   |                        |   |                   |   |
|                                             |   |                        |   |                   |   |
| Liabilities:                                     |   |                        |   |                   |   |
| Accounts payable and accrued liabilities         |   | $                           | 3.1    |                   | $      | 3.8 |   |
| Project debt                                     |   | 3.1                         |   | 6.3                    |   |
| Other liabilities                                |   | 15.2                        |   | 11.6                   |   |
|                                             |   |                        |   |                   |   |
| Total liabilities                                |   | 21.4                        |   | 21.7                   |   |
|                                             |   |                        |   |                   |   |
| Commitments and contingencies                    |   |                        |   |                   |   |
|                                             |   |                        |   |                   |   |
| Stockholders’ equity:                       |   |                        |   |                   |   |
| Common stock                                     |   | .5                          |   | .5                     |   |
| Capital in excess of par value                   |   | 139.8                       |   | 140.5                  |   |
| Retained earnings                                |   | 18.8                        |   | 20.4                   |   |
| Accumulated other comprehensive loss             |   | (.1                         | )      | (1.4                   | )      |
| Total stockholders’ equity                  |   | 159.0                       |   | 160.0                  |   |
|                                             |   |                        |   |                   |   |
|                                             |   | $                           | 180.4  |                   | $      | 181.7 |   |

 

See the accompanying notes to consolidated financial statements.

 

3

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CALIFORNIA COASTAL COMMUNITIES, INC.

 

CONSOLIDATEDSTATEMENTS OF OPERATIONS

 

(in millions,except per share amounts)

 

(unaudited)

 
|                                                                      |   | **Three Months Ended********September 30,** |       | **Nine Months Ended********September 30,** |       |
|---------------------------------------------------------------------------|--------|---------------------------------------------|------------|--------------------------------------------|------------|
|                                                                      |   | **2001**                                    |       | **2002**                                   |       | **2001** |   | **2002** |   |
|                                                                      |   |                                        | ** ** |                                       | ** ** |   |   |   |   |
| Revenues                                                                  |   | $                                           | 7.4        |                                       | $          | 5.2 |   | $ | 32.7 |   | $ | 13.2 |   |
|                                                                      |   |                                        |       |                                       |       |   |   |   |   |
| Costs of sales                                                            |   | 5.9                                         |       | 4.6                                        |       | 27.3 |   | 11.7 |   |
|                                                                      |   |                                        |       |                                       |       |   |   |   |   |
| Gross operating profit                                                    |   | 1.5                                         |       | .6                                         |       | 5.4 |   | 1.5 |   |
|                                                                      |   |                                        |       |                                       |       |   |   |   |   |
| Selling, general and administrative expenses                              |   | .6                                          |       | .2                                         |       | 2.3 |   | 2.1 |   |
| Interest expense                                                          |   | .1                                          |       | .1                                         |       | .2 |   | .2 |   |
| Income from unconsolidated joint ventures                                 |   | (1.0                                        | )          | (.2                                        | )          | (2.7 | ) | (.8 | ) |
| Other (income) expense, net                                               |   | .1                                          |       | .3                                         |       | (.1 | ) | (.3 | ) |
|                                                                      |   |                                        |       |                                       |       |   |   |   |   |
| Income before income taxes                                                |   | 1.7                                         |       | .2                                         |       | 5.7 |   | .3 |   |
|                                                                      |   |                                        |       |                                       |       |   |   |   |   |
| Provision (benefit) for income taxes                                      |   | .7                                          |       | .2                                         |       | (.8 | ) | (1.3 | ) |
|                                                                      |   |                                        |       |                                       |       |   |   |   |   |
| Net income                                                                |   | $                                           | 1.0        |                                       | $          | — |   | $ | 6.5 |   | $ | 1.6 |   |
|                                                                      |   |                                        |       |                                       |       |   |   |   |   |
| Other comprehensive income (loss):                                        |   |                                        |       |                                       |       |   |   |   |   |
|                                                                      |   |                                        |       |                                       |       |   |   |   |   |
| Less:   Reclassification adjustment for gains included in net income |   | —                                      |       | —                                     |       | — |   | (1.3 | ) |
|                                                                      |   |                                        |       |                                       |       |   |   |   |   |
| Total comprehensive income                                                |   | $                                           | 1.0        |                                       | $          | — |   | $ | 6.5 |   | $ | .3 |   |
|                                                                      |   |                                        |       |                                       |       |   |   |   |   |
| Earnings per common share – basic                                    |   | $                                           | .10        |                                       | $          | — |   | $ | .64 |   | $ | .16 |   |
|                                                                      |   |                                        |       |                                       |       |   |   |   |   |
| Earnings per common share – diluted                                  |   | $                                           | .10        |                                       | $          | — |   | $ | .64 |   | $ | .15 |   |

 

See the accompanying notes toconsolidated financial statements.

 

4

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CALIFORNIA COASTALCOMMUNITIES, INC.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

(in millions)

 

(unaudited)

 
|                                                                                                                      |   | **Nine Months Ended  September 30,** |   |
|---------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------|--------|
|                                                                                                                      |   | **2001**                             |   | **2002** |   |
|                                                                                                                      |   |                                 |   |   |   |
| Cash flows from operating activities:                                                                                     |   |                                 |   |   |   |
| Net income                                                                                                                |   | $                                    | 6.5    |   | $ | 1.6 |   |
| Adjustments to reconcile to cash provided by (used in)  operating activities:                                             |   |                                 |   |   |   |
| Non-cash interest expense                                                                                                 |   | .2                                   |   | .2 |   |
| Interest income on restricted cash                                                                                        |   | (.1                                  | )      | — |   |
| Deferred income taxes                                                                                                     |   | 2.1                                  |   | — |   |
| Gains on sales of real estate held for current  development or sale                                                       |   | (5.4                                 | )      | (1.5 | ) |
| Proceeds from asset sales, net                                                                                            |   | 32.2                                 |   | 13.0 |   |
| Gains on sales of short-term investments                                                                                  |   | —                               |   | (1.2 | ) |
| Changes in assets and liabilities:                                                                                        |   |                                 |   |   |   |
| Investments in real estate held for current  development or sale                                                          |   | (19.6                                | )      | (18.9 | ) |
| Investments in land held for future development                                                                           |   | (3.8                                 | )      | (4.0 | ) |
| Decrease in other assets                                                                                                  |   | 2.4                                  |   | — |   |
| Decrease in accounts payable, accrued and other  liabilities, net                                                         |   | (8.7                                 | )      | (2.4 | ) |
|                                                                                                                      |   |                                 |   |   |   |
| Cash provided by (used in) operating activities                                                                           |   | 5.8                                  |   | (13.2 | ) |
|                                                                                                                      |   |                                 |   |   |   |
| 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                                                                                                |   | 9.6                                  |   | 7.9 |   |
| Repayments of project debt                                                                                                |   | (15.5                                | )      | (4.7 | ) |
| Release of restricted cash                                                                                                |   | —                               |   | 1.5 |   |
|                                                                                                                      |   |                                 |   |   |   |
| Cash provided by (used in) financing activities                                                                           |   | (5.9                                 | )      | 4.7 |   |
|                                                                                                                      |   |                                 |   |   |   |
| Net decrease in cash and cash equivalents                                                                                 |   | (.1                                  | )      | (1.1 | ) |
|                                                                                                                      |   |                                 |   |   |   |
| Cash and cash equivalents - beginning of period                                                                           |   | 6.9                                  |   | 8.7 |   |
|                                                                                                                      |   |                                 |   |   |   |
| Cash and cash equivalents - end of period                                                                                 |   | $                                    | 6.8    |   | $ | 7.6 |   |
|                                                                                                                      |   |                                 |   |   |   |
| Supplemental disclosures of cash flow information:                                                                        |   |                                 |   |   |   |
| Cash paid during the period for income taxes, net of  refunds                                                             |   | $                                    | .2     |   | $ | .6 |   |
|                                                                                                                      |   |                                 |   |   |   |
| Supplemental disclosures of  non-cash investing and financing activities:                                                 |   |                                 |   |   |   |
| Reclassification adjustment for  gains included in net income                                                             |   | —                               |   | (1.3 | ) |
| Utilization of  pre-Reorganization net operating losses to offset tax liabilities, credited  to stockholders’ equity |   | 1.6                                  |   | — |   |

 

See the accompanying notes to consolidated financial statements.

