**This Form 10-Q consists of 22sequentially numbered pages.**

 

**FORM 10-Q**

 

**SECURITIES AND EXCHANGE COMMISSION**

 

**WASHINGTON, D.C. 20549**

 

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

 

**For the quarterly period ended March31, 2003**

 

**Commission file number 0-17189**

 

**CALIFORNIA COASTAL COMMUNITIES,INC.**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                                                      |   | **02-0426634**                        |
|-------------------------------------------------------------------|--------|---------------------------------------|
| (State or other jurisdiction  of  incorporation or organization.) |   | (I.R.S. Employer  Identification No.) |

 

| **6 Executive  Circle, Suite 250  Irvine, California** |   | **92614**  |
|--------------------------------------------------------|--------|------------|
| (Address of principal  executive offices)              |   | (Zip Code) |

 

Registrant’s telephone number, including areacode: **(949) 250-7700**

 

Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed by Section 13 or15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months(or for such shorter period that the registrant was required to file suchreports), and (2) has been subject to such filing requirements for the past 90days:

 

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

 

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 12b-2 of the Act).

 

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

 

The number of shares of CommonStock outstanding at April 30, 2003 was 10,057,212.

 

 

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CALIFORNIA COASTAL COMMUNITIES, INC.

 

FORM 10-Q

 

FOR THE QUARTER ENDED MARCH 31, 2003

 

I N D E X

 
| Part I -  | Financial Information:                     |                                                                                         |
|----------------|--------------------------------------------|----------------------------------------------------------------------------------------------|
|           |                                       |                                                                                         |   |
|           | Item 1 -                                   | Consolidated Financial  Statements                                                           |   |
|           |                                       |                                                                                         |   |
|           |                                       | Consolidated Balance Sheets  -                                                               |   |
|           |                                       | December 31, 2002 and March  31, 2003 (unaudited)                                            |   |
|           |                                       |                                                                                         |   |
|           |                                       | Consolidated Statements  of Operations -                                                     |   |
|           |                                       | Three Months  Ended March 31, 2002 and 2003 (unaudited)                                      |   |
|           |                                       |                                                                                         |   |
|           |                                       | Consolidated Statements  of Cash Flows -                                                     |   |
|           |                                       | Three Months  Ended March 31, 2002 and 2003 (unaudited)                                      |   |
|           |                                       |                                                                                         |   |
|           |                                       | Notes to  Consolidated Financial Statements                                                  |   |
|           |                                       |                                                                                         |   |
|           | Item 2 -                                   | Management’s  Discussion and Analysis of Financial  Condition and Results of Operations |
|           |                                       |                                                                                         |   |
|           | Item 3 -                                   | Quantitative and  Qualitative Disclosures About  Market Risk                                 |   |
|           |                                       |                                                                                         |   |
|           | Item 4 -                                   | Evaluation of  Disclosure Controls and Procedures                                            |   |
|           |                                       |                                                                                         |   |
| Part II - | Other Information:                         |                                                                                         |
|           |                                       |                                                                                         |   |
|           | Item 1 - Legal Proceedings                 |                                                                                         |
|           |                                       |                                                                                         |   |
|           | Item 6 - Exhibits  and Reports on Form 8-K |                                                                                         |
|           |                                       |                                                                                         |   |
| SIGNATURE      |                                       |                                                                                         |
|           |                                       |                                                                                         |   |
| CERTIFICATIONS |                                       |                                                                                         |

 

2

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PART I.  FINANCIAL INFORMATION

 

ITEM 1 – FINANCIAL STATEMENTS

 

CALIFORNIA COASTAL COMMUNITIES, INC.

 

CONSOLIDATEDBALANCE SHEETS

(unaudited)

(in millions)

 
|                                                                                                      |   | **December 31, 2002** |   | **March 31, 2003** |   |
|-----------------------------------------------------------------------------------------------------------|--------|-----------------------|--------|--------------------|--------|
|                                                                                                      |   |                  |   |               |   |
| ASSETS                                                                                                    |   |                  |   |               |   |
|                                                                                                      |   |                  |   |               |   |
| Cash and cash equivalents                                                                                 |   | $                     | 9.2    |               | $      | 5.9 |   |
| Real estate held for current  development or sale                                                         |   | 25.0                  |   | 26.2               |   |
| Land held for future  development                                                                         |   | 151.9                 |   | 152.4              |   |
| Other assets                                                                                              |   | 1.5                   |   | 1.8                |   |
|                                                                                                      |   |                  |   |               |   |
|                                                                                                      |   | $                     | 187.6  |               | $      | 186.3 |   |
|                                                                                                      |   |                  |   |               |   |
| LIABILITIES AND STOCKHOLDERS’  EQUITY                                                                |   |                  |   |               |   |
|                                                                                                      |   |                  |   |               |   |
| Liabilities:                                                                                              |   |                  |   |               |   |
| Accounts payable and accrued  liabilities                                                                 |   | $                     | 5.0    |               | $      | 3.0 |   |
| Project debt                                                                                              |   | 9.8                   |   | 11.0               |   |
| Other liabilities                                                                                         |   | 12.9                  |   | 12.8               |   |
|                                                                                                      |   |                  |   |               |   |
| Total liabilities                                                                                         |   | 27.7                  |   | 26.8               |   |
|                                                                                                      |   |                  |   |               |   |
| 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                                                                           |   | 141.3                 |   | 141.7              |   |
| Retained  earnings                                                                                        |   | 20.5                  |   | 19.7               |   |
| Accumulated  other comprehensive loss                                                                     |   | (2.4                  | )      | (2.4               | )      |
| Total  stockholders’ equity                                                                          |   | 159.9                 |   | 159.5              |   |
|                                                                                                      |   |                  |   |               |   |
|                                                                                                      |   | $                     | 187.6  |               | $      | 186.3 |   |

 

See the accompanying notes to consolidatedfinancial statements.

 

3

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CALIFORNIA COASTAL COMMUNITIES, INC.

 

CONSOLIDATED STATEMENTS OF OPERATIONS

 

(in millions, except per share amounts)

 

(unaudited)

 
|                                                                      |   | **Three Months Ended  March 31,** |   |
|---------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                      |   | **2002**                          |   | **2003** |   |
|                                                                      |   |                              |   |   |   |
| Revenues                                                                  |   | $                                 | 2.9    |   | $ | 3.9 |   |
|                                                                      |   |                              |   |   |   |
| Costs of sales                                                            |   | 2.7                               |   | 3.3 |   |
|                                                                      |   |                              |   |   |   |
| Gross margin                                                              |   | .2                                |   | .6 |   |
|                                                                      |   |                              |   |   |   |
| Selling, general and administrative  expenses                             |   | 1.0                               |   | 1.3 |   |
| Interest expense                                                          |   | .1                                |   | .1 |   |
| Income  from unconsolidated joint ventures                                |   | (.6                               | )      | (.1 | ) |
| Other expense, net                                                        |   | —                            |   | .1 |   |
|                                                                      |   |                              |   |   |   |
| Loss  before income taxes                                                 |   | (.3                               | )      | (.8 | ) |
|                                                                      |   |                              |   |   |   |
| Provision (benefit) for income  taxes                                     |   | (1.3                              | )      | — |   |
|                                                                      |   |                              |   |   |   |
| Net income (loss)                                                         |   | $                                 | 1.0    |   | $ | (.8 | ) |
|                                                                      |   |                              |   |   |   |
| Other comprehensive loss:                                                 |   |                              |   |   |   |
|                                                                      |   |                              |   |   |   |
| Unrealized  loss on short-term investments – available for sale      |   | (.5                               | )      | — |   |
| Less:  Reclassification adjustment for gains  included in net income |   | (.3                               | )      | — |   |
|                                                                      |   |                              |   |   |   |
|                                                                      |   | (.8                               | )      | — |   |
|                                                                      |   |                              |   |   |   |
| Total comprehensive income  (loss)                                        |   | $                                 | .2     |   | $ | (.8 | ) |
|                                                                      |   |                              |   |   |   |
| Earnings (loss) per common  share - basic                                 |   | $                                 | .10    |   | $ | (.08 | ) |
|                                                                      |   |                              |   |   |   |
| Earnings (loss) per common  share - diluted                               |   | $                                 | .09    |   | $ | (.08 | ) |

 

See the accompanying notes to consolidated financial statements.

