**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-Q**

**(Mark One)**

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934

**For the quarterly periodended March 31, 2007**

**OR**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934

**Forthe transition period from                        to**

**Commissionfile number: 0-17189**

**CALIFORNIA COASTAL COMMUNITIES, INC.**

(Exact name of registrantas specified in its charter)

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

 

**(949) 250-7700(Registrant’s telephone number, including area code)**

 

**Not applicable(Former name, former address and former fiscal year, if changed from lastreport)**

** **

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. YES x  NO o

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, or a non-accelerated filer. See definition of  “accelerated filer” and “large acceleratedfiler” in Rule 12b-2 of the Exchange Act. (Check one):

| **Large accelerated filer ****o** |   | **Accelerated  filer ****x** |   | **Non-accelerated  filer ****o** |
|----------------------------------------|--------|-----------------------------------|--------|---------------------------------------|

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2of the Act). YES o  NO x

Indicate the number of sharesoutstanding of each of the Issuer’s classes of common stock, as of the latestpracticable date:

As of April 30, 200710,855,963 shares of Common Stock par value $.05 per share were outstanding.

 

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CALIFORNIA COASTAL COMMUNITIES,INC.

FORM 10-Q

FOR THE QUARTER ENDED MARCH 31,2007

I N D E X
|                                                       | ** **                                                                            |
|-------------------------------------------------------|---------------------------------------------------------------------------------------|
| Cautionary Statement About Forward-Looking Statements |                                                                                  |
|                                                  |                                                                                  |
| Part I -                                         | Financial  Information:                                                               |   |
|                                                  |                                                                                  |   |
|                                                  | Item 1 -                                                                              | Consolidated Financial  Statements |   |
|                                                  |                                                                                  |   |   |
|                                                  |                                                                                  | Consolidated  Balance Sheets -  March 31, 2007 and December 31, 2006 (unaudited) |   |
|                                                  |                                                                                  |   |   |
|                                                  |                                                                                  | Consolidated Statements of Operations -  Three Months Ended March 31, 2007 and 2006 (unaudited) |   |
|                                                  |                                                                                  |   |   |
|                                                  |                                                                                  | Consolidated Statements of Cash Flows -  Three Months Ended March 31, 2007 and 2006 (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 1A - Risk Factors That May Affect Results of  Operations and Financial Condition |   |
|                                                  |                                                                                  |   |
|                                                  | Item 6  -                                                                             | Exhibits |   |
|                                                  |                                                                                  |
| SIGNATURE                                             |                                                                                  |

 

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CAUTIONARY STATEMENT ABOUT FORWARD-LOOKING STATEMENTS

This QuarterlyReport on Form 10-Q contains forward-looking statements within the meaning ofSection 27A of the Securities Exchange Act of 1933 and Section 21E of theSecurities Exchange Act of 1934 that relate to future events or our futurefinancial performance. In addition, other statements we may make from time totime, such as press releases, oral statements made by our officials and otherreports that we file with the Securities and Exchange Commission may alsocontain such forward-looking statements. Undue reliance should not be placed onthese statements which involve known and unknown risks, uncertainties and otherfactors which may cause our actual results, performance or achievements to bematerially different from any future results, performances or achievementsexpressed or implied by the forward-looking statements. In some cases, you canidentify 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 comparable terminology.

Theseforward-looking statements include, but are not limited to:

·                  statements about our strategies,plans, objectives, goals, expectations and intentions;

·                  information relating to anticipatedoperating results, financial resources, changes in revenues, changes inprofitability, interest expense, growth and expansion, anticipated income to berealized from our investments in unconsolidated entities;

·                  the impact of demographic trends andsupply constraints on the demand for and supply of housing;

·                  housing market conditions in thegeographic markets in which we operate;

·                  the number and types of homes andnumber of acres of land that we may develop and sell;

·                  the ability to deliver homes frombacklog;

·                  the timing and outcomes of regulatoryapproval processes or administrative proceedings, which may result in delays inthe land entitlement, development, construction, or the opening of newcommunities (including, but not limited to ongoing administrative proceedingsrelated to our joint venture near Oxnard, California);

·                  the ability to secure materials andsubcontractors;

·                  the ability to produce the liquidityand capital necessary to expand and take advantage of opportunities in thefuture;

·                  our ability to realize the value ofour net operating loss carry forwards;

·                  our ability to continue relationshipswith current or future partners;

·                  the effectiveness and adequacy of ourdisclosure and internal controls;

·                  the impact of recent accountingpronouncements; and

·                  stockmarket valuations.

Any or all of theforward-looking statements included in this report and in any other reports orpublic statements made by us may turn out to be inaccurate. This can occur as aresult of incorrect assumptions or as a consequence of known or unknown risksand uncertainties. These risks and uncertainties include the competitiveenvironment in which we operate; local, regional and national economicconditions; the demand for homes; fluctuations in interest rates and theavailability of mortgage financing; changes in home prices; the availabilityand cost of land for future growth; the availability of capital; uncertaintiesand fluctuations in capital and securities markets; changes in tax laws andtheir interpretation; legal proceedings; the ability of customers to financethe purchase of homes or sell existing homes; the availability and cost oflabor and materials; the amount of our debt and the impact of restrictivecovenants in our loan agreements; adverse weather conditions; domestic andinternational political events; uncertainties created by terrorist attacks; theeffects of governmental regulation, including regulations concerning developmentof land, the home building industry, sales and customer financing processes,and the environment; and other risks discussed in our filings with theSecurities and Exchange Commission. Many factors mentioned in this report or inother reports or public statements made by us, such as government regulationand the competitive environment, will be important in determining our futureperformance. Consequently, actual results may differ materially from those thatmight be anticipated from our forward-looking statements. You should not placeundue reliance on any of these forward-looking statements because they arebased on current expectations or beliefs regarding future events orcircumstances, which involve known and unknown risks, uncertainties and other factorswhich may cause our actual results, performance or achievements to bematerially different from any future results, performances or achievementsexpressed or implied by these forward-looking statements.

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Although webelieve that our strategies, plans, objectives, goals, expectations andintentions reflected in, or suggested by these forward-looking statements arereasonable given current information available to us, we can give no assurancethat any of them will be achieved. Forward-looking statements speak only as ofthe date they are made. We undertake no obligation to publicly update anyforward-looking statements, whether as a result of new information, futureevents or otherwise. However, any further disclosures made on related subjectsin our subsequent reports on Forms 10-K, 10-Q and 8-K should be consulted.

Theseforward-looking statements should be considered in light of the informationincluded in this report and our other filings with the Securities and ExchangeCommission, including, without limitation, the “Risk Factors” set forth below,as well as the description of trends and other factors in “Management’sDiscussion and Analysis of Financial Condition and Results of Operations,” setforth in our Form 10-K for the year ended December 31, 2006. You should alsoread the following “Management’s Discussion and Analysis of Financial Conditionand Results of Operations” in conjunction with the unaudited consolidatedfinancial statements and the related notes that appear elsewhere in this report.

We assume no, andhereby disclaim any, obligation to update any of the foregoing or any otherforward-looking statements. We nonetheless reserve the right to make suchupdates from time to time by press release, periodic report or other method ofpublic disclosure without the need for specific reference to this Form 10-Q orany other report filed by us.  No suchupdate shall be deemed to indicate that other statements not addressed by suchupdate remain correct or create an obligation to provide any other updates.

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PARTI.  FINANCIAL INFORMATION

ITEM 1 — FINANCIAL STATEMENTS

CALIFORNIA COASTAL COMMUNITIES, INC.

CONSOLIDATED BALANCE SHEETS

(unaudited)

(in millions)
| ** **                                                                                                                              | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                              | ** ** | **2007**           | ** ** | **2006**              | ** ** |
| **ASSETS**                                                                                                                              |       |               |       |                  |       |
| ** **                                                                                                                              |       |               |       |                  |       |
| Cash and cash  equivalents                                                                                                              |       | $                  | 8.7        |                  | $          | 10.6 |   |
| Short-term  investments                                                                                                                 |       | —             |       | .5                    |       |
| Restricted cash                                                                                                                         |       | 13.6               |       | 14.6                  |       |
| Real estate  inventories                                                                                                                |       | 268.0              |       | 264.8                 |       |
| Deferred tax  assets                                                                                                                    |       | 33.4               |       | 34.7                  |       |
| Other assets                                                                                                                            |       | 5.7                |       | 7.1                   |       |
|                                                                                                                                    |       |               |       |                  |       |
|                                                                                                                                    |       | $                  | 329.4      |                  | $          | 332.3 |   |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                          |       |               |       |                  |       |
| ** **                                                                                                                              |       |               |       |                  |       |
| Liabilities:                                                                                                                            |       |               |       |                  |       |
| Accounts payable  and accrued liabilities                                                                                               |       | $                  | 10.2       |                  | $          | 13.1 |   |
| Senior secured  project revolver                                                                                                        |       | 27.7               |       | 18.3                  |       |
| Senior secured  term loan                                                                                                               |       | 125.0              |       | 125.0                 |       |
| Other project  debt                                                                                                                     |       | 41.8               |       | 44.9                  |       |
| Other  liabilities                                                                                                                      |       | 7.5                |       | 7.5                   |       |
|                                                                                                                                    |       |               |       |                  |       |
| Total  liabilities                                                                                                                      |       | 212.2              |       | 208.8                 |       |
|                                                                                                                                    |       |               |       |                  |       |
| Commitments and  contingencies                                                                                                          |       |               |       |                  |       |
|                                                                                                                                    |       |               |       |                  |       |
| Stockholders’  equity:                                                                                                             |       |               |       |                  |       |
| Common  stock—$.05 par value; 13,500,000 shares authorized; 10,855,963 and 10,852,708  shares issued and outstanding, respectively |       | .5                 |       | .5                    |       |
| Excess  stock—$.05 par value; 13,500,000 shares authorized; no shares outstanding                                                  |       | —             |       | —                |       |
| Additional  paid-in capital                                                                                                             |       | 59.2               |       | 62.3                  |       |
| Retained  earnings                                                                                                                      |       | 59.0               |       | 62.2                  |       |
| Accumulated  other comprehensive loss                                                                                                   |       | (1.5               | )          | (1.5                  | )          |
| Total  stockholders’ equity                                                                                                        |       | 117.2              |       | 123.5                 |       |
|                                                                                                                                    |       |               |       |                  |       |
|                                                                                                                                    |       | $                  | 329.4      |                  | $          | 332.3 |   |

 

See the accompanying notes toconsolidated financial statements.

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CALIFORNIA COASTALCOMMUNITIES, INC.

