This Form 10-Qconsists of 23 sequentially numbered pages.

 

**FORM 10-Q**

 

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

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

 

**Forthe quarterly period ended September 30, 2003**

 

**Commissionfile number 0-17189**

 

**CALIFORNIA COASTAL COMMUNITIES, INC.**

(Exact name ofregistrant 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**

 

Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed bySection 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 |
|-----------------------|--------|------------|

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2 of theAct).

 

| Yes  o |   | No  ý |
|------------------|--------|-----------------|

 

Thenumber of shares of Common Stock outstanding at October 31, 2003 was10,057,212.

 

 

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CALIFORNIA COASTAL COMMUNITIES,INC.

 

FORM 10-Q

 

FOR THE QUARTER ENDEDSEPTEMBER 30, 2003

 

I N D E X

 
| Part I -  | Financial Information:                     |
|----------------|--------------------------------------------|
|           |                                       |   |
|           | Item 1  -                                  | Consolidated  Financial Statements |
|           |                                       |   |
|           |                                       | Consolidated Balance Sheets  -  September 30, 2003 and December 31, 2002 (unaudited) |
|           |                                       |   |
|           |                                       | Consolidated  Statements of Operations -  Three and Nine Months Ended September 30, 2003 and 2002 (unaudited) |
|           |                                       |   |
|           |                                       | Consolidated  Statements of Cash Flows -  Nine Months Ended September 30, 2003 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      |

 

2

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PART I. FINANCIAL INFORMATION

 

ITEM 1 – FINANCIALSTATEMENTS

 

CALIFORNIA COASTAL COMMUNITIES, INC.

 

CONSOLIDATED BALANCESHEETS

 

(in millions,except share amounts)

 

(unaudited)

 
|                                                                                                      |   | **September 30,  2003** |   | **December 31, 2002** |   |
|-----------------------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|----------------------------|--------|
|                                                                                                      |   |                              |   |                       |   |
| ASSETS                                                                                                    |   |                              |   |                       |   |
|                                                                                                      |   |                              |   |                       |   |
| Cash and cash equivalents                                                                                 |   | $                                 | 5.3    |                       | $      | 9.2 |   |
| Real estate held for current development or sale                                                          |   | 45.0                              |   | 25.0                       |   |
| Land held for future development                                                                          |   | 153.2                             |   | 151.9                      |   |
| Other assets                                                                                              |   | 2.1                               |   | 1.5                        |   |
|                                                                                                      |   |                              |   |                       |   |
|                                                                                                      |   | $                                 | 205.6  |                       | $      | 187.6 |   |
|                                                                                                      |   |                              |   |                       |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                 |   |                              |   |                       |   |
|                                                                                                      |   |                              |   |                       |   |
| Liabilities:                                                                                              |   |                              |   |                       |   |
| Accounts payable and accrued liabilities                                                                  |   | $                                 | 4.5    |                       | $      | 5.0 |   |
| Project debt                                                                                              |   | 23.4                              |   | 9.8                        |   |
| Other liabilities                                                                                         |   | 12.0                              |   | 12.9                       |   |
|                                                                                                      |   |                              |   |                       |   |
| Total liabilities                                                                                         |   | 39.9                              |   | 27.7                       |   |
|                                                                                                      |   |                              |   |                       |   |
| Minority interest                                                                                         |   | 3.9                               |   | —                     |   |
|                                                                                                      |   |                              |   |                       |   |
| Commitments and contingencies                                                                             |   |                              |   |                       |   |
|                                                                                                      |   |                              |   |                       |   |
| Stockholders’ equity:                                                                                |   |                              |   |                       |   |
| Common Stock—$.05 par value; 11,000,000 shares authorized; 10,057,212  shares issued and outstanding |   | .5                                |   | .5                         |   |
| Excess  Stock—$.05 par value; 11,000,000 shares authorized; no shares outstanding                    |   | —                            |   | —                     |   |
| Capital in  excess of par value                                                                           |   | 142.6                             |   | 141.3                      |   |
| Retained  earnings                                                                                        |   | 21.1                              |   | 20.5                       |   |
| Accumulated  other comprehensive loss                                                                     |   | (2.4                              | )      | (2.4                       | )      |
| Total  stockholders’ equity                                                                          |   | 161.8                             |   | 159.9                      |   |
|                                                                                                      |   |                              |   |                       |   |
|                                                                                                      |   | $                                 | 205.6  |                       | $      | 187.6 |   |

 

See the accompanying notes to consolidated financial statements.

 

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CALIFORNIA COASTALCOMMUNITIES, INC.

 

CONSOLIDATEDSTATEMENTS OF OPERATIONS

 

(in millions,except per share amounts)

 

(unaudited)

 
|                                                                      |   | **Three Months Ended  September 30,** |   | **Nine Months Ended  September 30,** |   |
|---------------------------------------------------------------------------|--------|--------------------------------------------|--------|-------------------------------------------|--------|
|                                                                      |   | **2003**                                   |   | **2002**                                  |   | **2003** |   | **2002** |   |
|                                                                      |   |                                       |   |                                      |   |   |   |   |   |
| Revenues                                                                  |   | $                                          | 8.4    |                                      | $      | 5.2 |   | $ | 21.5 |   | $ | 13.2 |   |
|                                                                      |   |                                       |   |                                      |   |   |   |   |   |
| Costs of sales                                                            |   | 6.8                                        |   | 4.6                                       |   | 17.7 |   | 11.7 |   |
|                                                                      |   |                                       |   |                                      |   |   |   |   |   |
| Gross operating profit                                                    |   | 1.6                                        |   | .6                                        |   | 3.8 |   | 1.5 |   |
|                                                                      |   |                                       |   |                                      |   |   |   |   |   |
| Selling, general and administrative expenses                              |   | .8                                         |   | .2                                        |   | 2.5 |   | 2.1 |   |
| Interest expense                                                          |   | .1                                         |   | .1                                        |   | .2 |   | .2 |   |
| Income from unconsolidated joint ventures                                 |   | (.1                                        | )      | (.2                                       | )      | (.4 | ) | (.8 | ) |
| Other expense (income), net                                               |   | (.1                                        | )      | .3                                        |   | .6 |   | (.3 | ) |
|                                                                      |   |                                       |   |                                      |   |   |   |   |   |
| Income before income taxes                                                |   | .9                                         |   | .2                                        |   | .9 |   | .3 |   |
|                                                                      |   |                                       |   |                                      |   |   |   |   |   |
| Provision (benefit) for income taxes                                      |   | .4                                         |   | .2                                        |   | .3 |   | (1.3 | ) |
|                                                                      |   |                                       |   |                                      |   |   |   |   |   |
| Net income                                                                |   | $                                          | .5     |                                      | $      | — |   | $ | .6 |   | $ | 1.6 |   |
|                                                                      |   |                                       |   |                                      |   |   |   |   |   |
| Other comprehensive income:                                               |   |                                       |   |                                      |   |   |   |   |   |
|                                                                      |   |                                       |   |                                      |   |   |   |   |   |
| Less:   Reclassification adjustment for gains included in net income |   | —                                     |   | —                                    |   | — |   | (1.3 | ) |
|                                                                      |   |                                       |   |                                      |   |   |   |   |   |
| Total comprehensive income                                                |   | $                                          | .5     |                                      | $      | — |   | $ | .6 |   | $ | .3 |   |
|                                                                      |   |                                       |   |                                      |   |   |   |   |   |
| Earnings per common share:                                                |   |                                       |   |                                      |   |   |   |   |   |
| Basic                                                                     |   | $                                          | .05    |                                      | $      | — |   | $ | .06 |   | $ | .16 |   |
| Diluted                                                                   |   | $                                          | .05    |                                      | $      | — |   | $ | .06 |   | $ | .15 |   |
|                                                                      |   |                                       |   |                                      |   |   |   |   |   |
| Weighted average common shares outstanding:                               |   |                                       |   |                                      |   |   |   |   |   |
| Basic                                                                     |   | 10.1                                       |   | 10.1                                      |   | 10.1 |   | 10.1 |   |
| Diluted                                                                   |   | 10.9                                       |   | 10.1                                      |   | 10.8 |   | 10.8 |   |

 

See the accompanying notes to consolidated financial statements.

 

4

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CALIFORNIA COASTALCOMMUNITIES, INC.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

(in millions)

 

(unaudited)

 
|                                                                              |   | **Nine Months Ended  September 30,** |   |
|-----------------------------------------------------------------------------------|--------|-------------------------------------------|--------|
|                                                                              |   | **2003**                                  |   | **2002** |   |
|                                                                              |   |                                      |   |   |   |
| Cash flows from operating activities:                                             |   |                                      |   |   |   |
| Net income                                                                        |   | $                                         | .6     |   | $ | 1.6 |   |
| Adjustments to reconcile to cash used in operating  activities:                   |   |                                      |   |   |   |
| Non-cash interest expense                                                         |   | .2                                        |   | .2 |   |
| Gains on sales of real estate held for current  development or sale               |   | (3.8                                      | )      | (1.5 | ) |
| Proceeds from asset sales                                                         |   | 21.5                                      |   | 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                  |   | (37.7                                     | )      | (18.9 | ) |
| Investments in land held for future development                                   |   | (1.3                                      | )      | (4.0 | ) |
| Increase in other assets                                                          |   | (.6                                       | )      | — |   |
| Decrease in accounts payable, accrued and other  liabilities, net                 |   | (.3                                       | )      | (2.4 | ) |
|                                                                              |   |                                      |   |   |   |
| Cash used in operating activities                                                 |   | (21.4                                     | )      | (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                                                        |   | 22.8                                      |   | 7.9 |   |
| Minority interest                                                                 |   | 3.9                                       |   | — |   |
| Repayments  of project debt                                                       |   | (9.2                                      | )      | (4.7 | ) |
| Release of restricted cash                                                        |   | —                                    |   | 1.5 |   |
|                                                                              |   |                                      |   |   |   |
| Cash provided by financing activities                                             |   | 17.5                                      |   | 4.7 |   |
|                                                                              |   |                                      |   |   |   |
| Net decrease in cash and cash equivalents                                         |   | (3.9                                      | )      | (1.1 | ) |
|                                                                              |   |                                      |   |   |   |
| Cash and cash equivalents - beginning of period                                   |   | 9.2                                       |   | 8.7 |   |
|                                                                              |   |                                      |   |   |   |
| Cash and cash equivalents - end of period                                         |   | $                                         | 5.3    |   | $ | 7.6 |   |
|                                                                              |   |                                      |   |   |   |
| Supplemental disclosures of cash flow information:                                |   |                                      |   |   |   |
| Cash paid during the period for  income taxes, net of refunds                     |   | $                                         | (.6    | ) | $ | (.6 | ) |
|                                                                              |   |                                      |   |   |   |
| Supplemental disclosures of  non-cash investing and financing activities:         |   |                                      |   |   |   |
| Utilization of  pre-Reorganization net operating losses to offset tax liabilities |   | $                                         | .3     |   | — |   |
| Reclassification adjustment for  gains included in net income                     |   | —                                    |   | (1.3 | ) |

 

See the accompanying notes to consolidated financial statements.