 

4

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CALIFORNIA COASTAL COMMUNITIES, INC.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

(in millions)

 

(unaudited)

 
|                                                                                                      |   | **Three Months Ended  March 31,** |   |
|-----------------------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                                                      |   | **2002**                          |   | **2003** |   |
|                                                                                                      |   |                              |   |   |   |
| Cash  flows from operating activities:                                                                    |   |                              |   |   |   |
| Net  income (loss)                                                                                        |   | $                                 | 1.0    |   | $ | (.8 | ) |
| Adjustments to reconcile to  cash used in operating activities:                                           |   |                              |   |   |   |
| Non-cash interest expense                                                                                 |   | .1                                |   | .1 |   |
| Deferred income taxes                                                                                     |   | .3                                |   | — |   |
| Gains on sales of short-term  investments                                                                 |   | (.3                               | )      | — |   |
| Stock-based compensation  expense                                                                         |   | .1                                |   | .4 |   |
| Gains  on sales of real estate held for current development or sale                                       |   | (.2                               | )      | (.6 | ) |
| Proceeds from asset sales, net                                                                            |   | 2.9                               |   | 3.9 |   |
| Changes in assets and  liabilities:                                                                       |   |                              |   |   |   |
| Investments  in real estate held for current development or sale                                          |   | (3.4                              | )      | (4.5 | ) |
| Investments  in land held for future development                                                          |   | (1.4                              | )      | (.5 | ) |
| Decrease  (increase) in other assets                                                                      |   | .3                                |   | (.3 | ) |
| Decrease in accounts payable,  accrued and other liabilities, net                                         |   | (2.4                              | )      | (2.2 | ) |
|                                                                                                      |   |                              |   |   |   |
| Cash used in operating  activities                                                                        |   | (3.0                              | )      | (4.5 | ) |
|                                                                                                      |   |                              |   |   |   |
| Cash flows from financing  activities:                                                                    |   |                              |   |   |   |
| Borrowings of project debt                                                                                |   | .1                                |   | 3.7 |   |
| Repayments  of project debt                                                                               |   | —                            |   | (2.5 | ) |
|                                                                                                      |   |                              |   |   |   |
| Cash provided by financing  activities                                                                    |   | .1                                |   | 1.2 |   |
|                                                                                                      |   |                              |   |   |   |
| Net  decrease in cash and cash equivalents                                                                |   | (2.9                              | )      | (3.3 | ) |
|                                                                                                      |   |                              |   |   |   |
| Cash and cash equivalents -  beginning of period                                                          |   | 8.7                               |   | 9.2 |   |
|                                                                                                      |   |                              |   |   |   |
| Cash and cash equivalents -  end of period                                                                |   | $                                 | 5.8    |   | $ | 5.9 |   |
|                                                                                                      |   |                              |   |   |   |
| Supplemental disclosures of  cash flow information:                                                       |   |                              |   |   |   |   |   |
| Cash paid during the period for  income taxes                                                             |   | $                                 | (.1    | ) | $ | (.6 | ) |
|                                                                                                      |   |                              |   |   |   |
| Supplemental disclosures of non-cash investing and  financing activities:                                 |   |                              |   |   |   |
| Unrealized loss on short-term investments – available  for sale recorded as other comprehensive loss |   | (.5                               | )      | — |   |
| Reclassification adjustment for gains included in net  income                                             |   | (.3                               | )      | — |   |

 

See the accompanying notes to consolidatedfinancial statements.

 

5

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CALIFORNIA COASTAL COMMUNITIES, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

**Note 1 - Basisof 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 generally accepted accounting principles have been condensed oromitted pursuant to such rules and regulations. The Company believes that theseunaudited consolidated financial statements reflect all material adjustments(consisting only of normal recurring adjustments) and disclosures necessary forthe fair presentation of the results of operations and statements of financialposition when read in conjunction with the Financial Statements and Notesthereto included in the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2002. The results for interim periods are not necessarilyindicative of the results to be expected for the full year. This reportcontains forward-looking statements. Readers are cautioned that any suchforward-looking statements are not guarantees of future performance and involverisks and uncertainties that actual events or results may differ materiallyfrom those described herein as a result of various factors, including withoutlimitation, the factors discussed generally in this report.

 

# **Note 2 – SignificantAccounting Policies**

 

#### *EarningsPer Common Share*

 

For the three months ended March 31, 2002 and 2003,the weighted-average common shares outstanding was 10.1 million. Earnings pershare, assuming dilution, is computed using the weighted-average number ofcommon shares outstanding and the dilutive effect of potential common sharesoutstanding. For the three months ended March 31, 2002, the average marketprice of the Company’s common stock exceeded the exercise price of outstandingstock options, but not the exercise price of outstanding warrants. Therefore,the dilutive effect of the 754,996 common shares from potential exercise ofoptions is reflected in the 10.8 million weighted average common sharesassuming dilution, in the related statement of operations. For the three monthsended March 31, 2003, the average market price of the Company’s common stockexceeded the exercise price of outstanding stock options, but not warrants.However, the options are not included in the loss per share calculation becausethe effect is anti-dilutive. 

 

*Stock-Based Compensation*

 

The Company accounts for its stock-based employeecompensation plan using the recognition and measurement principles (intrinsicvalue method) of Accounting Principles Board (“APB”) Opinion No. 25,“Accounting for Stock Issued to Employees,” and related interpretations. Forthe three months ended March 31, 2002 and 2003, the Company recordedstock-based compensation expense of $143,000 and $476,000, in net income (loss)as a result of the May 2001 repricing of outstanding stock options. The effectson net income (loss) and earnings (loss) per share were disclosed according tothe provisions of SFAS No. 123, “Accounting for Stock-Based Compensation”through 2001, when the options were fully vested. Therefore, the only effectson net income (loss) and earnings (loss) per share of stock-based employeecompensation shown below are those related to APB Opinion No. 25 (in millionsexcept per share amounts):

 

6

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|                                                                                                        |   | **Three  months ended March 31,** |   |
|-------------------------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                                                        |   | **2002**                          |   | **2003** |   |
| Net income (loss), as reported                                                                              |   | $                                 | 1.0    |   | $ | (.8 | ) |
| Add: Stock-based employee compensation expense  included in reported net income, net of related tax effects |   | .1                                |   | .5 |   |
| Proforma net income (loss)                                                                                  |   | $                                 | 1.1    |   | $ | (.3 | ) |
|                                                                                                        |   |                              |   |   |   |
| Earnings per share:                                                                                         |   |                              |   |   |   |
| Basic – as reported                                                                                    |   | $                                 | .10    |   | $ | (.08 | ) |
| Basic – Proforma                                                                                       |   | $                                 | .11    |   | $ | (.03 | ) |
| Diluted – as reported                                                                                  |   | $                                 | .09    |   | $ | (.08 | ) |
| Diluted – Proforma                                                                                     |   | $                                 | .10    |   | $ | (.03 | ) |