CONSOLIDATEDSTATEMENTS OF OPERATIONS

(in millions,except per share amounts)

(unaudited)
| ** **                                    | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|
| ** **                                    | ** ** | **March 31,**               | ** ** |
| ** **                                    | ** ** | **2007**                         | ** ** | **2006** | ** ** |
|                                          |       |                             |       |   |   |
| Revenues:                                     |       |                             |       |   |   |
| Homebuilding                                  |       | $                                | 12.2       |   | $ | 27.9 |   |
|                                          |       |                             |       |   |   |
| Cost of sales:                                |       |                             |       |   |   |
| Homebuilding                                  |       | 11.4                             |       | 23.2 |   |
| Loss on impairment of real estate inventories |       | 4.0                              |       | — |   |
|                                          |       | 15.4                             |       | 23.2 |   |
| Gross operating (loss) profit                 |       | (3.2                             | )          | 4.7 |   |
|                                          |       |                             |       |   |   |
| Selling, general  and administrative expenses |       | 1.7                              |       | 1.7 |   |
| Other expense  (income), net                  |       | .1                               |       | (.3 | ) |
|                                          |       |                             |       |   |   |
| (Loss) income before income taxes             |       | (5.0                             | )          | 3.3 |   |
|                                          |       |                             |       |   |   |
| (Benefit)  provision for income taxes         |       | (2.0                             | )          | 1.4 |   |
|                                          |       |                             |       |   |   |
| Net (loss) income                             |       | $                                | (3.0       | ) | $ | 1.9 |   |
|                                          |       |                             |       |   |   |
| Net (loss)  earnings per common share:        |       |                             |       |   |   |
|                                          |       |                             |       |   |   |
| Basic                                         |       | $                                | (.28       | ) | $ | .19 |   |
| Diluted                                       |       | $                                | (.28       | ) | $ | .18 |   |
|                                          |       |                             |       |   |   |
| Common  equivalent shares:                    |       |                             |       |   |   |
|                                          |       |                             |       |   |   |
| Basic                                         |       | 10.9                             |       | 10.2 |   |
| Diluted                                       |       | 10.9                             |       | 10.5 |   |

 

See the accompanying notes to consolidated financial statements.

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CALIFORNIA COASTALCOMMUNITIES, INC.

CONSOLIDATEDSTATEMENTS OF CASH FLOWS

(in millions)

(unaudited)
| ** **                                                                        | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                        | ** ** | **March 31,**               | ** ** |
| ** **                                                                        | ** ** | **2007**                         | ** ** | **2006** | ** ** |
|                                                                              |       |                             |       |   |   |
| Cash flows from  operating activities:                                            |       |                             |       |   |   |
| Net (loss) income                                                                 |       | $                                | (3.0       | ) | $ | 1.9 |   |
| Adjustments to reconcile net (loss) income to cash  used in operating activities: |       |                             |       |   |   |
| Stock-based compensation expense                                                  |       | —                           |       | .1 |   |
| Deferred taxes                                                                    |       | (2.0                             | )          | .9 |   |
| Gains on sales of real estate inventories                                         |       | (0.8                             | )          | (4.7 | ) |
| Loss on impairment of real estate inventories                                     |       | 4.0                              |       | — |   |
| Proceeds from real estate sales, net                                              |       | 11.7                             |       | 27.7 |   |
| Investments in real estate inventories                                            |       | (18.1                            | )          | (23.5 | ) |
| Changes in assets and liabilities:                                                |       |                             |       |   |   |
| Decrease in other assets                                                          |       | 1.5                              |       | .1 |   |
| Decrease in accounts payable, accrued and other  liabilities                      |       | (2.9                             | )          | (5.3 | ) |
|                                                                              |       |                             |       |   |   |
| Cash used in operating activities                                                 |       | (9.6                             | )          | (2.8 | ) |
|                                                                              |       |                             |       |   |   |
| Cash flows from  investing activities:                                            |       |                             |       |   |   |
| Sales of short-term investments                                                   |       | .5                               |       | 26.5 |   |
| Purchases of short-term investments                                               |       | —                           |       | (18.7 | ) |
| Investments in unconsolidated joint ventures                                      |       | (.1                              | )          | (.1 | ) |
| Decrease in restricted cash                                                       |       | 1.0                              |       | — |   |
|                                                                              |       |                             |       |   |   |
| Cash provided by investing activities                                             |       | 1.4                              |       | 7.7 |   |
|                                                                              |       |                             |       |   |   |
| Cash flows from  financing activities:                                            |       |                             |       |   |   |
| Borrowings of senior secured project revolver                                     |       | 9.4                              |       | — |   |
| Borrowings of other project debt                                                  |       | 5.3                              |       | 1.2 |   |
| Repayments of other project debt                                                  |       | (8.4                             | )          | (8.9 | ) |
| Minority interest distributions                                                   |       | —                           |       | (.3 | ) |
|                                                                              |       |                             |       |   |   |
| Cash provided by (used in) financing activities                                   |       | 6.3                              |       | (8.0 | ) |
|                                                                              |       |                             |       |   |   |
| Net decrease in  cash and cash equivalents                                        |       | (1.9                             | )          | (3.1 | ) |
| Cash and cash  equivalents - beginning of period                                  |       | 10.6                             |       | 7.7 |   |
|                                                                              |       |                             |       |   |   |
| Cash and cash  equivalents - end of period                                        |       | $                                | 8.7        |   | $ | 4.6 |   |
|                                                                              |       |                             |       |   |   |
| Supplemental  disclosures of cash flow information:                               |       |                             |       |   |   |
| Cash paid during the period for income taxes, net of  refunds received            |       | $                                | .2         |   | $ | 4.6 |   |
| Cash paid during  the period for interest                                         |       | $                                | 2.5        |   | $ | — |   |

 

See the accompanying notes to consolidatedfinancial statements.

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CALIFORNIA COASTAL COMMUNITIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

**Note 1 - Basis of Presentation**

The accompanying financial statements have beenprepared by California Coastal Communities, Inc. and its consolidatedsubsidiaries (the “Company”), without audit, pursuant to the rules andregulations of the Securities and Exchange Commission. Certain information andfootnote disclosures normally included in financial statements prepared inaccordance with generally accepted accounting principles have been condensed oromitted pursuant to such rules and regulations. The Company believes that theseunaudited consolidated financial statements reflect all material adjustments(consisting only of normal recurring adjustments) and disclosures necessary forthe fair presentation of the results of operations and statements of financialposition when read in conjunction with the Consolidated Financial Statementsand Notes thereto included in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2006. Intercompany accounts and transactionshave been eliminated.

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**

*Basis ofConsolidation*

Certain of ourwholly-owned subsidiaries are members in joint ventures involved in thedevelopment and sale of residential projects and residential loan production.Our consolidated financial statements include our accounts and all of ourmajority-owned and controlled subsidiaries and joint ventures. The financialstatements of joint ventures in which we generally have a controlling ormajority economic interest (and thus are controlled by us) are consolidatedwith our financial statements. Minority interest represents the equity interestof our joint venture partner for one consolidated venture and is furtherdescribed in Note 10 to the consolidated financial statements included in ourAnnual Report on Form 10-K for the year ended December 31, 2006. Ourinvestments in unconsolidated joint ventures are accounted for using the equitymethod when we do not have voting or economic control of the ventureoperations, as further discussed in Note 4 to the consolidated financialstatements included in our Annual Report on Form 10-K for the year endedDecember 31, 2006.

*RealEstate*

Real estateinventories primarily consist of homes under construction and lots underdevelopment and are carried at the lower of cost or fair value less costs tosell. The estimation process involved in the determination of fair value isinherently uncertain since it requires estimates as to future events and marketconditions. Such estimation process assumes the Company’s ability to completedevelopment and dispose of its real estate properties in the ordinary course ofbusiness based on management’s present plans and intentions. Economic, market,and environmental conditions may affect management’s development and marketingplans. In addition, the implementation of such development and marketing planscould be affected by the availability of future financing for development andconstruction activities. Accordingly, the ultimate values of the Company’s realestate properties depend upon future economic and market conditions, and theavailability of financing.

The cost of salesof multi-unit projects is generally computed using the relative salesvalue method. Interest and other carrying costs are capitalized to real estateprojects during their development and construction period.

*Impairmentof Long-Lived Assets*

The Companyassesses the impairment of real estate inventories and other long-lived assetsin accordance with Statement of Financial Accounting Standards (“SFAS”)No. 144, *“Accounting for the Impairment or Disposalof Long-Lived Assets”*, (“SFAS 144”) which requires thatlong-lived assets be reviewed for impairment whenever events or

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changes in circumstancesindicate that the carrying amount of an asset may not be recoverable. Asprovided by SFAS 144, impairment is evaluated by comparing an asset’s carryingvalue to the undiscounted estimated cash flows expected from the asset’soperations and eventual disposition. If the sum of the undiscounted estimatedfuture cash flows is less than the carrying value of the asset, an impairmentloss is recognized based on the fair value of the asset. If impairment occurs,the fair value of an asset for purposes of SFAS 144 is deemed to be theamount a willing buyer would pay a willing seller for such asset in a currenttransaction.

In accordance withSFAS 144, in developing estimated future cash flows for impairment testing, theCompany has incorporated its own market assumptions including those regardinghome prices, infrastructure and home-building costs and financing costsregarding real estate inventories. Additionally, as appropriate, the Company identifies alternative coursesof action to recover the carrying value of its long-lived assets and evaluatesall likely alternatives under a probability-weighted approach as described inSFAS 144.

During the firstquarter of 2007, the Company recorded an impairment charge of $4.0 millionrelated to its real estate inventories for the remaining 87 homes at itsWoodhaven project in Beaumont, California. To date, the Company has notrecorded impairment charges for its other projects primarily because most ofits lot acquisitions were negotiated prior to 2005 (thus reflecting less expensiveland prices and benefiting from home price appreciation during 2005 thatexceeded the decline in home prices during 2006 and the first quarter of 2007).However, as required by SFAS 144, should market conditions further deterioratein the future or other events occur that indicate the carrying amount of theCompany’s real estate inventories may not be recoverable, the Company willreevaluate the expected cash flows from each project to determine whether anyadditional impairment exists at any point in time.

*EarningsPer Common Share*

Earnings per common share is accounted for inaccordance with SFAS No. 128, *“Earnings Per Share”*.Basic earnings per common share is computed using the weighted-average numberof common shares outstanding for the period. Diluted earnings per common shareis computed using the weighted-average number of common shares outstanding andthe dilutive effect of potential common shares outstanding. For the threemonths ended March 31, 2006, the average market price of the Company’s commonstock exceeded the exercise price of approximately 700,000 outstanding stockoptions. Therefore, diluted earnings per share for the 2006 period includes thedilutive effect of the weighted average number of common shares from potentialexercise of approximately 700,000 options.

