**This Form 10-Q consists of 23 sequentiallynumbered pages.**

** **

**FORM 10-Q**

** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

** **

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

 

**For the quarterly period ended March 31, 2005**

 

**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 area code: **(949) 250-7700**

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15 (d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days:

 

Yes  ý                    No o

 

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

 

Yes  ý                    No o

 

Thenumber of shares of Common Stock outstanding at April 29, 2005 was 10,160,212.

 

 

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CALIFORNIA COASTAL COMMUNITIES, INC.

 

FORM 10-Q

 

FOR THE QUARTER ENDED MARCH 31, 2005

 

I N D E X

 
| Part I -  | Financial  Information:    |                                                                                                  |
|----------------|----------------------------|-------------------------------------------------------------------------------------------------------|
|           |                       |
|           | Item 1 -                   | Consolidated Financial  Statements                                                                    |   |
|           |                       |
|           |                       | Consolidated Balance Sheets  -  March 31, 2005 and December 31, 2004 (unaudited)            |   |
|           |                       |
|           |                       | Consolidated  Statements of Operations -  Three Months Ended March 31, 2005 and 2004 (unaudited) |   |
|           |                       |
|           |                       | Consolidated  Statements of Cash Flows -  Three Months Ended March 31, 2005 and 2004 (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         |                                                                                                  |
|           |                       |                                                                                                  |   |
| SIGNATURE      |                       |

 

2

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PART I. FINANCIAL INFORMATION

 

ITEM 1 – FINANCIALSTATEMENTS

 

 CALIFORNIA COASTAL COMMUNITIES,INC.

 

CONSOLIDATED BALANCE SHEETS

 

(unaudited)

 

(in millions)

 
| ** **                                                                                                                              | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                              |       |                     |       |                        |       |
|                                                                                                                                    |       |                     |       |                        |       |
| Cash and cash  equivalents                                                                                                              |       | $                        | 15.3       |                        | $          | 9.0 |   |
| Restricted cash                                                                                                                         |       | 1.1                      |       | 1.1                         |       |
| Real estate held  for current development or sale                                                                                       |       | 53.8                     |       | 49.9                        |       |
| Consolidated  real estate to be held for current development - not owned                                                                |       | 24.7                     |       | 24.7                        |       |
| Land held for  future development or sale                                                                                               |       | 156.8                    |       | 156.4                       |       |
| Deferred tax  assets                                                                                                                    |       | 47.7                     |       | 3.6                         |       |
| Other assets                                                                                                                            |       | 6.3                      |       | 6.1                         |       |
|                                                                                                                                    |       |                     |       |                        |       |
|                                                                                                                                    |       | $                        | 305.7      |                        | $          | 250.8 |   |
|                                                                                                                                    |       |                     |       |                        |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                          |       |                     |       |                        |       |
|                                                                                                                                    |       |                     |       |                        |       |
| Liabilities:                                                                                                                            |       |                     |       |                        |       |
| Accounts payable  and accrued liabilities                                                                                               |       | $                        | 10.9       |                        | $          | 15.0 |   |
| Project debt                                                                                                                            |       | 37.5                     |       | 22.6                        |       |
| Consolidated  obligations related to real estate - not owned                                                                            |       | 24.7                     |       | 24.7                        |       |
| Other  liabilities                                                                                                                      |       | 9.2                      |       | 9.3                         |       |
|                                                                                                                                    |       |                     |       |                        |       |
| Total  liabilities                                                                                                                      |       | 82.3                     |       | 71.6                        |       |
|                                                                                                                                    |       |                     |       |                        |       |
| Minority  interest                                                                                                                      |       | .1                       |       | .3                          |       |
|                                                                                                                                    |       |                     |       |                        |       |
| Commitments and  contingencies                                                                                                          |       |                     |       |                        |       |
|                                                                                                                                    |       |                     |       |                        |       |
| Stockholders’  equity:                                                                                                             |       |                     |       |                        |       |
| Common Stock—$.05  par value; 11,000,000 shares authorized; 10,160,212 and 10,130,212 shares  issued and outstanding, respectively |       | .5                       |       | .5                          |       |
| Excess Stock—$.05  par value; 11,000,000 shares authorized; no shares outstanding                                                  |       | —                   |       | —                      |       |
| Capital in  excess of par value                                                                                                         |       | 191.6                    |       | 152.8                       |       |
| Retained  earnings                                                                                                                      |       | 32.9                     |       | 28.2                        |       |
| Accumulated  other comprehensive loss                                                                                                   |       | (1.7                     | )          | (2.6                        | )          |
| Total  stockholders’ equity                                                                                                        |       | 223.3                    |       | 178.9                       |       |
|                                                                                                                                    |       |                     |       |                        |       |
|                                                                                                                                    |       | $                        | 305.7      |                        | $          | 250.8 |   |

 

See the accompanying notes to consolidated financial statements.

 

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CALIFORNIA COASTAL COMMUNITIES, INC.

 

CONSOLIDATED STATEMENTSOF OPERATIONS

 

(in millions, except per share amounts)

 

(unaudited)

 
| ** **                                                 | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                 | ** ** | **2005**                               | ** ** | **2004** | ** ** |
|                                                       |       |                                   |       |   |   |
| Revenues                                                   |       | $                                      | 6.5        |   | $ | 5.6 |   |
|                                                       |       |                                   |       |   |   |
| Costs of sales                                             |       | 4.8                                    |       | 4.3 |   |
|                                                       |       |                                   |       |   |   |
| Gross operating  profit                                    |       | 1.7                                    |       | 1.3 |   |
|                                                       |       |                                   |       |   |   |
| Selling, general  and administrative expenses              |       | 1.2                                    |       | .9 |   |
| Interest expense                                           |       | —                                 |       | .1 |   |
| Income from  unconsolidated joint ventures                 |       | —                                 |       | (.1 | ) |
| Other expense,  net                                        |       | .2                                     |       | — |   |
|                                                       |       |                                   |       |   |   |
| Income before  income taxes                                |       | .3                                     |       | .4 |   |
|                                                       |       |                                   |       |   |   |
| Provision  (benefit) for income taxes                      |       | (4.5                                   | )          | .1 |   |
|                                                       |       |                                   |       |   |   |
| Minority  interest in income of consolidated joint venture |       | .1                                     |       | — |   |
|                                                       |       |                                   |       |   |   |
| Net income                                                 |       | 4.7                                    |       | .3 |   |
|                                                       |       |                                   |       |   |   |
| Other  comprehensive income, net of income taxes:          |       |                                   |       |   |   |
| Minimum pension  liability income tax benefit              |       | .9                                     |       | — |   |
|                                                       |       |                                   |       |   |   |
| Comprehensive  income                                      |       | $                                      | 5.6        |   | $ | .3 |   |
|                                                       |       |                                   |       |   |   |
| Earnings per  common share:                                |       |                                   |       |   |   |
|                                                       |       |                                   |       |   |   |
| Basic                                                      |       | $                                      | .46        |   | $ | .03 |   |
|                                                       |       |                                   |       |   |   |
| Diluted                                                    |       | $                                      | .43        |   | $ | .03 |   |
|                                                       |       |                                   |       |   |   |
| Common  equivalent shares:                                 |       |                                   |       |   |   |
|                                                       |       |                                   |       |   |   |
| Basic                                                      |       | 10.2                                   |       | 10.1 |   |
|                                                       |       |                                   |       |   |   |
| Diluted                                                    |       | 10.9                                   |       | 10.8 |   |

 

See the accompanyingnotes to consolidated financial statements.

 

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CALIFORNIA COASTAL COMMUNITIES, INC.

 

CONSOLIDATED STATEMENTSOF CASH FLOWS

 

(in millions)

 

(unaudited)

 
| ** **                                                                 | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                 | ** ** | **2005**                               | ** ** | **2004** | ** ** |
|                                                                       |       |                                   |       |   |   |
| Cash flows from  operating activities:                                     |       |                                   |       |   |   |
| Net income                                                                 |       | $                                      | 4.7        |   | $ | .3 |   |
| Adjustments to  reconcile net income to cash used in operating activities: |       |                                   |       |   |   |
| Non-cash  interest expense                                                 |       | —                                 |       | .1 |   |
| Non-cash benefit  from reversal of deferred tax asset allowance            |       | (4.7                                   | )          | — |   |
| Gains on sales  of real estate held for current development or sale        |       | (1.7                                   | )          | (1.3 | ) |
| Minority  interest in income of consolidated joint venture                 |       | .2                                     |       | — |   |
| Proceeds from  asset sales, net                                            |       | 6.5                                    |       | 5.6 |   |
| Investments in  real estate held for current development or sale           |       | (8.7                                   | )          | (7.8 | ) |
| Investments in  land held for future development or sale                   |       | (.4                                    | )          | (.6 | ) |
| Changes in  assets and liabilities:                                        |       |                                   |       |   |   |
| Increase in  other assets                                                  |       | (.2                                    | )          | — |   |
| Decrease in  accounts payable, accrued and other liabilities               |       | (4.2                                   | )          | (3.0 | ) |
|                                                                       |       |                                   |       |   |   |
| Cash used in  operating activities                                         |       | (8.5                                   | )          | (6.7 | ) |
|                                                                       |       |                                   |       |   |   |
| Cash flows from  financing activities:                                     |       |                                   |       |   |   |
| Borrowings of  project debt                                                |       | 18.2                                   |       | 2.2 |   |
| Repayments of  project debt                                                |       | (3.3                                   | )          | — |   |
| Proceeds from  exercise of stock options                                   |       | .3                                     |       | — |   |
| Minority  interest distributions                                           |       | (.4                                    | )          | — |   |
|                                                                       |       |                                   |       |   |   |
| Cash provided by  financing activities                                     |       | 14.8                                   |       | 2.2 |   |
|                                                                       |       |                                   |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                      |       | 6.3                                    |       | (4.5 | ) |
|                                                                       |       |                                   |       |   |   |
| Cash and cash  equivalents - beginning of period                           |       | 9.0                                    |       | 14.7 |   |
|                                                                       |       |                                   |       |   |   |
| Cash and cash  equivalents - end of period                                 |       | $                                      | 15.3       |   | $ | 10.2 |   |
|                                                                       |       |                                   |       |   |   |
| Supplemental  disclosures of cash flow information:                        |       |                                   |       |   |   |
| Cash paid during  the period for income taxes                              |       | $                                      | (.8        | ) | $ | (.4 | ) |

 

See the accompanying notes to consolidated financial statements.