 

5

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CALIFORNIA COASTALCOMMUNITIES, INC.

 

NOTES TOCONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

**Note 1 - Basis of Presentation**

 

The accompanying financial statements have beenprepared by California Coastal Communities, Inc. and its consolidatedsubsidiaries (the “Company”), without audit, pursuant to the rules andregulations of the Securities and Exchange Commission. Certain information andfootnote disclosures normally included in financial statements prepared inaccordance with accounting principles generally accepted in the United Statesof America 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 in conjunctionwith the Financial Statements and Notes thereto included in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2002, 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.

 

**Note 2 – Significant AccountingPolicies**

 

#### *Earnings Per Common Share*

 

Forthe three and nine months ended September 30, 2003 and 2002, theweighted-average number of common shares outstanding was 10.1 million. Earningsper share, assuming dilution, is computed using the weighted-average number ofcommon shares outstanding and the dilutive effect of potential common sharesoutstanding. For the three months ended September 30, 2003, the averagemarket price of the Company’s common stock exceeded the exercise price of alloutstanding stock options and warrants. For the nine months endedSeptember 30, 2003, and the three and nine months ended September 30,2002, the average market price of the Company’s common stock exceeded theexercise price of outstanding stock options, but not the exercise price of outstandingwarrants. Therefore, the dilutive effect of the 754,996 common shares frompotential exercise of options is reflected in the 10.8 million weighted averagecommon shares outstanding assuming dilution in the related statement ofoperations for all periods presented. In addition, the dilutive effect of the48,000 common shares from potential exercise of warrants is reflected only inthe three month period ended September 30, 2003.

 

*Stock-Based Compensation – Change in Accounting*

 

Prior to the second quarter of 2003, the Companyaccounted for its stock-based employee compensation plan using the recognitionand measurement principles (intrinsic value method) of Accounting PrinciplesBoard (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” (“APB25”) and the related Financial Accounting Standards Board (“FASB”)Interpretation No. 44 “Accounting for Certain Transactions Involving StockCompensation” (“FIN 44”). As a result of the May 2001 repricing ofoutstanding stock options, the Company accounted for the options as variableawards and recorded non-cash stock-based compensation expense on a cumulativebasis as the difference between the option exercise price and the quoted marketprice of the Company’s common stock. From May 2001 through the first quarterof 2003, non-cash compensation expense was reflected for stock price changespursuant to variable accounting for repriced options.

 

During the second quarter of 2003, the Company adoptedthe fair value recognition provisions of FASB Statement of Financial Standards(“SFAS”) No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”). Forthis change in accounting, the Company selected the “modified prospectivemethod” under the provisions of SFAS No. 148 “Accounting for Stock-BasedCompensation – Transition and Disclosure – an Amendment of FASB Statement No.123” (“SFAS 148”). Under this method, the change is retroactive toJanuary 1, 2003 and compensation cost recognized for the three and ninemonths ended September 30, 2003 is the same as that which would have beenrecognized had the recognition provisions of SFAS 123 been applied from itsoriginal effective date. In accordance with SFAS 148, results for prior yearshave not been restated. SFAS

 

6

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123 states that the adoption of the fair value based method is a changeto a preferable method of accounting. Management believes that use of the fairvalue based method to record employee stock-based compensation expense isconsistent with the accounting for all other forms of compensation. Thefollowing table illustrates the effect on net income and earnings per share ifthe fair value based method had been applied to all outstanding awards in eachperiod (in millions, except per share amounts):

 
|                                                                                                                  |   | **Three months ended  September 30,** |   | **Nine months ended  September 30,** |   |
|-----------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------|--------|-------------------------------------------|--------|
|                                                                                                                  |   | **2003**                                   |   | **2002**                                  |   | **2003** |   | **2002** |   |
| Net  income, as reported                                                                                              |   | $                                          | .5     |                                      | $      | — |   | $ | .6 |   | $ | 1.6 |   |
| Add:  Stock-based employee compensation expense (income) included in reported net  income, net of related tax effects |   | —                                     |   | (.2                                       | )      | — |   | — |   |
| Proforma  net income (loss)                                                                                           |   | $                                          | .5     |                                      | $      | (.2 | ) | $ | .6 |   | $ | 1.6 |   |
|                                                                                                                  |   |                                       |   |                                      |   |   |   |   |   |
| Earnings  per share:                                                                                                  |   |                                       |   |                                      |   |   |   |   |   |
| Basic  – as reported                                                                                             |   | $                                          | .05    |                                      | $      | — |   | $ | .06 |   | $ | .16 |   |
| Basic  – Proforma                                                                                                |   | $                                          | .05    |                                      | $      | (.02 | ) | $ | .06 |   | $ | .16 |   |
| Diluted  – as reported                                                                                           |   | $                                          | .05    |                                      | $      | — |   | $ | .06 |   | $ | .15 |   |
| Diluted  – Proforma                                                                                              |   | $                                          | .05    |                                      | $      | (.02 | ) | $ | .06 |   | $ | .15 |   |

 

In adopting SFAS 123 retroactive to January 1,2003, during the second quarter of 2003, the Company reversed $476,000 ofnon-cash stock-based compensation expense recorded in the first quarter of 2003as prescribed by SFAS 148. Accordingly, the following amounts from theCompany’s financial statements for the three months ended March 31, 2003have been revised from amounts previously reported to account for stock compensationexpense under the fair value method prescribed by SFAS 123, in accordance withthe modified prospective method of SFAS 148 (in millions, except per shareamounts):

 
|                                          |   | **March 31, 2003** |   |
|-----------------------------------------------|--------|-------------------------|--------|
|                                          |   | **As Reported**         |   | **As Revised** |   |
|                                          |   |                    |   |   |   |
| Other  liabilities                            |   | $                       | 12.8   |   | $ | 12.7 |   |
| Capital  in excess of par value               |   | 141.7                   |   | 141.3 |   |
| Retained  earnings                            |   | 19.7                    |   | 20.3 |   |
| Stockholders’  equity                    |   | 159.5                   |   | 159.6 |   |
|                                          |   |                    |   |   |   |
| Selling,  general and administrative expenses |   | 1.3                     |   | .8 |   |
| Loss  before income taxes                     |   | (.8                     | )      | (.3 | ) |
| Provision  (benefit) for income taxes         |   | —                  |   | (.1 | ) |
| Net  loss                                     |   | (.8                     | )      | (.2 | ) |
|                                          |   |                    |   |   |   |
| Loss  per common share – basic           |   | (.08                    | )      | (.02 | ) |
| Loss  per common share – diluted         |   | (.08                    | )      | (.02 | ) |
|                                               |        |                         |        |  |  |  |  |

 

*Impairment ofLong-Lived Assets*

 

The Company assesses the impairment of long-livedassets, including land held for future development and real estate held forcurrent development or sale in accordance with SFAS No.144 “Accounting for theImpairment or Disposal of Long-Lived Assets” (“SFAS 144”). These assets arecarried at cost, unless the carrying amount of the parcel or subdivision isdetermined not to be fully recoverable, in which case the impaired real estateis written down to fair value. Impairment write-downs are recorded asadjustments to the cost basis of the real estate. Long-lived assets are reviewedfor impairment whenever events or changes in circumstances indicate that thecarrying amount of an asset may not be recoverable. As provided by SFAS 144,impairment is evaluated by comparing an asset’s carrying value to theundiscounted 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 144 is deemed to be the amount awilling buyer would pay a willing seller for such asset in a currenttransaction.

 

7

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*Basisof Consolidation*

 

Certain wholly-owned subsidiaries of the Company aremembers in joint ventures involved in the development and sale of residentialprojects and residential loan production. The consolidated statements of theCompany include the accounts of the Company and all majority-owned andcontrolled subsidiaries and joint ventures. The financial statements of jointventures in which the Company has a 50% or more voting or economic interest(and thus are controlled by the Company) are consolidated with the Company’sfinancial statements. Minority interest represents the equity interest of theCompany’s joint venture partner and is further described in Note 7. TheCompany’s investments in unconsolidated joint ventures are accounted for usingthe equity method, as the Company does not have voting or economic control ofthe venture operations.