 

*Impairment of Long-Lived Assets*

 

The Company assesses the impairment of land held forfuture development and other long-lived assets in accordance withSFAS No.144, which requires an impaired asset to be written down to fairvalue. Long-lived assets are reviewed for impairment whenever events or changesin circumstances indicate that the carrying amount of an asset may not berecoverable. As provided by SFAS No. 144, impairment is evaluated by comparingan asset’s carrying value to the undiscounted estimated cash flows expectedfrom the asset’s operations and eventual disposition. If the sum of the undiscountedestimated future cash flows is less than the carrying value of the asset, animpairment loss is recognized based on the fair value of the asset. If animpairment occurs, the fair value of an asset for purposes of SFAS No. 144is deemed to be the amount a willing buyer would pay a willing seller for suchasset in a current transaction. 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 real estate properties wasadjusted to fair value. Following the California Coastal Commission’s November2000 suggested modifications to the Bolsa Chica Local Coastal Program to limitdevelopment to only the upper bench of the Company’s 208-acre Bolsa Chica Mesa(see Note 3), the Company evaluated this asset’s carrying value. The Companyupdated its analysis as of December 31, 2001 and 2002, and has noted noindicators of impairment since that date. Therefore, since the undiscountedestimated future cash flows from the upper bench of the Bolsa Chica mesa andthe Company’s additional 242 acres at Bolsa Chica exceed its March 31, 2003carrying value, the Company believes that there has been no impairment.

 

### *RecentAccounting Pronouncements*

 

In November 2002, the FASB issued FASB Interpretation(“FIN”) No. 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 No.34, “Disclosure of Indirect Guarantees of Indebtedness of Others.” FIN No. 45elaborates on the disclosures to be made by the guarantor in its interim andannual financial statements about its obligations under certain guarantees thatit has issued. It also requires that a guarantor recognize, at the inception ofa guarantee, 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 7 to theseconsolidated financial statements.

 

In January 2003, the FASB issued FIN No. 46,“Consolidation of Variable Interest Entities. “In general, a variable interestentity is a corporation, partnership, trust, or any other legal structure usedfor business purposes that either (a) does not have equity investors withvoting rights or (b) has equity investors that do not provide sufficientfinancial resources for the entity to support its activities. FIN No. 46requires certain variable interest entities to be consolidated by the primarybeneficiary of the entity if the entity 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 No. 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 applicable toolder entities in the first fiscal year or interim period beginning after June25, 2003. The adoption of the requirements of FIN No. 46 did not have amaterial impact on its financial position or results of operations because theCompany has no variable interest entities.

 

7

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**Note 3 - LandHeld for Future Development**

 

The Company owns approximately 350 acres located inOrange County, California overlooking the Pacific Ocean and the Bolsa Chicawetlands (which were sold by the Company to the State of California in 1997),surrounded by the City of Huntington Beach and approximately 35 miles south ofdowntown Los Angeles. The Company’s holdings include 208 acres on a mesa northof the Bolsa Chica wetlands (“Bolsa Chica Mesa”), approximately 100 acres on,or adjacent to, the Huntington Mesa and 42 acres of lowlands which wereacquired by the Company in September 1997.

 

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, in response to a trialcourt decision in connection with a lawsuit which challenged the 1996 approvalsof the Coastal Commission (the “Coastal Act Lawsuit”), the Coastal Commissionapproved modifications to the LCP which eliminated the filling of Warner Pondand thereby reduced the maximum number of homes to be built from 2,500 to no morethan 1,235 homes on the Bolsa Chica Mesa. The Orange County Board ofSupervisors subsequently accepted the Coastal Commission’s suggestedmodifications.

 

In November 2000, in response to the April 1999 Courtof Appeal’s decision in the Coastal Act Lawsuit which prohibited relocation ofa 14-acre grove of dying eucalyptus trees which serves as raptor habitat, theCoastal Commission held another public hearing on the LCP and decided to limitdevelopment to only the upper bench of the Bolsa Chica Mesa (the “Upper Mesa”).The Coastal Commission’s November 2000 suggested modifications to the LCP wouldprohibit the Company and other landowners from development on the approximately100-acre lower bench of the Bolsa Chica Mesa (the “Lower Mesa”). In May 2001,the County of Orange declined to consider the Coastal Commission’s November2000 suggested modifications. In their response to the Coastal Commission, theCounty stated that the Commission’s suggested modifications were infeasible andunacceptable. In particular, the County noted that the Commission’s suggestedmodifications would remove 140 acres of viable residentially-zoned land fromthe County’s plan.

 

In January 2001, the Company legally 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 certain raptorhabitat on the Bolsa Chica Mesa, including the Commission’s recommendation thatthe Lower Mesa not be developed. On February 14, 2003 the court issued a rulingwhich denied the Company’s petition on the grounds that the CoastalCommission’s November 2000 decision expired by operation of law when the Countyrejected the Coastal Commission’s suggested modifications. As a result, theCoastal Commission’s decision to prohibit development on the Lower Mesa is nolonger of any force or effect. The Company intends to continue its pursuit ofreasonable development on the Bolsa Chica Mesa.

 

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, in July 2002,the Orange County Board of Supervisors upheld the Planning Commission’s priorapproval of the site plan and tentative tract map. The planned community on theUpper Mesa is currently expected to offer a broad mix of home choices, rangingin size from 1,560 square feet to 4,450 square feet. This development plan alsorequires approval by the Coastal Commission. The Company submitted a CoastalDevelopment Permit (“CDP”) application for this plan to the Coastal Commissionin November 2002. The Company is in the process of responding to comments fromthe Coastal Commission staff to have its CDP application deemed complete andcurrently expects the Coastal Commission to hold a public hearing on the CDPlater this year, or early next year. The Company does not believe that theCoastal Commission process will permanently prevent it from developing a plannedcommunity at Bolsa Chica; however, there can be no assurance in that regard, oras to when development could commence, or as to the number of acres or homesthe Company will be permitted to develop, or that further litigation oradministrative delay will not result.

 

8

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Upon completion of the Company’s Recapitalization asdiscussed in Note 2, the Company applied the principles required by Fresh-StartReporting and the carrying value of land held for development (Bolsa Chica) wasadjusted to fair value as of September 2, 1997, after consideration of theOctober 1997 Coastal Commission action discussed above. The fair value wasdetermined in 1997 using discounted estimated cash flows expected from the asset’soperations and eventual disposition. In addition, given the significance of theBolsa Chica asset to the financial statements of the Company, the value of theCompany’s stock immediately following the closing of the Recapitalization wasused as an indicator of value of the subject property. Following the November2000 Coastal Commission action, an assessment of impairment was conducted bythe Company for the year ended December 31, 2000. The Company updated itsanalysis at each year end since December 31, 2000, and has noted no indicatorsof impairment since that date. In accordance with the Company’s policydescribed in Note 2 – Impairment of Long-Lived Assets and based upon theCompany’s assessment of estimated undiscounted future cash flows, no provisionfor impairment has been considered necessary subsequent to theRecapitalization.