 

5

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CALIFORNIA COASTAL COMMUNITIES, INC.

 

NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS

(UNAUDITED)

 

**Note 1 -Basis of Presentation**

 

The accompanying financial statements have been preparedby California Coastal Communities, Inc. and its consolidated subsidiaries(the “Company”), without audit, pursuant to the rules and regulations ofthe Securities and Exchange Commission. Certain information and footnotedisclosures normally included in financial statements prepared in accordancewith generally accepted accounting principles have been condensed or omittedpursuant 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 theyear ended December 31, 2004. Intercompany accounts and transactions havebeen eliminated.  Certain prior yearamounts have been reclassified to conform to the current year presentation.

 

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 -Significant Accounting Policies**

 

*Earnings Per Common Share*

 

The weighted-average number of common sharesoutstanding was 10.2 million and 10.1 million for the three months ended March 31,2005 and 2004, respectively.  Earningsper share, assuming dilution, are computed using the weighted-average number ofcommon shares outstanding and the dilutive effect of potential common sharesoutstanding. For the three months ended March 31, 2005 and 2004, theaverage market price of the Company’s common stock exceeded the exercise priceof outstanding stock options.  Therefore,the dilutive effect of the weighted average number of common shares frompotential exercise of approximately 700,000 options is reflected in the 10.9million and 10.8 million weighted-average common shares assuming dilution,respectively, in the related consolidated statements of operations.

 

*Real Estate*

 

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

 

The cost of sales of multi-unit projects is generallycomputed using the relative sales value method. Interest cost is capitalized toreal estate projects during their development and construction period.

 

6

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*Impairment of Long-Lived Assets*

 

The Company assesses the impairment of land held forfuture development and other long-lived assets in accordance with Statement ofFinancial Accounting Standards (“SFAS”) No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets”, which requires that an impairedasset, for which costs cannot be recovered from estimated undiscounted futurecash flows, be written down to fair value. Long-lived assets are reviewed forimpairment whenever events or changes in circumstances indicate that thecarrying amount of an asset may not be recoverable. As provided by SFAS No. 144,impairment is evaluated by comparing an asset’s carrying value to theundiscounted estimated cash flows expected from the asset’s operations andeventual disposition. If the sum of the undiscounted estimated future cashflows is less than the carrying value of the asset, an impairment loss isrecognized based on the fair value of the asset. If impairment occurs, the fairvalue of an asset for purposes of SFAS No. 144 is deemed to be theamount a willing buyer would pay a willing seller for such asset in a currenttransaction. On September 2, 1997, the Company completed itsRecapitalization pursuant to court confirmation of a Prepackaged Plan ofReorganization, and the Company applied the principles required by the AmericanInstitute of Certified Public Accountants Statement of Position (“SOP”) 90-7,“Financial Reporting by Entities in Reorganization Under the Bankruptcy Code” (“Fresh-StartReporting”), and the carrying value of real estate properties was adjusted tofair value.  Following the CaliforniaCoastal Commission’s November 2000 approval of suggested modifications tothe Bolsa Chica Local Coastal Program, which would limit development to onlythe upper bench of the Company’s 208-acre mesa property (“Bolsa ChicaMesa”) (see Note 3), the Company evaluated this asset’s carrying value. TheCompany has updated its analysis at each year-end since December 31, 2000.Since the undiscounted estimated future cash flows from the upper bench of theBolsa Chica Mesa (the “Upper Mesa”) and the Company’s pending sale of its 103-acreLower Bench at Bolsa Chica exceed its carrying value, there has been noimpairment.

 

In accordance with SFAS No. 144, in developingestimated future cash flows for impairment testing, the Company hasincorporated its own assumptions regarding the entitlement prospects of landheld for future development and its own market assumptions including thoseregarding home prices, infrastructure and home-building costs regarding bothland held for future development (see Management’s Discussion and Analysis) andreal estate held for current development or sale.  Additionally, as appropriate, the Companyidentifies alternative courses of action to recover the carrying value of itslong-lived assets and evaluates all likely alternatives under aprobability-weighted approach as described in SFAS No. 144.

 

*Consolidation of Variable InterestEntities*

 

A Variable InterestEntity (“VIE”) is created when (i) the equity investment at risk is notsufficient to permit the entity from financing its activities withoutadditional subordinated financial support from other parties or (ii) equityholders either (a) lack direct or indirect ability to make decisions aboutthe entity, (b) are not obligated to absorb expected losses of the entityor (c) do not have the right to receive expected residual returns of theentity if they occur.  If an entity is deemedto be a VIE, pursuant to Financial Interpretation FIN No. 46, “Consolidationof Variable Interest Entities – an interpretation of ARB No. 51.” (“FIN 46”),an enterprise that has the majority of the variability in gains and losses ofthe VIE is considered to be the primary beneficiary and must consolidate theVIE.  FIN 46 was effective immediatelyfor VIEs created after January 31, 2003.

 

Based on the provisionsof FIN 46, the Company has concluded that whenever it options land or lots froman entity and pays a non-refundable deposit, a VIE may be created undercondition (ii)(b) and (c) of the previous paragraph.  The Company may be deemed to have providedsubordinated financial support, which refers to variable interests that willabsorb some or all of an entity’s expected theoretical losses if theyoccur.  For each VIE created with asignificant nonrefundable option fee, the Company will compute expected losses and residual returns based onthe probability of future cash flows as outlined in FIN 46.  If the Company is deemed to be the primarybeneficiary of the VIE, the VIE will be consolidated on the Company’s balancesheet.  The fair value of the VIE’s realestate will be reported as consolidated real estate to be held for currentdevelopment - not owned and the related theoretical liability will be reportedas consolidated obligations related to real estate - not owned.

 

The Company’s exposure toloss as the result of a purchase contract with a VIE is limited to the amountof the non-refundable option deposit, which is typically 10% or less of thepurchase price, not total assets on the balance sheet of the VIE.  Therefore, the Company believes thatconsolidating the VIE does not reflect the economic realities or risks ofowning and developing land.  The Companyhas no material third party guarantees related to these contracts.  Creditors of these VIEs, if any, have norecourse against the Company.

 

7

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During November 2004, the Company entered into anagreement to purchase land from a third party entity deemed to be a VIE, withthe Company as the primary beneficiary of the entity.  Because the Company does not have access tothe financial information of the VIE, the fair value of the optioned propertyless the cash deposit and consolidated obligations related to consolidated realestate - not owned of $24.7 million is reflected on the Company’s balance sheetas of March 31, 2005 and December 31, 2004.  Not all of the Company’s deposits are withVIEs.  See Note 8 – Real Estate Matters.

 

*Recent Accounting Pronouncements*

 

In December 2004, the Financial AccountingStandards Board (“FASB”) issued SFAS No. 123 (revised 2004), “Share-BasedPayment”.  This Statement replaces SFAS123, “Accounting for Stock-Based Compensation” and supersedes APB 25.  SFAS No. 123R addresses the accountingfor share-based payment transactions in which an enterprise receives employeeservices in exchange for (a) equity instruments of the enterprise or (b) liabilitiesthat are based on the fair value of the enterprise’s equity instruments or thatmay be settled by the issuance of such equity instruments.  SFAS No. 123R eliminates the ability toaccount for share-based compensation transactions using the intrinsic valuemethod under APB 25, and generally would require instead that such transactionsbe accounted for using a fair-value-based method.  The Company is currently evaluating SFAS No. 123Rto determine which fair-value-based model and transitional provision it willfollow upon adoption.  SFAS No. 123Rwill be effective for the Company beginning in the first quarter of 2006.  The Company is evaluating the impactapplication of SFAS No. 123R will have on the Company’s results ofoperations.

 

In December 2004, the FASB issued SFAS No. 153,“Exchanges of Nonmonetary Assets – An amendment of APB 29, Accounting forNonmonetary Transactions”.  Thisstatement amends APB 29 to eliminate the exception for nonmonetary exchanges ofsimilar productive assets and replaces it with a general exception forexchanges of nonmonetary assets that do not have commercial substance.  A nonmonetary exchange has commercialsubstance if the future cash flows of the entity are expected to changesignificantly as a result of the exchange. The Company will evaluate the effect, if any, of adopting SFAS 153.