 

*Recent Accounting Pronouncements*

 

In November 2002,the FASB issued FIN 45, “Guarantors Accounting and Disclosure Requirements forGuarantees, Including Indirect Guarantees and Indebtedness of Others,” aninterpretation of FASB Statements No. 5, 57 and 107, and rescission of FIN 34,“Disclosure of Indirect Guarantees of Indebtedness of Others.” FIN 45elaborates on the disclosures to be made by the guarantor in its interim and annualfinancial statements about its obligations under certain guarantees that it hasissued. It also requires that a guarantor recognize, at the inception of aguarantee, a liability for the fair value of the obligation undertaken inissuing the guarantee. The initial recognition and measurement provisions ofthis interpretation are applicable on a prospective basis to guarantees issuedor modified after December 31, 2002. The Company adopted the disclosureprovision of such interpretation on December 31, 2002, and the recognitionprovision on January 1, 2003, as required. The Company’s adoption of suchinterpretation did not have a material impact on its results of operations orfinancial position. Additional disclosures are presented in Note 6 to theseconsolidated financial statements.

 

In January 2003, theFASB issued FIN 46, “Consolidation of Variable Interest Entities”. In general,a variable interest entity is a corporation, partnership, trust, or any otherlegal structure used for business purposes that either (a) does not have equityinvestors with voting rights or (b) has equity investors that do not providesufficient financial resources for the entity to support its activities. FIN 46requires certain variable interest entities to be consolidated by the primarybeneficiary of the entity if the investors in the entity do not have thecharacteristics of a controlling financial interest or do not have sufficientequity at risk for the entity to finance its activities without additionalsubordinated financial support from other parties. The Company adopted allrequirements of FIN 46 effective January 1, 2003, including those whichapply immediately to variable interest entities created after January 31,2003, and certain of the disclosure requirements applicable in all financialstatements issued after January 31, 2003, regardless of when the variableinterest entity was established and the consolidation requirements applicableto older entities in the first fiscal year or interim period ending afterDecember 15, 2003. The adoption of the requirements of FIN 46 did not havea material impact on its financial position or results of operations becausethe Company has no variable interest entities.

 

In May 2003, the FASB issued SFAS No. 150, “Accounting forCertain Instruments with Characteristics of Both Liabilities and Equity”,(“SFAS 150”) which establishes standards for how an issuer classifies andmeasures certain financial instruments with characteristics of both liabilitiesand equity. SFAS 150 requires that an issuer classify a financial instrumentthat is within its scope, which may have previously been reported as equity, asa liability (or an asset in some circumstances). This statement is effectivefor financial instruments entered into or modified after May 31, 2003, andotherwise is effective at the beginning of the first interim period beginningafter June 15, 2003 for public companies. In October 2003, the FASBdeferred implementation of paragraphs 9 and 10 of SFAS 150 regarding certainlimited life entities with equity consolidated as minority interest by theparent company. This deferral is for an indefinite period. As ofSeptember 30, 2003 the Company consolidates one joint venture which isaffected by this deferral (see Note 7). The Company is evaluating the impactadoption of SFAS 150 will have on its financial statements.

 

**Note 3 - LandHeld for Future Development**

 

TheCompany owns approximately350acreslocatedin 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 a mesa south of the Bolsa Chica wetlands and 42 acres oflowlands which were acquired by the Company in September 1997.

 

8

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A Local Coastal Program (“LCP”) for development of upto 2,500 homes on the Bolsa Chica Mesa was approved by the Orange County Boardof Supervisors in December 1994 and by the California Coastal Commission(the “Coastal Commission”) in January 1996. In October 1997, inresponse to a trial court decision which challenged the 1996 approval of theCoastal Commission (the “Coastal Act Lawsuit”), the Coastal Commission approvedmodifications to the LCP which reduced the maximum number of homes to be builtto no more than 1,235 homes on the Bolsa Chica Mesa. The Orange County Board ofSupervisors accepted the Coastal Commission’s suggested modifications; however,this approval was challenged in trial court and then in the Court of Appeals.

 

In November 2000, in response to theApril 1999 Court of Appeal’s decision in the Coastal Act Lawsuit whichprohibited relocation of a 14-acre grove of dying eucalyptus trees which servesas raptor habitat, the Coastal Commission held another public hearing on theLCP and decided to limit development to only the upper bench of the Bolsa ChicaMesa (the “Upper Mesa”). The Coastal Commission’s November 2000 suggestedmodifications to the LCP would prohibit the Company and other landowners fromdevelopment on the approximately 100-acre lower bench of the Bolsa Chica Mesa(the “Lower Mesa”). In May 2001, the County of Orange declined to considerthe Coastal Commission’s November 2000 suggested modifications. In theirresponse to the Coastal Commission, the County stated that the Commission’ssuggested modifications were infeasible and unacceptable. In particular, theCounty noted that the Commission’s suggested modifications would remove 140acres of viable residentially-zoned land from the County’s plan.

 

In January 2001, the Company challenged theCoastal Commission’s November 2000 decision to substantially change thepreviously approved LCP. The Company’s petition alleged that the CoastalCommission arbitrarily abandoned decades of prior approvals that would havepermitted development on the entire Bolsa Chica Mesa. The petition challengedthe Commission’s November 2000 decision as to how to protect certainraptor habitat on the Bolsa Chica Mesa, including the Commission’srecommendation that the Lower Mesa not be developed. On February 14, 2003the court issued a ruling which denied the Company’s petition on the groundsthat the Coastal Commission’s November 2000 decision expired by operationof law when the County rejected the Coastal Commission’s suggestedmodifications. As a result, the Coastal Commission’s decision to prohibitdevelopment on the Lower Mesa is no longer of any force or effect. In addition,the court’s opinion recommended that the Company put a new, legally reviewableplan before the Commission and, accordingly, the Company is continuing itspursuit of reasonable development on the Bolsa Chica Mesa as discussed below.

 

The Company is currently pursuing approval of permitsfor development of the Upper Mesa. During May 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, inJuly 2002, the Orange County Board of Supervisors upheld the PlanningCommission’s prior approval of the site plan and tentative tract map. The plannedcommunity on the Upper Mesa is currently expected to offer a broad mix of homechoices, ranging in size from 1,560 square feet to 4,450 square feet. Thisdevelopment plan also requires approval by the Coastal Commission. The Companysubmitted a Coastal Development Permit (“CDP”) application for this plan to theCoastal Commission in November 2002. In October 2003, the Company wasnotified by the Coastal Commission staff that the Company’s CDP application hasbeen deemed complete. As a result, the Company currently expects the CoastalCommission to hold a public hearing on the CDP during the first half of 2004,however, there can be no assurance that further delays will not be encountered.The Company does not believe that the Coastal Commission process willpermanently prevent it from developing a planned community at Bolsa Chica;however, there can be no assurance in that regard, or as to (i) whendevelopment could commence, (ii) the number of acres or homes the Company willbe permitted to develop, or (iii) the absence of further litigation oradministrative delay.

 

On September 2, 1997, the Company completed arecapitalization (the “Recapitalization”) and applied the principles requiredby the American Institute of Certified Public Accountant’s SOP 90-7, “FinancialReporting by Entities in Reorganization Under the Bankruptcy Code”(“Fresh-Start Reporting”) and the carrying value of land held for development(Bolsa Chica) was adjusted to fair value as of September 2, 1997, afterconsideration of the October 1997 Coastal Commission action discussedabove. The fair value was determined in 1997 using discounted estimated cashflows expected from the asset’s operations and eventual disposition. Inaddition, given the significance of the Bolsa Chica asset to the financialstatements of the Company, the value of the Company’s stock immediatelyfollowing the closing of the Recapitalization was used as an indicator of valueof the subject property. Following the November 2000 Coastal Commissionaction, an assessment of impairment was conducted by the Company for the yearended December 31, 2000. The Company updated its analysis at each year endsince December 31, 2000, and has noted no indicators of impairment sincethat date. Future costs incurred for capitalizable development activities forthe Bolsa Chica project

 

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will increase the basis of the land. An estimate for these costs hasbeen included in the Company’s estimated undiscounted future cash flow forecastused in its impairment analyses. In accordance with the Company’s policydescribed in Note 2 – Impairment of Long-Lived Assets, since the estimatedundiscounted future cash flows from the upper bench of the Bolsa Chica Mesa andthe Company’s additional 242 acres at Bolsa Chica exceed its September 30,2003 carrying value, the Company believes that there has been no impairment.

 

The estimation process involved in the determinationof value is inherently uncertain since it requires estimates as to futureevents and market conditions. Such estimation process assumes the Company’sability to complete development and dispose of its real estate properties inthe ordinary course of business based on management’s present plans andintentions. Economic, market, environmental and political conditions may affectmanagement’s development and marketing plans. In addition, the implementationof such development and marketing plans could be affected by the availabilityof future financing for development and construction activities. Accordingly,the ultimate values of the Company’s land held for future development aredependent upon future economic and market conditions, the availability offinancing, and the resolution of political, environmental and other relatedissues. The development of the Company’s Bolsa Chica Mesa project is dependentupon various governmental approvals and economic factors. 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 acquisition of single-familyresidential lots, the Company’s homebuilding subsidiary, Hearthside Homes,Inc., enters into construction loan agreements with a commercial bank. Theseloan facilities finance a portion of the land acquisition and the majority ofthe construction of infrastructure and homes. The loans are secured by deeds oftrust on individual projects and require principal repayments upon the deliveryof homes. The loans bear an interest rate of prime plus three-fourths percent(4.75% at September 30, 2003).  Thefollowing amounts were outstanding under these loan facilities as ofSeptember 30, 2003 and December 31, 2002 (in millions):

 
|         |   |                    |   |                |   |               |     | **Outstanding at**           |   |
|--------------|--------|-------------------------|--------|---------------------|--------|--------------------|----------|------------------------------|--------|
| **Project**  |   | **Amount  of Facility** |   | **Number  of Lots** |   | **Maturity  Date** |     | **September 30,  2003** |   | **December 31,  2002** |   |
|         |   |                    |   |                |   |               |     |                         |   |   |   |
| North Corona |   | $                       | 17.1   |                | 93     |               | 11/29/03 |                         | $      | 13.8 |   | $ | 6.4 |   |
| Riverside    |   | 7.8                     |   | 37                  |   | 7/28/03            |     | —                       |   | 2.1 |   |
| Riverside    |   | 6.4                     |   | 47                  |   | 10/10/03           |     | —                       |   | 1.3 |   |
| Chino        |   | 15.4                    |   | 77                  |   | 5/30/04            |     | 9.6                          |   | — |   |
|         |   |                    |   |                |   |               |     | $                            | 23.4   |   | $ | 9.8 |   |
|              |        |                         |        |                     |        |                    |          |                              |        |  |  |  |  |  |

 

Construction period interest was capitalized toprojects in the construction stage in the amount of approximately $200,000 and$500,000 for the three and nine months ended September 30, 2003,respectively, and less than $100,000 for each of the three and nine monthsended September 30, 2002.