 

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. At such timeas the Company’s homebuilding activities at Bolsa Chica commence, the Companywould be required to account for such property at the lower of cost or market,which may necessitate a write-down of its carrying value. Accordingly, theultimate values of the Company’s land held for future development are dependentupon future economic and market conditions, the availability of financing, andthe resolution of political, environmental and other related issues. Thedevelopment of the Company’s Bolsa Chica Mesa project is dependent upon variousgovernmental approvals and economic factors. Accordingly, the amount ultimatelyrealized from such project may differ materially from current estimates and theproject’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(5.0% at March 31, 2003).  The followingamounts were available and outstanding under these loan facilities as ofDecember 31, 2002 and March 31, 2003 ($ in millions):

 
|          |   |                    |   |                |   |               |     | **Outstanding  at**     |   |
|---------------|--------|-------------------------|--------|---------------------|--------|--------------------|----------|-------------------------|--------|
|          |   | **Amount  of Facility** |   | **Number  of Lots** |   | **Maturity  Date** |     | **December  31,  2002** |   | **March 31,  2003** |   |
|          |   |                    |   |                |   |               |     |                    |   |   |   |
| North  Corona |   | $                       | 17.1   |                | 93     |               | 10/29/03 |                    | $      | 6.4 |   | $ | 6.5 |   |
| Riverside     |   | 7.8                     |   | 37                  |   | 7/28/03            |     | 2.1                     |   | 3.1 |   |
| Riverside     |   | 6.4                     |   | 47                  |   | 10/10/03           |     | 1.3                     |   | 1.4 |   |
|          |   |                    |   |                |   |               |     | $                       | 9.8    |   | $ | 11.0 |   |
|               |        |                         |        |                     |        |                    |          |                         |        |  |  |  |  |  |

 

For the three months ended March 31, 2002 and 2003,approximately $100,000 of construction period interest was capitalized toprojects in the construction stage for each period.

 

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**Note 5 – Income Taxes**

 

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

 
|                                     |   | **Three Months Ended  March 31,** |   |
|------------------------------------------|--------|-----------------------------------|--------|
|                                     |   | **2002**                          |   | **2003** |   |
| Current  taxes                           |   | $                                 | (.2    | ) | $ | — |   |
| Deferred  taxes                          |   | (.2                               | )      | — |   |
| Reduction  in contingent tax liabilities |   | (.9                               | )      | — |   |
| Provision  (benefit) for income taxes    |   | $                                 | (1.3   | ) | $ | — |   |

 

Deferred tax benefits resulting from reductions in thedeferred tax asset valuation allowance on NOLs are recorded when the Companyconcludes that it is more likely than not that it will utilize additional NOLsto offset taxable income. Increases in the deferred tax asset valuationallowance on NOLs are recorded when the Company determines that it cannotconclude that it is more likely than not that it will utilize additional NOLsto offset taxable income. During the three months ended March 31, 2003,increases in valuation allowances on post-Reorganization NOLs of approximately$300,000 were recorded, which resulted in no deferred tax benefits for theperiod. Pursuant to Fresh-Start Reporting, during the three months ended March31, 2002, deferred tax benefits resulting from reductions in valuation allowanceson pre-Reorganization NOLs of approximately $200,000 were reflected byincreasing 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 the Company paid$759,000 in full settlement of the IRS claims. The Company has reviewed theextent of potential accompanying state tax liability adjustments and does notbelieve that any such adjustments would have a negative material impact on theCompany’s financial statements. Nearly all of the state jurisdictions in whichthe Company filed amended returns for 1989, 1990 and 1991 have accepted suchreturns, thereby reducing the Company’s exposure to potential claims. Inconjunction with periodic reviews of the adequacy of reserves for estimatedstate income taxes, the Company reduced its reserves by approximately $900,000during the first quarter of 2002. The reduction in estimated tax liabilities isreflected 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-termtax-exempt rate. The federal NOLs available as of March 31, 2003 wereapproximately $181 million. The amount of federal NOLs which expire if notutilized is $6 million, $20 million, $8 million, $19 million and $128 millionfor 2005, 2006, 2007, 2008 and thereafter, respectively.

 

The Company amended its certificate of incorporationin October 1999, in response to an unsolicited written consent from a majorityof its stockholders,  in order toprotect the ability of the Company to utilize its tax loss carryforwards. Sincethe Company’s use of its NOLs would be severely restricted if it experiences anownership change of more than 50%, the Company’s majority stockholdersrequested that the Board of Directors enact the amendments, which weredetermined to be in the best interest of the Company and its stockholders. Theamendments prohibit future purchases of the Company’s common stock by personswho would become new 5% holders, and also prohibit current holders of over 5%from increasing their positions, except in certain permissible circumstanceswhich would not jeopardize the Company’s ability to use its NOLs. While theseamendments reduced the Company’s risk of an ownership change occurring due tothe acquisition of shares by 5% stockholders, the risk remains that anownership change could result from the sale of shares by existing 5%stockholders. The Company estimates that after giving effect to varioustransactions by stockholders who hold a 5% or greater interest in the Company,it has experienced a three-year cumulative ownership shift of approximately 8%as of March 31, 2003.

 

##### **Note 6 – Stock Plans**

 

In accordance with Financial Accounting StandardsBoard Interpretation No. 44 “Accounting for Certain Transactions InvolvingStock Compensation”, the May 2001 modification of stock options requires thatthey be accounted for as variable awards, which measures compensation expenseas the difference between the option exercise price and the quoted market priceof the Company shares. Accordingly, during the current quarter,  $476,000 of expense was recorded based uponthe Company’s market price of $6.16 per share at March 31, 2003 as comparedwith the December 31, 2002 market price of

 

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$5.53 per share. Based upon the Company’s market price of $4.69 pershare at March 31, 2002 versus the option exercise price of $4.50 per share,the Company recorded compensation expense of $143,000 during the quarter endedMarch 31, 2002. Future increases (or decreases) in the fair value of theCompany’s common stock above (or below) the March 31, 2003 market price of$6.16 would result in additional compensation expense (or income). Suchadjustment would be offset by an adjustment to capital in excess of par value.

 

**Note 7**–**Other Liabilities**

 

Other liabilities werecomprised of the following (in millions):

** **
|                                                |   | **December 31,  2002** |   | **March 31,  2003** |   |
|-----------------------------------------------------|--------|------------------------|--------|---------------------|--------|
| Net  deferred taxes and other tax liabilities       |   | $                      | 3.7    |                | $      | 3.7 |   |
| Accrued  pensions and benefits                      |   | 4.8                    |   | 4.8                 |   |
| Home  warranty reserves                             |   | 1.2                    |   | 1.2                 |   |
| Contingent  indemnity and environmental obligations |   | 4.4                    |   | 4.2                 |   |
| Unamortized  discount                               |   | (1.2                   | )      | (1.1                | )      |
|                                                |   | $                      | 12.9   |                | $      | 12.8 |   |

 

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 subsidiary of the Company’s liabilityfor PCB contamination on its 42-acre Bolsa Chica lowlands property as furtherdescribed 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 of JeffersonCounty, Texas. Dresser seeks a declaratory judgment regarding the rights andobligations of the parties under a January 1988 purchase agreement, wherebyDresser acquired an engineering and construction business from a former parentof the Company. Dresser’s indemnity claims relate to several hundred contestedasbestos claims made by third parties in connection with work in facilitieswith which the business disposed of by the former parent was allegedlyconnected. The Company was not formed until September 1988 and, upon beingspun-off in December 1988, indemnified its former parent for potentialliabilities under the January 1988 purchase agreement with Dresser to theextent that any such liabilities are not covered by insurance. However, theCompany believes its indemnity for any third-party asbestos claims expired inMarch 1991 under the terms of the January 1988 purchase agreement. Thislitigation is in the early stages of discovery and the Company intends tovigorously defend itself in this case and related matters. The Company alsobelieves that it has a number of other meritorious defenses to this litigation.Thus far, no claim for monetary damages has been made in connection with thislitigation and, given the preliminary nature of these proceedings, the Companyis not able to assess its potential exposure with any degree of accuracy. Whilethe Company currently believes its reserves are adequate, damage awards inasbestos cases can involve amounts that would have a material adverse effect onthe Company’s business, operations or financial condition, in the event thatsuch an award was to be rendered against the Company.