 

5

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CALIFORNIA COASTALCOMMUNITIES, INC.

 

NOTES TOCONSOLIDATED FINANCIAL STATEMENTS

 

**Note 1 - Basisof Presentation**

 

The accompanying financial statements have been prepared by CaliforniaCoastal Communities, Inc. and its consolidated subsidiaries (the “Company”), withoutaudit, pursuant to the rules and regulations of the Securities and ExchangeCommission. Certain information and footnote disclosures normally included infinancial statements prepared in accordance with generally accepted accountingprinciples have been condensed or omitted pursuant to such rules andregulations. The Company believes that these unaudited consolidated financialstatements reflect all material adjustments (consisting only of normalrecurring adjustments) and disclosures necessary for the fair presentation ofthe results of operations and statements of financial position when read inconjunction with the Financial Statements and Notes thereto included in theCompany’s Annual Report on Form 10-K for the year ended December 31, 2001, and thecurrent year’s previously issued Quarterly Reports on Form 10-Q. The resultsfor interim periods are not necessarily indicative of the results to beexpected for the full year. This report contains forward-looking statements.Readers are cautioned that any such forward-looking statements are notguarantees of future performance and involve risks and uncertainties thatactual events or results may differ materially from those described herein as aresult of various factors, including without limitation, the factors discussedgenerally in this report.

 

The Company completed its recapitalization (the “Recapitalization”) which became effective on September 2, 1997, pursuant to aprepackaged plan of reorganization which was confirmed by the U.S. BankruptcyCourt for the District of Delaware. The prepackaged plan was filed by theCompany, excluding all of its subsidiaries and affiliates, contemporaneouslywith a voluntary petition for relief under Chapter 11 of the bankruptcy code.On the effective date of the Recapitalization, the Company adopted theprovisions of Statement of Position No. 90-7, “Financial Reporting by Entities in Reorganization Under the BankruptcyCode” (“Fresh-Start Reporting”) as promulgated by the American Institute ofCertified Public Accountants. Accordingly, all assets and liabilities wererevalued to reflect their reorganization value, approximating their fair valueat the effective date of the Recapitalization. In addition, the accumulateddeficit of the Company was eliminated and its capital structure recast inconformity with the Recapitalization.

 

# **Note 2 –Significant Accounting Policies**

 

#### *Earnings Per Common Share*

 

For the three and nine months ended September 30, 2001 and 2002, theweighted average common shares outstanding were 10.1 million. Earnings pershare, assuming dilution, is computed using the weighted average number ofcommon shares outstanding and the dilutive effect of potential common sharesoutstanding. For the three and nine months ended September 30, 2001 and the threemonths ended September 30, 2002, the exercise price of outstanding stockoptions and warrants exceeded the average market price of the Company’s commonstock. For the nine months ended September 30, 2002, the average market priceof the Company’s common stock exceeded the exercise price of outstanding stockoptions, but not warrants. Therefore, for the nine months ended September 30,2002, the dilutive effect of the 754,996 common shares from potential exerciseof options is reflected in the 10.8 million weighted average common sharesassuming dilution, in the related statements of operations.

 

### *New Accounting Pronouncements*

 

In July 2001, the Financial Accounting Standards Board (“FASB”) issuedStatement of Accounting Standards (“SFAS”) No. 142, “Goodwill and otherIntangible Assets”. As required, the Company adopted the new standard effectiveJanuary 2002. The new standard did not have a significant impact on theCompany’s financial statements.

 

In August 2001, the FASB issued SFAS No. 143 “Accounting for AssetRetirement Obligations”, which addresses financial accounting and reporting forobligations associated with the retirement of tangible long-lived assets andthe associated asset retirement costs. SFAS No. 143 is required to be adoptedfor fiscal years beginning after June 15, 2002, with early adoptionpermitted. The Company adopted this new standard effective January 2002, whichdid not have a significant impact on the Company’s financial statements.

 

6

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Also in August 2001, the FASB issued SFAS No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets”, which supersedes SFAS No. 121,“Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assetsto be Disposed Of”. This new statement also supersedes certain aspects of APB30, “Reporting the Results of Operations—Reporting the Effects of Disposal of aSegment of a Business, and Extraordinary, Unusual and Infrequently OccurringEvents and Transactions”, with regard to reporting the effects of a disposal ofa segment of a business and will require expected future operating losses fromdiscontinued operations to be reported in discontinued operations in the periodincurred (rather than as of the measurement date as presently required by APB30). In addition, more dispositions may qualify for discontinued operationstreatment. SFAS No. 144 retains the requirements of SFAS No. 121 whereby animpairment loss is recognized if the carrying value of the asset is notrecoverable from its undiscounted cash flows or fair values are less thancarrying values. As required, the Company adopted this new standard in January2002, which did not have a significant impact on the Company’s financialstatements.

 

In July 2002, the FASB issued SFAS 146 “Accounting for Costs Associatedwith Exit or Disposal Activities,” which addresses financial accounting andreporting for costs associated with exit or disposal activities and supersedesEmerging Issues Task Force (“EITF”) Issue 94-3, “Liability Recognition forCertain Employee Termination Benefits and Other Costs to Exit an Activity(including Certain Costs Incurred in a Restructuring).” SFAS 146 requires thata liability for a cost associated with an exit or disposal activity berecognized when the liability is incurred. Under Issue 94-3, a liability for anexit cost as defined in EITF 94-3 was recognized at the date of an entity’scommitment to an exit plan. SFAS 146 also establishes that the liability shouldinitially be measured and recorded at fair value. The Company will adopt theprovisions of SFAS 146 for exit or disposal activities that are initiated afterDecember 31, 2002.

 

*Impairment of Long-Lived Assets*

 

The Company assesses the impairment of land held for future developmentand other long-lived assets in accordance with SFAS No.144, which requiresan impaired asset to 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 carrying value tothe undiscounted estimated cash flows expected from the asset’s operations andeventual disposition. If the sum of the undiscounted estimated future cashflows is less than the carrying value of the asset, an impairment loss isrecognized based on the fair value of the asset. If an impairment occurs, thefair value of an asset for purposes of SFAS No. 144 is deemed to be theamount a willing buyer would pay a willing seller for such asset in a currenttransaction. On September 2, 1997, the Company completed itsRecapitalization as discussed in Note 1, and the Company applied the principlesrequired by the American Institute of Certified Public Accountant’s SOP 90-7,“Financial Reporting by Entities in Reorganization Under the Bankruptcy Code”(“Fresh-Start Reporting”) and the carrying value of real estate properties wasadjusted to fair value (see Note 1). Following the California CoastalCommission’s November 2000 suggested modifications to the Bolsa Chica LocalCoastal Program to limit development to only the upper bench of the Company’s208-acre Bolsa Chica mesa (see Note 3), the Company evaluated this asset’scarrying value. The Company updated its analysis as of December 31, 2001, andhas noted no indicators of impairment since that date. Therefore, since theundiscounted estimated future cash flows from the upper bench of the BolsaChica mesa and the Company’s additional 242 acres at Bolsa Chica exceed itsSeptember 30, 2002 carrying value, there has been no impairment.