 

**Note 5 – Income Taxes**

 

The following is a summary of thetax provision (benefit) (in millions):

 
|                                     |   | **Three Months  Ended  September 30,** |   | **Nine Months  Ended  September 30,** |   |
|------------------------------------------|--------|---------------------------------------------|--------|--------------------------------------------|--------|
|                                     |   | **2003**                                    |   | **2002**                                   |   | **2003** |   | **2002** |   |
| Current  tax                             |   | $                                           | .1     |                                       | $      | .2 |   | $ | — |   | $ | .1 |   |
| Deferred  tax                            |   | .4                                          |   | .1                                         |   | .4 |   | — |   |
| Reduction in  contingent tax liabilities |   | (.1                                         | )      | (.1                                        | )      | (.1 | ) | (1.4 | ) |
| Provision  (benefit) for income taxes    |   | $                                           | .4     |                                       | $      | .2 |   | $ | .3 |   | $ | (1.3 | ) |

 

Deferred tax benefits resulting from reductions in thedeferred tax asset valuation allowance on net operating losses (“NOLs”) arerecorded when the Company concludes that it is more likely than not that itwill utilize additional NOLs to offset taxable income. Increases in thedeferred tax asset valuation allowance on NOLs are recorded when the

 

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Company cannot conclude that it is more likely than not that it willutilize additional NOLs to offset taxable income. Pursuant to Fresh-StartReporting, during the three months ended September 30, 2003 and 2002 andthe nine months ended September 30, 2003 and 2002, deferred tax benefitsresulting from reductions in valuation allowances on pre-Reorganization NOLs ofapproximately $400,000, $0, $1.3 million and $200,000, respectively, werereflected by increasing the Company’s capital in excess of par value.

 

During 1998, the Company executed a settlementagreement with the Internal Revenue Service (“IRS”) with respect to adjustmentsproposed to the tax returns of the Company and its consolidated subsidiaries,including formerly affiliated entities, for the years ended December 31,1989, 1990 and 1991. As a result of this agreement, in February 1999 theCompany paid $759,000 in full settlement of the IRS claims. Nearly all of thestate jurisdictions in which the Company filed amended returns for 1989, 1990and 1991 have accepted such returns, thereby reducing the Company’s exposure topotential claims to approximately $100,000 as of September 30, 2003. Inconjunction with periodic reviews of the adequacy of reserves for estimatedstate income taxes, the Company reduced its reserves by approximately $100,000and $1.4 million during the nine months ended September 30, 2003 and 2002,respectively. The Company has consistently evaluated its tax reserves based onan analysis of open statutes of limitations by state. Tax reserves are reducedby the estimated exposure for each individual state upon the expiration of thestate’s statute of limitations. Each reduction in estimated tax liabilities hasbeen reflected as an income tax (benefit).

 

The Internal Revenue Code (the “Code”) generallylimits the availability of NOLs if an ownership change occurs within anythree-year period under Section 382. If the Company were to experience anownership change of more than 50%, the use of all remaining NOLs wouldgenerally be subject to an annual limitation equal to the value of theCompany’s equity before the ownership change, multiplied by the long-term tax-exemptrate. The federal NOLs available as of September 30, 2003 wereapproximately $180 million. The amount of federal NOLs which expire if notutilized is approximately $6 million, $20 million, $8 million, $19 million and$128 million for 2005, 2006, 2007, 2008 and thereafter, respectively.

 

The Company amended its certificate of incorporationin October 1999, in response to an unsolicited written consent from amajority of its stockholders, in order to protect the ability of the Company toutilize its tax loss carryforwards. Since the Company’s use of its NOLs wouldbe severely restricted if it experiences an ownership change of more than 50%,the Company’s majority stockholders requested that the Board of Directors enactthe amendments, which were determined to be in the best interest of the Companyand its stockholders. The amendments prohibit future purchases of the Company’scommon stock by persons who would become new 5% holders, and also prohibitcurrent holders of over 5% from increasing their positions, except in certainpermissible circumstances which would not jeopardize the Company’s ability touse its NOLs. During September 2003, the Company’s Board of Directorsauthorized two new investors to purchase an aggregate of approximately 15% ofthe Company’s common stock since such transactions would not jeopardize theCompany’s ability to use its NOLs. The Company estimates that after givingeffect to these transactions and various other transactions by stockholders whohold a 5% or greater interest in the Company, it has experienced a three-yearcumulative ownership shift of approximately 24% as of September 30, 2003.

 

**Note 6 – Other Liabilities**

 

Other liabilities were comprised of the following (inmillions):

 
|                                                |   | **September 30,  2003** |   | **December 31,  2002** |   |
|-----------------------------------------------------|--------|------------------------------|--------|-----------------------------|--------|
| Net deferred  taxes and other tax liabilities       |   | $                            | 2.6    |                        | $      | 3.7 |   |
| Accrued pensions  and benefits                      |   | 4.9                          |   | 4.8                         |   |
| Home warranty  reserves                             |   | 1.1                          |   | 1.2                         |   |
| Contingent  indemnity and environmental obligations |   | 4.4                          |   | 4.4                         |   |
| Unamortized  discount                               |   | (1.0                         | )      | (1.2                        | )      |
|                                                |   | $                            | 12.0   |                        | $      | 12.9 |   |

 

Contingent indemnity andenvironmental obligations primarily reflect reserves before related discount(recorded pursuant to Fresh-Start Reporting) for contingent indemnityobligations for businesses disposed of by former affiliates and unrelated tothe Company’s current operations, and a liability of a subsidiary of theCompany for PCB contamination on its 42-acre Bolsa Chica lowlands property asfurther described below.

 

In May 2002, DresserIndustries, Inc. (“Dresser”) filed litigation, captioned Dresser Industries,Inc. vs. California Coastal Communities, Inc. and RESCO Holdings, Inc. (aformer affiliate), in the 58th Judicial District Court

 

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of Jefferson County, Texas. Dresser seeks a declaratoryjudgment regarding the rights and obligations of the parties under aJanuary 1988 purchase agreement, whereby Dresser acquired an engineeringand construction business from a former parent of the Company, and the formerparent agreed to indemnify Dresser against certain pre-closing claims. Dresseralso seeks unspecified damages for breach of the 1988 purchase agreement, alongwith attorneys’ fees and costs. Dresser’s indemnity claims relate to severalhundred lawsuits encompassing approximately 4,900 contested asbestos claimsmade by third parties in connection with work in facilities with which thedisposed-of business was allegedly connected. The Company was not formed untilSeptember 1988 and, upon being spun-off in December 1988, indemnifiedits former parent for its parent’s potential liabilities under theJanuary 1988 purchase agreement with Dresser to the extent that any suchliabilities are not covered by insurance. However, the Company believes itsformer parent’s agreement to indemnify Dresser for any third-party asbestosclaims expired in March 1991 under the terms of the January 1988purchase agreement. This litigation is in the early stages of discovery, thetrial is scheduled for March 2004, and the Company intends to vigorouslydefend itself in this case and related matters. The Company also believes thatit has a number of other meritorious defenses to this litigation. Given thepreliminary nature of these proceedings, the Company is not able to assess itspotential exposure with any degree of accuracy. While the Company currentlybelieves its reserves are adequate, damage awards in asbestos cases can involveamounts that would have a material adverse effect on the Company’s business,operations and financial condition, in the event that such an award was to berendered against the Company.

 

In September 1997,the Company acquired 42 acres in the Bolsa Chica lowlands with the intent ofselling it to the State of California in connection with their plannedrestoration of 1,000 acres of adjacent wetlands. While the State continues toexpress interest in acquiring this property, no such agreement has been reachedto date and there can be no assurances that any agreement will ever be reached.However, in anticipation of entering into a purchase agreement, the Stateperformed limited soils sampling on this property and notified the Company in1999 that it had discovered contamination from a group of chemicals calledPCBs. The source of the contamination is presently unknown; however, the Companyhas never conducted any development, business or operations on this property.In January 2002, the State’s Department of Toxic Substances Control(“DTSC”) became the regulatory agency responsible for overseeing the Company’sefforts to remediate the contamination on this property. On July 1, 2002 asubsidiary of the Company entered into a consent order with DTSC regardingremediation. The Company’s subsidiary prepared a Remedial Investigation (“RI”)Workplan, which was approved by DTSC in August 2003. The subsidiary isanalyzing sampling data recently gathered from the site according to the RIWorkplan to determine the nature and extent of contamination, and preparing anRI Report for DTSC. As of September 30, 2003, the Company has accruedapproximately $1.3 million for environmental testing and remediation of thisproperty. While the accrual reflects the estimate for the minimum costs whichare probable and estimable, such accrual may not be adequate to satisfy thefull amount of remediation that may be required by the DTSC. Until analysis ofthe additional soils sampling is completed and a remediation plan has beenapproved by DTSC, the Company cannot accurately estimate how much, if any,additional costs may ultimately be incurred; however, the Company has beenadvised that costs could range up to approximately $500,000 to $1.5 million inexcess of the current accrual. There is no maximum limitation to the subsidiaryof the Company’s obligation to remediate under the DTSC consent order. Otherparties, who have yet to be identified, may be responsible for all or a portionof these remediation costs. If any such party is subsequently identified, theCompany’s subsidiary may be entitled to seek reimbursement for some or all ofits costs; however, there can be no assurance in that regard.