 

In September 1997, theCompany 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 1999, in anticipation of entering into a purchase agreement, theState performed limited soils sampling on this property and discoveredcontamination from a group of chemicals called PCBs. The source of thecontamination is presently unknown; however, the Company has never conductedany development, business or operations on this property. In January 2002, theState’s Department of Toxic Substances Control (“DTSC”) became the regulatoryagency responsible for overseeing the Company’s efforts to remediate thecontamination on this property. On July 1, 2002 a subsidiary of the Companyentered into a consent order with DTSC regarding remediation. The Company’ssubsidiary is in the process of preparing a Remedial Investigation Workplan,and upon obtaining DTSC approval, will perform additional sampling on theproperty to determine the nature and extent of contamination. The Company’sfinancial statements include a reserve of approximately $700,000 forenvironmental testing and remediation of this property. While the reservereflects the estimate for the minimum costs which are probable and estimable,such reserve may not be adequate to satisfy the full amount of remediation thatmay be required by the DTSC. Until additional soils sampling and analysis arecompleted later this year, the Company cannot accurately estimate how much, ifany, additional costs may ultimately be incurred; however, the Company has beenadvised that costs could range up to approximately $1.0 million to $2.0 millionin excess of the current reserve. There is no maximum limitation to thesubsidiary of the Company’s obligation to remediate under the DTSC consentorder. Other parties, who have yet to be identified, may be responsible for allor a portion of these remediation costs. If 

 

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any such party issubsequently identified, the Company’s subsidiary may be entitled to seekreimbursement for some or all of its costs; however, there can be no assurancein 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, subject to certain minimums. The homewarranty reserve activity for the three month periods is presented below:

 
|                            |   | **March 31,  2002** |   | **March 31,  2003** |   |
|---------------------------------|--------|---------------------|--------|---------------------|--------|
|                            |   |                |   |                |   |
| Balance  at beginning of period |   | $                   | 1.2    |                | $      | 1.2 |   |
| Provision                       |   | —              |   | —              |   |
| Payments                        |   | —              |   | —              |   |
| Balance  at end of period       |   | $                   | 1.2    |                | $      | 1.2 |   |

 

##### **Note 8 – Commitments and Contingencies**

 

The Company and itsformer affiliates have, through a variety of transactions effected since 1986,disposed of several assets and businesses, many of which are unrelated to theCompany’s current operations. By operation of law or contractual indemnityprovisions, the Company may have retained liabilities relating to certain ofthese assets and businesses.  There isgenerally 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.

 

*Legal Proceedings*

 

See Note 7 for adiscussion of pending litigation filed against the Company by Dresser.

 

There are various otherlawsuits and claims pending against the Company and certain subsidiaries. Inthe opinion of the Company’s management, ultimate liability, if any, will nothave a material adverse effect on the Company’s financial condition or resultsof operations.

 

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ITEM 2 -                                                                                                    MANAGEMENT’SDISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OFOPERATIONS

 

**General**

### * *

The Company is aresidential land development and homebuilding company with properties locatedprimarily in southern California. The principal activities of the Company andits consolidated subsidiaries include: (i) obtaining zoning and otherentitlements for land it owns and improving the land for residentialdevelopment; and (ii) designing, constructing and selling single-familyresidential homes in southern California. Once the residential land owned bythe Company is entitled, the Company may build homes, sell unimproved land toother developers or homebuilders, sell improved land to homebuilders, orparticipate in joint ventures with other developers, investors or homebuildersto finance and construct infrastructure and homes. During 2003, the Companywill 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) maintain 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(2000 – 2002), the Company has generated gross margins from homebuildingactivities and cash flows on assets other than Bolsa Chica. The Companycurrently has on-going southern California projects in Riverside County nearthe cities of North Corona and Riverside, and expects to begin an additionalproject in the city of Chino in San Bernardino County during the second quarterof 2003. These homebuilding projects are expected to generate significant cashflows and modest gross margins through the first quarter of 2005. However, theCompany’s inventory of entitled land available for homebuilding projects isstill limited. Given this limited inventory of buildable lots, the Company iscontinuing to pursue residential lot acquisition opportunities. Due to delaysin approvals for homebuilding at Bolsa Chica, continuation of homebuildingoperations beyond 2004 is dependent upon acquisition of suitable, entitledresidential lots within the southern California area or Coastal Commissionapproval of the Company’s development plan for 379 homes on the Upper Mesa.

 

Bolsa Chica is theCompany’s principal asset, representing 82% of total assets at March 31, 2003.It has required and continues to require significant investments forentitlement and land development activities. Due to the November 2000 CoastalCommission recommendation to limit residential development to only the UpperMesa, the Company is faced with further delays in implementing its plans forresidential development on the Bolsa Chica Mesa. The Company is currentlypursuing approval of development permits for the Upper Mesa. In May 2002, theCounty of Orange Planning Commission approved the Company’s site plan fordevelopment of 379 single-family homes on the Upper Mesa. In response to anappeal, in July 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 in November2002. The Company is currently in the process of responding to comments fromthe Coastal Commission staff to have its CDP application deemed complete andcurrently expects the Coastal Commission to hold a public hearing on the CDPlater this year, or early next year. The Company does not believe that theCoastal Commission process will ultimately prevent it from developing a plannedcommunity at Bolsa Chica; however, there can be no assurance in that regard, oras to when development could commence, or as to the number of acres or homesthe Company will be permitted to develop, or that further litigation oradministrative delay will not result.

 

The Bolsa Chica LandTrust 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 $3.4billion 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; reach a mutuallyacceptable agreement on price and terms; or that a sale transaction will everbe completed.

 

The Company believes thatthe Bolsa Chica Mesa can ultimately be developed and will realize an amountthat is substantially in excess of the $152.4 million book value presentlyreflected in the Company’s consolidated financial statements, although therecan be no assurance in that regard. The Company also believes that the currentand historic public trading prices of the Company’s common stock have notadequately reflected the Bolsa Chica Mesa’s true value. From time to time, theCompany has received outside appraisals on an “as developed basis” which havesupported the 

 

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Company’s beliefs.Therefore, the Company has no present intention of selling the Bolsa Chica Mesato the State at any price that is not substantially in excess of present bookvalue.

 

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

 

**Impact of Inflation; Changing Prices and 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 from homesales would decrease. If interest rates increase, construction and financingcosts, as well as the cost of borrowings, also would increase, which can alsoresult in lower gross margin from home sales. The volatility of interest ratescould have an adverse effect on the Company’s future operations and liquidity.Among other things, these conditions may affect adversely the demand forhousing and the availability of mortgage financing and may reduce the creditfacilities offered to the Company.

 

During the last sixmonths of 2001 it became apparent that both the national and Californiaeconomies were in a recession, and economic data for 2002 and early 2003 havenot yielded convincing evidence of an economic recovery. Therefore, there canbe no assurance regarding the continued health of the southern Californiaresidential real estate market. In particular, (i) the slow-down in thenational economy during the past several years, (ii) the significant decreasesin the value of national stock market indices and the resulting volatility ofthose markets; (iii) the events of September 11, 2001 and their continuingeffects on the economy; (iv) economic uncertainty related to the recent warwith Iraq; and (v) the State of California’s $35 billion estimated budget deficit,collectively appear to be exerting recessionary pressures on the Californiaeconomy and may have a negative impact on the southern California housingmarket.