 

**Note 3 - LandHeld for Future Development**

 

The Company owns approximately350acres located in Orange County, California overlooking the Pacific Ocean and theBolsa Chica wetlands (which were sold by the Company to the State of Californiain 1997), surrounded bythe City of Huntington Beach and approximately 35 miles south of downtown Los Angeles. The Company’s holdings include 208 acres on a mesa north of the Bolsa Chica wetlands (“BolsaChica Mesa”), approximately 100 acres on,or adjacent to, the Huntington Mesa and 42 acres of lowlands which wereacquired by the Company in September 1997.

 

A Local Coastal Program (“LCP”) for development of up to 2,500 homes onthe Bolsa Chica Mesa was approved by the Orange County Board of Supervisors inDecember 1994 and by the California Coastal Commission (the “CoastalCommission”) in January 1996. In October 1997, in response to a trial courtdecision in connection with a lawsuit which challenged the 1996 approvals ofthe Coastal Commission (the “Coastal Act Lawsuit”), the Coastal Commissionapproved modifications to the LCP which eliminated the filling of Warner Pondand thereby reduced the maximum number of homes to be built from 2,500 to no morethan 1,235 homes on the Bolsa Chica Mesa. The Orange County Board ofSupervisors subsequently accepted the Coastal Commission’s suggestedmodifications.

 

In November 2000, in response to the April 1999 Court of Appeal’sdecision in the Coastal Act Lawsuit which prohibited relocation of a 14-acregrove of dying eucalyptus trees which serves as raptor habitat, the CoastalCommission held another public hearing on the LCP and decided to limitdevelopment to only the upper bench of the Bolsa Chica Mesa (the “Upper Mesa”).The Coastal Commission’s latest suggested modifications to the LCP wouldprohibit the

 

7

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Company and other landowners from development on the approximately100-acre lower bench of the Bolsa Chica Mesa (the “Lower Mesa”). In May 2001,the County of Orange declined to consider the Coastal Commission’s November2000 suggested modifications. In their response to the Coastal Commission, theCounty stated that the Commission’s suggested modifications were infeasible andunacceptable. In particular, the County noted that the Commission’s suggestedmodifications would remove 140 acres of viable residentially-zoned land fromthe County’s plan.

 

In January 2001, the Company filed a petition for writ of mandate inOrange County Superior Court challenging the Coastal Commission’s November 2000decision to substantially change the previously approved LCP. In February 2001,the Orange County Superior Court ordered that the case be reassigned to SanDiego Superior Court based on the request of the Coastal Commission. TheCompany’s petition alleges that the Coastal Commission arbitrarily abandoneddecades of prior approvals that would have permitted development on the entireBolsa Chica Mesa. The petition challenges the Commission’s November 2000decision as to how to protect certain raptor habitat on the Bolsa Chica Mesa,including the Commission’s recommendation that the Lower Mesa not be developed.The complaint also includes causes of action for violation of the Company’sconstitutional rights of equal protection and due process, and for a publictaking of its private property without compensation in contravention of theU.S. and California Constitutions. After overcoming various legal challengesbrought by the Coastal Commission, the court held a hearing on the petition forwrit of mandate on October 23 and 24, 2002. The court continued the hearinguntil November 19, 2002 when additional arguments will be heard. A decision onthe writ of mandate action is expected to be rendered within 90 days of theNovember hearing. However, there can be no assurance that further delays willnot be encountered and due to the uncertainty of the litigation process, theCompany cannot predict how long it will take to fully pursue its claims, or theprobability for success.

 

While the Company vigorously pursues its litigation to obtainentitlement for residential construction on the Lower Mesa, it is also pursuingapproval of permits for development of the Upper Mesa. On May 8, 2002, theCounty of Orange Planning Commission approved the Company’s site plan fordevelopment of 379 single-family homes on the Upper Mesa. In response to anappeal, on July 23, 2002, the Orange County Board of Supervisors upheld thePlanning Commission’s prior approval of the site plan and tentative tract map.The planned community on the Upper Mesa is currently expected to offer a broadmix of home choices, ranging in size from 1,560 square feet to 4,450 squarefeet. This development plan will also require approval by the CoastalCommission. The Company currently expects to present this plan to the CoastalCommission early next year. The Company does not believe that the CoastalCommission process will permanently prevent it from developing a planned communityat Bolsa Chica, however, there can be no assurance in that regard, or as towhen development could commence, or as to the number of acres or homes theCompany would be permitted to develop, or that further litigation oradministrative delay will not result.

 

Upon completion of the Company’s Recapitalization as discussed in Note1, the Company applied the 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, after consideration of the October 1997 CoastalCommission action discussed above. The fair value was determined in 1997 usingdiscounted estimated cash flows expected from the asset’s operations andeventual disposition. In addition, given the significance of the Bolsa Chicaasset to the financial statements of the Company, the value of the Company’sstock immediately following the closing of the Recapitalization was used as anindicator of value of the subject property. Following the November 2000 CoastalCommission action, an assessment of impairment was conducted by the Company forthe year ended December 31, 2000. The Company updated its analysis as ofDecember 31, 2001, and has noted no indicators of impairment since that date.Therefore, in accordance with the Company’s policy described in Note 2 –Impairment of Long-Lived Assets and based upon the Company’s assessment ofestimated undiscounted future cash flows, no provision for impairment has beenconsidered necessary subsequent to the Recapitalization.

 

The estimation process involved in the determination of value isinherently uncertain 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. At such time as the Company’shomebuilding activities at Bolsa Chica commence, the Company would be requiredto account for such property at the lower of cost or market, which maynecessitate a write-down of its carrying value. Accordingly, the ultimatevalues of the Company’s land held for future development are dependent uponfuture economic and market conditions, the availability of financing, and theresolution of political, environmental and other related issues. Thedevelopment of the Company’s Bolsa Chica Mesa project is dependent upon variousgovernmental approvals, results of litigation and economic factors.

 

8

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Accordingly, theamount ultimately realized from such project may differ materially from currentestimates and the project’s carrying value.

 

**Note 4 - Project Debt**

 

In conjunction with the July 2001 acquisition of 83 single-familyresidential lots in North Corona, California, the Company’s homebuildingsubsidiary, Hearthside Homes, Inc. (“Hearthside”), entered into a constructionloan agreement with a commercial bank to finance the project. The $10.9 millionloan facility was secured by a deed of trust on the North Corona project andrequired principal repayments upon the sale of homes. As of September 30, 2002,approximately $9.0 million had been drawn under this facility, and repayments of$4.7 million had been made resulting in a balance of $4.3 million. The loanbore an interest rate of prime plus three-fourths percent (5.5% at September30, 2002) and was repaid in full in early November 2002.

 

On July 29, 2002, Hearthside entered into a construction loan agreementwith a commercial bank to finance the majority of Hearthside’s April 23, 2002acquisition of 37 lots near the city of Riverside and related homeconstruction. The $7.8 million loan facility is secured by a deed of trust on the37 lots and requires principal repayments upon the sale of homes. The loanbears an interest rate of prime plus three-fourths percent (5.5% at September30, 2002) and matures on July 29, 2003 unless extended for six months, atHearthside’s option. As of September 30, 2002, approximately $2.0 million hadbeen drawn under this facility.