 

The Company provides ahome warranty reserve to reflect its contingent liability for product warranty.The Company generally records a provision as homes are delivered, based uponhistorical and industry experience. The home warranty reserve activity for thenine month periods is presented below (in millions):

 
|                           |   | **September 30,  2003** |   | **September 30,  2002** |   |
|--------------------------------|--------|------------------------------|--------|------------------------------|--------|
|                           |   |                         |   |                         |   |
| Balance at beginning of period |   | $                            | 1.2    |                         | $      | 1.2 |   |
| Provision                      |   | .1                           |   | —                       |   |
| Payments                       |   | (.2                          | )      | (.1                          | )      |
| Balance at end of period       |   | $                            | 1.1    |                         | $      | 1.1 |   |

 

**Note 7 –Minority Interest**

 

In April 2003, theCompany entered into a Limited Liability Company (“ Chino LLC”) joint ventureagreement for the purpose of designing, constructing and selling 77 homes inChino, California. The Chino LLC acquired the 77 lots in May 2003 and iscurrently constructing the on-site infrastructure for the homes. HearthsideHomes, Inc. (one of the Company’s principal subsidiaries) is the managingmember of the Chino LLC, manages its

 

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operations and contributed capital of approximately$400,000 (approximately 10%) to the venture. Minority interest represents thenon-managing member’s equity interest in the venture including a capitalcontribution of approximately $4.0 million (approximately 90%), as adjusted forthe member’s allocation of profits and losses. Profits and losses are generallyallocated 50% to each member, after a 10% preferred return on invested capital.The losses of the non-managing member are limited to the amount of its capitalcontribution of approximately $4 million.

 

During October 2003, the Company entered into aLimited Liability Company (“Oxnard LLC”) joint venture agreement with a majorfinancial partner to pursue the Oxnard development opportunity. The Companyassigned the land purchase option contracts to the Oxnard LLC.  Hearthside Homes, Inc. (the Company’shomebuilding subsidiary) is the managing member of the Oxnard LLC, and hascontributed $500,000 to the venture. The non-managing member also contributed$500,000 to the venture.  Future capitalcontributions of up to an additional $4 million are to be made by thenon-managing member. Under the Oxnard LLC operating agreement, if contributionsin excess of $5 million are required and approved by the members, the next $1million would be contributed equally by the members. Total contributions of thenon-managing member are generally limited to $5 million. After payment of a 10%preferred return on invested capital, first tier profits are generallyallocated 75% to the non-managing member and 25% to the managing member andsecond tier profits and all losses are generally allocated 50% to each member.While the non-managing member does have various approval rights with regard tothe operation, the Company will exert a large degree of control over theventure, and therefore expects to consolidate the operations of the venture.

 

**Note 8 –Commitments and Contingencies**

 

The Company and its former affiliates have, through avariety of transactions effected since 1986, disposed of several assets andbusinesses, many of which are unrelated to the Company’s current operations. Byoperation of law or contractual indemnity provisions, the Company may haveretained liabilities relating to certain of these assets and businesses. Thereis generally no maximum obligation or amount of indemnity provided for suchliabilities. A portion of such liabilities are supported by insurance or byindemnities from certain of the Company’s previously affiliated companies. TheCompany believes its balance sheet reflects adequate reserves for thesematters; however there can be no assurance in that regard.

 

*LegalProceedings*

 

See Note 6 for a discussion of pending litigationfiled against the Company by Dresser.

 

There are various other lawsuits and claims pendingagainst the Company and certain subsidiaries. In the opinion of the Company’smanagement, ultimate liability, if any, will not have a material adverse effecton the Company’s financial condition or results of operations; however therecan be no assurance in that regard.

 

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

 

**General**

 

The Company is a residential landdevelopment and homebuilding company with properties located primarily insouthern California. The principal activities of the Company and itsconsolidated subsidiaries include: (i) obtaining zoning and otherentitlements for land it owns or controls through purchase options andimproving the land for residential development; and (ii) designing,constructing and selling single-family residential homes in southernCalifornia. Once the residential land owned or controlled by the Company isentitled, the Company may build homes, sell unimproved land to other developersor homebuilders, sell improved land to homebuilders, or participate in jointventures with other developers, investors or homebuilders to finance andconstruct infrastructure and homes. During the remainder of 2003 and 2004, theCompany will focus its immediate efforts to (i) obtain approval from theCalifornia Coastal Commission (“Coastal Commission”) for  development permits to build 379 homes onthe upper bench of the Bolsa Chica Mesa (“Upper Mesa”), as further described inNote 3 to the Company’s Consolidated Financial Statements; and (ii) expandits profitable homebuilding operations. However, the Company may also considerother strategic and joint venture opportunities; and there can be no assurancethat the Company will accomplish, in whole or in part, all or any of thesestrategic goals.

 

Over the last three years and the current year todate, the Company has generated gross margins from homebuilding activities andcash flows on assets other than Bolsa Chica. The Company currently has on-goingsouthern California projects in Riverside County near the cities of NorthCorona and Riverside, and in the city of Chino in San Bernardino County. Thesehomebuilding projects are expected to generate significant cash flows andimproved gross margins through the first half of 2005. However, the Company’sinventory of entitled land available for homebuilding projects is stilllimited. Given this limited inventory of buildable lots, the Company iscontinuing to pursue residential land development and lot acquisitionopportunities. Due to delays in approvals for homebuilding at Bolsa Chica,continuation of homebuilding operations beyond 2005 is dependent uponacquisition of suitable, entitled residential lots within the southernCalifornia area or Coastal Commission approval of the Company’s developmentplan for 379 homes on the Upper Mesa.

 

Bolsa Chica is the Company’s principal asset,representing 75% of total assets at September 30, 2003. It has requiredand continues to require significant investments for entitlement and landdevelopment activities. Due to the November 2000 Coastal Commissionrecommendation to limit residential development to only the Upper Mesa, theCompany is faced with further delays in implementing its plans for residentialdevelopment on the Bolsa Chica Mesa. The Company is currently pursuing approvalof development permits for the Upper Mesa. In May 2002, the County ofOrange Planning Commission approved the Company’s site plan for development of379 single-family homes on the Upper Mesa. In response to an appeal, inJuly 2002, the Orange County Board of Supervisors upheld the PlanningCommission’s prior approval of the site plan and tentative tract map. Thisdevelopment plan also requires approval by the Coastal Commission. The Companysubmitted a CDP application for this plan to the Coastal Commission inNovember 2002. In October 2003, the Company was notified by theCoastal Commission staff that the Company’s CDP application has been deemedcomplete.  As a result, the Companycurrently expects the Coastal Commission to hold a public hearing on the CDPduring the first half of 2004. The Company does not believe that the CoastalCommission process will ultimately prevent it from developing a plannedcommunity at Bolsa Chica; however, there can be no assurance in that regard, oras to (i) when development could commence, (ii) the number of acres or homesthe Company will be permitted to develop, or (iii) the absence of furtherlitigation or administrative delay.

 

The Bolsa ChicaLand Trust and other environmental groups have periodically suggested that theCompany consider selling the Bolsa Chica Mesa to a nonprofit corporation or theState of California. Historically, there has been no source of funding tofinance such a transaction. However, in November 2002, voters approved a$3.4 billion bond measure on California’s ballot known as Proposition 50 andentitled the “Water Quality, Supply and Safe Drinking Water Projects. CoastalWetlands Purchase and Protection. Bonds.” The bond initiative includes anunquantified line item for the State of California to pursue the acquisition ofall or a part of the Bolsa Chica Mesa. The State is conducting an appraisal ofthe Bolsa Chica Mesa, however, there can be no assurances that the Company willever receive an offer from the State for the Bolsa Chica Mesa, or any portionthereof; reach a mutually acceptable agreement on price and terms; or that asale transaction will ever be completed.

 

The Company believes that the BolsaChica Mesa can ultimately be developed and will realize an amount that issubstantially in excess of the $153.2 million book value presently reflected inthe Company’s consolidated financial statements, although there can be no assurancein that regard. The Company also believes that the current and historic publictrading prices of the Company’s common stock have not adequately reflected theBolsa Chica Mesa’s true value.

 

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However, there can be no assurance that such publictrading price will ever reflect what the Company may believe to be the truevalue of the Bolsa Chica Mesa. From time to time, the Company has receivedoutside appraisals on an “as developed basis” which have supported theCompany’s beliefs. Therefore, the Company has no present intention of sellingthe Bolsa Chica Mesa to the State at any price that is not substantially inexcess of present book value.

 

Land held for future development (Bolsa Chica) iscarried at fair value which was established as of September 2, 1997,following adoption of Fresh-Start Reporting as discussed in Note 3 to theConsolidated Financial Statements, as adjusted by subsequent activity. TheCompany’s real estate properties (real estate held for current development orsale and land held for future development) are subject to a number ofuncertainties which can affect the values of those assets. These uncertaintiesinclude litigation or appeals of regulatory approvals (as discussed above) and availabilityof adequate capital, financing and cash flow. In addition, future values may beadversely affected by increases in property taxes, increases in the costs oflabor and materials and other development risks, changes in general economicconditions, including higher mortgage interest rates, and other real estaterisks such as the general demand for housing and the supply of competitiveproducts. Real estate properties do not constitute liquid assets and, at anygiven time, it may be difficult to sell a particular property for anappropriate price.

 

**Impact of Inflation; Changing Pricesand Economic Conditions**

 

Real estate andresidential housing prices are affected by inflation, which can cause increasesin the price of land, raw materials and subcontracted labor. Unless theseincreased costs are recovered through higher sales prices, gross margin fromhome sales would decrease. If interest rates increase, construction andfinancing costs would also increase, which can also result in lower gross marginfrom home sales. The volatility of interest rates could have an adverse effecton the Company’s future operations and liquidity. Among other things, theseconditions may affect adversely the demand for housing and the availability ofmortgage financing and may reduce the credit facilities offered to the Company.