 

While low mortgage ratesappear to have sustained housing demand to date, any future increase inmortgage rates or significant loss of jobs in southern California would mostlikely slow demand for new homes. Increases in home mortgage interest ratesmake it more difficult for the Company’s customers to qualify for home mortgageloans, potentially decreasing home sales volume and prices. The tight supply ofnew homes in southern California has resulted in significant home priceincreases over the last five years. As a result, the affordability of new homeshas been declining and could further jeopardize future demand.

 

All of the Company’sactive homebuilding projects are located in the “Inland Empire” area ofsouthern California, which includes Riverside and San Bernardino counties. 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, diminishor cause such growth to discontinue. The Company is continuing to pursue lotacquisition opportunities throughout southern California.

 

**CriticalAccounting Policies**

 

In the preparation of theConsolidated Financial Statements, the Company applies accounting principlesgenerally accepted in the United States. The application of generally acceptedaccounting principles may require management to make estimates and assumptionsthat affect the amounts reported in the financial statements and accompanying results.Listed below are those policies that the Company believes are critical andrequire the use of complex judgment in their application. The Company’scritical accounting policies include the evaluation of the impairment oflong-lived assets and the evaluation of the probability of being able torealize the future benefits indicated by its significant federal tax netoperating losses.

 

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*Impairment of Long-Lived Assets*

 

The Company assesses theimpairment of land held for future development and other long-lived assets inaccordance with Statement of Financial Accounting Standards (“SFAS”) No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets”, whichrequires an impaired asset, for which costs cannot be recovered from estimatedundiscounted future cash flows, to be written down to fair value. Given thesignificance of the carrying value of land held for future development, theapplication of SFAS No. 144 in evaluating any potential impairment is criticalto the Company’s consolidated financial statements, as discussed further inNote 2 to the Consolidated Financial Statements. At such time as the Company’shomebuilding activities at Bolsa Chica commence, the Company would be requiredto account for such property at the lower of cost or market, which maynecessitate a write-down of its carrying value. Accordingly, the amountultimately realized from such project may differ materially from currentestimates and the project’s carrying value.

 

*Income Taxes*

 

The Company accounts forincome taxes on the liability method. Deferred income taxes are determinedbased on the difference between the consolidated financial statement and taxbases of assets and liabilities. The liability method requires an evaluation ofthe probability of being able to realize the future benefits indicated bydeferred tax assets, such as tax net operating losses (“NOLs”). A valuationallowance related to the deferred tax asset is recorded when uncertaintiespreclude the Company from determining that it is more likely than not that someportion or all of the deferred tax asset will be realized. Given thesignificance of the Company’s historical federal tax NOLs, as discussed in Note5 to the Consolidated Financial Statements, the application of the Company’spolicy in evaluating the expected future benefit of NOLs is critical. Inapplying those policies, estimates and judgments affect the amounts at whichcertain assets and liabilities are recorded. The Company applies its accountingpolicies on a consistent basis. As circumstances change, they are considered inthe Company’s estimates and judgments, and future changes in circumstancescould result in changes in amounts at which assets and liabilities arerecorded.

 

*Homebuilding Revenues and Cost ofSales*

 

The Company’shomebuilding operation generates revenues from the sale of homes to homebuyers.The majority of these homes is designed to appeal to move-up homebuyers and thehomes are generally offered for sale in advance of their construction. Salescontracts are usually subject to certain contingencies such as the buyer’sability to qualify for financing. Revenue from the sale of homes is recognizedat closing when title passes to the buyer, and the earnings process is complete.As a result, the Company’s revenue recognition process does not involvesignificant judgments or estimates. However, the Company does rely on certainestimates to determine the related construction costs and resulting grossmargins associated with revenues recognized. The Company’s construction costsare comprised of direct and allocated costs, including estimated costs forfuture warranties and indemnities. The Company’s estimates are based onhistorical results, adjusted for current factors.

 

*Warranty Costs*

 

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

 

*Litigation Reserves*

 

The Company and certainof its subsidiaries have been named as defendants in various cases arising inthe normal course of business and regarding disposed assets and businesses ofthe Company or former affiliates. The Company has reserved for costs expectedto be incurred with respect to these cases based upon information provided byits legal counsel.

 

**Recent Accounting Pronouncements**

 

See discussion regardingrecent accounting pronouncements in Note 2 to the Consolidated FinancialStatements.

 

**Liquidity and Capital Resources**

 

The principal assets inthe Company’s portfolio are residential land which must be held over anextended period of time in order to be developed to a condition that, inmanagement’s opinion, will ultimately maximize the return to the Company.Consequently, the Company requires significant capital to finance its realestate development and homebuilding

 

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operations. Historically,sources of capital have included bank lines of credit, specific propertyfinancings, asset sales and available internal funds. The Company is utilizingproject debt and internally generated cash to fund construction of the secondphase of the North Corona project and the Riverside projects, and is utilizinginternally generated cash to fund the first phase of the North Corona projectand the Bolsa Chica project. As of March 31, 2003, the Company had internallyfinanced approximately $15.0 million of investments in homebuilding projects.These projects are expected to generate approximately $18.0 million of positivecash flows during the next 24 months, based on present economic conditions andmarket assumptions. The Company’s cash and cash equivalents as of March 31,2003 were approximately $5.9 million. The Company believes that its cash andcash equivalents, future real estate sales proceeds, and funds available underits credit agreements will be sufficient to meet anticipated operating andcapital investment requirements, primarily project development costs forhomebuilding projects and Bolsa Chica, along with general and administrativeexpenses and certain liabilities, for the next 12 months.

 

The Company is subject tothe usual obligations associated with entering into contracts for the purchaseof land and improved homesites. These purchase contracts typically require acash deposit and the purchase of properties under these contracts is generallycontingent upon satisfaction of certain requirements by the sellers, includingobtaining applicable property entitlements. The Company also utilizes optioncontracts with third-party land sellers and financial entities as a method ofacquiring land in staged takedowns and minimizing the use of funds from othercorporate financing sources. These option contracts also help to manage thefinancial and market risk associated with land holdings. Option contractsgenerally require the payment of a non-refundable cash deposit for the right toacquire lots over a specified period of time at predetermined prices. TheCompany has the right at its discretion to terminate the obligations underthese option agreements by forfeiting the cash deposit with no further financialresponsibility. The Company may enter into land development and homebuildingjoint ventures from time to time as a means of expanding its marketopportunities, establishing strategic alliances, managing its risk profile andleveraging the Company’s capital base. These joint ventures may obtain securedacquisition, development and construction financing, which minimizes the use offunds from other corporate financing sources.

 

**Homebuilding**

 

*NorthCorona*.  In July 2001,the Company acquired 83 finished lots in Riverside County, California nearNorth Corona in the master-planned community known as Providence Ranch. Thecommunity of Providence Ranch and the adjacent community of Corona Valley, areplanned for a total of 2,600 homes, and are well-located to serve theemployment centers of the greater Los Angeles area, Orange County and theOntario international airport. The Company commenced home construction inOctober 2001, opened for sales in February 2002 and released 73 homes for saleduring 2002 at an average price of approximately $295,000. During 2002 and thefirst quarter of 2003, 58 homes and one home were delivered, respectively. Asof May 5, 2003, 11 additional homes had been delivered and four homes remainedin escrow.

 

In October 2002, the Companyacquired an additional 93 finished lots in the Providence Ranch community.Construction of homes in this second phase began during the first quarter of2003. These homes are being sold from the original model complex and as of May5, 2003, 44 homes had been released for sale at an average price of $334,000and 42 were in escrow.