 

On October 11, 2002, Hearthside entered into a construction loanagreement with a commercial bank to finance the majority of Hearthside’sacquisition of 47 additional lots near the city of Riverside and related homeconstruction. The $10.1 million loan facility is secured by a deed of trust onthe 47 lots and requires principal repayments upon the sale of homes. The loanbears an interest rate of prime plus three-fourths percent and matures onOctober 11, 2003 unless extended for six months, at Hearthside’s option.

 

On October 31, 2002, Hearthside entered into a construction loanagreement with a commercial bank to finance the majority of Hearthside’sacquisition of 93 additional lots near the city of North Corona and relatedhome construction. The $17.1 million loan facility is secured by a deed oftrust on the 93 lots and requires principal repayments upon the sale of homes.The loan bears an interest rate of prime plus three-fourths percent and matureson October 31, 2003 unless extended for six months, at Hearthside’s option.

 

Approximately $.4 and $.1 million of construction period interest wascapitalized to projects in the construction stage for the nine months endedSeptember 30, 2001 and 2002.

 

**Note 5 – Income Taxes**

 

The following is a summary of the tax provision (benefit):

 
|                                     |   | **Three Months Ended  September 30,** |   | **Nine Months Ended  September 30,** |   |
|------------------------------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
|                                     |   | **2001**                              |   | **2002**                             |   | **2001** |   | **2002** |   |
| Current  taxes                           |   | $                                     | .1     |                                 | $      | .2 |   | $ | .3 |   | $ | .1 |   |
| Deferred  taxes                          |   | .6                                    |   | .1                                   |   | 2.1 |   | — |   |
| Reduction in  contingent tax liabilities |   | —                                |   | (.1                                  | )      | (3.2 | ) | (1.4 | ) |
| Provision  (benefit) for income taxes    |   | $                                     | .7     |                                 | $      | .2 |   | $ | (.8 | ) | $ | (1.3 | ) |

 

The income tax benefits in the nine month periods presented primarilyreflect reductions in reserves for estimated state income taxes discussedbelow. During each of the 2001 periods, the current tax provision consistedprimarily of alternative minimum taxes. For the nine months ended September 30,2002, current taxes include a reversal of $.2 million of 2001 alternativeminimum taxes payable due to a change in the federal income tax law enacted inthe first quarter, which is offset by a third quarter expense due to anincrease in the deferred tax asset valuation allowance related to state netoperating losses (“NOLs”). The valuation allowance was increased due to aCalifornia state tax law change enacted during the third quarter which imposeda moratorium on utilization of state NOLs during 2002 and 2003.

 

Pursuant to Fresh-Start Reporting during the three and nine monthsended September 30, 2001 and the nine months ended September 30, 2002,reductions in valuation allowances on pre-Reorganization NOLs of $.6 million,$2.1 million and $.7 million, respectively, were reflected by increasing the Company’scapital in excess of par value.

 

9

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Reductions in thedeferred tax asset valuation allowance on NOLs are recorded when the Companyconcludes that it is more likely than not that it will utilize additional NOLsto offset taxable income.

 

The Internal Revenue Code (the “Code”) generally limits theavailability of NOLs if an ownership change occurs within any three-year periodunder Section 382. If the Company were to experience an ownership change of morethan 50%, the use of all remaining NOLs would generally be subject to an annuallimitation equal to the value of the Company’s equity before the ownershipchange, multiplied by the long-term tax-exempt rate. The federal NOLs availableas of September 30, 2002 were approximately $182 million. The amount of federalNOLs which expire if not utilized is $7 million, $20 million and $155 millionfor 2005, 2006 and thereafter, respectively.

 

In response to an unsolicited written consent from a majority of itsstockholders, the Company amended its certificate of incorporation in October1999 in order to protect the ability of the Company to utilize its tax losscarryforwards. Since the Company’s use of its NOLs would be severely restrictedif it experiences an ownership change of more than 50%, the Company’s majoritystockholders requested that the Board of Directors enact the amendments, whichwere determined to be in the best interest of the Company and its stockholders.The amendments prohibit future purchases of the Company’s common stock bypersons who would become new 5% holders, and also prohibit current holders ofover 5% from increasing their positions, except in certain permissiblecircumstances which would not jeopardize the Company’s ability to use its NOLs.While these amendments reduced the Company’s risk of an ownership changeoccurring due to the acquisition of shares by 5% stockholders, the risk remainsthat an ownership change could result from the sale of shares by existing 5%stockholders.

 

During April 2002, following reduction of the cumulative ownershipshift, as computed in accordance with Section 382, to below 20% due to thepassage of time since certain stockholder transactions, the Company’s Board ofDirectors authorized an investor to purchase up to a specified number of shareswhich, if purchased, would result in the investor owning over 5% of theCompany’s common stock. On April 25, 2002, this investor reported that it hadbecome a 5% holder. In June 2002, the Company’s Board of Directors authorizedan additional investor to purchase up to a specified number of shares which, ifpurchased, would result in the investor owning over 5% of the Company’s stock.On August 27, 2002, this investor reported that it had become a 5% holder. TheCompany estimates that after giving effect to various transactions bystockholders who hold a 5% or greater interest in the Company, it hasexperienced a three-year cumulative ownership shift of approximately 7%.

 

In 1995, the Internal Revenue Service (“IRS”) proposed material auditadjustments with respect to the tax returns of the Company and its consolidatedsubsidiaries, including formerly affiliated entities, for the years endedDecember 31, 1989, 1990 and 1991. The adjustments proposed by the IRS could haveresulted in federal tax liability, before interest, of approximately $17million and disallowance of up to $132 million of NOL carryforwards. TheCompany disagreed with the positions taken by the IRS and filed protests withthe IRS to contest the proposed adjustments. In December 1998, the Companyexecuted a settlement agreement with the IRS with respect to the proposedadjustments described above. As a result of this agreement, in February 1999the Company paid $759,000 (which included $280,000 of tax and $479,000 ofinterest through January 1999), net of the Company’s refund claim for 1992 NOLcarrybacks of approximately $1.6 million, in full settlement of such claims.Under this settlement agreement approximately $10 million of the Company’s NOLcarryforwards were disallowed. The Company utilized $8.1 million of NOLcarryback from 1992 to 1991 in connection with its refund claim. In June 2001,the Company received a refund of $28,000, including interest, indicatingacceptance by the IRS of the refund claim. Accordingly, pursuant to Fresh-StartReporting, the Company recorded utilization of approximately $1.6 million ofpre-Reorganization NOL, through a reduction in the valuation allowance,resulting in an equivalent amount credited to capital in excess of par value,during the second quarter of 2001.

 

The Company has reviewed the extent of potential accompanying state taxliability adjustments and does not believe that any such adjustments would havea material negative impact on the Company’s financial statements. Nearly all ofthe state jurisdictions in which the Company filed amended returns for 1989,1990 and 1991 have accepted such returns, thereby reducing the Company’sexposure to potential claims. In conjunction with periodic reviews of its liabilitiesfor estimated state income taxes, the Company reduced its reserves byapproximately $3.2 and $2.3 million in the second and fourth quarters of 2001,respectively, and by approximately $.9, $.4 and $.1 million, respectively,during the first, second and third quarters of 2002. The reductions inestimated tax liabilities are reflected as income tax (benefits).