The table below sets forththe reconciliation of the denominator of the earnings per share calculation (inmillions):

|                                                             | ** ** | **March 31,** | ** ** |
|-------------------------------------------------------------|------------|--------------------|------------|
| ** **                                                  | ** ** | **2007**           | ** ** | **2006** | ** ** |
| Shares used in  computing basic earnings per common share   |       | 10.9               |       | 10.2 |   |
| Dilutive effect  of stock options                           |       | —-            |       | .3 |   |
| Shares used in  computing diluted earnings per common share |       | 10.9               |       | 10.5 |   |

 

*RecentAccounting Pronouncements*

In July 2006,the FASB issued FASB Interpretation No. 48, *”Accountingfor Uncertainty in Income Taxes”*, (“FIN 48”), which prescribes arecognition threshold and measurement process for recording in the financialstatements uncertain tax positions taken or expected to be taken in a taxreturn. Additionally, FIN 48 provides guidance on derecognition,classification, interest and penalties, accounting in interim periods anddisclosure requirements for uncertain tax positions. The accounting provisionsof FIN 48 are effective for reporting periods beginning after December 15,2006.  The Company adopted FIN 48 during the first quarter of 2007 andrecorded a net reduction to deferred tax assets of $3.3 million. This reductionwas recorded as an adjustment to retained earnings as of January 1, 2007 as acumulative effect of a change in accounting principle.

In September 2006, theFASB issued SFAS No. 157, *“Fair Value Measurements”*(“SFAS 157”), which defines fair value, establishes a framework for measuringfair value in generally accepted accounting principles and expands disclosuresabout fair value measurements. SFAS 157 is effective for financial statementsissued for fiscal periods beginning after November 15, 2007 (the Company’sfiscal year beginning January 1, 2008), and interim periods within

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those fiscal years. TheCompany is currently evaluating the impact of adopting SFAS 157 on theconsolidated financial statements.

In February 2007, theFASB issued SFAS No. 159, *“The Fair Value Option forFinancial Assets and Financial Liabilities”* (“SFAS 159”), whichexpands the standards under SFAS 157 and provides entities a one-time electionto measure financial instruments and certain other items at fair value. SFAS159 is effective for financial statements issued for fiscal periods beginningafter November 15, 2007 (the Company’s fiscal year beginning January 1, 2008).The Company is currently evaluating the impact of adopting SFAS 159 on itsconsolidated financial statements.

 

**Note 3 — Real Estate Inventories**

Real estateinventories primarily consist of homes under construction and lots underdevelopment at Brightwater and seven additional communities in four SouthernCalifornia counties.  At March 31, 2007,real estate inventories aggregated 782 lots and homes, including 35 homescompleted and unsold, and 15 homes completed and in escrow. Real estate inventoriesat March 31, 2007 included $167.1 million recorded for the Brightwatercommunity which is located on a 105-acre parcel on a mesa north of the BolsaChica wetlands (“Upper Mesa”). Brightwater is under development for 356 homesas discussed below. In addition, real estate inventories include approximately51 acres nearby which have been offered for dedication to the County of Orangefor inclusion in the Harriet M. Weider Linear Park in conjunction with thedevelopment of Brightwater, and 51 additional acres which are subject to aconservation easement. The carrying value of these two properties is zero. TheCompany capitalizes carrying costs including interest and property taxes, aswell as direct construction costs, to real estate inventories during thedevelopment and construction period.

The Brightwaterplanned community will offer a broad mix of home choices, averaging 2,860square feet and ranging in size from 1,710 square feet to 4,140 squarefeet.  The plan also includes 37 acres ofopen space and conservation area.  With349 homes permitted on 68 acres of the Upper Mesa, the resulting low-densityplan equates to approximately five homes per acre, consistent and compatiblewith the neighboring Huntington Beach communities.  In addition, the Company owns land adjacentto the planned Brightwater development, on which it intends to process permitsto build seven additional homes which will be included in the Brightwatercommunity. The Company completed grading during October 2006, and is currently constructinginfrastructure (sewer, water, storm drain, streets, utilities, etc.) Model homeconstruction began in December 2006 for two of the four home products andconstruction for the additional two products began during the first quarter of2007. The Company expects to start selling homes during the summer of 2007 andbegin delivering homes by the end of 2007. However, there can be no assurance in that regard, or as to the absenceof further development or construction delay.

The estimationprocess involved in the determination of value is inherently uncertain since itrequires estimates as to future events and market conditions. Such estimationprocess assumes the Company’s ability to complete development and dispositionof its real estate properties in the ordinary course of business based onmanagement’s present plans and intentions. Economic and market conditions mayaffect management’s development and marketing plans. In addition, theimplementation of such development and marketing plans could be affected by theavailability of future financing for development and construction activities.Accordingly, the amount ultimately realized from such project may differmaterially from current estimates and the project’s carrying value.

Capitalizedinterest is allocated to real estate inventories when incurred and charged tocost of sales when the related property is delivered. Changes in capitalizedinterest follow (in millions):

|                                            | ** ** | **March 31,** | ** ** |
|--------------------------------------------|------------|--------------------|------------|
| ** **                                 | ** ** | **2007**           | ** ** | **2006** | ** ** |
|                                       |       |               |       |   |   |
| Capitalized  interest, beginning of period |       | $                  | 10.2       |   | $ | 6.1 |   |
| Interest  incurred and capitalized         |       | 4.1                |       | 1.1 |   |
| Charged to cost  of sales                  |       | (0.6               | )          | (1.1 | ) |
| Capitalized interest,  end of period       |       | $                  | 13.7       |   | $ | 6.1 |   |

 

**Note 4 —Senior Secured Project Revolver**

On September 15,2006, the Company entered into a three-year, $100 Million Senior SecuredRevolving Credit Agreement with KeyBank National Association, as a lender andagent for several other lenders (the “Revolving Loan”).

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The Revolving Loanis secured by a first trust deed on the Brightwater project, and stock pledgesof the Company’s material subsidiaries. The Revolving Loan will fund the first$100 million of development and construction costs for the project. At the endof the second year of the term of this facility and each subsequent quarter,the commitment amount will decrease by $25 million until the commitment underthe Revolving Loan is reduced to zero by the final maturity date, September 15,2009. The Revolving Loan is also subject to earlier commitment reductions basedon 40% of the $600,000 release price on the first 50 units closed at theBrightwater project, and 40% of the $1 million release price per unitthereafter.

Availability underthe $100 million Revolving Loan is subject to the applicable borrowing base limitations.The borrowing base limits lender advances to 50% of asset value. The borrowingbase value is the appraised value of the Brightwater project, increased forcosts incurred subsequent to the most recent lender appraisal and reduced by72% of the sales value of homes sold. The initial borrowing base value of theBrightwater project was determined by an independent third-party appraisal ofthe project on an “as-is” basis as of July 6, 2006. Certain subsidiaries of theCompany provided full unconditional guarantees. The Revolving Loan includesfinancial covenants which may limit the amount that may be borrowed.Outstanding advances bear interest at the Company’s option at either (i) theAlternate Base rate (“Prime”) minus 25 basis points or (ii) LIBOR plus 200basis points.

As of March 31,2007, $27.7 million was outstanding under the Revolving Loan. The undrawnavailability was $72.3 million, as limited by the borrowing base formulas.Interest on the facility is calculated on the average, outstanding dailybalance and is paid monthly.  Interestincurred on the Revolving Loan for the three months ended March 31, 2007 was$500,000, at a weighted-average interest rate of 7.32%, which reflects theCompany’s elected rate of LIBOR plus 2%.

Initial loan feesand closing costs of approximately $800,000 incurred for the Revolving Loan onSeptember 15, 2006 are deferred and included in other assets and amortizedover the life of the loan. Amortization of these costs is included in thecapitalization of interest allocated to real estate inventories when incurred,and charged to cost of sales when the related homes are delivered. As of March31, 2007, approximately $666,000 of deferred loan fees and closing costsrelated to the Revolving Loan are included in other assets.

Under theRevolving Loan, the Company is required to comply with a number of covenants,including a leverage covenant and a minimum consolidated tangible net worthcovenant. The Company is in compliance with these covenants as of March 31,2007.

**Note 5 —Senior Secured Term Loan**

On September 15,2006, the Company entered into a five-year, $125 Million Senior Secured TermLoan Agreement with KeyBank National Association, as a lender and agent forseveral other lenders (the “Term Loan”), and on September 15, 2006, theCompany borrowed the maximum loan amount of $125 million. The proceeds wereused to fund a “special dividend” of $12.50 per share, totaling $135.7 million,to common stockholders paid on September 28, 2006. At the end of the second,third and fourth years of the term of this agreement, the commitment amountwill decrease by $15 million, $25 million, and $35 million, respectively.Thereafter, for each subsequent quarter, the Term Loan commitment amount willdecrease in four equal installments, until the commitment under the agreementis reduced to zero by the final maturity date, September 15, 2011. The TermLoan is also subject to mandatory repayments based on 60% of the $600,000release price on the first 50 units closed at the Brightwater project, and 60%of the $1 million release price per unit thereafter.

Availability underthe Term Loan is subject to the applicable borrowing base loan to valuelimitations. The loan to value limits total lender advances under the Term Loanand the Revolving Loan to 65% of asset value. This is based upon the initialappraised value of the Brightwater project, increased for costs incurredsubsequent to the most recent lender appraisal and reduced by 72% of the salesvalue of homes sold. The Term Loan is secured by a second trust deed on theBrightwater project, and a general pledge and assignment of the Company’sownership interests in all material subsidiaries.  All existing material subsidiaries of theCompany have provided full unconditional guarantees. The Term Loan includesfinancial covenants which may limit the amount that may be outstanding. Theoutstanding balance bears interest at the Company’s option at either (i) theprime interest rate plus 25 basis points, or (ii) LIBOR plus 275 basis points.

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As of March 31,2007, $125 million was outstanding under the Term Loan. Interest on theTerm Loan is calculated on the average, outstanding daily balance and is paidmonthly. Interest incurred on the Term Loan for the three months ended March31, 2007 was $2.6 million, at a weighted-average interest rate of 8.07%, whichreflects the Company’s elected rate of LIBOR plus 2.75%.

Initial loan feesand closing costs of $2.3 million incurred for the Term Loan onSeptember 15, 2006 are deferred and included in other assets and amortizedover the life of the loan. Amortization of these costs is included in thecapitalization of interest allocated to real estate inventories when incurred,and charged to cost of sales when the related homes are delivered. As of March31, 2007, approximately $2.1 million of deferred loan fees and closing costsrelated to the Term Loan are included in other assets.

Under the TermLoan, the Company is required to comply with a number of covenants, includingcovenants related to  leverage, a minimumratio of EBITDA to interest, and a minimum consolidated tangible net worth. TheCompany is in compliance with these covenants as of March 31, 2007.

Under the TermLoan agreement, the Company was required to enter into a swap agreement tohedge against risks associated with fluctuating interests rates related to$62.5 million of floating rate debt. On September 15, 2006 the Company enteredinto an interest rate swap transaction to effectively fix the interest rate on$62.5 million in floating rate debt at 8.015% per annum. The swap transactionterminates in September 2008. Since the Company does not use derivativefinancial instruments for trading purposes, the swap did not qualify for hedgeaccounting under SFAS No. 133, *“Accounting for DerivativeInstruments and Hedging Activities”*. The fair value of the interestrate swap agreement represents the spread between the interest rate the Companypaid and the interest rate the Company would receive over the remaining life ofthe agreement, however, this was insignificant at March 31, 2007. The change infair value of the interest rate swap agreement during the three months endedMarch 31, 2007 was not material. The counterparties to the interest rate swapagreement are financial institutions.