 

*Riverside.*  During 2002 and the first quarter of 2003,the Company acquired a total of 84 finished lots near the city of Riverside, inRiverside County, in the master-planned community known as Victoria Grove. Thiswell-established community is planned for a total of 855 homes. The Company isin escrow to acquire 41 additional lots for a total project of 125 homes,including two product types. The Company began home construction and opened forsales during August 2002 on the Harvest product which is comprised of 60 homes,averaging 2,934 square feet.  All 60homes in the Harvest product type have been released for sale at an average homeprice of approximately $330,000. As of May 5, 2003, 15 homes had beendelivered, including 10 during the first quarter of 2003 and of the 45remaining homes, 41 were in escrow.

 

The Company beganconstruction of homes on the larger Jasper Ranch product during the secondquarter of 2003, which is comprised of 65 homes, averaging 3,648 squarefeet.  The Company expects to open forsales on these homes during the second quarter of 2003.

 

*Chino.*  The Company has an agreement to acquire 77finished lots in Chino, California in San Bernardino County. This infill siteis part of a new community encompassing 244 homes, and the Company expects tocomplete the purchase of the 77 lots during the second quarter of 2003.

## ** **

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## **Financial Condition**

 

*March 31, 2003 Compared withDecember 31, 2002*

 

Cash flows fromhomebuilding operations for the first quarter of 2003 primarily reflect a useof cash for investments in real estate and construction costs of $4.5 millionand payment of accrued construction costs of approximately $1.0 million, fundedby real estate sales proceeds of $3.9 million from deliveries of 13 homes, andnet borrowing under project debt financing of $1.2 million. Significant uses ofcash include approximately $500,000 for investment in the Bolsa Chica Mesaproject, primarily for consultants engaged in the entitlement process andselling, general and administrative expenses of approximately $800,000,excluding non-cash compensation expense of $476,000. These items, as well asother activity presented in the Statements of Cash Flows, resulted in the $3.3million decrease in cash and cash equivalents.

 

Accounts payable andaccrued liabilities decreased by $2.0 million, to a balance of $3.0 million asof March 31, 2003, primarily reflecting payments of accounts payable forconstruction costs, state income taxes, and homebuilding employees’ bonuses.

 

The increase in capitalin excess of par value reflects recognition of non-cash compensation expenserecorded under variable accounting for repriced stock options.

 

**Results ofOperations**

 

The nature of theCompany’s business, including its limited inventory of buildable lots, is suchthat individual transactions often cause significant fluctuations in operatingresults from quarter to quarter and from year to year.

 

*Three Months Ended March 31, 2003 Compared with the ThreeMonths Ended March 31, 2002*

 

The Company reportedrevenues of $3.9 million and gross operating profit of approximately $600,000for the first quarter of 2003, compared with $2.9 million in revenues and grossoperating profit of approximately $200,000 for the first quarter of 2002.Revenues in the current period reflect deliveries of 13 homes, including twohomes at the Company’s Yucaipa project, one home at the North Corona projectand the first 10 homes at the Riverside project. The comparable period of theprior year reflects deliveries of 12 homes at the Yucaipa project. The currentquarter’s gross margin of 15% is higher than the prior period gross margin of7%, due to the higher profitability of the Riverside project.

 

The $300,000 increase inselling, general and administrative expenses during the first quarter of 2003,as compared to the first quarter of 2002, reflects $476,000 of non-cashcompensation expense recorded pursuant to variable accounting for repricedoptions in the recent quarter compared with approximately $143,000 of suchexpense in the first quarter of 2002.

 

Income fromunconsolidated joint ventures of approximately $600,000 for the three monthsended March 31, 2002 reflects the sale of the final four homes at the FairbanksHighlands project, which was completed in 2002.

 

During the three monthsended March 31, 2002, the Company recorded a tax benefit of $1.3 million,including $900,000 in connection with the reduction in reserves for contingenttax liabilities, reversal of $200,000 of alternative minimum taxes payable dueto a change in the federal income tax law enacted in that quarter, and a$200,000 tax benefit from a reduction in the deferred tax asset valuationallowance on post-Reorganization state NOLs. During the three months ended March 31, 2003, increases in the valuationallowances on post-Reorganization NOLs were recorded due to the uncertainty ofrealizing such deferred tax assets, which offset the tax benefit for theperiod.

 

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*Payments Under Contractual Obligations*

 

The Company has enteredinto certain contractual obligations to make future payments for items such asproject debt and lease agreements.  Asummary of the payments due under specified contractual obligations, aggregatedby category of contractual obligation, for specified time periods is presentedbelow as of March 31, 2003 (in millions):

 
|              |   |      |   | **Payments  due by period** |   |
|-------------------|--------|-----------|--------|-----------------------------|--------|
|              |   | **Total** |   | **Less  than 1  year**      |   | **1-3  years** |   | **3-5  years** |   | **More  than 5  years** |   |
|              |   |      |   |                        |   |   |   |   |   |   |   |
| Project  debt     |   | $         | 11.0   |                        | $      | 11.0 |   | — |   | — |   | — |   |
| Operating  leases |   | .4        |   | .2                          |   | .2 |   | — |   | — |   |
| Total             |   | $         | 11.4   |                        | $      | 11.2 |   | $ | .2 |   | — |   | — |   |
|                   |        |           |        |                             |        |  |  |  |  |  |  |  |  |  |

 

The Company’s purchasecontracts which are made in the normal course of its homebuilding business forland acquisition and construction subcontracts are generally cancelable atwill. Other contractual obligations including the Company’s other taxliabilities, accrued benefit liability for a frozen retirement plan and other accruedpensions, home warranty reserves and contingent indemnity and environmentalobligations are estimated based on various factors. Payments are not due as ofa given date, but rather are dependent upon the incurrence of professionalservices, the lives of annuitants and other factors. The estimation processinvolved in the determination of carrying values of these obligations isinherently uncertain since it requires estimates as to future events andcontingencies. The Company has provided additional disclosure in itsConsolidated Financial Statements in Notes 7 and 8.

 

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

 

Certain of the foregoinginformation and the information following this Item 2 contains forward-lookingstatements that relate to future events or the Company’s future financialperformance.  These statements involveknown and unknown risks, uncertainties and other factors which may cause theCompany’s actual results, performance or achievements to be materially differentfrom any future results, performances or achievements expressed or implied bythe forward-looking statements.  In somecases, you can identify forward-looking statements by terminology such as“may”, “will”, “should”, “expects”, “plans”, “anticipates”, “believes”,“estimates”, “predicts”, “potential”, “continue”, or the negative of such termsor other comparable terminology.  Theseforward-looking statements include, but are not limited to, (1) statementsabout the Company’s plans, objectives, goals, expectations and intentions; (2)the number and types of homes and number of acres of land that the Company maydevelop and sell; (3) the timing and outcomes of litigation, regulatoryapproval processes or administrative proceedings (including, but not limited toongoing administrative proceedings related to the Company’s principal asset,the Bolsa Chica Mesa); (4) the Company’s ability to continue relationships withcurrent or future partners; (5) the Company’s ability to expend resources tocomply with environmental regulations and local permitting requirements; (6)the effect of certain costs, contractual obligations and tax liabilities, bothknown and unknown, on the Company’s business, results of operations andfinancial condition; (7) the condition and adequacy of the Company’sproperties; (8) the Company’s ability to estimate cash flow projections due touncertainties in valuing real property; (9) the Company’s ability to acquireresidential lots in order to continue homebuilding operations; (10) the adequacyof capital, financing and cash flow required to continue the Company’soperations and land development activities; (11) the future condition of thereal estate market in southern California; (12) 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; (13) general economic and business conditions; (14) interest ratechanges; (15) the relative stability of debt and equity markets; (16)competition; (17) the availability and cost of raw materials used by theCompany in its homebuilding operations; (18) shortages and the cost of labor;(19) weather related slowdowns; (20) slow growth and no growth initiatives ormoratoria; (21) governmental regulation, including the interpretation of tax,labor and environmental laws; (22) changes in consumer confidence andpreferences; (23) accounting changes; (24) terrorist acts and other acts ofwar; (25) other factors over which the Company has little or no control; and(26) other statements contained herein that are not historical facts.