 

10

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# **Note 6 – Stock Plans**

 

In accordance with Financial AccountingStandards Board Interpretation No. 44 “Accounting for Certain TransactionsInvolving Stock Compensation”, the May 2001 modification of stock optionsrequires that they be accounted for as variable awards, which measurescompensation expense as the difference between the option exercise price andthe quoted market price of the Company shares. Accordingly, based upon theCompany’s market price of $4.90 per share at June 30, 2002 versus the optionexercise price of $4.50 per share, during the first half of 2002, the Companyrecorded compensation expense of approximately $.3 million. During the currentquarter, the $.3 million of previously recorded expense was reversed based uponthe Company’s market price of $3.96 per share at September 30, 2002. Futureincreases above the exercise price in the fair value of the Company’s commonstock would result in compensation expense, offset by an adjustment to capitalin excess of par value.

 

##### **Note 7 – Commitments andContingencies**

 

The Company and its predecessors have, through a variety of transactionseffected since 1986, disposed of several assets and businesses, many of whichare unrelated to the Company’s current operations. By operation of law orcontractual indemnity provisions, the Company has retained liabilities relatingto certain of these assets and businesses. Many of such liabilities aresupported by insurance or by indemnities from certain of the Company’spredecessors and currently or previously affiliated companies. The Companybelieves its balance sheet reflects adequate reserves for these matters.

 

See Note 3 for a discussion of pending litigation relating to theCalifornia Coastal Commission’s decision to prohibit development on the LowerMesa of Bolsa Chica.

 

 
| ITEM 2 - |   | MANAGEMENT’S DISCUSSION  AND ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
|----------|--------|----------------------------------------------------------------------------------------------|

 

**General**

### * *

The Company is a residential land development and homebuilding companywith properties located primarily in southern California. The principalactivities of the Company and its consolidated subsidiaries include:(i) obtaining zoning and other entitlements for land it owns and improvingthe land for residential development; and (ii) single-family residentialconstruction in southern California. Once the residential land owned by theCompany is entitled, the Company may build homes, sell unimproved land to otherdevelopers or homebuilders, sell improved land to homebuilders, or participatein joint ventures with other developers, investors or homebuilders to financeand construct infrastructure and homes. During the remainder of 2002 and 2003,the Company will focus its immediate efforts to (i) obtain approval fromthe California Coastal Commission (“Coastal Commission”) for developmentpermits to build 379 homes on the upper bench of the Bolsa Chica Mesa (“UpperMesa”), as further described in Note 3 to the Company’s Financial Statements;(ii) vigorously pursue litigation (the “Coastal Commission Lawsuit”)challenging the Coastal Commission’s November 2000 decision to prohibitdevelopment on the lower bench of the Bolsa Chica Mesa (“Lower Mesa”); and(iii) maintain profitable homebuilding operations. However, the Company mayalso consider other strategic joint venture opportunities. There can be noassurance that the Company will accomplish, in whole or in part, all or any ofthese strategic goals.

 

During 2001 and the first nine months of 2002, the Company generatedgross operating margins and cash flows from homebuilding activities on assetsother than Bolsa Chica. The Company currently has on-going southern Californiaprojects in Yucaipa, North Corona and near the city of Riverside. DuringOctober 2002, the Company acquired 93 additional lots at the North Coronaproject and entered into an escrow to acquire 41 additional lots at theRiverside project. These homebuilding projects are expected to generatesignificant cash flows and modest gross operating margins through 2004.However, the Company’s inventory of entitled land available for homebuildingprojects is still limited. Given this limited inventory of buildable lots, theCompany is striving to maintain profitable operating results for 2002 andcontinuing to pursue residential lot acquisition opportunities. Due to delaysin approvals for homebuilding at Bolsa Chica, continuation of homebuildingoperations beyond 2004 is dependent upon acquisition of suitable, entitledresidential lots within the southern California area and Coastal Commissionapproval of the Company’s development plan for the Upper Mesa.

 

Bolsa Chica is the Company’s principal asset, representing 83% of totalassets at September 30, 2002. It has required and continues to requiresignificant investments for entitlement and land development activities. Due tothe November 2000 Coastal Commission decision to limit residential developmentto only the Upper Mesa, the Company is faced with further delays inimplementing its plans for residential development on the Bolsa Chica Mesa.While the Company vigorously pursues its litigation to obtain entitlement forresidential construction on the Lower Mesa, it is also

 

11

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pursuing approvalof development permits for the Upper Mesa. On May 8, 2002, the County of OrangePlanning Commission approved the Company’s site plan for development of 379single-family homes on the Upper Mesa. In response to an appeal, on July 23,2002, the Orange County Board of Supervisors upheld the Planning Commission’sprior approval of the site plan and tentative tract map. This development planwill also require approval by the Coastal Commission. The Company currentlyexpects to present this plan to the Coastal Commission early next year. TheCompany does not believe that the Coastal Commission process will ultimatelyprevent it from developing a planned community at Bolsa Chica, however, therecan be no assurance in that regard, or as to when development could commence,or as to the number of acres or homes the Company will be permitted to develop,or that further litigation or administrative delay will not result.

 

In addition to the Upper Mesa land, the Company holds several otherBolsa Chica parcels aggregating approximately 242 acres which may be developedas residential lots or sold as park lands to various governmental agencies,subject to the outcome of litigation against the Coastal Commission andnegotiations, if any, with potential purchasers of the various parcels. TheCompany believes that those additional parcels represent substantial value tobe realized upon resolution of litigation and/or through sales to thirdparties.

 

The Bolsa Chica Land Trust and other environmental groups haveperiodically suggested that the Company consider selling the Bolsa Chica Mesato a nonprofit corporation or the State of California. Historically, there hasbeen no source of funding to finance such a transaction. However, on November5, 2002 a $3.4 billion bond measure on California’s ballot known as Proposition50 and entitled the “Water Quality, Supply and Safe Drinking Water Projects.Coastal Wetlands Purchase and Protection. Bonds.” was approved by the voters.The bond initiative includes an unquantified line item for the State ofCalifornia to pursue the acquisition of all or a part of the Bolsa Chica Mesa.The Company is in the process of evaluating the feasibility of this potentialalternative. Although the bond measure was approved by the voters, there can beno assurances that the Company will ever receive an offer from the State forthe Bolsa Chica Mesa; reach a mutually acceptable agreement on price and terms;or that a sale transaction will ever be completed.

 

Real estate held for current development or sale and land held forfuture development (real estate properties) are carried at fair value as ofSeptember 2, 1997, following adoption of Fresh-Start Reporting as discussed inNotes 1 and 2 to the Financial Statements, as adjusted by subsequent activity.The Company’s real estate properties are subject to a number of uncertaintieswhich can affect the values of those assets. These uncertainties includelitigation or appeals of regulatory approvals (as discussed above) andavailability of adequate capital, financing and cash flow. In addition, futurevalues may be adversely affected by increases in property taxes, increases inthe costs of labor and materials and other development risks, changes in generaleconomic conditions, including higher mortgage interest rates, and other realestate risks such as the general demand for housing and the supply ofcompetitive products. Real estate properties do not constitute liquid assetsand, at any given time, it may be difficult to sell a particular property foran appropriate price.

 

During the last six months of 2001 it became apparent that both thenational and California economies were in a recession, and economic data forthe first nine months of 2002 has not yielded convincing evidence of aneconomic recovery. Therefore, there can be no assurance regarding the continuedhealth of the southern California residential real estate market. Inparticular, (i) the slow-down in the national economy during the past 18months, (ii) the significant decreases in the value of national stock marketindices and the resulting volatility of those markets; (iii) the events ofSeptember 11, 2001 and their effects on the economy; and (iv) potentialelectricity shortages and related price increases in California, collectivelyappear to be exerting recessionary pressures on the California economy and mayhave a negative impact on the southern California housing market.