 

**Note 3 -Land Held for Future Development or Sale**

 

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

 

On April 14, 2005, the Company obtained approval fromthe California Coastal Commission for a Coastal Development Permit (“CDP”) tobuild 349 homes on 68 acres of its approximately 105-acre upper bench ofthe Bolsa Chica Mesa (“Upper Mesa”).

 

The Company currently expects that a CDP could beissued by the end of 2005, subject to satisfying the Coastal Commission’s permitconditions.  The Company will be workingdiligently over the next several months to satisfy the various conditionsnecessary for the Coastal Commission to issue the permit.  While it is difficult to predict how longthis will take, the Company currently expects to begin grading during the firsthalf of 2006, begin building model homes in the second half of 2006 and startselling homes in the first half of 2007. However, there can be no assurance in that regard, or as to (i) whendevelopment could commence, or (ii) the absence of further litigation oradministrative delay.

 

During 2002, the County of Orange approved a site planand tentative tract map for development of 379 single-family homes on 77 acresof the Upper Mesa.  Subsequentmodifications approved by the Coastal Commission reduced the development areaby nine acres and 30 homes.  As a resultof the modifications made to the development plans by the Company and approvedby the Coastal Commission, further approval will be required by the County ofOrange.  Based on discussions with theCounty staff, the Company expects that such approval will be processed by theCounty’s staff without a public hearing.

 

The planned community at Bolsa Chica, known as “Brightwater”is currently expected to offer a broad mix of home choices, averaging 2,740square feet and ranging in size from 1,560 square feet to 4,000 squarefeet.  The plan also includes 37 acres ofopen space and conservation area on the 105-acre Upper Mesa.  With only 349 homes on 68 acres of 

 

8

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the Upper Mesa, the resulting low-density plan equates to approximately5 homes per acre, consistent and compatible with the neighboring HuntingtonBeach communities. In addition, the Company will offer to dedicate 51 acres ofland on the Huntington Mesa to the County of Orange to complete the Harriett M.Wieder Linear Park, a 105-acre planned regional park. The 1,200-acreBolsa Chica Wetlands are fully preserved and protected in accordance withprevious agreements with the State of California and are not included in theBrightwater plan.

 

On August 12, 2004, an agreement to sell a 103-acreparcel of the Bolsa Chica Mesa known as the “Lower Bench” to the State’sWildlife Conservation Board (“WCB”) for $65 million was approved by theWCB.  The sale remains subject toshareholder approval and the terms of the agreement include an outside closingdate of June 30, 2005. If the proposed sale is completed, WCB’s purchaseof the property will be funded with bond proceeds authorized by voter-approvedProposition 50, which was passed in November 2002.  The Company has indicated that it willrequire shareholder approval and issuance of the CDP for the Upper Mesa by theCoastal Commission prior to closing the sale. Therefore, the Company has initiated discussions with the WCB to extendthe outside closing date for completing the sale in order to allow time for ashareholder vote and to satisfy the conditions for issuance of the CDP, whichmay take six to nine months to complete. The WCB has indicated a willingness to extend the outside closing dateto December 31, 2005.  However,there can be no assurances that a sale transaction will ever be completed.

 

On September 2, 1997, the Company completed arecapitalization pursuant to court confirmation of a Prepackaged Plan ofReorganization (the “Recapitalization”), and the Company applied the principlesrequired by the American Institute of Certified Public Accountant’s Statementof Position (“SOP”) 90-7, “Financial Reporting by Entities inReorganization Under the Bankruptcy Code” (“Fresh-Start Reporting”), and thecarrying value of land held for development (Bolsa Chica) was adjusted to fairvalue.  The fair value was determined in1997 using discounted estimated cash flows expected from the asset’s operationsand eventual disposition.  The Companyhas updated its analysis at each year-end since 1997, and has noted noindicators of impairment since that date. Future costs incurred forcapitalizable development activities for the Bolsa Chica project will increasethe basis of the land. An estimate for these costs has been included in theCompany’s estimated undiscounted cash flow forecast used in its impairmentanalyses. In accordance with the Company’s policy described in Note 2 –Impairment of Long-Lived Assets, since the estimated undiscounted future cashflows from the proposed Upper Mesa development plan for 349 single-family homesand the pending sale of the Lower Bench to WCB are expected to exceed itscarrying value, the Company believes there has been no impairment.

 

The estimation process involved in the determinationof value is inherently uncertain since it requires estimates as to futureevents and market conditions. Such estimation process assumes the Company’sability to complete development and disposition of its real estate propertiesin the 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. Thedevelopment of the Company’s Upper Mesa project is dependent upon satisfyingthe Coastal Commission’s conditions of approval, market conditions and economicfactors. Accordingly, the amount ultimately realized from such project maydiffer materially from current estimates and the project’s carrying value.

 

**Note 4 –Project Debt**

 

In conjunction with the acquisition of single-familyresidential lots, the Company’s homebuilding subsidiary, Hearthside Homes, Inc.and its subsidiaries, enter into construction loan agreements with a commercialbank.  These loan facilities finance aportion of the land acquisition and the majority of the construction ofinfrastructure and homes.  The loans aresecured by deeds of trust on individual projects and require principalrepayments upon the delivery of homes. The loans bear an interest rate of prime plus three-fourths percent (6.5% at March 31, 2005).  During the threemonths ended March 31, 2005, subsidiaries of Hearthside Homes, Inc.entered into two new loan facilities aggregating $23.3 million in conjunctionwith the acquisitions and development of a total of 33 single familyresidential lots, including 27 

 

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acquired during 2004.  Thefollowing amounts were available and outstanding under these loan facilities asof March 31, 2005 and December 31, 2004 ($ in millions):

 
| ** **      | ** ** | ** **              | ** ** | ** **          | ** ** | ** **         | ** ** | **Outstanding at**       | ** ** |
|-----------------|------------|-------------------------|------------|---------------------|------------|--------------------|------------|--------------------------|------------|
| ** **      | ** ** | **Amount  of Facility** | ** ** | **Number  of Lots** | ** ** | **Maturity  Date** | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|            |       |                    |       |                |       |               |       |                     |       |   |   |
| Riverside       |       | $                       | 2.3        |                | —     |               | Repaid     |                     | $          | — |   | $ | 2.3 |   |
| Chino II        |       | 6.3                     |       | 17                  |       | 5/11/05            |       | 3.4                      |       | 1.7 |   |
| Rancho Santa Fe |       | 5.2                     |       | 8                   |       | 5/19/05            |       | 2.8                      |       | 1.6 |   |
| Lancaster       |       | 10.7                    |       | 104                 |       | 5/23/05            |       | 7.1                      |       | 4.0 |   |
| Corona          |       | 21.1                    |       | 83                  |       | 5/24/05            |       | 12.6                     |       | 11.4 |   |
| Rancho Santa Fe |       | 3.9                     |       | 6                   |       | 6/13/05            |       | 1.2                      |       | 1.1 |   |
| Chino           |       | 9.6                     |       | 11                  |       | 7/29/05            |       | —                   |       | .5 |   |
| Riverside       |       | 7.9                     |       | 15                  |       | 3/27/06            |       | 4.6                      |       | — |   |
| Rancho Santa Fe |       | 15.4                    |       | 18                  |       | 3/27/06            |       | 5.8                      |       | — |   |
|            |       |                    |       |                |       |               |       |                     |       |   |   |
|            |       |                    |       |                |       |               |       | $                        | 37.5       |   | $ | 22.6 |   |
|                 |            |                         |            |                     |            |                    |            |                          |            |  |  |  |  |  |

 

For the three months ended March 31, 2005 and 2004,approximately $400,000 and $100,000, respectively, of construction period interestincurred was capitalized.

 

**Note 5 -Other Liabilities**

 

Other liabilities werecomprised of the following (in millions):

 
| ** **                                          | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|-----------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Accrued pensions  and benefits                      |       | $                        | 4.9        |                        | $          | 4.9 |   |
| Home warranty  reserves                             |       | 1.6                      |       | 1.6                         |       |
| Contingent  indemnity and environmental obligations |       | 3.4                      |       | 3.5                         |       |
| Unamortized  discount                               |       | (.7                      | )          | (.7                         | )          |
|                                                |       | $                        | 9.2        |                        | $          | 9.3 |   |

 

Contingent indemnity and environmental obligationsprimarily reflect (i) reserves before related discount (recorded pursuantto Fresh-Start Reporting) for contingent indemnity obligations for businessesdisposed of by former affiliates and unrelated to the Company’s currentoperations, and (ii) the contingent liability of a subsidiary of theCompany for PCB contamination on its 43-acre Bolsa Chica lowlandsproperty as further described below.