**Note 6 — Other 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 commercialbanks.  These loan facilities finance aportion of the land acquisition and the majority of the construction ofinfrastructure and homes.  Each loanfacility requires a guaranty of project completion and an environmentalindemnity. The loans are secured by first trust deeds and bear an interest rateof prime plus three-fourths percent (9% at March 31, 2007), except for one loanfacility for the Corona-Hellman project which bears interest at a rate of primeplus one-half percent (8.75% at March 31, 2007). These loan facilities have aminimum interest rate ranging from 5.75% to 7.5%. During the three months endedMarch 31, 2007, Hearthside Homes, Inc. did not enter into any new loanfacilities.  The following amounts wereavailable and outstanding under these loan facilities as of March 31, 2007 andDecember 31, 2006 ($ in millions):

|                 | ** ** | ** **           | ** ** | ** **       | ** ** | ** **   | ** ** | **Outstanding at** | ** ** |
|-----------------|------------|----------------------|------------|------------------|------------|--------------|------------|-------------------------|------------|
| ** **      | ** ** | **Amount**           | ** ** | **Number**       | ** ** | **Maturity** | ** ** | **March 31,**      | ** ** | **December 31,** | ** ** |
| ** **      | ** ** | **of Facility** | ** ** | **of Lots** | ** ** | **Date**     | ** ** | **2007**                | ** ** | **2006** | ** ** |
|            |       |                 |       |             |       |         |       |                    |       |   |   |
| Rancho Santa Fe |       | $                    | 10.4       |             | —     |         | —     |                    | $          | — |   | $ | 3.8 |   |
| Corona-Chandler |       | 14.8                 |       | —           |       | —       |       | —                  |       | .8 |   |
| Corona-Chandler |       | 1.9                  |       | —           |       | —       |       | —                  |       | 1.9 |   |
| Lancaster       |       | 17.7                 |       | 72               |       | 7/1/07       |       | 4.2                     |       | 2.2 |   |
| Beaumont        |       | 20.7                 |       | 87               |       | 8/17/07      |       | 12.5                    |       | 10.7 |   |
| Ontario         |       | 11.7                 |       | 15               |       | 10/19/07     |       | 3.7                     |       | 4.6 |   |
| Corona-Hellman  |       | 54.5                 |       | 151              |       | 1/7/09       |       | 21.4                    |       | 20.9 |   |
|            |       |                 |       |             |       |         |       |                    |       |   |   |
|            |       |                 |       |             |       |         |       | $                       | 41.8       |   | $ | 44.9 |   |
|                 |            |                      |            |                  |            |              |            |                         |            |  |  |  |  |  |

** **

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**Note 7 - Other Liabilities**

Otherliabilities were comprised of the following (in millions):

|                                                     | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                          | ** ** | **2007**           | ** ** | **2006**              | ** ** |
| Accrued pensions  and benefits                      |       | $                  | 4.1        |                  | $          | 4.1 |   |
| Home warranty  reserves                             |       | 2.4                |       | 2.4                   |       |
| Contingent  indemnity and environmental obligations |       | 1.4                |       | 1.4                   |       |
| Unamortized  discount                               |       | (.4                | )          | (.4                   | )          |
|                                                |       | $                  | 7.5        |                  | $          | 7.5 |   |

 

Contingent indemnity and environmental obligationsprimarily reflect reserves before related discount (recorded pursuant to Fresh-StartReporting) for contingent indemnity obligations for businesses disposed of byformer affiliates and unrelated to the Company’s current operations.

*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, for the items listed in the homeowner warranty manual, which doesnot include items that are covered by manufacturers’ warranties or items thatare not installed by the Company’s employees or contractors. The home warrantyreserve activity is presented below (in millions):

|                                 | ** ** | **Three Months Ended** | ** ** |
|---------------------------------|------------|----------------------------------|------------|
| ** **                      | ** ** | **March 31,**               | ** ** |
| ** **                      | ** ** | **2007**                         | ** ** | **2006** | ** ** |
| ** **                      | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Balance at  beginning of period |       | $                                | 2.4        |   | $ | 2.1 |   |
| Provision                       |       | .1                               |       | .2 |   |
| Payments                        |       | (.1                              | )          | (.1 | ) |
| Balance at end of  period       |       | $                                | 2.4        |   | $ | 2.2 |   |

 

**Note 8 - Income Taxes**

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

|                                       | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------|------------|----------------------------------|------------|
| ** **                            | ** ** | **March 31,**               | ** ** |
| ** **                            | ** ** | **2007**                         | ** ** | **2006** | ** ** |
| Current taxes                         |       | $                                | —     |   | $ | .5 |   |
| Deferred taxes                        |       | (2.0                             | )          | .9 |   |
| (Benefit) provision for  income taxes |       | $                                | (2.0       | ) | $ | 1.4 |   |

 

The net deferredtax balance at March 31, 2007 and 2006 is primarily composed of federal netoperating losses (“NOLs”).  The Companyhas concluded that it is “more likely than not” that the Company will be ableto generate sufficient taxable income to realize such assets. Therefore, theCompany has no valuation allowance related to the potential utilization of itsdeferred tax assets due to uncertainties. Such uncertainties included theavailability of real estate for development at economically viable prices,government approvals, results of litigation and economic factors affecting theCompany’s operations. The Company monitors these, as well as other positive andnegative factors that may arise in the future, as it assesses the need for avaluation allowance against its deferred tax assets.

The federal NOLs available as of March 31, 2007 wereapproximately $134 million. The amount of federal NOLs which expire if notutilized is zero for 2007 and $3 million, $11 million, $49 million, $42million, and $29 million for 2008, 2009, 2010, 2011 and thereafter,respectively.

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The InternalRevenue Code (the “Code”) generally limits the availability of NOLs if anownership change occurs within any three-year period under Section 382. If theCompany were to experience an ownership change of more than 50%, the use of allremaining NOLs would generally be subject to an annual limitation equal to thevalue of the Company’s equity before the ownership change, multiplied by thelong-term tax-exempt rate (4.18% as of April 2007) plus (ii) recognizedbuilt-in-gains, defined as those gains recognized within five years of theownership change subject to an overall limitation of the net unrealizedbuilt-in gains existing as of the ownership change date. The Company believesit has net unrealized built-in gains sufficient to allow utilization of theentire net operating loss, assuming that the Company is able to recognize thesegains within the five-year time limitation. The Company estimates that aftergiving effect to various transactions by stockholders who hold a 5% or greaterinterest in the Company, it has experienced a three-year cumulative ownershipshift of approximately 35% as of April 30, 2007, as computed in accordance withSection 382.

On September 18,2006, the Company’s Board of Directors suspended enforcement of the Company’scharter documents that restrict stockholders from acquiring more than 5% of theoutstanding shares of Common Stock. The Board determined that such restrictionswere not currently required to preserve the tax benefits of the Company’s $134million of NOLs. While the Company remains subject to Code section 382, whichlimits the availability of NOLs in the event of an ownership change, theCompany would have five years from the date of any such ownership change torecognize its built in gains and utilize its NOLs. With the commencement ofconstruction at Brightwater in 2006, and the related built-in-gain of theproject,  the Company believes it willfully utilize its NOLs within the next five years if an ownership change doesoccur; however, the Board may reinstitute the 5% ownership limitation ifcurrently unanticipated events so require.

Pursuant to SFAS123(R), the Company has elected to recognize stock option deductions on the taxlaw ordering method, which maximizes the realization of the stock optiondeductions in the current year. While the Company realized the majority of its2006 stock option deductions, approximately $400,000 of unrealized tax benefitsrelated to stock option deductions are not reflected in the consolidatedfinancial statements. Upon realization of the tax benefits, the Company willincrease its additional paid-in capital.

*UncertainTax Positions*

The Companyadopted the provisions of FASB Interpretation No. 48, *“Accountingfor Uncertainty in Income Taxes”* (“FIN 48”), on January 1, 2007. Asa result of the implementation of FIN 48, the Company recorded a $5.1 milliondecrease in deferred tax assets for unrecognized tax benefits, which was offsetby an increase in deferred tax assets of $1.8 million for assets re-evaluatedas recognizable. The net change in deferred tax assets of $3.3 million resultedin a decrease to the January 1, 2007 retained earnings balance of $200,000 anda decrease to the additional paid in capital balance of $3.1 million related tofresh-start accounting pursuant to a 1997 pre-packaged bankruptcy. There havebeen no changes to this amount during the quarter ended March 31, 2007. Of theCompany’s unrecognized tax benefits of $5.1 million at March 31, 2007, $200,000would decrease the Company’s effective tax rate if recognized. The Company doesnot believe that its unrecognized tax benefits will significantly fluctuate orchange within twelve months of the reporting date.

The Companyrecognizes interest expense and penalties related to uncertain tax positions asgeneral and administrative expenses. As of March 31, 2007, the Company has notrecorded any interest or penalties related to unrecognized tax benefits.

The tax years2003-2006 remain open to Federal and California examination, which are theCompany’s primary tax jurisdictions. The Company has utilized NOLs generatedbetween 1990 and 1994 to offset taxable income in those years and expects toutilize NOLs generated between 1994 and 1997 and in 1999 and 2006 in futureyears.

**Note 9 - Commitments and Contingencies**

*RealEstate Matters*

The Company issubject to the usual obligations associated with entering into contracts forthe purchase of land and improved home sites. The purchase of properties underthese contracts is generally contingent upon satisfaction of certainrequirements by the sellers, including obtaining applicable propertyentitlements. The Company also utilizes option contracts with third-party landsellers and financial entities as a method of acquiring land in stagedtakedowns and minimizing the use of funds from other corporate financingsources. These option contracts also help to manage the financial and marketrisk associated with land holdings. Option contracts generally require thepayment of a 

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non-refundablecash deposit of 5% to 15% of the purchase price for the right to acquire lotsover a specified period of time (usually one to two years) at predeterminedprices. The Company has the right at its discretion to terminate itsobligations under these land purchase and option agreements by forfeiting thecash deposit with no further financial responsibility.  As of March 31, 2007 and December 31, 2006,the Company has one consolidated $25,000 land option deposit.

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 at March 31,2007.  The Company does not believe thatdraws upon these bonds, if any, will have a material effect on the Company’sfinancial position, results of operations or cash flows.

*OxnardLand Development Joint Venture*

In February 2003,the Company entered into two option contracts to acquire land adjacent to theCity of Oxnard in Ventura County, California aggregating approximately 168acres.  The Company is developing a landplan for the area, which also includes an additional 149 acres owned by otherlandowners, with the intention of entitling the property for residentialdevelopment and annexing it into Oxnard. During October 2003, the Company entered into a limited liabilitycompany joint venture agreement with a major financial partner to pursue theOxnard development opportunity. The Company assigned the land purchase optioncontracts to the Oxnard limited liability company (“Oxnard LLC”). HearthsideHomes, Inc., the Company’s homebuilding subsidiary, is the managing member ofthe Oxnard LLC.