 

While low mortgage rates appear to have sustained housing demand todate, any future increase in mortgage rates would most likely slow demand fornew homes. The tight supply of new homes in California has resulted insignificant home price increases over the last five years. As a result, theaffordability of new homes has been declining and could further jeopardizefuture demand.

 

All three of the Company’s active homebuilding projects are located inthe “Inland Empire” area of southern California, which includes Riverside andSan Bernardino counties. The Inland Empire has experienced significantpopulation and job growth in the past decade. While continued growth isexpected, partially due to the limited supply of affordably priced housing incoastal areas such as Orange County, there can be no assurance that economic,demographic or other factors will not slow, diminish or cause such growth todiscontinue. The Company is continuing to pursue lot acquisition opportunitiesthroughout southern California.

 

12

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*ChapmanHeights.*  Between June2000 and December 2001, the Company acquired 86 finished lots, which are partof a master-planned community known as Chapman Heights, in the city of Yucaipa,California. The community surrounds an operating 18-hole public golf course andis planned for a total of approximately 2,100 homes, civic and commercialcenters and two school sites. The Company opened for sales at the project inJanuary of 2001, and has released all 86 homes for sale at an average price ofapproximately $260,000. As of November 11, 2002, closings on 65 homes werecompleted and 20 of the remaining 21 homes were in escrow.

 

*ProvidenceRanch. *In July 2001,the Company acquired 83 finished lots in the master-planned community known asProvidence Ranch in Riverside County, California near North Corona. Thecommunities of Providence Ranch and the adjacent community of Corona Valley,are planned for a total of 2,600 homes, and are well-located to serve theemployment centers of the greater Los Angeles area, Orange County and theOntario international airport. The Company commenced home construction inOctober 2001, opened for sales in February 2002 and has released 73 homes forsale at an average price of approximately $290,000. As of November 11, 2002, 35homes had been delivered and 38 additional homes were in escrow. In October2002, the Company acquired an additional 93 finished lots in the ProvidenceRanch community. Construction of homes in this second phase is expected tobegin during the first quarter of 2003.

 

*VictoriaGrove.* In April and September 2002, the Company acquired atotal of 84 finished lots in the master-planned community known as VictoriaGrove, near the city of Riverside, in Riverside County. This well-establishedcommunity is planned for a total of 855 homes. The Company is in escrow toacquire 41 additional lots for a total project of 125 homes, including twoproduct types. The Company began home construction and opened for sales duringAugust 2002. Home deliveries are expected to begin during the first quarter of2003. As of November 11, 2002, 24 homes had been released for sale at anaverage home price of approximately $300,000, and all were in escrow.

 

**NewAccounting Pronouncements**

 

See Note 2 to Consolidated Financial Statements.

 

**Liquidityand Capital Resources**

 

The principal assets in the Company’s portfolio are residential landwhich must be held over an extended period of time in order to be developed toa condition that, in management’s opinion, will ultimately maximize the returnto the Company. Consequently, the Company requires significant capital tofinance its real estate development and homebuilding operations. Historically,sources of capital have included bank lines of credit, specific propertyfinancings, asset sales and available internal funds. The Company is utilizingproject debt and internally generated cash to fund construction on the NorthCorona project and the recently acquired Riverside project, and is utilizinginternally generated cash to fund the Yucaipa and Bolsa Chica projects. As ofSeptember 30, 2002, the Company had internally financed approximately $16.0million of investments in homebuilding projects. These projects are expected togenerate approximately $20.0 million of positive cash flows during the next 24months, based on present economic conditions and market assumptions. TheCompany’s cash on hand and cash equivalents as of September 30, 2002 wereapproximately $7.6 million. The Company believes that its cash on hand and cashequivalents, future real estate sales proceeds, and funds available under itscredit agreements for the North Corona and Riverside projects will besufficient to meet anticipated operating and capital investment requirements,primarily project development costs for homebuilding projects and Bolsa Chica,along with general and administrative expenses, for the next 12 months.

 

## **Financial Condition**

 

*September 30, 2002 Comparedwith December 31, 2001*

 

The $1.1 million decrease in cash and cash equivalents primarilyreflects spending on project development costs, partially offset by netproceeds from sales at the Yucaipa and Providence Ranch projects, proceeds fromsales on short-term investments, and the release of restricted cash, as well asother activity presented in the Statements of Cash Flows.

 

Restricted cash equivalents as of December 31, 2001 reflects amortgage-backed security which was restricted as collateral for a letter ofcredit obtained by the Company to secure certain indemnity obligations under atax sharing agreement with a former affiliate. The security was released in May2002 upon settlement of certain state tax audits.

 

13

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The absence of short-term investments as of September 30, 2002 reflectsthe sale of all such securities held at December 31, 2001 for $7.4 millionduring the first half of 2002.

 

The $7.4 million increase in real estate held for current developmentor sale reflects an aggregate of $18.9 million for land acquisitions at theCompany’s Riverside project and for infrastructure and home-building costs forall three of the Company’s homebuilding projects. These investments werepartially offset by $11.5 million charged to cost of sales for deliveries of anaggregate of 50 homes at the Yucaipa and Providence Ranch projects during thefirst nine months of 2002.

 

The $4.0 million increase in land held for future development reflectsinvestment in the Bolsa Chica Mesa project during the first nine months of theyear.

 

Accounts payable and accrued liabilities increased by $.7 million, to abalance of $3.8 million as of September 30, 2002, primarilyreflecting increases in accounts payable for construction and increased accruedstate taxes payable, partially offset by the reversal of federal alternativeminimum taxes payable due to a first quarter change in the federal income taxlaw.

 

The $3.6 million decrease in other liabilities primarily reflectsreductions in tax reserves and deferred tax liabilities. An aggregate of $1.4million of reductions in reserves for estimated state income taxes was recordedin conjunction with the Company’s periodic review of such reserves. Suchreserves were also reduced by payments in January and May 2002 of approximately$.6 million and $.3 million, respectively to state jurisdictions based upon settlementsof audits of 1991 income tax returns. In addition, net deferred taxes payabledecreased by approximately $1.0 million. The decrease primarily resulted fromreductions in the deferred tax asset valuation allowance on federalpre-Reorganization tax net operating losses (“NOLs”) as a result of theCompany’s periodic review of the potential utilization of NOLs and therealization of certain state deferred tax items.

 

The $.7 million increase in capital in excess of par value reflectsreductions of $.7 million in the deferred tax asset valuation allowances onpre-Reorganization state and federal NOLs.

 

**Resultsof Operations**

 

The nature of the Company’s business, including its limited inventoryof buildable lots, is such that individual transactions often cause significantfluctuations in operating results from quarter to quarter and from year toyear.

 

*Three MonthsEnded September 30, 2002 Compared with the Three Months Ended September 30,2001*

 

The Company reported revenues of $5.2 million and gross operatingprofit of $.6 million for the third quarter of 2002, compared with $7.4 millionin revenues and gross operating profit of $1.5 million for the third quarter of2001. Revenues in the current period reflect deliveries of 19 homes, including11 homes at the Company’s Yucaipa project and eight homes at the ProvidenceRanch project. The comparable period of the prior year reflects deliveries of22 homes, including 14 homes at the Company’s Rancho San Pasqual project inEscondido, California, and eight homes at the Yucaipa project. The currentquarter’s gross margin of 12%, which reflects sales at the Yucaipa andProvidence Ranch projects, is lower than the prior period margin of 20% whichprimarily reflects sales at the Escondido and Yucaipa projects, due to therelatively lower basis of the Escondido land.