 

There can be no assurance regarding the continuedhealth of the southern California residential real estate market. Inparticular, (i) the slow-down in the national economy during the past severalyears and the “jobless recovery” to date, (ii) the significant decreases in thevalue of national stock market indices and the resulting volatility of thosemarkets; (iii) the events of September 11, 2001 and their continuingeffects on the economy; and (iv) the State of California’s budget deficit andthe recent gubernatorial recall election, collectively appear to be exertingrecessionary pressures on the California economy and may have a negative impacton the southern California housing market.

 

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

 

Most of the Company’s active homebuilding projects arelocated in the “Inland Empire” area of southern California, which includesRiverside and San Bernardino counties. None of the Company’s projectsexperienced any direct impact from the recent Southern California fires. TheInland Empire has experienced significant population and job growth in the pastdecade. While continued growth is expected, partially due to the limited supplyof affordably priced housing in coastal areas such as Orange County, there canbe no assurance that economic, demographic or other factors will not slow,diminish or cause such growth to discontinue. The Company is continuing topursue land development and lot acquisition opportunities throughout southernCalifornia.

 

**Critical Accounting Policies**

 

In the preparation of the Consolidated FinancialStatements, the Company applies accounting principles generally accepted in theUnited States. The application of generally accepted accounting principles mayrequire management to make estimates and assumptions that affect the amountsreported in the financial statements and accompanying results. Listed below arethose policies that the Company believes are critical and require the use ofcomplex judgment in their application. The Company’s critical accountingpolicies include the evaluation of the impairment of long-lived assets and theevaluation of the probability of being able to realize the future benefitsindicated by its significant federal tax net operating losses.

 

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*Stock-Based Compensation*

 

Prior to the second quarter of 2003, the Companyaccounted for its stock-based employee compensation plan using the recognitionand measurement principles (intrinsic value method) of Accounting PrinciplesBoard (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” andthe related Financial Accounting Standards Board (“FASB”) Interpretation No. 44“Accounting for Certain Transactions Involving Stock Compensation” (“FIN 44”).As a result of the May 2001 repricing of outstanding stock options, theCompany accounted for the options as variable awards and recorded non-cash stock-basedcompensation expense on a cumulative basis as the difference between the optionexercise price and the quoted market price of the Company’s common stock. FromMay 2001 through the first quarter of 2003, non-cash compensation expensewas reflected for stock price changes pursuant to variable accounting forrepriced options.

 

During the second quarter of 2003, the Company adoptedthe fair value recognition provisions of FASB Statement of Financial StandardsNo. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”). For thischange in accounting, the Company selected the “modified prospective method”under the provisions of SFAS No. 148 “Accounting for Stock-Based Compensation –Transition and Disclosure – an Amendment of FASB Statement No. 123” (“SFAS148”). Under this method, the change is retroactive to January 1, 2003,and compensation cost recognized for the three and nine months endedSeptember 30, 2003 is the same as that which would have been recognizedhad the recognition provisions of SFAS 123 been applied from its originaleffective date. In accordance with SFAS 148, results for prior years have notbeen restated. SFAS 123 states that the adoption of the fair value based methodis a change to a preferable method of accounting. Management believes that useof the fair value based method to record employee stock-based compensationexpense is consistent with the accounting for all other forms of compensation.The adoption of SFAS 123 may have a significant impact on the Company’s futureconsolidated results of operations, due to the elimination of the potentialfuture effects of variable accounting for repriced stock options.

 

*Impairment of Long-Lived Assets*

 

The Company assesses the impairment of long-livedassets including land held for future development (the Bolsa Chica project) andreal estate held for current development or sale in accordance with Statementof Financial Accounting Standards (“SFAS”) No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets”. These assets are carried at cost,unless the carrying amount of the parcel or subdivision is determined not to befully recoverable, in which case the impaired real estate is written down tofair value. Impairment write-downs are recorded as adjustments to the costbasis of the real estate. Given the significance of the carrying value of landheld for future development, the application of SFAS No. 144 in evaluating anypotential impairment is critical to the Company’s consolidated financialstatements, as discussed further in Note 2 to the Consolidated FinancialStatements. Accordingly, the amount ultimately realized from the Bolsa Chicaproject may differ materially from current estimates and the project’s carryingvalue.

 

*Basis of Consolidation*

 

Certain wholly-owned subsidiaries of the Company aremembers in joint ventures involved in the development and sale of residentialprojects and residential loan production. The consolidated statements of theCompany include the accounts of the Company and all majority-owned and controlledsubsidiaries and joint ventures. The financial statements of joint ventures inwhich the Company has a 50% or more voting or economic interest (and thus arecontrolled by the Company) are consolidated with the Company’s financialstatements. Minority interest represents the equity interest of the Company’sjoint venture partner and is further described in Note 7 to the consolidatedfinancial statements. The Company’s investments in unconsolidated jointventures are accounted for using the equity method, as the Company does nothave voting or economic control of the venture operations.

 

*Income Taxes*

 

The Company accounts for income taxes on the liabilitymethod. Deferred income taxes are determined based on the difference betweenthe consolidated financial statement and tax bases of assets and liabilities.The liability method requires an evaluation of the probability of being able torealize the future benefits indicated by deferred tax assets, such as tax netoperating losses (“NOLs”). A valuation allowance related to the deferred taxasset is recorded when uncertainties preclude the Company from determining thatit is more likely than not that some portion or all of the deferred tax assetwill be realized. Given the significance of the Company’s historical federaltax NOLs, as discussed in Note 5 to the Consolidated Financial Statements, theapplication of the Company’s policy in evaluating the expected future benefitof NOLs is critical. In applying those policies, estimates and judgments affectthe amounts at which certain assets and liabilities are recorded. The Companyapplies its accounting policies on a consistent basis. As circumstances change,they are considered in the Company’s estimates and judgments, and futurechanges in circumstances could result in changes in amounts at which assets andliabilities are recorded.

 

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*Homebuilding Revenues and Cost ofSales*

 

The Company’s homebuilding operation generatesrevenues from the sale of homes to homebuyers. The majority of these homes aredesigned to appeal to move-up homebuyers and the homes are generally offeredfor sale in advance of their construction. Sales contracts are usually subjectto certain contingencies such as the buyer’s ability to qualify for financing.Revenue from the sale of homes is recognized at closing when title passes tothe buyer, and the earnings process is complete. As a result, the Company’srevenue recognition process does not involve significant judgments orestimates. However, the Company does rely on certain estimates to determine therelated construction costs and resulting gross margins associated with revenuesrecognized. The Company’s construction costs are comprised of direct andallocated costs, including estimated costs for future warranties andindemnities. The Company’s estimates are based on historical results, adjustedfor current factors.

 

*Warranty Costs*

 

Warranty reserves are established as homes closeescrow on a per-unit basis in an amount estimated to be adequate to coverexpected warranty-related costs for materials and outside labor to be incurredduring the warranty period. Reserves are determined based upon historical datawith respect to similar product types and geographical areas. There can be no assurancethat the amount reserved will be sufficient to fully satisfy allwarranty-related costs ultimately incurred during the warranty period.

 

*Litigation Reserves*

 

The Company and certain of its subsidiaries have beennamed as defendants in various cases arising in the normal course of businessand regarding disposed assets and businesses of the Company or formeraffiliates (see Notes 6 and 8). The Company has reserved for costs expected tobe incurred with respect to these cases based upon information provided by itslegal counsel. There can be no assurance that total litigation costs actuallyincurred will not exceed the amount of such reserve.

 

**RecentAccounting Pronouncements**

 

See discussionregarding recent accounting pronouncements in Note 2 to the ConsolidatedFinancial Statements.

 

**Liquidityand Capital Resources**

 

The principal assets in the Company’s portfolio areresidential land which must be held over an extended period of time in order tobe developed to a condition that, in management’s opinion, will ultimatelymaximize the return to the Company. Consequently, the Company requiressignificant capital to finance its real estate development and homebuildingoperations. Historically, sources of capital have included specific propertyfinancings, asset sales and available internal funds. The Company is currentlyutilizing project debt, joint venture contributions and internally generatedcash to fund construction of the second phase of the North Corona project, andthe Chino and Oxnard projects, and is utilizing internally generated cash tofund the first phase of the North Corona project, the Riverside projects andthe Bolsa Chica project. As of September 30, 2003, of the $45.0 millioninvested in real estate held for current development or sale (homebuildingprojects), the Company had internally financed approximately $17.7 million ofits investments. These projects are expected to generate approximately $27.0million of positive cash flows during the next 21 months, based on presenteconomic conditions and market assumptions. The Company expects to continue tomake investments in homebuilding projects to the extent funds are available anddesirable lots are identified. For the nine months ended September 30,2003, $21.4 million of cash was used in operating activities, and was primarilyfunded by $17.5 million of borrowings under project debt agreements andminority interest investments. The Company’s cash and cash equivalents as ofSeptember 30, 2003 were approximately $5.3 million. The Company believesthat its cash and cash equivalents, future real estate sales proceeds, andfunds available under its existing and planned project debt agreements andjoint venture agreements will be sufficient to meet anticipated operating andcapital investment requirements, primarily project development costs forhomebuilding projects and entitlement efforts for the Bolsa Chica and Oxnardprojects, along with general and administrative expenses and certainliabilities, for the next 12 months.