 

*Dresser Litigation*

 

In May 2002, Dresser Industries, Inc. (“Dresser”)filed litigation, captioned Dresser Industries, Inc. vs. CaliforniaCoastal Communities, Inc. and RESCO Holdings, Inc. (“RESCO”, a formeraffiliate), in the 58th Judicial District Court of Jefferson County,Texas.  Dresser sought a declaratoryjudgment regarding the rights and obligations of the parties under a January 1988purchase agreement. Dresser’s indemnity claims related to several hundredlawsuits encompassing approximately 5,900 contested asbestos claims made bythird parties in connection with work in facilities in which theDresser-acquired engineering and construction business was allegedly connected.The Company denied Dresser’s allegations and vigorously defended itself in thiscase and related matters.  On April 6,2005, RESCO and the Company settled this litigation with Dresser and theCompany paid $1.33 million, its share of the settlement, which is the amount ofthe Company’s litigation accrual as of March 31, 2005 and December 31,2004.  The Company and RESCO did notadmit fault or liability with respect to Dresser’s claims, but settled thematter in order to avoid the continued cost and uncertainty of litigation.

 

*Lowland Remediation*

 

In September 1997, the Company acquired 43 acresin the Bolsa Chica lowlands with the intent of selling it to the State ofCalifornia in connection with their planned restoration of 1,000 acres ofadjacent wetlands.  While the State isnegotiating to acquire this property from the Company, no such agreement hasbeen reached to date and there can be no assurances that any agreement willever be reached.  However, inanticipation of entering into a purchase agreement, 

 

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the State performed limited soils sampling on this property andnotified the Company in 1999 that it had discovered contamination from a groupof chemicals called PCBs.  The source ofthe contamination is presently unknown; however, the Company has neverconducted any development, business or operations on this property.  In January 2002, the State’s Departmentof Toxic Substances Control (“DTSC”) became the regulatory agency responsiblefor overseeing the Company’s efforts to remediate the contamination on thisproperty.  In July 2002, asubsidiary of the Company entered into a consent order with DTSC regardingremediation.  The Company’s subsidiaryprepared a Remedial Investigation (“RI”) Workplan, which was approved by DTSCin August 2003.  During 2003, thesubsidiary performed soil sampling at the site according to the RI Workplan todetermine the nature and extent of contamination, and submitted an RI Report toDTSC in February 2004.  A RemedialAction Workplan (“RAW”) was approved by DTSC in December 2004.  As of March 31, 2005, the subsidiary hasaccrued approximately $700,000 for environmental testing and remediation ofthis property. While the accrual reflects the estimate for the minimum costswhich are probable and estimable, such accrual may not be adequate to satisfythe full amount of remediation that may be required by the DTSC.

 

In May 2004, the Company’s subsidiary received aninvoice from DTSC seeking reimbursement for $793,000 of oversight andremediation costs incurred by DTSC with respect to PCBs found on neighboringresidential properties.  Since receivingthe original invoice, the Company’s subsidiary has received four similarinvoices for an aggregate additional $94,000 including accrued interest.  However, the Company’s subsidiary contends,based upon advice of counsel, that it is not responsible for such costs becausethe Company did not develop or build the neighboring residential properties,the Company did not generate the contamination, the contamination did notemanate from the Company’s property and the 43-acre site should not bepart of the same “site” as the residential properties. Furthermore, the Company’ssubsidiary has also disputed such charges due to the fact that DTSC did notbill the Company’s subsidiary in accordance with the requirements of theapplicable law. The Company’s subsidiary intends to vigorously defend itself inthis matter. Therefore, the Company has not accrued for any of DTSC’s $887,000of claims related to these residential properties.

 

*Home Warranty Reserve*

 

The Company provides a home warranty reserve toreflect its contingent obligation for product liability. The Company generallyrecords a provision as homes are delivered, based upon historical and industryexperience, subject to certain minimums. The home warranty reserve activity ispresented below (in millions):

 
| ** **                      | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------------------|------------|----------------------------------------|------------|
| ** **                      | ** ** | **2005**                               | ** ** | **2004** | ** ** |
|                            |       |                                   |       |   |   |
| Balance at  beginning of period |       | $                                      | 1.6        |   | $ | 1.2 |   |
| Provision                       |       | .1                                     |       | — |   |
| Payments                        |       | (.1                                    | )          | — |   |
| Balance at end  of period       |       | $                                      | 1.6        |   | $ | 1.2 |   |

 

**Note 6 - Income Taxes**

 

Thefollowing is a summary of the tax provision (benefit):

 
| ** **                                               | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                               | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| Current taxes                                            |       | $                                      | .1         |   | $ | — |   |
| Deferred taxes                                           |       | .1                                     |       | .2 |   |
| Reversal of  valuation allowances on deferred tax assets |       | (4.7                                   | )          | — |   |
| Reduction in  contingent tax liabilities                 |       | —                                 |       | (.1 | ) |
| Provision  (benefit) for income taxes                    |       | $                                      | (4.5       | ) | $ | .1 |   |

 

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 future taxable income.  As aresult of the California Coastal Commission’s approval of the Company’sdevelopment plan for the Bolsa Chica Upper Mesa on April 14, 2005, theCompany has concluded that it is more likely than not that it will utilize

 

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all of its deferred tax assets. Therefore, during the three months ended March 31, 2005, theCompany has recorded a reversal of valuation allowances on post-reorganization NOLsand other deferred tax assets of approximately $4.7 million, which is reflectedin the tax benefit.  Pursuant to FreshStart Reporting, also during the three months ended March 31, 2005, a reversalof valuation allowance on federal Pre-reorganization NOLs of approximately $38.5million was reflected by increasing the Company’s capital in excess of parvalue.

 

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 the Company’sequity before the ownership change, multiplied by the long-term tax-exemptrate. The Company estimates that after giving effect to various transactions bystockholders who hold a 5% or greater interest in the Company, it hasexperienced a three-year cumulative ownership shift of approximately 38% as of April 25,2005.

 

The federal NOLs available as of March 31, 2005were approximately $167 million. The amount of federal NOLs which expire if notutilized is zero, $10 million, $8 million, $21 million, $11 million and $117million for  2005, 2006, 2007, 2008, 2009and thereafter, respectively.

 

In October 1999, in response to an unsolicitedwritten consent from a majority of its stockholders, the Company amended itscertificate of incorporation in order to protect the ability of the Company toutilize its tax loss carryforwards. Since the Company’s use of its NOLs wouldbe severely restricted if it experiences an ownership change of more than 50%,the Company’s majority stockholders requested that the Board of Directors enactthe amendments, which were determined to be in the best interest of the Companyand its stockholders. The amendments prohibit future purchases of the Company’scommon stock by persons who would become new 5% holders, and also prohibit currentholders of over 5% from increasing their positions, except in certainpermissible circumstances which would not jeopardize the Company’s ability touse its NOLs. While these amendments reduced the Company’s risk of an ownershipchange occurring due to the acquisition of shares by 5% stockholders, the riskremains that an ownership change could result from the sale of shares byexisting 5% stockholders. During August 2004, the Company announced thatit would not approve further purchases in the foreseeable future.  However, since the calculation of thecumulative ownership shift is based on a rolling three years, the Company’sBoard of Directors will re-evaluate such requests in the future.

 

**Note 7 –Minority Interest**

 

In April 2003, the Company entered into a LimitedLiability Company (“Chino LLC”) joint venture agreement for the purpose ofdesigning, constructing and selling 77 homes in Chino, California. The ChinoLLC acquired the 77 lots in May 2003 and is currently constructing andselling homes. Hearthside Homes, Inc. (one of the Company’s principalsubsidiaries) is the managing member of the Chino LLC, manages its operationsand contributed capital of approximately $400,000 (approximately 10%) to theventure. Minority interest represents the non-managing member’s equity interestin the venture including a capital contribution of approximately $4.0 million(approximately 90%), net of distributions and as adjusted for the member’sallocation of profits and losses. Profits and losses are generally allocated50% to each member, after a 10% preferred return on invested capital.    During the year ended December 31,2004, capital distributions of approximately $7.6 million were made to thenon-managing member, repaying all of its initial capital contribution, plus all$600,000 of accumulated preferred return and $3.1 million in profitdistributions, in conjunction with the delivery of the first 65 homes.  During the three months ended March 31,2005, additional distributions of $450,000 were made to the non-managing memberand the Company recorded minority interest in income of consolidated jointventure of $100,000, net of income tax benefit.

 

**Note 8 -Commitments and Contingencies**

 

*Real Estate Matters*

 

The Company is subject to the usual obligations associatedwith entering into contracts for the purchase of land and improved home sites.The purchase of properties under these contracts is generally contingent uponsatisfaction of certain requirements by the sellers, including obtainingapplicable property entitlements. The Company also utilizes option contractswith third-party land sellers and financial entities as a method of acquiringland in staged takedowns and minimizing the use of funds from other corporatefinancing sources. These option contracts also help to manage the financial andmarket risk associated with land holdings. Option contracts generally requirethe payment of a non-

 

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refundable cash deposit of 5% to 20% of the purchase price for theright to acquire lots over a specified period of time (usually one to twoyears) at predetermined prices. The Company has the right at its discretion toterminate its obligations under these land purchase and option agreements byforfeiting the cash deposit with no further financial responsibility.  Summary information regarding the Company’sland option deposits is as follows as of March 31, 2005:

 

| Total number of  projects                                                      |   | 4      |   |
|--------------------------------------------------------------------------------|--------|--------|--------|
|                                                                           |   |   |   |
| Total number of  lots                                                          |   | 351    |   |
|                                                                           |   |   |   |
| Total forfeited  deposits if lots are not purchased (included in other assets) |   | $      | 4.8    |   |
|                                                                           |   |   |   |
| Total remaining  purchase price                                                |   | $      | 40.6   |   |

 

During April 2005, the Company acquired three ofthe projects (249 lots) described above. The Company currently expects to complete the fourth purchase during thethird quarter of 2005.