 

The reduction in selling, general and administrative expenses in thecurrent period primarily reflects reversal of $.3 million of compensationexpense related to variable accounting for stock options (see Note 6 to theCompany’s financial statements).

 

The income from unconsolidated joint ventures of $.2 million for thethree months ended September 30, 2002 as compared to $1.0 million reflected inthe third quarter of 2001, reflects the sale of an out-parcel at the FairbanksHighlands project during the current period as compared to nine home closingsat the Fairbanks Highlands project during the third quarter of 2001. The finalhome closing for the project occurred during the first quarter of 2002.

 

Other income, net of $.3 million of expense during the three monthsended September 30, 2002 primarily reflects real estate holding and otherperiod costs for the Bolsa Chica project.

 

14

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During the three months ended September 30, 2002, the Company recordedtax expense related to an increase in the deferred tax asset valuationallowance related to state NOLs due to a California state tax law changeenacted during the third quarter, which imposed a moratorium on utilization ofstate NOLs during 2002 and 2003.

 

*Nine MonthsEnded September 30, 2002 Compared with the Nine Months Ended September 30, 2001*

 

The Company reported revenues of $13.2 million and gross operatingprofit of $1.5 million for the first nine months of 2002, compared withrevenues of $32.7 million and gross operating profit of $5.4 million for thesame period of 2001. Revenues in the current nine-month period reflectdeliveries of an aggregate of 50 homes, including 19 homes at the Providence Ranchproject near North Corona, California and 31 homes at the Yucaipa project.Revenues in the prior period reflect deliveries of an aggregate of 72 homes,including 41 homes at the Rancho San Pasqual project, 15 homes at the Sandoverproject on the Bolsa Chica Mesa in Huntington Beach, California and 16 homes atthe Yucaipa project. The decrease in the average price of homes sold from$454,000 in the first three quarters of 2001 to $264,000 in the first threequarters of 2002 reflects the lower price ranges commanded by the Inland Empirein comparison to Orange County and San Diego County. The gross margin of 11%for the nine months ended September 30, 2002 reflects the aggregate margin onthe Yucaipa and Providence Ranch projects as compared to the gross margin of17% for the comparable prior year period primarily from the Rancho San Pasqualand Sandover projects, which had lower land cost bases. The 12% gross marginfor the third quarter of 2002 compared with the 11% gross margin for the firstnine months of 2002 reflects higher profitability on the Providence Ranchproject where home deliveries commenced in June 2002.

 

The $.2 million decrease in selling, general and administrativeexpenses during the nine months ended September 30, 2002, compared to the sameperiod of 2001, primarily reflects a reduction in corporate directors’ andofficers’ insurance expense.

 

The $1.9 million decrease in income from unconsolidated joint venturesin the nine months ended September 30, 2002 of $.8 million ascompared to $2.7 million in the same period of 2001 reflects the decrease inthe Company’s share of venture profits from deliveries of four homes and oneout-parcel at Fairbanks Highlands at higher prices during the current period,as compared with deliveries of 27 homes in the comparable period of last year.

 

The increase in other income, net from $.1 million in the 2001 periodto $.3 million in the nine months ended September 30, 2002 primarily reflects$1.2 million in gains on sales of short-term investments in the current period,partially offset by increased period costs for land held for futuredevelopment.

 

During the nine months ended September 30, 2001 and 2002, the Companyrecorded reductions of reserves for estimated state tax liabilities of $3.2million and $1.4 million, respectively, and recognized equivalent tax benefits.The income tax benefit in the 2002 period also reflects reversal of $.2 millionof alternative minimum taxes payable due to a change in the federal income taxlaw enacted in the first quarter, offset by a $.2 million tax expense from achange in California state tax law creating a moratorium on usage of state NOLsretroactively to January 1, 2002.

 
| ITEM 3 - |   | QUANTITATIVE AND  QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
|----------|--------|-------------------------------------------------------------|

 

None.

 
| ITEM 4 - |   | EVALUATION OF  DISCLOSURE CONTROLS AND PROCEDURES |
|----------|--------|---------------------------------------------------|

 

Within 90 days prior to the date of this report,the Company carried out an evaluation, under the supervision and with theparticipation of the Company’s management, including the Chief ExecutiveOfficer and Chief Financial Officer, of the effectiveness of the design andoperation of the Company’s disclosure controls and procedures. The Company’sdisclosure controls and procedures are designed to ensure that informationrequired to be disclosed by the Company in its periodic filings with theSecurities and Exchange Commission (“SEC”) is recorded, processed and reportedwithin the time periods specified in the SEC’s rules and forms. In designingand evaluating the disclosure controls and procedures, the Company’s managementrecognized that any controls and procedures, no matter how well designed andoperated, can provide only reasonable assurance of achieving the desiredobjectives and management necessarily was required to apply its judgment inevaluating the cost-benefit relationship of possible controls and procedures.It should be noted that the design of any system of controls is based in partupon certain assumptions about the likelihood of future events, and there canbe no assurance that any design will succeed in achieving its stated goalsunder all potential future conditions, regardless of how remote. Based on theforegoing, the Company’s Chief Executive Officer and Chief Financial Officerconcluded that the Company’s disclosure controls and procedures were effectivein timely alerting them to material information relating to the

 

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Company (including its consolidated subsidiaries) required to beincluded in the Company’s periodic SEC filings. Additionally, there have beenno significant changes in the Company’s internal controls or in other factorsthat could significantly affect the internal controls subsequent to the datethe Company completed its evaluation.

 

**Safe HarborStatement Under the Private Securities Litigation Reform Act of 1995**

 

Certain of the foregoing information contains forward-lookingstatements that relate to future events or the Company’s future financialperformance.  These statements involveknown and unknown risks, uncertainties and other factors which may cause theCompany’s actual results, performance or achievements to be materiallydifferent from any future results, performances or achievements expressed orimplied by the forward-looking statements. 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-looking statementsinclude, but are not limited to, statements about the Company’s plans,objectives, goals, expectations and intentions, the number and types of homesand number of acres of land that the Company may develop and sell, the timingand outcomes of litigation, regulatory approval processes or administrativeproceedings (including, but not limited to ongoing litigation andadministrative proceedings in the Coastal Commission Lawsuit related to theCompany’s principal asset, the Bolsa Chica Mesa), the Company’s ability tocontinue relationships with current or future partners, the Company’s abilityto expend resources to comply with environmental regulations and localpermitting requirements, the effect of certain costs, contractual obligationsand tax liabilities, both known and unknown, on the Company’s business, resultsof operations and financial condition, the condition and adequacy of theCompany’s properties, the Company’s ability to estimate cash flow projectionsdue to uncertainties in valuing real property, the Company’s ability to acquireresidential lots in order to continue home-building operations, the adequacy ofcapital, financing and cash flow required to continue the Company’s operationsand land development activities, the future condition of the real estate marketin southern California, the Company’s ability to maintain profitableoperations, the possible negotiation of a sale transaction with the State ofCalifornia and other statements contained herein that are not historical facts.