The Oxnard LLC isfunded by both of its members. Hearthside Homes, Inc. made an initialcontribution of $500,000. The non-managing member also made an initialcontribution of $500,000 to the joint venture and, as of December 31, 2005, hadmade an aggregate of $4 million of first tier additional contributions. Themembers have provided a second tier of additional capital contributions of $1million each, as originally provided in the venture agreement. In addition, themembers have provided an additional $325,000 each of temporary advances tocomplete the business plan. During the first quarter of 2007, the members eachcontributed approximately $100,000 to the Oxnard LLC.

In addition to theland purchase options for the project property, the Oxnard LLC held a landpurchase option which controlled property which was expected to provide filldirt for the project property.  On April16, 2007, the Oxnard LLC sold the non-project land purchase option for $1.8million since the venture has contracted for an alternate source for the filldirt. The Oxnard LLC received net proceeds of approximately $700,000 in cashand a $1.0 million note receivable due July 20, 2007 for this transaction.After paying the balance of commissions and closing costs of $100,000, OxnardLLC plans to utilize the proceeds to fund ongoing development costs.

The Company’stotal investment in the Oxnard LLC as of March 31, 2007 is $1.8 million. TheCompany expects to make additional aggregate capital contributions ofapproximately $100,000 to the Oxnard LLC during the remaining nine months of2007, bringing the Company’s total expected investment to $1.9 million. Duringthe first half of 2008, the Company expects to make additional aggregatecapital contributions of approximately $650,000 to $800,000. The amount ofcontributions could be substantially increased if the note receivable is notcollected as discussed above.

While the Companyexerts a large degree of influence over the venture, the Company’s partner doeshave various substantive participating rights such as approval rights withregard to the majority of business decisions, including approval of projectbudgets.

*LegalProceedings*

There are various lawsuits and claims pending againstthe 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.

*GoldenState Water*

On December 14, 2006 Golden State Water Company (“GoldenState”) filed a complaint in Orange County Superior Court (the “Court”) againstthe City of Huntington Beach (the “City”) and two of the Company’s subsidiariesclaiming alleged breaches of contract.

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Following the Court’s denial of Golden State’smotion for a preliminary injunction and the Court’s ruling on Defendants’demurrer motion, the Company’s subsidiaries and the City reached a preliminaryagreement to settle this claim, pursuant to which the Company’s subsidiarieswill pay an immaterial amount to Golden State. The Company’s subsidiaries and the City did not admit fault or liabilitywith respect to Golden State’s claims, but agreed to settle the matter to avoidthe continued cost and uncertainty of litigation. This agreement remainssubject to negotiation of a definitive settlement agreement, and there can beno assurances that such agreement will be finalized.

*California Department of ToxicSubstances Control*

On October 13,2006, the California Department of Toxic Substances Control (“DTSC”) filed acivil complaint against our Hearthside Residential Corp. subsidiary (“HRC”) inthe Federal District Court for the Southern Division of the Central District ofCalifornia.  The DTSC’s complaintrequests that HRC pay for approximately $1.0 million of costs incurred by theDTSC, together with interest on that amount, primarily in connection with theoversight and remediation of PCB contamination found on residential propertiesadjacent to a 43-acre site where HRC completed the removal of PCB contaminatedsoil during September 2005.  HRC’sremediation process was approved by the DTSC in December 2005 when it issued afinal acceptance of the remediation work. The complaint also seeks an order for HRC to pay any future costs whichmay be incurred in connection with further remediation, together with courtcosts and attorney’s fees.

Since May 2004,HRC has received invoices from DTSC seeking reimbursement for these costs;however, HRC contends, based upon advice of counsel, that it is not responsiblefor such costs because neither HRC nor any affiliate ever developed or builtthe neighboring residential properties, neither HRC nor any affiliate generatedthe contamination, and the contamination did not emanate from the 43-acre sitethat HRC remediated. Furthermore, HRC has also disputed such charges due to thefact that DTSC improperly submitted its bill. The Company’s subsidiary intendsto vigorously defend itself in this matter. Therefore, the Company has notaccrued for any of DTSC’s approximately $1.0 million of claims related to theseresidential properties.

See Note 7 for adiscussion of other contingencies.

*CorporateIndemnification 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.

**Note 10 -Stock Plan**

*1993 Stock Option/Stock IssuancePlan*

The 1993 StockOption/Stock Issuance Plan (“1993 Plan”) was approved at the 1994 Annual Meetingof Stockholders, reserving 7.5 million shares each of Series A PreferredStock and Class A Common Stock for issuance to officers, key employees andconsultants of the Company and its subsidiaries and the non-employeemembers of the Board of Directors (the “Board”). On April 28, 1997, in connection with the Recapitalization, a new classof Common Stock replaced the Series A Preferred Stock and Class A Common Stock,and the Compensation Committee of the Board authorized the grant of stockoptions for 759,984 shares, equivalent at that time to 6% of the Company’sfully diluted equity, for certain directors and officers. At the May 2004 andJune 2006 stockholder meetings, the stockholders of the Company authorized anadditional 150,000 and 250,000 stock options, respectively, for the 1993 Plan,resulting in total authorized grants of 1,159,984.

The Company did not grant any options during the firstquarter of 2007. The Company granted 2,500 options during the three monthsended March 31, 2006, with a fair value of $24,000. The grant vests 50% afterone year and 100% after two years, and the options have a term of 10 years. Pursuantto SFAS 123 and SFAS 123(R), the Company recorded $38,000 and $16,000 ofcompensation expense during the three months ended March 31, 2007 and 2006,respectively, which is reflected in additional paid-in capital.

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A summary of the status of the Company’s 1993 Plan forthe three months ended March 31, 2007 follows:

|                                           | ** ** | **Number of  Options** | ** ** | **Weighted-Average  Exercise  Price** | ** ** | **Weighted-Average  Remaining  Life** | ** ** |
|-------------------------------------------|------------|-----------------------------|------------|---------------------------------------|------------|---------------------------------------|------------|
| Outstanding,  January 1                   |       | 17,500                      |       | $                                     | 21.58      |                                  |       |   |
| Granted                                   |       | —                      |       | $                                     | —     |                                  |       |   |
| Exercised                                 |       | —                      |       | $                                     | —     |                                  |       |   |
|                                      |       |                        |       |                                  |       |                                  |       |
| Outstanding,  March 31                    |       | 17,500                      |       | $                                     | 21.58      |                                  | 8.85 years |   |
|                                      |       |                        |       |                                  |       |                                  |       |
| Fully vested and  exercisable at March 31 |       | 10,000                      |       | $                                     | 22.15      |                                  | 8.48 years |   |
| Available for future  grants at March 31  |       | 361,733                     |       |                                  |       |                                  |       |

 

As of March 31,2007, there were 17,500 options outstanding with a weighted-average exerciseprice of $21.58 (ranging from $13.35 to $25.99) and a weighted-averageremaining life of 8.85 years.  Alloutstanding unvested stock options are expected to vest. The aggregateintrinsic value of all outstanding, fully-vested and exercisable stock optionsat March 31, 2007 was insignificant.

The Companyadopted SFAS 123(R) in the first quarter of 2006 using the modified prospectivemethod. Similar to SFAS 123, which the Company adopted in 2003, SFAS 123(R)requires the cost of all share-based payments to employees, including grants ofemployee stock options, to be recognized in the financial statements based ontheir fair values measured at the grant date, or the date of latermodification, over the requisite service period. For tax purposes, the Companyexpects to be entitled to a tax deduction, subject to certain limitations,based on the fair value of certain equity awards when stock options areexercised. SFAS****123(R) requiresthat compensation cost be recognized in the financial statements based on thefair value measured at the grant date, or the date of later modification, overthe requisite service period. The cumulative compensation cost recognized forequity awards pursuant to SFAS 123(R) and amounts that ultimately will bedeductible for tax purposes are temporary differences as prescribed by SFAS109,*******“Accounting for IncomeTaxes”*. The taxeffect of compensation deductions for tax purposes in excess of compensationcost recognized in the financial statements, if any, will be recorded as anincrease to additional paid-in capital when realized. A deferred tax assetrecorded for compensation cost recognized in the financial statements thatexceeds the amount that is ultimately realized on the tax return, if any, willbe charged to income tax expense when the restrictions lapse or stock optionsare exercised or expire unless the Company has an available additional paid-incapital pool (“APIC Pool”), as defined pursuant to SFAS 123(R). The Company isrequired to assess whether there is an available APIC Pool when the stockoptions are exercised or expire.

SFAS 123(R) alsoamends SFAS 95, *“Statement of Cash Flows”*, torequire companies to change the classification in the statement of cash flowsof any tax benefits realized upon the exercise of stock options or issuance ofnonvested share unit awards in excess of that which is associated with the expenserecognized for financial reporting purposes. These amounts are required to bereported as a financing cash inflow rather than as a reduction of income taxespaid in operating cash flows.

In addition, SFAS123(R) requires a calculation to establish the beginning pool of excess taxbenefits, or the additional paid-in capital pool (“APIC pool”), available toabsorb any tax deficiencies recognized after the adoption of SFAS 123(R). TheCompany has elected the alternative transition method, which includes asimplified calculation method, set forth in FASB Staff Position No. FAS123(R)-3, *“Transition Election Related to Accounting for theTax Effects of Share-Based Payment Awards”* to calculate itsbeginning APIC pool.

The Companyestimates the fair value of its stock options using the Black-Scholes optionpricing model (the “Option Model”).  The Option Model requires the use ofsubjective and complex assumptions, including the option’s expected term andthe estimated future price volatility of the underlying stock, which determinethe fair value of the share-based awards.  The Company’s estimate ofexpected term in 2006 was determined based on the weighted-average period oftime that options granted are expected to be outstanding considering currentvesting schedules and the historical exercise patterns of the existing optionplan.  The expected volatility assumption used in the Option Model isbased on historical volatility of the Company’s stock in accordance withguidance provided in SFAS 123(R) and SAB 107.  The risk-free interest rateused in the Option Model is based on the yield of U.S. Treasuries with amaturity closest to the expected term of the Company’s stock options.

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Theweighted-average assumptions used for stock option grants during the three monthsended March 31 follows:

|                           | ** ** | **2007** | ** ** | **2006** | ** ** |
|---------------------------|------------|----------|------------|----------|------------|
| Risk-free  interest rate  |       | n/a      |       | 4.6      | %          |
| Expected life  (in years) |       | n/a      |       | 4        |       |
| Expected  volatility      |       | n/a      |       | 21.0     | %          |
| Expected dividends        |       | None     |       | None     |       |

 

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

**Overviewof California Coastal Communities, Inc.**

We are aresidential land development and homebuilding company with properties owned orcontrolled in five Southern California counties (Los Angeles, Orange,Riverside, San Bernardino and Ventura). Our principal activities include:

·                  obtaining zoning and otherentitlements for land we own or control through purchase options or jointventures;

·                  improving the land for residentialdevelopment; and

·                  designing,constructing and selling single-family homes in Southern California.