 

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ITEM 3  -  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

The Company utilizesproject debt financing for acquisition, development and construction of homes.The interest rates on the Company’s project debt approximate the current ratesavailable for secured real estate financing with similar terms and maturities,and as a result, their carrying amounts approximate fair value. While changesin interest rates generally do not impact the fair market value of the debtinstrument, they do affect the Company’s earnings and cash flows. Holding theCompany’s variable rate debt balance constant as of March 31, 2003, each onepoint percentage increase in interest rates would result in an increase invariable rate interest incurred for 2003 of approximately $100,000.

 

ITEM 4  -   EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

 

Within90 days prior to the date of this report, the Company carried out anevaluation, under the supervision and with the participation of the Company’smanagement, including the Chief Executive Officer and Chief Financial Officer,of the effectiveness of the design and operation of the Company’s disclosurecontrols and procedures. The Company’s disclosure controls and procedures aredesigned to ensure that information required to be disclosed by the Company inits periodic filings with the Securities and Exchange Commission (“SEC”) isrecorded, processed and reported within the time periods specified in the SEC’srules and forms. In designing and evaluating the disclosure controls andprocedures, the Company’s management recognized that any controls andprocedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving the desired objectives and managementnecessarily was required to apply its judgment in evaluating the cost-benefitrelationship of possible controls and procedures. It should be noted that thedesign of any system of controls is based in part upon certain assumptionsabout the likelihood of future events, and there can be no assurance that anydesign will succeed in achieving its stated goals under all potential futureconditions, regardless of how remote. Based on the foregoing, the Company’sChief Executive Officer and Chief Financial Officer concluded that theCompany’s disclosure controls and procedures were effective in timely alertingthem to material information relating to the Company (including itsconsolidated subsidiaries) required to be included in the Company’s periodicSEC filings. Additionally, there have been no significant changes in theCompany’s internal controls or in other factors that could significantly affectthe internal controls subsequent to the date the Company completed itsevaluation.

 

PART II - OTHER INFORMATION

 

ITEM 1 -                                                 Legal Proceedings

 

See Note 7 to theConsolidated Financial Statements above, and “Item 1 - Business - CorporateIndemnification Matters” and “Item 3 - Legal Proceedings” in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2002.

 

ITEM 6 -                                                 Exhibits and Reports on Form 8-K

 

(a)                                  Exhibits:

 

10.1                           Extensionand Modification of Employment Agreement between the Registrant and Raymond J.Pacini, dated as of March 17, 2003.

 

10.2                           Extensionand Modification of Employment Agreement between the Registrant and Sandra G.Sciutto, dated as of March 17, 2003.

 

99.1                           Certificate of Raymond J. Pacini, Chief Executive Officer ofCalifornia Coastal Communities, Inc.

 

99.2                           Certificate of Sandra G. Sciutto, Chief Financial Officer ofCalifornia Coastal Communities, Inc.

 

(b)                                 Reports on Form 8-K:

 

Current report on Form8-K dated February 18, 2003, attaching a press release regarding  a February 14, 2003 court opinion, a copy ofwhich was attached.

 

Current report on Form8-K dated February 27, 2003, attaching a press release reporting fourth quarterand year end results, a copy of which was attached.

 

 

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**SIGNATURE**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, theregistrant has caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
| Date:  May 7, 2003 | CALIFORNIA COASTAL  COMMUNITIES, INC. |
|-------------------------|---------------------------------------|
|                    |                                  |
|                    |                                  |
|                    | By:                                   | /s/ Sandra G. Sciutto |   |
|                    |                                  | SANDRA G. SCIUTTO |
|                    |                                  | Senior Vice President and |
|                    |                                  | Chief Financial Officer |

 

 

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**Certifications**

 

I,Raymond J. Pacini, certify that:

 

1.               Ihave reviewed this quarterly report on Form 10-Q of California CoastalCommunities, Inc.;

 

2.               Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport;

 

3.               Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this quarterly report;

 

4.               Theregistrant’s other certifying officer and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

(a)          designed such disclosure controls and procedures to ensure that materialinformation relating to the registrant, including its consolidatedsubsidiaries, is made known to us by others within those entities, particularlyduring the period in which this quarterly report is being prepared;

 

(b)         evaluated the effectiveness of the registrant’s disclosure controls andprocedures as of a date within 90 days prior to the filing date of thisquarterly report (the “Evaluation Date”); and

 

(c)          presented in this quarterly report our conclusions about theeffectiveness of the disclosure controls and procedures based on our evaluationas of the Evaluation Date;

 

5.               Theregistrant’s other certifying officer and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

(a)          all significant deficiencies in the design or operation of internalcontrols which could adversely affect the registrant’s ability to record,process, summarize and report financial data and have identified for theregistrant’s auditors any material weaknesses in internal controls; and

 

(b)         any fraud, whether or not material, that involves management or otheremployees who have a significant role in the registrant’s internal controls;and

 

6.               The registrant’sother certifying officer and I have indicated in this quarterly report whetheror not there were significant changes in internal controls or in other factorsthat could significantly affect internal controls subsequent to the date of ourmost recent evaluation, including any corrective actions with regard tosignificant deficiencies and material weaknesses.

 
| Date: May 7, 2003 |                                  |
|-------------------|---------------------------------------|
|              |                                  |
|              | *   /s/  Raymond J. Pacini* |   |
|              | Raymond  J. Pacini                    |
|              | Chief  Executive Officer              |

 

 

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I,Sandra G. Sciutto, certify that:

 

1.               Ihave reviewed this quarterly report on Form 10-Q of California CoastalCommunities, Inc.;

 

2.               Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport;

 

3.               Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this quarterly report;

 

4.               Theregistrant’s other certifying officer and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

(a)          designed such disclosure controls and procedures to ensure that materialinformation relating to the registrant, including its consolidatedsubsidiaries, is made known to us by others within those entities, particularlyduring the period in which this quarterly report is being prepared;

 

(b)         evaluated the effectiveness of the registrant’s disclosure controls andprocedures as of a date within 90 days prior to the filing date of thisquarterly report (the “Evaluation Date”); and

 

(c)          presented in this quarterly report our conclusions about theeffectiveness of the disclosure controls and procedures based on our evaluationas of the Evaluation Date;

 

5.               Theregistrant’s other certifying officer and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

(a)          all significant deficiencies in the design or operation of internalcontrols which could adversely affect the registrant’s ability to record, process,summarize and report financial data and have identified for the registrant’sauditors any material weaknesses in internal controls; and

 

(b)         any fraud, whether or not material, that involves management or otheremployees who have a significant role in the registrant’s internal controls;and

 

6.               Theregistrant’s other certifying officer and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 
| Date: May 7, 2003 |                            |
|-------------------|---------------------------------|
|              |                            |
|              |                            |
|              | *   /s/ Sandra G. Sciutto* |   |
|              | Sandra  G. Sciutto              |
|              | Chief  Financial Officer        |

 

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