 

The Company has outstanding performance and suretybonds, for the benefit of city and county jurisdictions, related principally toits obligations for site improvements at various projects.  The Company does not believe that draws uponthese bonds, if any, will have a material effect on the Company’s financialposition, results of operations or cash flows.

 

*Legal Proceedings*

 

See Note 5 for a discussion of settled litigationfiled against the Company by Dresser.

 

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

 

See Notes 3 and 5 for a discussion of othercontingencies.

 

*Corporate Indemnification Matters*

 

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

 

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

 

**Overview**

 

The Company is a residential land development andhomebuilding company with properties located primarily in Southern California.The principal activities of the Company and its consolidated subsidiariesinclude: (i) obtaining zoning and other entitlements for land it owns orcontrols through purchase options and improving the land for residentialdevelopment; and (ii) designing, constructing and selling single-familyresidential homes in Southern California. Once the residential land owned bythe Company is entitled, the Company may build homes, sell unimproved land toother developers or homebuilders, sell improved land to homebuilders, orparticipate in joint ventures with other developers, investors or homebuildersto finance and construct infrastructure and homes. During the remainder of2005, the Company will focus its immediate efforts to (i) satisfy theconditions required to complete the process of obtaining a Coastal DevelopmentPermit (“CDP”) from the California Coastal Commission (“Coastal Commission”) tobuild 349 homes on the upper bench of the Bolsa Chica Mesa (“Upper Mesa”), asfurther described in Note 3 to the Company’s Consolidated Financial Statements;and (ii) continue to expand its profitable homebuilding operations. However,the Company may also consider other strategic and joint venture opportunities;and there can be no assurance that the Company will accomplish, in whole or inpart, all or any of these strategic goals.

 

The Company currently has on-going Southern Californiaprojects in Riverside County near the cities of North Corona and Riverside, inthe cities of Chino and Ontario in San Bernardino County, in the city ofLancaster in northern Los Angeles County, and in the Rancho Santa Fe area inSan Diego County.  These homebuildingprojects are expected to generate cash flows and gross operating marginsthrough 2007.  With the April 14,2005 Coastal Commission approval of 349 homes on the Upper Mesa, the Company’sinventory of entitled land available for homebuilding projects represents approximatelya four-year supply at levels at or above recent years.  The Company is continuing to pursueresidential lot acquisition opportunities throughout Southern California,including increasing lot inventory in existing successful submarkets andexpansion into additional submarkets.  Inaddition, if the Company obtains entitlements for its Oxnard project, up toapproximately 543 additional single-family lots would be available forhomebuilding operations, however, these numbers are subject to change duringthe course of the entitlement process.

 

Bolsa Chica is the Company’s principal asset,representing 51% of total assets at March 31, 2005. On April 14,2005, the Company obtained approval from the Coastal Commission for a CoastalDevelopment Permit (“CDP”) to build 349 homes on 68 acres of its approximately105-acre upper bench of the Bolsa Chica Mesa (“Upper Mesa”).

 

The Company currently expects that a CDP could beissued by the end of 2005, subject to satisfying the Coastal Commission’s permitconditions.  The Company will be workingdiligently over the next several months to satisfy the various conditionsnecessary for the Coastal Commission to issue the permit.  While it is difficult to predict how longthis will take, the Company currently expects to begin grading during the firsthalf of 2006, begin building model homes in the second half of 2006 and startselling homes in the first half of 2007. However, there can be no assurance in that regard, or as to (i) whendevelopment could commence, or (ii) the absence of further litigation oradministrative delay.

 

During 2002, the County of Orange approved a site planand tentative tract map for development of 379 single-family homes on 77 acresof the Upper Mesa.  Subsequentmodifications approved by the Coastal Commission reduced the development areaby nine acres and 30 homes.  As a resultof the modifications made to the development plans by the Company and approvedby the Coastal Commission, further approval will be required by the County ofOrange.  Based on discussions with theCounty staff, the Company expects that such approval will be processed by theCounty’s staff without a public hearing.

 

The planned community at Bolsa Chica, known as “Brightwater”is currently expected to offer a broad mix of home choices averaging 2,740square feet and ranging in size from 1,560 square feet to 4,000 squarefeet.  The plan also includes 37 acres ofopen space and conservation area on the 105-acre Upper Mesa. With only349 homes on 68 acres of the Upper Mesa, the resulting low-density plan equatesto approximately 5 homes per acre, consistent and compatible with theneighboring Huntington Beach communities. In addition, the Company will offerto dedicate 51 acres of land on the Huntington Mesa to the County of Orange tocomplete the Harriett M. Wieder Linear Park, a 105-acre planned regionalpark. The 1,200-acre Bolsa Chica Wetlands are fully preserved andprotected in accordance with previous agreements with the State of Californiaand are not included in the Brightwater plan.

 

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On August 12, 2004, an agreement to sell a 103-acreparcel of the Bolsa Chica Mesa known as the “Lower Bench” to the State’sWildlife Conservation Board (“WCB”) for $65 million was approved by theWCB.  The sale remains subject toshareholder approval and the terms of the agreement include an outside closingdate of June 30, 2005. If the proposed sale is completed, WCB’s purchaseof the property will be funded with bond proceeds authorized by voter-approvedProposition 50, which was passed in November 2002.  The Company has indicated that it willrequire shareholder approval and issuance of the CDP for the Upper Mesa by theCoastal Commission prior to closing the sale. Therefore, the Company has initiated discussions with the WCB to extendthe outside closing date for completing the sale in order to allow time for ashareholder vote and to satisfy the conditions for issuance of the CDP, whichmay take six to nine months to complete. The WCB has indicated a willingness to extend the outside closing dateto December 31, 2005.  However,there can be no assurances that a sale transaction will ever be completed.

 

The following facts and assumptions were utilized bythe Company in evaluating the potential value which could be derived fromdevelopment of the Bolsa Chica Upper Mesa:

 

•                  TheUpper Mesa development plan encompasses 349 homes aggregating approximately950,000 square feet.

•                  Followingthe Coastal Commission’s approval on April 14, 2005, the Company currentlyexpects it may take approximately six to nine months to satisfy the Commission’spermit conditions, which are a pre-requisite to issuance of a CDP.

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

•                  TheCompany currently expects to begin grading during the first half of 2006, beginbuilding model homes in the second half of 2006 and start selling homes in thefirst half of 2007.

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

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

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

•                  Homeprices in the coastal Huntington Beach area (as well as other Orange Countycoastal areas) appreciated approximately 20% during 2004.  While demand continues to exceed the supplyof housing, pressure for continued appreciation of home prices may be reducedby any significant increases in interest rates.

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

 

Given the facts and circumstances described above, theCompany believes that the eventual development of the Upper Mesa and thepending sale of the Lower Bench will result in realization of an amount that issubstantially in excess of the $156.8 million book value presently reflected inthe Company’s consolidated financial statements.  From time to time, the Company has receivedoutside appraisals on an “as developed basis” which have supported the Company’sbeliefs, although there can be no assurance that those beliefs will be validated.

 

Real estate held for current development or sale andland held for future development (real estate properties) are carried at fairvalue as of September 2, 1997, following adoption of Fresh-Start Reportingas discussed in Note 2 to the Consolidated Financial Statements, as adjusted bysubsequent activity. The Company’s real estate properties are subject to anumber of uncertainties which can affect the values of those assets. Theseuncertainties include litigation or appeals of regulatory approvals (asdiscussed above) and availability of adequate capital, financing and cash flow.In addition, future values may be adversely affected by increases in propertytaxes, increases in the costs of labor and materials and other developmentrisks, changes in general economic conditions, including higher mortgageinterest rates, and other real estate risks such as the general demand forhousing and the supply of competitive products. Real estate properties do notconstitute liquid assets and, at any given time, it may be difficult to sell aparticular property for an appropriate price.

 

**Impact of Inflation; ChangingPrices and Economic Conditions**

 

Real estate and residential housing prices areaffected by inflation, which can cause increases in the price of land, rawmaterials and subcontracted labor. Unless these increased costs are recoveredthrough higher sales prices, gross margin from home sales would decrease. Ifinterest rates increase, construction and financing costs would also increase,which can also result in lower gross margin from home sales. The volatility ofinterest rates could have an adverse effect on the Company’s future operationsand liquidity. Among other things, these conditions may affect adversely thedemand for housing and the availability of mortgage financing and may reducethe credit facilities offered to the Company.

 

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There can be no assurance regarding the continuedhealth of the Southern California residential real estate market.  In particular, (i) the state of thenational economy and the level of employment growth, (ii) the State ofCalifornia’s budget deficit, and (iii) the volatility in the stock market,collectively may exert recessionary pressures on the California economy and mayhave a negative impact on the Southern California housing market.