Once ourresidential land is entitled, we may build homes, sell unimproved land to otherdevelopers or homebuilders, sell improved land to homebuilders, or participatein joint ventures with other developers, investors or homebuilders to financeand construct infrastructure and homes. The majority of our homes are designed to appeal to move-up homebuyers andare generally offered for sale in advance of their construction. During thenext 12 months, we will focus our primary efforts to:

·                  complete infrastructure and modelhome construction, and begin selling production homes at the 356-homeBrightwater project located on the Bolsa Chica mesa in Orange County,California;

·                  complete the entitlement process fora 168-acre joint venture project near Oxnard, California currently beingplanned for 554 single-family detached homes and 500 attached homes (townhomes,condominiums and apartments); and

·                  maximizedeliveries, revenues and profitability of our homebuilding operationsthroughout Southern California.

However, we mayalso consider other strategic opportunities; and there can be no assurance thatwe will accomplish, in whole or in part, all or any of these strategic goals.

Our total revenuesfor the three months ended March 31, 2007 and 2006 were $12.2 million and $27.9million, respectively. For the three months ended March 31, 2007 and 2006, wedelivered 15 and 49 homes, respectively. Our total assets as of March 31, 2007and December 31, 2006 were $329.4 million and $332.3 million, respectively. Ourhomebuilding subsidiary, Hearthside Homes, Inc., has delivered over 2,000 homesto families throughout Southern California since its formation in 1994.

Prior to obtainingthe Coastal Development Permit for our Brightwater project in December 2005, wehistorically maintained a minimal amount of leverage. In September 2006, weobtained $225 million of debt financing as described in Notes 4 and 5 to the consolidatedfinancial statements in this Form 10-Q, which provided $125 million to fund the$12.50 special dividend to our stockholders on September 28, 2006 that isdescribed in Note 13 to the consolidated financial statements in our AnnualReport on Form 10-K for the year ended December 31, 2006. As of March 31, 2007,we had $194.5 million of debt against $117.2 million of book equity and a$220.3 million equity market capitalization.

We were formed in1988 and our executive offices are located at 6 Executive Circle, Suite 250,Irvine, California 92614.  Our websiteaddress is http://www.californiacoastalcommunities.com and our telephone numberis (949) 250-7700. We make available through our website our annualreport on Form 10-K, quarterly reports on Form 10-Q, current reports on Form8-K, and amendments to these reports filed or furnished pursuant to Section13(d) or 15(d) of the Exchange Act as soon as reasonably practicable after theyare filed with, or furnished to, the SEC. Copies of our Form 10-K, quarterlyreports on Form 10-Q, current reports on Form 8-K, and amendments to thesereports are available free of charge upon request. In addition, at our websitewe post current versions of or code of ethics, audit committee charter andnominating committee charter.

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**Outlook**

Our homebuilding outlook varies significantly betweenthe high-end coastal location of our Brightwater project in Huntington Beachand our “affordable” home projects in the Inland Empire and Lancaster.  Conditions in these affordable marketscontinue to be very challenging. We expect these conditions to continue formost of 2007 and we may not be able to generate sufficient gross operatingprofits during the second and third quarters of 2007 to cover our selling,general and administrative expenses.

Based on input from realtors and fellow homebuilders,as well as reports in the press, it appears that high-end coastal markets arecontinuing to report steady sales and increasing prices. Therefore, we areoptimistic about our Brightwater project and, given Brightwater’s superiorlocation, the extremely limited supply of new homes on the coast of SouthernCalifornia and the absence of significant competition from other homebuildersin the Huntington Beach market, we believe the project creates a unique futureopportunity.  We are planning to completemodel homes for two of our four products and open Brightwater for sale thissummer.  We anticipate first deliveriesin the fourth quarter of 2007 which should generate significant gross operatingprofits.

The housing market downturn that began in 2006continued into the first quarter of 2007 and is expected to continue throughoutthe year. The sustained softness in the housing market was compounded by recentdifficulties in the subprime lending industry and the resulting tightening ofcredit available to homebuyers.  Duringthe first quarter of 2007, net new orders decreased to 13 homes compared with29 homes during the comparable period of 2006. Cancellations as a percentage ofnew orders were 32% during the first quarter of 2007, compared withapproximately 29% during the comparable period of 2006 and 41% for the fourthquarter of 2006. At the same time, backlog as of March 31, 2007 decreased to 15homes compared with 60 homes as of March 31, 2006 due to fewer homes in backlogat the prior period end and reduced sales activity during the first quarter of2007.

This slowdown reflects an overall softening of demandfor new homes, as well as an oversupply of homes available for sale. Weattribute the reduction in demand to reduced affordability of new homes due torapid price increases between 2002 and 2005 and declines in consumer confidencerelated to concerns on the part of prospective home buyers about the futuredirection of home prices, and their ability to obtain financing and sellexisting homes. In addition, speculators and investors are no longer helping tofuel demand. We try to avoid selling homes to speculators and start few homeswithout having a signed agreement of sale. However, as of March 31, 2007 we hadstanding inventory of 35 homes compared with 46 homes at December 31, 2006 andtwo homes as of March 31, 2006.

We have also been impacted by an overall increase inthe supply of homes available for sale in our markets as certain large homebuilderscontinue to build product in excess of current demand and as speculatorsattempt to sell the homes they previously purchased. At the same time, many ofthe large national homebuilders operating in our markets are aggressivelyattempting to reduce their inventories by offering incentives and/or loweringprices, leading to lower gross margins on home sales. We will continue toassess our owned land position to identify those assets that should be reducedor repositioned. Additionally, our strategy is to adjust our cost structure totoday’s market conditions by rebidding subcontracts and materials in line withreduced demand, all in an effort to partially offset our declining margins.

Despite this slowdown, we continue to remaincautiously optimistic about the future growth of our business given thepotential of our Brightwater project. The long-term outlook for homebuilding inSouthern California remains strong due to the continuing regulation-inducedconstraints on lot supplies. We have traditionally employed a conservativeapproach to managing our real estate inventories and believe we arewell-positioned to withstand the effects of the market downturn as it continuesto unfold.  We do not presently expectthat current weaknesses in the homebuilding market will significantly impactour Brightwater project given the site’s superior coastal location, theextremely limited supply of new homes on the coast of Southern California andthe absence of significant competition from other homebuilders in the HuntingtonBeach market.

There can be no assurance regarding the duration ofthe current slowdown of the Southern California residential real estatemarket.  In particular, (i) the recentdifficulties in the subprime lending industry, (ii) the significant increasesin home prices between 2002 and 2005 and the related decline in theaffordability of new homes in Southern California, (iii) the decline inconsumer confidence with respect to the housing market, (iv)  the state of the national economy, increasesin interest rates by the Federal Reserve Board between mid-2004 and 2006 andthe possibility of a recession in the future, and (v) the continued threat ofinflation and potential for further increases in interest rates by the FederalReserve Board, collectively may exert recessionary pressures on the SouthernCalifornia economy and may have further negative impacts on the SouthernCalifornia housing market.

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In response toslower sales and to remain competitive in our markets, we are offering moreincentives and some price reductions, and we have determined that theconstruction start for the 73-unit Lancaster II project, which has no recordedloan, will be deferred until sales activity improves.

**OurCurrent and Future Homesites**

Wecurrently have on-going Southern California homebuilding projects in:

·                  Orange County inthe Huntington Beach area;

·                  Riverside Countynear the cities of Corona and North Corona, and in the City of Beaumont;

·                  San BernardinoCounty in the City of Ontario; and

·                  NorthernLos Angeles county in the City of Lancaster.

We completedgrading our Brightwater development project in Orange County during October2006 and plan to process permits for seven homes on adjacent parcels in theCity of Huntington Beach, which would bring the total unit count up to 356. Thefollowing chart describes our current projects, their location and our lotinventories as of March 31, 2007:

| Project              | ** ** | **Location**                     | ** ** | **3/31/07  Lot  Inventory** | ** ** |
|----------------------|------------|----------------------------------|------------|-----------------------------|------------|
|                 |       |                             |       |                        |       |
| Orange  County:      |       |                             |       |                        |       |
| Brightwater          |       | Bolsa Chica                      |       | 356                         |       |
|                 | * *   | * *                         |       |                        |       |
| Inland  Empire:      |       |                             |       |                        |       |
| Chandler  Ranch      |       | North Corona                     |       | 22                          |       |
| Alisal  at Ontario   |       | Ontario                          |       | 15                          |       |
| Woodhaven            |       | Beaumont                         |       | 87                          |       |
| Hearthside  Lane     |       | Corona                           |       | 151                         |       |
|                 | * *   | *Subtotal  — Inland Empire* |       | 275                         |       |
|                 |       |                             |       |                        |       |
| Lancaster:           |       |                             |       |                        |       |
| Alisal  at Lancaster |       | Lancaster                        |       | 6                           |       |
| Lancaster  II        |       | Lancaster                        |       | 73                          |       |
| Quartz  Hill         |       | Lancaster                        |       | 72                          |       |
|                 | * *   | *Subtotal  — Lancaster*     |       | 151                         |       |
|                 |       |                             |       |                        |       |
|                 | * *   | *Total — All Projects*      |       | 782                         |       |

 

These homebuildingprojects are currently expected to generate cash flows and gross operatingmargins through mid-2010.  Up to approximately554 additional single-family lots could be available for homebuildingoperations if we obtain entitlements for our Oxnard project; however, the exactnumber of homes will depend on the final outcome of the entitlement process.

*Brightwater at Bolsa Chica*

The 110-acre BolsaChica upper mesa is the largest property in our portfolio, representingapproximately 51% of our total assets as of March 31, 2007. The Bolsa Chicaupper mesa is one of the last large undeveloped coastal properties in SouthernCalifornia, and is located in Orange County, approximately 35 miles south ofdowntown Los Angeles. Bolsa Chica is bordered on the north and east byresidential development in the City of Huntington Beach and Huntington Harbor,to the south by open space and the 1,200-acre Bolsa Chica wetlands, and to thewest by 120 acres of publicly-owned space on the lower bench of the Bolsa Chicamesa, Pacific Coast Highway, Bolsa Chica State Beach, and the Pacific Ocean.Our holdings on the Bolsa Chica mesa include 68 acres of developable land onthe upper mesa

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currently underdevelopment for a residential community known as Brightwater, 37 acres of openspace and conservation area in the planned community, and five acres in theCity of Huntington Beach which are currently zoned agricultural. We areanalyzing development alternatives for this 5-acre parcel and expect to submita proposed site plan to the City of Huntington Beach during 2007.

We also ownapproximately 104 non-developable acres on, or adjacent to, the HuntingtonMesa. Approximately 51 acres of land on the Huntington Mesa have been offeredfor dedication to the County of Orange for inclusion in the Harriet M. WeiderLinear Park in conjunction with the development of Brightwater and anadditional 51 acres are subject to a conservation easement.