 

The Company is subject to the usual obligationsassociated with entering into contracts for the purchase of land and improvedhomesites. These purchase contracts typically require a cash deposit and thepurchase of properties under these contracts is generally contingent upon satisfactionof certain requirements, including obtaining applicable property entitlements.The Company also utilizes option contracts with third-party land sellers andfinancial entities as a method of acquiring land in staged takedowns andminimizing the use of funds from other corporate financing sources. Theseoption contracts also help to manage the financial and market risk associatedwith land holdings. Option contracts generally require the payment of anon-refundable cash deposit for the right to acquire lots over a specifiedperiod of time at predetermined

 

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prices. The Company has the right at its discretion to terminate theobligations under these option agreements by forfeiting the cash deposit withno further financial responsibility. The Company may enter into landdevelopment and homebuilding joint ventures from time to time as a means ofexpanding its market opportunities, establishing strategic alliances, managingits risk profile and leveraging the Company’s capital base. These jointventures may obtain secured acquisition, development and constructionfinancing, which minimizes the use of funds from other corporate financingsources.

 

**LandDevelopment**

 

*Oxnard.*  In February 2003, the Company enteredinto two option contracts to acquire land adjacent to the City of Oxnard inVentura County, California aggregating approximately 168 acres. The Company isin the process of developing a land plan for the site, which includes anadditional 149 acres owned by other landowners, with the intention of entitlingthe property for residential development and annexing it to the City of Oxnard.The Company currently expects that the residential development plan willinclude approximately 1,100 single-family and approximately 400 multi-familyresidential sites; however, these numbers are subject to change during thecourse of the entitlement process. The option contracts allow for two years,plus up to three additional years through the exercise of extensions, for theCompany to complete these entitlement activities in advance of consummating thepurchase transactions. The option-holder has the right in its sole discretionto terminate the obligations under these option agreements by forfeiting thecash deposits with no further financial responsibility.

 

During October 2003, the Company entered into aLimited Liability Company (“Oxnard LLC”) joint venture agreement with a majorfinancial partner to pursue the Oxnard development opportunity.  The Company assigned the land purchaseoption contracts to the Oxnard LLC. Hearthside Homes, Inc. (the Company’s homebuilding subsidiary) is themanaging member of the Oxnard LLC, and has contributed $500,000 to the venture.  The non-managing member also contributed$500,000 to the venture.  Future capitalcontributions of up to an additional $4 million are to be made by thenon-managing member.  Under the OxnardLLC operating agreement, if contributions in excess of $5 million are requiredand approved by the members, the next $1 million would be contributed equallyby the members.  Total contributions ofthe non-managing member are generally limited to $5 million.  After payment of a 10% preferred return oninvested capital, first tier profits are generally allocated 75% to thenon-managing member and 25% to the managing member and second tier profits andall losses are generally allocated 50% to each member. While the non-managingmember does have various approval rights with regard to the operation, theCompany will exert a large degree of control over the venture, and thereforeexpects to consolidate the operations of the venture.

 

**Homebuilding**

 

*North Corona*.  In July 2001, the Company acquired 83 finished lots inRiverside County, California near North Corona in the master-planned communityknown as Providence Ranch. The community of Providence Ranch and the adjacentcommunity of Corona Valley, are planned for a total of 2,600 homes, and arewell-located to serve the employment centers of the greater Los Angeles area,Orange County and the Ontario international airport. The Company commenced homeconstruction in October 2001, opened for sales in February 2002 andreleased 73 homes for sale during 2002 at an average price of approximately$298,000. During 2002 and the first half of 2003, 58 homes and 15 homes weredelivered, respectively. As of November 11, 2003, the final phase of sevenhomes, (excluding the three models) has been released for sale and all sevenare in escrow.

 

In October 2002, theCompany acquired an additional 93 finished lots in the Providence Ranchcommunity. Construction of homes in this second phase began during the firstquarter of 2003. The Company is selling these homes from the original modelcomplex.  As of November 11, 2003,78 homes had been released for sale at an average price of $370,000, 28 homeshave been delivered during the fourth quarter, and 50 homes were inescrow.  Additionally, the Companypresently expects to deliver 32 or more of these homes to homebuyers during thebalance of the fourth quarter, for a fourth quarter total of 60 or more homedeliveries at this project; however, there can be no assurance in this regard.

 

*Riverside*.  During 2002 and the first quarter of 2003, the Company acquired atotal of 84 finished lots near the city of Riverside, in Riverside County, inthe master-planned community known as Victoria Grove. 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 on the “Harvest” product which is comprised of 60 homes,averaging 2,934 square feet. All 60 homes in the Harvest product type have beenreleased for sale at an average home price of approximately $345,000. As ofNovember 11, 2003, 52 homes had been delivered, including 24 during thethird quarter of 2003 and four in the

 

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fourth quarter. All of the eight remaining homes arein escrow and are presently expected to close during the balance of the fourthquarter of 2003; however, there can be no assurance in this regard.

 

 The Company began construction of homes,averaging 3,648 square feet, on the larger “Jasper Ranch” product during thethird quarter of 2003, which is comprised of 65 homes, including 41 lots whichare in escrow and the Company expects to acquire in early 2004. The Companyopened for sales on these homes during June 2003. As of November 11,2003, 11 homes had been released for sale at an average price of approximately$450,000 and all 11 homes were in escrow. Completion of homes and close ofescrows is presently scheduled to begin late in the fourth quarter of 2003;however, there can be no assurance in this regard.

 

*Chino. *In May 2003, theCompany, through a joint venture, acquired 77 finished lots in Chino,California in San Bernardino County. This infill site is part of a newcommunity encompassing 244 homes. Construction of homes averaging approximately3,230 square feet began during the fourth quarter of 2003.

* *

*RanchoSanta Fe.*  InOctober 2003, the Company entered into an agreement to acquire 32 lots ina luxury golf community in the Rancho Santa Fe area of California in San DiegoCounty.  The Company presently expectsto begin construction of models late in the fourth quarter of 2003.

 

**Financial Condition**

 

*September 30, 2003 Comparedwith December 31, 2002*

 

Cash flows from homebuildingoperations for the first nine months of 2003 primarily reflect uses of cash forinvestments in real estate and construction costs of $37.7 million, includingthe acquisition of 77 lots in Chino, California. These investments were fundedby sales proceeds of $21.5 million from deliveries of 66 homes, net borrowingunder project debt financing of $13.6 million, and joint venture capitalcontributed (minority interest) for the Chino project of $3.9 million. Othersignificant uses of cash include approximately $1.3 million for investment inthe Bolsa Chica Mesa project, primarily for consultants engaged in theentitlement process, and selling, general and administrative expenses ofapproximately $2.5 million. These items, as well as other activity presented inthe Statements of Cash Flows, resulted in the $3.9 million decrease in cash andcash equivalents.

 

Accounts payable and accruedliabilities decreased by approximately $500,000, to a balance of $4.5 millionas of September 30, 2003, primarily reflecting payments of state incometaxes related to 2002.

 

The increase in capital in excessof par value of approximately $1.3 million and the decrease in otherliabilities primarily reflect reversal of valuation reserve onpre-Reorganization NOLs, pursuant to the Company’s evaluation that it is morelikely than not that the Company will utilize the NOLs to offset taxesotherwise payable.

 

**Results ofOperations**

 

The nature of the Company’s business, including itslimited inventory of buildable lots, is such that the number of active sellingcommunities over a given time period may often cause significant fluctuationsin operating results from quarter to quarter and from year to year.

 

*Three  Months Ended September 30, 2003Compared with the Three Months Ended September 30, 2002*

 

The Company reported revenues of $8.4 million andgross operating profit of approximately $1.6 million for the third quarter of2003, compared with $5.2 million in revenues and gross operating profit ofapproximately $600,000 for the third quarter of 2002. Revenues in the currentperiod reflect deliveries of 24 homes at the Company’s Riverside project. Thecomparable period of the prior year reflects deliveries of 11 homes at theYucaipa project and eight homes at the North Corona project. The currentquarter’s gross margin of 19% is higher than the prior period gross margin of12% due to home price appreciation experienced over the past year and thehigher profitability of the Riverside project as compared with the Yucaipaproject.

 

Selling general and administrative expense for thethree months ended September 30, 2002 reflects the reversal ofapproximately $300,000 of expense recorded during the first half of 2002, asthe market price of the Company’s common stock as of September 30, 2002was lower than the exercise price of the options. During the second quarter of2003, the Company

 

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adopted Statement of Financial Accounting Standards No. 123 “Accountingfor Stock-Based Compensation” under the modified prospective method prescribedby SFAS No. 148 “Accounting for Stock-Based Compensation – Transition andDisclosure -an amendment of FASB Statement No. 123”, resulting in no suchexpense or credit during the three months ended September 30, 2003. Theremaining $300,000 increase in selling, general and administrative expensesduring the third quarter of 2003 as compared with the third quarter of 2002primarily reflects an increase in accrued incentive compensation for theCompany’s homebuilding business and increased selling costs associated withgreater sales volume.

 

The other income of approximately $100,000, net in thecurrent quarter as compared with $300,000 of expense in the third quarter of2002, primarily reflects recovery of the value of water rights certificates,which had been reserved,  related to acompleted project, which offset recurring real estate holding costs for landheld for future development during the current quarter.

 

During the three months ended September 30, 2002,the Company’s tax provision of $300,000 was partially offset by a benefit of$100,000 recorded in connection with the reduction in reserves for contingenttax liabilities, following the expiration of statutes of limitations in onestate.

 

*Nine MonthsEnded September 30, 2003 Compared with the Nine  Months Ended September 30, 2002*

 

The Company reported revenues of $21.5 million andgross operating profit of approximately $3.8 million for the first nine monthsof 2003, compared with $13.2 million in revenues and gross operating profit ofapproximately $1.5 million for the first nine months of 2002. Revenues in thefirst nine months of 2003 reflect deliveries of 66 homes, including 48 homes atthe Company’s Riverside project, 15 homes at the North Corona project and thefinal three homes at the Yucaipa project. The comparable period of the prioryear reflects deliveries of an aggregate of 50 homes at the Yucaipa and NorthCorona projects. The 18% gross margin for the first nine months of 2003 ishigher than the prior period gross margin of 11% due to home price appreciationexperienced over the past year and higher profitability of the Riversideproject as compared with the Yucaipa project.