 

While low mortgage rates have sustained housing demandto date, any significant future increase in mortgage rates or significant lossof jobs in Southern California would most likely slow demand for new homes.Increases in home mortgage interest rates make it more difficult for theCompany’s customers to qualify for home mortgage loans, potentially decreasinghome sales volume and prices. The tight supply of new homes in SouthernCalifornia has resulted in significant home price increases over the last fiveyears. As a result, the affordability of new homes has been declining and couldfurther jeopardize future demand.  Thepercentage of home buyers utilizing variable-rate and/or interest onlymortgages to afford Southern California new home prices has been increasing.  These buyers may be more sensitive toincreases in interest rates and may encounter difficulty in making increasedmortgage payments on their homes in the future. This could have negative consequences on the demand for new homes if itresults in reduced buyer confidence and an increase in secondary market homesavailable for sale, competing with sales of new homes.

 

Most of the Company’s active homebuilding projects arelocated in the “Inland Empire” area of Southern California, which includes Riversideand San Bernardino counties. None of the Company’s projects experienced anydirect impact from the Southern California fires during late 2003 or fromlandslides in early 2005. The Inland Empire has experienced significantpopulation and job growth in the past decade. While continued growth isexpected, partially due to the limited supply of affordably priced housing incoastal areas such as Orange County, there can be no assurance that economic,demographic or other factors will not slow, diminish or cause such growth todiscontinue. The Company is continuing to pursue land development and lotacquisition opportunities throughout Southern California.

 

**Critical Accounting Policies**

 

In the preparation of the Consolidated FinancialStatements, the Company applies accounting principles generally accepted in theUnited States. The application of generally accepted accounting principles mayrequire management to make estimates and assumptions that affect the amountsreported in the financial statements and accompanying results. Listed below arethose policies that the Company believes are critical and require the use ofcomplex judgment in their application. In particular, the Company’s criticalaccounting policies include the evaluation of the impairment of long-livedassets and the evaluation of the probability of being able to realize thefuture benefits indicated by its significant federal tax net operating losses,as discussed further in Notes 2 and 6 to the Consolidated Financial Statements.

 

*Impairment of Long-Lived Assets*

 

The Company assesses the impairment of land held forfuture development (the Bolsa Chica project) and real estate held for currentdevelopment or sale including long-lived assets in accordance with Statement ofFinancial Accounting Standards (“SFAS”) No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets”. These assets are carried at cost,unless the carrying amount of the parcel or subdivision is determined not to befully recoverable, in which case the impaired real estate is written down tofair value. Given the significance of the carrying value of land held forfuture development, the application of SFAS No. 144 in evaluating anypotential impairment is critical to the Company’s consolidated financialstatements, as discussed further in Notes 2 and 6 to the Consolidated FinancialStatements.

 

In accordance with SFAS No. 144, in developingestimated future cash flows for impairment testing, the Company hasincorporated its own assumptions regarding the entitlement prospects of landheld for future development and its own market assumptions including thoseregarding home prices, infrastructure and home-building costs regarding bothland held for future development and real estate held for current developmentor sale.  Additionally, as appropriate,the Company identifies alternative courses of action to recover the carryingvalue of its long-lived assets and evaluates all likely alternatives under aprobability-weighted approach as described in SFAS No. 144.

 

*Basis of Consolidation*

 

Certain wholly-owned subsidiaries of the Company aremembers in joint ventures involved in the development and sale of residentialprojects and residential loan production. The consolidated statements of theCompany include the accounts of the Company and all majority-owned andcontrolled subsidiaries and joint ventures. The financial statements 

 

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of joint ventures in which the Company generally has a controlling ormajority economic interest (and thus are controlled by the Company) areconsolidated with the Company’s financial statements. Minority interestrepresents the equity interest of the Company’s joint venture partner for oneconsolidated venture and is further described in Note 7 to the ConsolidatedFinancial Statements. The Company’s investments in unconsolidated jointventures are accounted for using the equity method when the Company does nothave voting or economic control of the venture operations, as further discussedin Note 4 to the Consolidated Financial Statements.

 

*Income Taxes*

 

The Company accounts for income taxes on the liabilitymethod. Deferred income taxes are determined based on the difference betweenthe financial statement and tax bases of assets and liabilities. The liabilitymethod requires an evaluation of the probability of being able to realize thefuture benefits indicated by deferred tax assets, such as tax net operatinglosses (“NOLs”). A valuation allowance related to the deferred tax asset isrecorded when it is more likely than not that some portion or all of thedeferred tax asset will not be realized. Given the significance of the Company’shistorical federal tax NOLs, as discussed in Note 6 to the ConsolidatedFinancial Statements, the application of the Company’s policy in evaluating theexpected future benefit of NOLs is critical. In applying those policies,estimates and judgments affect the amounts at which certain assets andliabilities are recorded. The Company applies its accounting policies on a consistentbasis. As circumstances change, they are considered in the Company’s estimatesand judgments, and future changes in circumstances could result in changes inamounts at which assets and liabilities are recorded.

 

*Homebuilding Revenues andCost of Sales*

 

The Company’s homebuilding operation generatesrevenues from the sale of homes to homebuyers. The majority of these homes aredesigned to appeal to move-up homebuyers and the homes are generally offeredfor sale in advance of their construction. Sales contracts are usually subjectto certain contingencies such as the buyer’s ability to qualify for financing.Revenue from the sale of homes is recognized at closing when title passes tothe buyer, and the earnings process is complete. As a result, the Company’srevenue recognition process does not involve significant judgments orestimates. However, the Company does rely on certain projections and estimatesto determine the related construction costs and resulting gross marginsassociated with revenues recognized. The cost of sales is recorded based upontotal estimated costs within a subdivision and allocated using the relativesales value method. The Company’s construction costs are comprised of directand allocated costs, including estimated costs for future warranties andindemnities. The Company’s estimates are based on historical results, adjustedfor current factors.

 

*Litigation Reserves*

 

The Company and certain of its subsidiaries have beennamed as defendants in various cases arising in the normal course of businessand regarding disposed assets and businesses of the Company or formeraffiliates (see Notes 5 and 8 to the Consolidated Financial Statements). TheCompany has reserved for costs expected to be incurred with respect to thesecases based upon information provided by its legal counsel. There can be noassurance that total litigation costs actually incurred will not exceed theamount of such reserve.

 

**Recent Accounting Pronouncements**

 

See discussion regarding recent accountingpronouncements in Note 2 to the Consolidated Financial Statements.

 

**Liquidity and Capital Resources**

 

The principal assets in the Company’s portfolio areresidential land which must be held over an extended period of time in order tobe developed to a condition that, in management’s opinion, will ultimatelymaximize the return to the Company. Consequently, the Company requiressignificant capital to finance its real estate development and homebuildingoperations. Historically, sources of capital have included loan facilitiessecured by specific projects, asset sales and available internal funds. TheCompany is utilizing internally generated cash to fund its Bolsa Chica landdevelopment project and joint venture contributions to fund the Oxnard landdevelopment project.   The Company isutilizing internally generated cash and project debt to fund construction ofits homebuilding projects. The Company’s current and pending homebuildingprojects, which are primarily in the “Inland Empire” area of SouthernCalifornia (Riverside and San Bernardino counties), are currently expected togenerate approximately $29.0 million of positive cash flows during the next 24months, after net investments in new projects to acquire 351 lots, based onpresent economic conditions and market assumptions. The Company’s unrestrictedcash and cash equivalents as of March 31, 2005 were 

 

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approximately $15.3 million. The Company utilized $5.5 million of thiscash in April 2005 to complete three acquisitions in Corona, Lancaster andOntario aggregating 249 lots. The Company believes that its cash and cashequivalents, future real estate sales proceeds, and funds available under itscredit agreements will be sufficient to meet anticipated operating and capitalinvestment requirements, primarily project development costs for homebuildingprojects, and the Oxnard and Bolsa Chica land development projects, along withgeneral and administrative expenses, for the next 12 months.

 

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

 

Summary information regarding the Company’s landoption deposits is as follows as of March 31, 2005:

 

| Total number of  projects                                                      |   | 4      |   |
|--------------------------------------------------------------------------------|--------|--------|--------|
|                                                                           |   |   |   |
| Total number of  lots                                                          |   | 351    |   |
|                                                                           |   |   |   |
| Total forfeited  deposits if lots are not purchased (included in other assets) |   | $      | 4.8    |   |
|                                                                           |   |   |   |
| Total remaining  purchase price                                                |   | $      | 40.6   |   |

 

During April 2005, the Company acquired three ofthe projects (249 lots) described above. The Company currently expects to complete the fourth purchase during thethird quarter of 2005.

 

 The Company mayenter into land development and homebuilding joint ventures from time to timeas a means of expanding its market opportunities, establishing strategicalliances, managing its risk profile and leveraging the Company’s capital base.These joint ventures may obtain secured acquisition, development andconstruction financing, which minimize the use of funds from other corporatefinancing sources.

 

**Land Development - UnconsolidatedJoint Venture**

 

*Oxnard.*  In February 2003, the Company enteredinto two option contracts to acquire land adjacent to the City of Oxnard inVentura County, California aggregating approximately 168 acres. The Company isin the process of developing a land plan for the area, which also includes anadditional 149 acres owned by other landowners, with the intention of entitlingthe property for residential development and annexing it to the City of Oxnard.The Company currently expects that the residential development plan willinclude approximately 700 single-family detached lots and approximately 800 attachedfamily residential units; however, these numbers are subject to change duringthe course of the entitlement process. Approximately 543 of the single-familylots and 490 of the attached units would be developed on the 168 acres ofoptioned land expected to be purchased by the Company.  The option contracts allow for two years,plus up to three additional years through the exercise of extensions, for theCompany to complete these entitlement activities in advance of consummating thepurchase transactions. The entitlement process is expected to be completedduring the second quarter of 2006; however, delays could be encountered.  During January 2005, the first six-monthoption extensions were exercised.  The option-holderhas the right in its sole discretion to terminate the obligations under theseoption agreements by forfeiting the cash deposits with no further financialresponsibility.