The Brightwaterresidential community will offer a broad mix of home choices averaging 2,860square feet and ranging in size from 1,710 square feet to 4,140 square feet.The smaller homes are currently expected to be offered at prices starting inthe low to mid $1 millions and the larger homes are currently expected to startin excess of $2 million. With 356 homes on 68 acres of the upper mesa, theresulting low-density plan equates to approximately five homes per acre, consistentand compatible with the neighboring Huntington Beach communities. To date, over2,600 people have registered on our website requesting information aboutpurchasing a home at Brightwater. We completed grading the Brightwaterdevelopment during October 2006, started building eight of the 17 model homesin December 2006, and construction for the remaining nine model homes began inFebruary 2007. We currently expect to:

·                  complete construction of the firsteight model homes, which range from 1,710 to 2,160 square feet, during thesummer of 2007,

·                  start selling production homes fromthe first eight model homes during the summer of 2007,

·                  complete construction of nineadditional model homes, which will range from 2,720 to 4,140 square feet,during the fall of 2007,

·                  start selling production homes fromthe nine additional model homes during the fall of 2007, and

·                  begindelivering homes for the first eight models by the end of 2007.

However, there canbe no assurance in that regard, or as to the absence of further delays.

Weused the following facts and assumptions in estimating the value that we expectto receive from the Brightwater development project:

·                  TheBrightwater coastal development permit provides for 349 homes aggregatingapproximately 995,000 square feet.

·                  Weown land adjacent to Brightwater in the City of Huntington Beach, for which weintend to process permits to build seven additional homes which would beincluded in the Brightwater community.

·                  Modelhomes for the first two products at Brightwater are projected to be completedduring the summer of 2007 and build-out of production homes is expected to takeapproximately two to three years.

·                  Weare currently planning to: (i) begin selling homes during the summer of 2007,and (ii) begin delivering homes by the end of 2007.

·                  Wecurrently expect to deliver the majority of the Brightwater homes in 2008 and2009.

·                  Asof January 2006, new home prices approximated $650 per square foot, includingview and other premiums, in the local residential market (coastal HuntingtonBeach). We expect to conduct an updated market survey during the second quarterof 2007 as we prepare to open for sale during the summer of 2007.

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

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·                  Coststo improve the lots from their raw condition to finished lots, including Countypermits and City annexation fees, approximate $170,000 to $180,000 per lot.

·                  Thedirect costs (excluding indirect costs such as supervision, overhead, sales andmarketing, warranty, insurance, etc.) of building homes at Brightwater arecurrently expected to range from approximately $120 to $150 per square foot.

·                  Indirectcosts are expected to approximate 5 to 6% of sales revenues.

·                  Brightwater iscurrently expected to generate gross margins that are approximately two tothree times our 2006 homebuilding margins of 14% due to our low carrying valuein Brightwater.

The estimationprocess involved in the determination of value is inherently uncertain becauseit requires estimates as to future events and market conditions. Thisestimation process assumes our ability to complete development and dispositionof our real estate inventories in the ordinary course of business based onmanagement’s present plans and intentions. Economic, market, and environmentalconditions may affect our development and marketing plans. The development ofBrightwater depends upon various factors. Accordingly, the amount ultimatelyrealized from the Brightwater project may differ materially from our currentestimates and the project’s carrying value.

*OxnardLand Development - Unconsolidated Joint Venture*

In February 2003,we entered into two option contracts to acquire land adjacent to the City ofOxnard in Ventura County, California aggregating approximately 168 acres. Weare developing a land plan for the area, which also includes an additional 149acres owned by other landowners, with the intention of entitling the propertyfor residential development and annexing it into Oxnard.  During October 2003, we entered into a jointventure agreement with a major financial partner to pursue the Oxnarddevelopment opportunity. We assigned the land purchase option contracts to theOxnard joint venture. Hearthside Homes, Inc., our homebuilding subsidiary, isthe manager of the Oxnard joint venture.

We currentlyexpect the residential development plan to include approximately 760single-family detached lots and approximately 630 attached residential units(townhomes, condominiums and apartments); however, these numbers are subject tochange during the course of the entitlement process. Approximately 554 of thesingle-family lots and approximately 500 of the attached units would bedeveloped on the 168 acres of optioned land that we currently expect the Oxnardjoint venture to purchase.  Thesingle-family detached product is currently expected to range fromapproximately 1,700 square feet to 3,400 square feet and the attached units arecurrently expected to range from approximately 1,030 square feet to 1,850square feet. An independent market study as of March 2007 estimated averagehome prices for the project of approximately $603,000, or an average of $303per square foot.

The optioncontracts give the Oxnard joint venture two years, plus up to three additionalyears through the exercise of extensions, to complete entitlement activitiesbefore purchasing the land. The Oxnard joint venture has the right to terminatethese option agreements by forfeiting the cash deposits. The Oxnard jointventure is striving to obtain approval of its plan from the Oxnard City Councilin the second half of 2007 and approval of annexation into the City of Oxnardfrom the Local Agency Formation Commission in the first quarter of 2008;however, delays could be encountered. If the Oxnard joint venture completes theentitlement process in the time frame set forth above, and decides to buildhomes (rather than sell lots), most of the homes would be delivered between2010 and 2012, based on current expectations and assumptions. The Oxnard jointventure has exercised five six-month extensions, extending the current closingdate for the option contracts to August 2007, and there is one remainingsix-month extension through February 2008. The Oxnard joint venture has commenced preliminary discussions with thelandowners regarding an additional six-month extension to August 2008, however,there can be no assurances that the landowners will agree to sell an option forsuch further extension on terms acceptable to the venture.

The Oxnard jointventure is funded by both of its members. Hearthside Homes, Inc. made an initial contribution of $500,000. Thenon-managing member also made an initial contribution of $500,000 to the jointventure and, as of December 31, 2005, had made an aggregate of $4 million offirst tier additional contributions. The members have provided a second tier ofadditional capital contributions of $1 million each, as originally provided inthe joint venture agreement.  Inaddition, the members have provided an additional $325,000 each of temporaryadvances to continue the business plan. During the first quarter of 2007, the members each contributed $100,000to the joint venture.

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In addition to theland purchase options for the project property, the Oxnard joint venture held aland purchase option which controlled property which was expected to providefill dirt for the project property.  OnApril 16, 2007, the Oxnard joint venture sold the non-project land purchaseoption for $1.8 million since the venture has contracted for an alternatesource for the fill dirt. The Oxnard joint venture received net proceeds ofapproximately $700,000 in cash and a $1.0 million note receivable due July 20,2007 for this transaction. After paying the balance of commissions and closingcosts of $100,000, Oxnard LLC plans to utilize the proceeds to fund ongoingdevelopment costs.

Our totalinvestment in the venture as of March 31, 2007 is $1.8 million. We expect tomake additional aggregate capital contributions of approximately $100,000 tothe joint venture during the remaining nine months of 2007, bringing our totalexpected investment in the venture to $1.9 million.  During the first half of 2008, we expect tomake additional aggregate capital contributions of approximately $650,000 to$800,000. The amount of contributions could be substantially increased if thenote receivable is not collected as discussed above.

After payment of a10% preferred return on invested capital to us and our partner, the first $8million of profits are allocated 75% to our partner and 25% to us, and profitsover $8 million and losses over $5 million are generally allocated on a 50/50basis in accordance with the operating agreement. The first $5 million oflosses are generally allocated 80% to our partner and 20% to us.

While we exert alarge degree of influence over the joint venture, our partner does have varioussubstantive participating rights such as approval rights with regard to themajority of business decisions, including approval of project budgets.

*Homebuilding*

We delivered 15 homesduring the first quarter of 2007, compared with 49 deliveries during thecomparable period of 2006. We acquired no single-family residential lots duringthe first quarter of 2007. After several years of dramatic home priceappreciation in Southern California, we saw price depreciation during 2006 inthe Inland Empire (Corona, Ontario and Beaumont) and Lancaster markets. Thistrend continued in the first four months of 2007 and we expect it to continuein these markets throughout the year. Therefore, we have further reduced salesprices and offered incentives for a number of our homes which are not yet inescrow in response to our competition and to reflect current market pricing.

Our homebuildingprojects are described below:
| ** **           | ** ** | ** **                   | ** ** | ** **      | ** ** | ** **       | ** ** | ** **         | ** ** | **Deliveries**         | ** ** |
|----------------------|------------|------------------------------|------------|-----------------|------------|------------------|------------|--------------------|------------|------------------------|------------|
| ** **           | ** ** | ** **                   | ** ** | ** **      | ** ** | ** **       | ** ** | ** **         | ** ** | **Quarter Ended** | ** ** |
| ** **           | ** ** | ** **                   | ** ** | **Land**        | ** ** | **Commenced**    | ** ** | **Commenced**      | ** ** | **March 31,**     | ** ** |
| ** **           | ** ** | **Location**                 | ** ** | **Acquisition** | ** ** | **Construction** | ** ** | **Sales**          | ** ** | **2007**               | ** ** | **2006** | ** ** |
|                 |       |                         |       |            |       |             |       |               |       |                   |       |   |   |
| Completed  Projects  |       | Rancho  Santa Fe / Riverside |       | n/a             |       | n/a              |       | n/a                |       | 6                      |       | 1 |   |
|                 |       |                         |       |            |       |             |       |               |       |                   |       |   |   |
| Active Projects      |       |                         |       |            |       |             |       |               |       |                   |       |   |   |
| Brightwater          |       | Bolsa  Chica                 |       | 1970            |       | 2006             |       | 2007               | (a)        | —                 |       | — |   |
| Chandler Ranch       |       | North  Corona                |       | 2004            |       | 2005             |       | 2005               |       | 3                      |       | 38 |   |
| Alisal at  Ontario   |       | Ontario                      |       | 2005            |       | 2005             |       | 2006               |       | 2                      |       | — |   |
| Woodhaven            |       | Beaumont                     |       | 2005            |       | 2005             |       | 2006               |       | —                 |       | — |   |
| Hearthside Lane      |       | Corona                       |       | 2005            |       | 2005             |       | 2007               |       | —                 |       | — |   |
| Alisal at  Lancaster |       | Lancaster                    |       | 2004            |       | 2004             |       | 2005               |       | 2                      |       | 10 |   |
| Quartz Hill          |       | Lancaster                    |       | 2005            |       | 2006             |       | 2006               |       | 2                      |       | — |   |
| Lancaster II         |       | Lancaster                    |       | 2005            |       | 2008             | (a)        | 2008               | (a)        | —                 |       | — |   |
|                 |       |                         |       |            |       |             | * *   | *Total Deliveries* |       | 15                     |       | 49 |   |

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(a) Planned

*RanchoSanta Fe.*  In October2003, we entered into an agreement to acquire 32 lots in a luxury golfcommunity known as Crosby Estates in the Rancho Santa Fe area of San DiegoCounty in California. We acquired the lots during the period from October 2003to March 2005.  During 2005, two model homesaveraging approximately 3,370 square feet were completed and six homes weredelivered at an average price of $1.2 million. We delivered 20 homes during 2006 at an average price of $1.4 million,and the remaining six homes were delivered during the first quarter of 2007 atan average price of $1.2 million.