 

The $400,000 increase in selling, general andadministrative expenses during the first nine months of 2003, as compared withthe first nine months of 2002, primarily reflects an increase in accruedincentive compensation for the Company’s homebuilding business.

 

The $400,000 decrease in income from unconsolidatedjoint ventures from approximately $800,000 for the nine months endedSeptember 30, 2002 to approximately $400,000 for the nine months endedSeptember 30, 2003 primarily reflects reduced income from the FairbanksHighlands project, due to the completion of home deliveries during the firstquarter of 2002.

 

The $600,000 of other expense, net in the current yearto date period as compared with $300,000 of income in the same period of 2002,primarily reflects an additional accrual of approximately $700,000 in the 2003period for estimated environmental remediation costs, partially offset byrecovery of the value of water rights certificates, which had been reserved,related to a completed project. The increase in expense also reflects theabsence in the current year’s period of $1.2 million in gains on sales ofshort-term investments, which were realized during the second quarter of 2002.These gains were partially offset by increased non-recurring period costsrelated to land held for future development in the 2002 period.

 

During the nine months ended September 30, 2003,the Company’s tax provision was partially offset by a tax benefit ofapproximately $100,000 in connection with the reduction in reserves forcontingent tax liabilities. During the nine months ended September 30,2002, the Company recorded a tax benefit of $1.3 million, including $1.4million in connection with the reduction in reserves for contingent taxliabilities, reversal of $200,000 of alternative minimum taxes payable due to achange in the federal income tax law enacted in that quarter, and a $200,000tax benefit from a reduction in the deferred tax asset valuation allowance onpost-Reorganization state NOLs. The reduction in tax reserves in 2002 was dueto expiration of statutes of limitations or settlements in eight states, whichreduced the Company’s exposure.

 

**Payments Under ContractualObligations**

 

The Company has entered into certain contractualobligations to make future payments for items such as project debt and leaseagreements.  A summary of the paymentsdue under specified contractual obligations, aggregated by category ofcontractual obligation, for specified time periods is presented below as ofSeptember 30, 2003 (in millions):

 

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|             |   | **Payments  due by period** |
|------------------|--------|-----------------------------|
|             |   | **Total**                   |   | **Less  than 1  year** | ** ** | **1-3  years** | ** ** | **3-5  years** | ** ** | **More  than 5  years** | ** ** |
|             |   |                        |   |   |   |   |   |   |   |   |   |
| Project debt     |   | $                           | 23.4 |   | $ | 23.4 |   | — |   | — |   | —- |   |
| Operating leases |   | .2                          |   | .2 |   | — |   | — |   | — |   |
| Total            |   | $                           | 23.6 |   | $ | 23.6 |   | — |   | — |   | — |   |

 

The Company’s purchase contracts which are made in thenormal course of its homebuilding business for land acquisition andconstruction subcontracts are generally cancelable at will. Other contractualobligations including the Company’s other tax liabilities, accrued benefitliability for a frozen retirement plan and other accrued pensions, homewarranty reserves and contingent indemnity and environmental obligations areestimated based on various factors. Payments are not due as of a given date,but rather are dependent upon the incurrence of professional services, thelives of annuitants and other factors. The estimation process involved in thedetermination of carrying values of these obligations is inherently uncertainsince it requires estimates as to future events and contingencies. The Companyhas provided additional disclosure in its Consolidated Financial Statements inNotes 6 and 8.

 

**Safe Harbor, Statement Under thePrivate Securities Litigation Act of 1995**

 

Certain of the foregoing information and the information following thisItem 2 contains forward-looking statements that relate to future events or theCompany’s future financial performance. These statements involve known and unknown risks, uncertainties andother factors which may cause the Company’s actual results, performance orachievements to be materially different from any future results, performancesor achievements expressed or implied by the forward-looking statements.  In some cases, you can identifyforward-looking statements by terminology such as “may”, “will”, “should”,“expects”, “plans”, “anticipates”, “believes”, “estimates”, “predicts”,“potential”, “continue”, or the negative of such terms or other comparableterminology.  These forward-lookingstatements include, but are not limited to, (1) statements about the Company’splans, objectives, goals, expectations and intentions; (2) the number and typesof homes and number of acres of land that the Company may develop and sell; (3)the timing and outcomes of litigation, regulatory approval processes oradministrative proceedings (including, but not limited to ongoing administrativeproceedings related to the Company’s principal asset, the Bolsa Chica Mesa);(4) the Company’s ability to continue relationships with current or futurepartners; (5) the Company’s ability to expend resources to comply withenvironmental regulations and local permitting requirements; (6) the effect ofcertain costs, contractual obligations and tax liabilities, both known andunknown, on the Company’s business, results of operations and financialcondition; (7) the condition and adequacy of the Company’s properties; (8) theCompany’s ability to estimate cash flow projections due to uncertainties invaluing real property; (9) the Company’s ability to acquire residential lots inorder to continue homebuilding operations; (10) the adequacy of capital,financing and cash flow required to continue the Company’s operations and landdevelopment activities; (11) the adequacy of cash reserves for litigation,warranties and other contingent obligations; (12) the future condition of thereal estate market in southern California; (13) the possible negotiation of asale transaction with the State of California and the ability to realize asales price for the Bolsa Chica Mesa that is substantially in excess of bookvalue; (14) general economic and business conditions; (15) interest ratechanges; (16) the relative stability of debt and equity markets; (17)competition; (18) the availability and cost of raw materials used by theCompany in its homebuilding operations; (19) shortages and the cost of labor;(20) weather and fire related slowdowns; (21) slow growth and no growthinitiatives or moratoria; (22) governmental regulation, including theinterpretation of tax, labor and environmental laws; (23) changes in consumerconfidence and preferences; (24) accounting changes; (25) terrorist acts andother acts of war; (26) other factors over which the Company has little or nocontrol; and (27) other statements contained herein that are not historicalfacts.

 

As a result of these and other factors, the Company may experiencematerial fluctuations in future operating results on a quarterly or annualbasis, which could materially and adversely affect the Company’s business,financial condition, operating results and stock price. An investment in theCompany’s stock involves various risks, including those mentioned above andelsewhere in this report and those which are detailed from time to time in theCompany’s other filings with the Securities and Exchange Commission. Unduereliance should not be placed on forward-looking statements, which reflect theCompany’s view only as of the date hereof. The Company undertakes no obligationto publicly release revisions to these forward-looking statements that reflectfuture events or circumstances or reflect the occurrence of unanticipatedevents.

 

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ITEM 3  -  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

The Company utilizes project debtfinancing for acquisition, development and construction of homes. The interestrates on the Company’s project debt approximate the current rates available forsecured real estate financing with similar terms and maturities, and as aresult, their carrying amounts approximate fair value. While changes ininterest rates generally do not impact the fair market value of the debtinstrument, they do affect the Company’s earnings and cash flows. Holding theCompany’s variable rate debt balance constant as of September 30, 2003,each one point percentage increase in interest rates would result in anincrease in variable rate interest incurred for the next 12 months ofapproximately $200,000.

 

ITEM 4 -   EVALUATION OF DISCLOSURECONTROLS AND PROCEDURES

 

An evaluation was performedunder the supervision and with the participation of the Company’s management,including the Chief Executive Officer and Chief Financial Officer, of theeffectiveness of the design and operation of the Company’s disclosure controlsand procedures (as defined in Exchange Act Rules 13a-14(c) and 15d-14(c)) as ofthe end of the quarter covered by this report. In designing and evaluating thedisclosure controls and procedures, management recognized that any controls andprocedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving the desired control objectives, andmanagement necessarily was required to apply its judgment in evaluating thecost-benefit relationship of possible controls and procedures. Based on theforegoing, the Company’s Chief Executive Officer and Chief Financial Officerconcluded that the Company’s disclosure controls and procedures were effectiveat the reasonable assurance level. There has been no change in the Company’sinternal controls over financial reporting during the Company’s most recentfiscal quarter that has materially affected, or is reasonably likely tomaterially affect, the Company’s internal controls over financial reporting.

 

PARTII - OTHER INFORMATION

 

ITEM 1 -                                                 Legal Proceedings

 

See Note 6 to the ConsolidatedFinancial Statements above, and “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, 2002.

 

ITEM 6 -                                                Exhibits and Reports on Form 8-K

 

(a)                                  Exhibits:

 

31.1         Section 302 Certificate of Raymond J.Pacini, Chief Executive Officer of California Coastal Communities, Inc.

 

31.2         Section 302 Certificate of Sandra G.Sciutto, Chief Financial Officer of California Coastal Communities, Inc.

 

32.1         Section 906 Certificate of Raymond J.Pacini, Chief Executive Officer of California Coastal Communities, Inc.*

 

32.2         Section 906 Certificate of Sandra G.Sciutto, Chief Financial Officer of California Coastal Communities, Inc.*

 

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*                       These certifications are being furnished solelyto accompany this report pursuant to 18 U.S.C. Section 1350, and are notbeing filed for purposes of Section 18 of the Securities Exchange Act of1934, as amended, and are not to be incorporated by reference into any filingof the Company, whether made before or after the date hereof, regardless of anygeneral incorporation language in such filing.

 

(b)                                Reports on Form 8-K:

 

Current report on Form 8-K dated August 7, 2003, attaching a pressrelease reporting second quarter results.

 

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**SIGNATURE**

 

Pursuant to the requirements of Section 13 or15(d) of the Securities Exchange Act of 1934, the registrant has caused thisreport to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 

 
| Date:   November 13, 2003 | CALIFORNIA COASTAL COMMUNITIES, INC. |
|-------------------------------------|--------------------------------------|
|                                |                                 |
|                                |                                 |
|                                | By:                                  | /s/ Sandra G. Sciutto |   |
|                                |                                 | SANDRA G. SCIUTTO |
|                                |                                 | Senior Vice President and  Chief Financial Officer |

 

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