 

During October 2003, the Company entered into aLimited Liability Company (“Oxnard LLC”) joint venture agreement with a majorfinancial partner to pursue the Oxnard development opportunity. The Companyassigned the land purchase option contracts to the Oxnard LLC.  Hearthside Homes, Inc. (the Company’shomebuilding subsidiary) is the managing member of the Oxnard LLC, and hascontributed $500,000 to the venture. The non-managing member also made aninitial contribution of $500,000 to the venture. Capital contributions of up toan additional $4 million are to be made by the non-managing member. As of March 31,2005, the non-managing member had made an aggregate of approximately $3.2million of additional contributions. Under the Oxnard LLC operating agreement,if contributions in 

 

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excess of $5 million are required and approved by the members, the next$1 million would be contributed equally by the members. Total contributions ofthe non-managing member are generally limited to $5 million. After payment of a10% preferred return on invested capital to each member, first tier profits aregenerally allocated 75% to the non-managing member and 25% to the managingmember and second tier profits and losses over $5 million are generallyallocated 50% to each member. The first $5 million of losses are generallyallocated 80% to the non-managing member and 20% to the managing member.  While the Company exerts a large degree ofinfluence over the venture, the non-managing member does have various participatingrights such as approval rights with regard to major business decisions.  In addition, the Company is not the primarybeneficiary of the entity; therefore, the venture is not consolidated.

 

**Homebuilding**

 

The Company acquired 271 single-family residentiallots during 2004 and the first quarter of 2005, increasing lot inventory inRiverside and San Bernardino Counties and expanding into northern Los AngelesCounty and returning to the San Diego County market.  The Company also acquired an additional 249lots during April 2005, increasing inventory in existing markets, and hasan agreement to acquire an additional 102 lots in Beaumont in Riverside County.  Although home prices in Southern Californiahave increased 20% to 30% annually over the last few years, the Company doesnot expect appreciation to continue at that rate, but rather expects modestincreases of less than 10% over the next year. While the 10 home deliveries for the first quarter of 2005 are less thanthe 13 homes delivered in the first quarter of 2004, homebuilding revenues andmargins for 2005 exceeded first quarter 2004 results.  The record rainfall during the last quarterof 2004 and the first quarter of 2005 has negatively impacted the Company’sconstruction schedule and has resulted in the Company’s modest expectationfor home deliveries during the second quarter of 2005 and a more robust secondhalf, as in recent prior years.  TheCompany’s active homebuilding projects are described below.

 

*Riverside.*  During 2003 and 2004, the Company acquired 67lots for a project known as “Jasper Ranch” near the city of Riverside, inRiverside County, in the master-planned community known as “Victoria Grove”.The Company began construction of homes averaging 3,673 square feet during thethird quarter of 2003 and opened for sales on these homes during June 2003.The Company delivered the first phase of five homes during the fourth quarterof 2003 at an average price of approximately $468,000, and an additional 38homes during 2004, at an average price of approximately $612,000. The Companydelivered six additional homes during the first quarter of 2005 at an averageprice of $705,000.  As of May 2,2005, 15 of the 18 remaining homes are in escrow at an average price of$681,000.

 

*Chino.*  In May 2003, through a consolidatedjoint venture, the Company acquired 77 finished lots in Chino, California inSan Bernardino County. This infill site is part of a new community known as “TheReserve”, encompassing 244 homes. Construction of homes averaging approximately3,320 square feet began during the fourth quarter of 2003. The Company openedfor home sales in February 2004, and delivered 65 homes at an averageprice of $593,000 during 2004.  As of May 2,2005, all eight of the remaining eight homes are currently in escrow at anaverage price of $617,000

 

During January 2004, the Company acquired 17additional finished lots in the City of Chino which are near, but not a part ofThe Reserve, and are not a part of the joint venture described above. TheCompany began construction of homes averaging 2,990 square feet during thefourth quarter of 2004.  The Companyopened for sales at this project during January 2005 and all 17 homes arein escrow as of May 2, 2005 at an average price of $560,000.

 

*Corona.*  The Company acquired 83 lots in North Coronain May 2004.  Following constructionof infrastructure, the Company began construction of homes averaging 3,250square feet during April 2005.

 

*Rancho Santa Fe.*  In October 2003, the Company enteredinto an agreement to acquire 32 lots in a luxury golf community known as CrosbyEstates in the Rancho Santa Fe area of California in San Diego County. TheCompany acquired eight of the lots during the fourth quarter of 2003, 18additional lots during 2004 and the final six lots during March 2005.  Two model homes are under construction forhomes averaging approximately 3,370 square feet.  The two phases of six homes each have been releasedfor sale and as of May 2, 2005, and six of the twelve homes are in escrowat an average price of $1,178,000.

 

*Lancaster.*   The Company acquired 104 lots in the city ofLancaster in northern Los Angeles County during May 2004. The Companybegan construction of model homes averaging approximately 2,800 square feetduring the third quarter of 2004.  TheCompany opened for sales of the first phase in January 2005, and hasreleased a total of 31 homes.  As of May 2,2005 30 of these homes are in escrow at an average price of $391,000.  The Company acquired an additional 72 lots inLancaster, during April 2005.

 

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*Ontario.  *DuringApril 2005, the Company acquired 26 lots in the City of Ontario inRiverside County, California.  This smallcommunity of homes, planned to average 3,415 square feet, is an infill sitesituated very near to the Company’s projects in the City of Chino.  The project is currently scheduled for aconstruction start during the third quarter of 2005.

 

**Financial Condition**

 

*March 31, 2005 Compared withDecember 31, 2004*

 

Cash flows from homebuilding operations for the first quarterof 2005 primarily reflect a use of cash for investments in real estate andconstruction costs of $8.7 million and a $4.2 million decrease in accountspayable and accrued liabilities for payment of accrued construction,compensation and tax liabilities. Additional significant uses of cash includeapproximately $400,000 for investment in the Bolsa Chica Mesa project,primarily for consultants engaged in the entitlement process, and selling,general and administrative expenses of approximately $1.2 million. The primarysources of cash during the quarter were real estate sales proceeds of $6.5million from deliveries of 10 homes, and net borrowing under project debtfinancing of $14.9 million. These items, as well as other activity presented inthe Statements of Cash Flows, resulted in a $6.3 million increase in cash andcash equivalents.  The current quarterborrowing in excess of uses of cash for investments in real estate andconstruction costs was made to prepare for the acquisition of 249 lots during April 2005,including the 151 lots reflected in consolidated real estate to be held forcurrent development – not owned as of December 31, 2004 and March 31,2005.

 

The $3.9 million increase in real estate held forcurrent development or sale reflects the purchase of six lots in the RanchoSanta Fe area of San Diego County and project construction costs, partiallyoffset by reductions recorded upon the deliveries of 10 homes.

 

Accounts payable and accrued liabilities decreased by$4.1 million, to a balance of $10.9 million as of March 31, 2005,primarily reflecting payment of accrued liabilities for profit-based incentivecompensation, income taxes and an amount due to a land seller for participationin homebuilding profits.

 

The $38.8 million increase in capital in excess of parvalue primarily reflects the reversal of $38.5 million of valuation reserves onpre-Reorganization federal NOLs anticipated to be utilized in the future as aresult of the development of the Bolsa Chica Upper Mesa (see Note 6).  An increase of approximately $300,000 forissuance of common stock pursuant to option exercises and the related state taxeffect is also reflected in capital in excess of par value.

 

**Resultsof Operations**

 

The nature of the Company’s business, including its limitedinventory of buildable lots, is such that individual transactions often causesignificant fluctuations in operating results from quarter-to-quarter and fromyear-to-year.

 

* Three Months Ended March 31, 2005Compared with the Three Months Ended March 31, 2004*

 

The Company reported revenues of $6.5 million andgross operating profit of $1.7 million for the first quarter of 2005, comparedwith $5.6 million in revenues and gross operating profit of approximately $1.3million for the first quarter of 2004. Revenues in the current period reflectdeliveries of 10 homes, including six homes at the “Jasper Ranch” project inRiverside and four homes at the Chino project. The comparable period of theprior year reflects deliveries of 13 homes, including six homes at theRiverside project and seven homes at a North Corona project. The currentquarter’s gross margin of 26.2% is higher than the prior period gross margin of23.2%, due to price appreciation, and the long holding period of lots for homesdelivered at Jasper Ranch.

 

The $300,000 increase in selling, general andadministrative expenses during the first quarter of 2005, as compared with thefirst quarter of 2004, primarily reflects an increase in selling expenses correspondingto the increase in the number of projects currently selling.

 

During the quarter ended March 31, 2005, theCompany recorded reversals of valuation allowances on post-reorganization NOLsof $4.7 million following the Coastal Commission’s approval of the developmentplan for 349 homes on the Bolsa Chica Upper Mesa (see Note 6).   During the three months ended March 31,2004, the Company 

 

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recorded a $100,000 tax benefit from a reduction in contingent taxliabilities, partially offsetting the tax provision on income for the period.