 

PART II - OTHER INFORMATION

 
| ITEM 1 - |   | Legal Proceedings |
|----------|--------|-------------------|

 

See “Item 1 - Business - CorporateIndemnification Matters” and “Item 3 - Legal Proceedings” in the Company’s Annual Report on Form 10-K forthe year ended December 31, 2001.

 
| ITEM 6 - |   | Exhibits and Reports on  Form 8-K |
|----------|--------|-----------------------------------|
|     |   |                              |
| (a)      |   | Exhibits:                         |
|     |   |                              |
|     |   | 10.1                              |   | Amended and  Restated Independent Contractor Consulting Agreement between the Registrant  and GSSW-REO, L.L.C. |
|     |   |                              |   |   |
|     |   | 99.1                              |   | Certificate  of Raymond J. Pacini, Chief Executive Officer of California Coastal  Communities, Inc. |
|     |   |                              |   |   |
|     |   | 99.2                              |   | Certificate  of Sandra G. Sciutto, Chief Financial Officer of California Coastal  Communities, Inc. |
|     |   |                              |
| (b)      |   | Reports  on Form 8-K:             |   |   |
|     |   |                              |   |   |
|     |   | None.                             |   |   |
|          |        |                                   |  |  |  |  |

 

16

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SIGNATURE

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
|                         |   | CALIFORNIA COASTAL  COMMUNITIES, INC. |
|------------------------------|--------|---------------------------------------|
|                         |   |                                  |   |
| Date  November 12, 2002 |   | By                                    | */s/*  Sandra G. Sciutto |   |
|                         |   |                                  | SANDRA  G. SCIUTTO |
|                         |   |                                  | Senior  Vice President and  Chief Financial Officer |

 

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I, Raymond J. Pacini, certify that:

 
| 1.     |   | I have reviewed this quarterly  report on Form 10-Q of California Coastal Communities, Inc.;                                                                                                                                                                                                                                                                                                       |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                               |   |   |
| 2.     |   | Based on my knowledge, this  quarterly report does not contain any untrue statement of a material fact or  omit to state a material fact necessary to make the statements made, in light  of the circumstances under which such statements were made, not misleading  with respect to the period covered by this quarterly report;                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                               |   |   |
| 3.     |   | Based on my knowledge, the  financial statements, and other financial information included in this  quarterly report, fairly present in all material respects the financial  condition, results of operations and cash flows of the registrant as of, and  for, the periods presented in this quarterly report;                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                               |   |   |
| 4.     |   | The registrant’s other  certifying officer and I are responsible for establishing and maintaining  disclosure controls and procedures (as defined in Exchange Act Rules 13a-14  and 15d-14) for the registrant and we have:                                                                                                                                                                   |
|   |
|   |   | (a)                                                                                                                                                                                                                                                                                                                                                                                                | designed such disclosure  controls and procedures to ensure that material information relating to the  registrant, including its consolidated subsidiaries, is made known to us by  others within those entities, particularly during the period in which this  quarterly report is being prepared; |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                               |   |   |
|   |   | (b)                                                                                                                                                                                                                                                                                                                                                                                                | evaluated the effectiveness of  the registrant’s disclosure controls and procedures as of a date within 90  days prior to the filing date of this quarterly report (the “Evaluation  Date”); and |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                               |   |   |
|   |   | (c)                                                                                                                                                                                                                                                                                                                                                                                                | presented in this quarterly  report our conclusions about the effectiveness of the disclosure controls and  procedures based on our evaluation as of the Evaluation Date; |
|   |
| 5.     |   | The registrant’s other  certifying officer and I have disclosed, based on our most recent evaluation,  to the registrant’s auditors and the audit committee of registrant’s board of  directors (or persons performing the equivalent function):                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                               |   |   |
|   |   | (a)                                                                                                                                                                                                                                                                                                                                                                                                | all significant deficiencies  in the design or operation of internal controls which could adversely affect  the registrant’s ability to record, process, summarize and report financial  data and have identified for the registrant’s auditors any material  weaknesses in internal controls; and |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                               |   |   |
|   |   | (b)                                                                                                                                                                                                                                                                                                                                                                                                | any fraud, whether or not  material, that involves management or other employees who have a significant  role in the registrant’s internal controls; and |
|   |
| 6.     |   | The registrant’s other  certifying officer and I have indicated in this quarterly report whether or  not there were significant changes in internal controls or in other factors  that could significantly affect internal controls subsequent to the date of  our most recent evaluation, including any corrective actions with regard to  significant deficiencies and material weaknesses. |
|        |        |                                                                                                                                                                                                                                                                                                                                                                                                    |  |  |  |  |  |  |  |  |  |  |

 

Date: November 12, 2002

 

 
| */s/*   Raymond J. Pacini |   |
|--------------------------------|--------|
| Raymond J. Pacini              |
| Chief Executive Officer        |

 

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I, Sandra G. Sciutto, certify that:

 
| 1.     |   | I have reviewed this quarterly  report on Form 10-Q of California Coastal Communities, Inc.;                                                                                                                                                                                                                                                                                                       |                                                                                                                                                                                                                                                                                                         |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                         |   |   |
| 2.     |   | Based on my knowledge, this  quarterly report does not contain any untrue statement of a material fact or  omit to state a material fact necessary to make the statements made, in light  of the circumstances under which such statements were made, not misleading  with respect to the period covered by this quarterly report;                                                                 |                                                                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                         |   |   |
| 3.     |   | Based on my knowledge, the  financial statements, and other financial information included in this  quarterly report, fairly present in all material respects the financial  condition, results of operations and cash flows of the registrant as of, and  for, the periods presented in this quarterly report;                                                                                    |                                                                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                         |   |   |
| 4.     |   | The registrant’s other  certifying officer and I are responsible for establishing and maintaining  disclosure controls and procedures (as defined in Exchange Act Rules 13a-14  and 15d-14) for the registrant and we have:                                                                                                                                                                   |                                                                                                                                                                                                                                                                                                         |
|   |
|   |   | (a)                                                                                                                                                                                                                                                                                                                                                                                                | designed such disclosure  controls and procedures to ensure that material information relating to the  registrant, including its consolidated subsidiaries, is made known to us by  others within those entities, particularly during the period in which this  quarterly report is being prepared;          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                         |   |
|   |   | (b)                                                                                                                                                                                                                                                                                                                                                                                                | evaluated the effectiveness of  the registrant’s disclosure controls and procedures as of a date within 90  days prior to the filing date of this quarterly report (the “Evaluation  Date”); and                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                         |   |
|   |   | (c)                                                                                                                                                                                                                                                                                                                                                                                                | presented in this quarterly  report our conclusions about the effectiveness of the disclosure controls and  procedures based on our evaluation as of the Evaluation Date;                                                                                                                                    |
|   |
| 5.     |   | The registrant’s other  certifying officer and I have disclosed, based on our most recent evaluation,  to the registrant’s auditors and the audit committee of registrant’s board of  directors (or persons performing the equivalent function):                                                                                                                                    |                                                                                                                                                                                                                                                                                                         |
|   |
|   |   | (a)                                                                                                                                                                                                                                                                                                                                                                                                | all significant deficiencies  in the design or operation of internal controls which could adversely affect the  registrant’s ability to record, process, summarize and report financial data  and have identified for the registrant’s auditors any material weaknesses in  internal controls; and |   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                         |   |   |
|   |   | (b)                                                                                                                                                                                                                                                                                                                                                                                                | any fraud, whether or not  material, that involves management or other employees who have a significant  role in the registrant’s internal controls; and                                                                                                                                                |   |
|   |
| 6.     |   | The registrant’s other  certifying officer and I have indicated in this quarterly report whether or  not there were significant changes in internal controls or in other factors  that could significantly affect internal controls subsequent to the date of  our most recent evaluation, including any corrective actions with regard to  significant deficiencies and material weaknesses. |                                                                                                                                                                                                                                                                                                         |
|        |        |                                                                                                                                                                                                                                                                                                                                                                                                    |                                                                                                                                                                                                                                                                                                              |  |  |  |  |  |

 

Date: November 12, 2002

 

 
| */s/* Sandra G. Sciutto |   |
|-------------------------|--------|
| Sandra G. Sciutto       |
| Chief Financial Officer |

 

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