 

*Payments Under ContractualObligations*

 

The Company has entered into certain contractualobligations to make future payments for items such as project debt and leaseagreements.  A summary of the paymentsdue under specified contractual obligations, aggregated by category ofcontractual obligation, for specified time periods is presented below as of March 31,2005 (in millions):

 

| ** **       | ** ** | **Payments due by period** | ** ** |
|------------------|------------|----------------------------|------------|
| ** **       | ** ** | **Total**                  | ** ** | **Less  than 1  year** | ** ** | **1-3  years** | ** ** | **3-5  years** | ** ** | **More  than 5  years** | ** ** |
|             |       |                       |       |   |   |   |   |   |   |   |   |
| Project debt     |       | $                          | 37.5       |   | $ | 37.5 |   | — |   | — |   | — |   |
| Operating leases |       | .4                         |       | .2 |   | .2 |   | — |   | — |   |
| Other            |       | 1.3                        |       | 1.3 |   | — |   | — |   | — |   |
| Total            |       | $                          | 39.2       |   | $ | 39.0 |   | .2 |   | — |   | — |   |

 

The Company’s purchase contracts which are made in thenormal course of its homebuilding business for land acquisition andconstruction subcontracts are generally cancelable at will. Other contractualobligations including the Company’s other tax liabilities, accrued benefitliability for a frozen retirement plan and other accrued pensions, homewarranty reserves and contingent indemnity and environmental obligations areestimated based on various factors. Payments are not due as of a given date,but rather are dependent upon the incurrence of professional services, the livesof annuitants and other factors. The estimation process involved in thedetermination of carrying values of these obligations is inherently uncertainsince it requires estimates as to future events and contingencies. The Companyhas provided additional disclosure in its Consolidated Financial Statements in Notes5 and 6 – Other Liabilities.

 

**Forward Looking Statements**

 

Certain of the foregoing information containsforward-looking statements within the meaning of Section 21E of theSecurities Exchange Act of 1934, that relate to future events or the Company’sfuture financial performance.  Inaddition, other statements the Company may make from time to time, such aspress releases, oral statements made by Company officials and other reports theCompany files with the Securities and Exchange Commission, may also containsuch forward-looking statements.  Unduereliance should not be placed on these statements which involve known andunknown risks, uncertainties and other factors which may cause the Company’sactual results, performance or achievements to be materially different from anyfuture results, performances or achievements expressed or implied by theforward-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 terms or other comparableterminology.

 

These forward-looking statements include, but are notlimited to, (1) statements about the Company’s strategies, plans,objectives, goals, expectations and intentions; (2) the number and typesof homes and number of acres of land that the Company may develop and sell; (3) thetiming and outcomes of litigation, regulatory approval processes oradministrative proceedings, which may result in delays in the land entitlement,development, construction, or the opening of new communities (including, butnot limited to ongoing administrative proceedings related to the Company’sprincipal asset, the Bolsa Chica Mesa); (4) the Company’s ability torealize the value of its net operating loss carry forwards; (5) thecompletion of the pending $65 million sale of the lower bench of the BolsaChica Mesa to the State of California’s Wildlife Conservation Board; (6) theCompany’s ability to continue relationships with current or future partners; (7) theCompany’s ability to expend resources to comply with environmental regulationsand local permitting requirements; (8) the effect of certain costs,contractual obligations and tax liabilities, both known and unknown, on theCompany’s business, results of operations and financial condition; (9) thecondition and adequacy of the Company’s properties; (10) the Company’sability to estimate cash flow projections due to uncertainties in valuing realproperty; (11) the Company’s ability to acquire residential lots in order tocontinue homebuilding operations; (12) the adequacy of capital, financing andcash flow required to continue the Company’s operations and land developmentactivities; (13) the future condition of the real estate market in SouthernCalifornia; (14) the ability to react to increases or decreases in demand forhousing and to rapidly take advantage of local market opportunities as theyarise; (15) local and general economic and market conditions, includingconsumer confidence, employment rates, interest rates, the cost andavailability of mortgage 

 

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financing, and stock market, home and land valuations; (16)competition; (17) the availability and cost of raw materials used by theCompany in its homebuilding operations; (18) homebuilding litigation andwarranty claims; (19) shortages and the cost of labor; (20) adverse weather andnatural disaster related slowdowns; (21) slow growth and no growth initiativesor moratoria; (22) governmental regulation, including the interpretation oftax, labor and environmental laws; (23) accounting changes, including theexpected impact of new accounting pronouncements; (24) the effectiveness andadequacy of the Company’s disclosure and internal controls; (25) the impact oneconomic conditions of terrorist attacks or the outbreak or escalation of armedconflict involving the United States; (26) other factors over which the Companyhas little or no control; and (27) other statements contained herein that arenot historical facts.

 

The Company assumes no, and hereby disclaims any,obligation to update any of the foregoing or any other forward-lookingstatements.  The Company nonethelessreserves the right to make such updates from time to time by press release,periodic report or other method of public disclosure without the need forspecific reference to this Report.  Nosuch update shall be deemed to indicate that other statements not addressed bysuch update remain correct or create an obligation to provide any otherupdates.

 

**Prohibition Against Becoming a 5%Stockholder and No Further Acquisitions by Current 5% or Greater Stockholders**

 

Unless the Company has previously consented in writing(i) no stockholder holding less than 5% of the outstanding shares of theCompany’s Common Stock may acquire additional shares of Common Stock in anamount that would take such shareholder to 5% or more; and (ii) no current5% or greater stockholder may acquire any additional shares.  The foregoing prohibition is contained in theCompany’s charter documents, in order to preserve the tax benefits of theCompany’s $167 million of NOLs.  Allacquisitions of the Company’s Common Stock in violation of its charterprohibitions are null and void, and the Company is empowered to effectivelyrescind such acquisitions.  The Company mayentertain requests for permission to exceed the limitations on stockacquisitions in the future, if the Company’s board of directors determines thatsuch acquisitions would not jeopardize the Company’s ability to preserve anduse its NOLs.

 

ITEM 3 - QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

The Company utilizes project debt financing foracquisition, development and construction of homes. The interest rates on theCompany’s project debt approximate the current rates available for secured realestate financing with similar terms and maturities, and as a result, theircarrying amounts approximate fair value. While changes in interest ratesgenerally do not impact the fair market value of the debt instrument, they doaffect the Company’s earnings and cash flows. Holding the Company’s variablerate debt balance constant as of March 31, 2005, each one point percentageincrease in interest rates would result in an increase in variable rateinterest incurred for 2005 of approximately $400,000.

 

ITEM 4 -   EVALUATION OF DISCLOSURE CONTROLS ANDPROCEDURES 

 

The Company maintains disclosure controls andprocedures that are designed to ensure that information relating to the Company(including its consolidated subsidiaries) required to be disclosed in theCompany’s periodic filings with the Securities and Exchange Commission (“SEC”)is recorded, processed, summarized and reported within the time periodsspecified in the SEC’s rules and forms, and that such information isaccumulated and communicated to the Company’s management, including its ChiefExecutive Officer and Chief Financial Officer, as appropriate, to allow timelydecisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures,management recognizes that any controls and procedures, no matter how welldesigned and operated, can provide only reasonable assurance of achieving thedesired control objectives, and management is required to apply its judgment inevaluating the cost-benefit relationship of possible controls and procedures.

 

As of March 31, 2005, the end of the quartercovered by this report, the Company carried out an evaluation, under thesupervision and with the participation of the Company’s management, includingthe Chief Executive Officer and Chief Financial Officer, of the effectivenessof the design and operation of the Company’s disclosure controls andprocedures. Based on the foregoing, the Company’s Chief Executive Officer andChief Financial Officer concluded that the Company’s disclosure controls andprocedures were effective at the reasonable assurance level.  Although the Company’s disclosure controlsand procedures have been designed to provide reasonable assurance of achievingtheir objectives, there can be no assurance that such disclosure controls andprocedures will always achieve their stated goals under all circumstances.

 

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There have been no significant changes that occurredduring the quarter covered by this report in the Company’s internal controlover financial reporting identified in connection with the evaluationreferenced above that has materially affected, or is reasonable likely tomaterially affect, the Company’s internal control over financial reporting.

 

PART II -OTHER INFORMATION

 

ITEM 1 -                                                 LEGALPROCEEDINGS

 

See Note 5 to the Consolidated Financial Statementsabove, and “Item 1 - Business - Corporate Indemnification Matters” and “Item 3- Legal Proceedings” in the Company’s Annual Report on Form 10-K forthe year ended December 31, 2004.

 

ITEM 6 -                                                 EXHIBITS

 

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

 

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

 

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

 

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

 

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

 

**SIGNATURE**

 

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the registrant has caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized.

 

 
| Date: May 6, 2005 | CALIFORNIA COASTAL  COMMUNITIES, INC. |
|------------------------|---------------------------------------|
|                   |                                  |
|                   |                                  |
|                   | By:                                   | * /s/ Sandra G. Sciutto* | * * |
|                   |                                  | SANDRA G.  SCIUTTO |
|                   |                                  | Senior Vice  President and |
|                   |                                  | Chief Financial  Officer |

 

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