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*Corona.*  We acquired 83 lots in North Corona in May2004. Following construction of infrastructure, during April 2005, we beganconstruction of homes averaging 3,160 square feet. We opened for sales duringthe third quarter of 2005 and delivered 58 homes during 2006 at an averageprice of $600,000.  During the firstquarter of 2007, three additional homes were delivered at an average price of$605,000. As of April 30, 2007, five homes are in escrow at an average price of$605,000 and 13 additional homes are completed and have been released for sale.

During April 2005,we acquired 151 additional lots in Corona. Following construction of infrastructure, construction of five modelhomes averaging 3,600 square feet on lots of approximately 7,200 square feetbegan during the fourth quarter of 2006. These models were completed duringApril 2007, and we released the first six production phase homes for sale atthe April 21, 2007 grand opening at an average price of $587,000.

*Ontario.*  During April 2005, we acquired 26 lots in theCity of Ontario in Riverside County, California. This small community of homes,averaging 3,380 square feet, is an infill site situated very close to theprojects we completed in the City of Chino in 2005. Construction of the firstphase of 13 homes began during the fourth quarter of 2005, and we opened forsales during March 2006. We delivered nine homes during 2006 at an averageprice of $675,000, and two homes during the first quarter of 2007 at an averageprice of $676,000. As of April 30, 2007, one home is in escrow at a price of$643,000 and seven additional homes are completed or under construction andhave been released for sale.

*Beaumont*.We acquired 102 lots in the City of Beaumont during the third quarter of 2005.Following construction of infrastructure, construction of homes averaging 2,500square feet began during the first quarter of 2006, and sales commenced duringMarch 2006. We delivered 15 homes during 2006 at an average price of$387,000.  As of April 30, 2007 two homesare in escrow at an average price of $440,000 and 14 additional homes arecompleted and have been released for sale.

During the firstquarter of 2007, we recorded an impairment charge of $4.0 million related toour real estate inventories for the remaining 87 homes at our Beaumont project.The impairment charge reflects our current expectations about selling pricesand gross margins for the project. As required by SFAS 144, should marketconditions further deteriorate, we will reevaluate the expected cash flows fromthis project to determine whether any additional impairment exists.

*Lancaster.*   We acquired 104 lots in the City ofLancaster in northern Los Angeles County during May 2004. We began constructionof model homes averaging approximately 2,850 square feet during the thirdquarter of 2004 and opened for home sales in January 2005.  During 2005, we delivered 55 homes at anaverage price of $406,000. We delivered 41 homes during 2006 at an average priceof $448,000, and delivered two additional homes during the first quarter of2007 at an average price of $470,000. One additional home was delivered inApril 2007 at a price of $405,000 and as of April 30, 2007 three homes are inescrow at an average price of $433,000 and one additional home is completed andhas been released for sale.

In April 2005, weacquired an additional 73 unentitled lots in Lancaster. The entitlement processis near completion; however, we have determined that the construction start forthe 73-unit project, which has no recorded loan, will be deferred until salesactivity in the market has improved.

In December 2005,we acquired 77 additional lots in an area known as Quartz Hill in the City ofLancaster. The homes in this community are on 10,000 square foot lots and willaverage 3,640 square feet. Construction of models began in May 2006 and weopened for sales during July 2006. During 2006, we delivered three homes at anaverage price of $537,000, and two additional homes during the first quarter of2007 at an average price of $552,000. One additional home was delivered inApril 2007 at a price of $494,000 and as of April 30, 2007 three homes are inescrow at an average price of $554,000 and 11 additional homes are completed orunder construction and have been released for sale.

**Critical Accounting Policies**

In the preparationof the consolidated financial statements, we applied accounting principlesgenerally accepted in the United States of America. The application ofgenerally accepted accounting principles may require management to makeestimates and assumptions that affect the amounts reported in the financialstatements and accompanying results. Listed below are those policies andestimates that we believe are critical and require the use of complex judgmentin their application. In particular, our critical accounting policies andestimates include the evaluation of the impairment of 

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long-lived assets and theevaluation of the probability of being able to realize the future benefitsindicated by our significant federal tax net operating losses, as discussedfurther in Notes 2 and 8 to the consolidated financial statements.

*Basis ofConsolidation*

Certain of ourwholly-owned subsidiaries are members in joint ventures involved in thedevelopment and sale of residential projects and residential loan production.Our consolidated financial statements include our accounts and all of ourmajority-owned and controlled subsidiaries and joint ventures. The financialstatements of joint ventures in which we generally have a controlling ormajority economic interest (and thus are controlled by us) are consolidatedwith our financial statements. Minority interest represents the equity interestof our joint venture partner for one consolidated venture and is furtherdescribed in Note 10 to the consolidated financial statements included in ourAnnual Report on Form 10-K for the year ended December 31, 2006. Ourinvestments in unconsolidated joint ventures are accounted for using the equitymethod when we do not have voting or economic control of the ventureoperations, as further discussed in Note 4 to the consolidated financialstatements included in our Annual Report on Form 10-K for the year endedDecember 31, 2006.

*Impairmentof Long-Lived Assets*

We assess theimpairment of real estate inventories and other long-lived assets in accordancewith Statement of Financial Accounting Standards (“SFAS”) No. 144, *“Accounting for the Impairment or Disposal of Long-Lived Assets,”*(“SFAS144”) which requires that long-lived assets be reviewed for impairment wheneverevents or changes in circumstances indicate that the carrying amount of anasset may not be recoverable. As provided by SFAS 144, impairment is evaluatedby comparing an asset’s carrying value to the undiscounted estimated cash flowsexpected from the asset’s operations and eventual disposition. If the sum ofthe undiscounted estimated future cash flows is less than the carrying value ofthe asset, an impairment loss is recognized based on the fair value of theasset. If impairment occurs, the fair value of an asset for purposes of SFAS144 is deemed to be the amount a willing buyer would pay a willing seller forsuch asset in a current transaction.

In accordance withSFAS 144, in developing estimated future cash flows for impairment testing, weincorporated our own market assumptions including those regarding home prices,infrastructure and home-building costs and financing costs regarding realestate inventories.  Additionally, asappropriate, we identify alternative courses of action to recover the carryingvalue of our long-lived assets and evaluate all likely alternatives under aprobability-weighted approach as described in SFAS 144.

During the firstquarter of 2007, we recorded an impairment charge of $4.0 million related toour real estate inventories for the remaining 87 homes at our Woodhaven projectin the City of Beaumont. To date, we have not recorded impairment charges forour other projects primarily because most of our lot acquisitions werenegotiated prior to 2005 (thus reflecting less expensive land prices andbenefiting from home price appreciation during 2005 that exceeded the declinein home prices during 2006 and the first quarter of 2007).  However, as required by SFAS 144, shouldmarket conditions further deteriorate in the future or other events occur thatindicate the carrying amount of our real estate inventories may not berecoverable, we will reevaluate our expected cash flows from each project todetermine whether any additional impairment exists at any point in time.

*IncomeTaxes*

We account forincome taxes on the liability method. Deferred income taxes are determinedbased on the difference between the financial statement and tax bases of assetsand liabilities. The liability method requires an evaluation of the probabilityof being able to realize the future benefits indicated by deferred tax assets,such as tax net operating losses. A valuation allowance related to the deferredtax asset is recorded when it is more likely than not that some portion or allof the deferred tax asset will not be realized. Given the significance of ourhistorical federal tax net operating losses, as discussed in Note 8 to theconsolidated financial statements, the application of our policy in evaluatingthe expected future benefit of net operating losses is critical. In applyingthose policies, estimates and judgments affect the amounts at which certainassets and liabilities are recorded. We apply our accounting policies on aconsistent basis. As circumstances change, they are considered in our estimatesand judgments, and future changes in circumstances could result in changes inamounts at which assets and liabilities are recorded.

We remain subject to the general rules of Section 382of the Internal Revenue Code, which limit the availability of net operatinglosses if an ownership change occurs. If we were to experience anotherownership change, the amount of net

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operating losses available would generally be limited to an annualamount equal to (i) the value of our equity immediately before the ownershipchange, multiplied by the long-term tax-exempt rate (4.18% as of April 2007)plus (ii) recognized built-in-gains, defined as those gains recognized withinfive years of the ownership change subject to an overall limitation of the netunrealized built-in gains existing as of the ownership change date. We believewe have net unrealized built-in gains sufficient to allow utilization of theentire net operating loss, assuming that we are able to recognize these gainswithin the five-year time limitation. We estimate that as of April 30, 2007, wehave experienced a three-year cumulative ownership shift of approximately 35%,as computed in accordance with Section 382.

*HomebuildingRevenues and Cost of Sales*

Our homebuildingoperation generates revenues from the sale of homes to homebuyers. The majorityof these homes are designed to appeal to move-up homebuyers and the homes aregenerally offered for sale in advance of their construction. Sales contractsare usually subject to certain contingencies such as the buyer’s ability toqualify for financing. Revenue from the sale of homes is recognized at closingwhen title passes to the buyer, and the earnings process is complete. As aresult, our revenue recognition process does not involve significant judgmentsor estimates. However, we do rely on certain projections and estimates todetermine the related construction costs and resulting gross margins associatedwith revenues recognized. The cost of sales is recorded based upon totalestimated costs within a subdivision and allocated using the relative salesvalue method. Our construction costs are comprised of direct and allocatedcosts, including estimated costs for future warranties and indemnities. Our estimatesare based on historical results, adjusted for current factors.

*LitigationReserves*

We and certain ofour subsidiaries have been named as defendants in various cases arising in thenormal course of business and regarding assets and businesses disposed of by usor our former affiliates. See Note 9 in our consolidated financial statementsincluded in this Quarterly Report. We have reserved for costs expected to beincurred with respect to these cases based upon information provided by ourlegal counsel. There can be no assurance that total litigation costs actuallyincurred will not exceed the amount of such reserve.

**Recent Accounting Pronouncements**

See discussion regarding recent accountingpronouncements in Note 2 to the consolidated financial statements.

**Results of Operations**

*Three Months Ended March 31, 2007 Compared with theThree Months Ended March 31, 2006*

We reported revenues of $12.2 million and grossoperating loss of $3.2 million for the first quarter of 2007, compared with$27.9 million in revenues and gross operating profit of $4.7 million for thefirst quarter of 2006. Revenues in the current period reflect deliveries of 15homes, including the final six homes at the Rancho Santa Fe project, threehomes at the Chandler Ranch project in North Corona, and two homes each at ourAlisal project in Ontario, our Las Colinas project in Quartz Hill, and ourAlisal project in Lancaster. The comparable period of the prior year reflectsdeliveries of 49 homes, including 38 homes at the Chandler Ranch project and 10homes at the Alisal project in Lancaster. We generated $3.9 million less ingross operating profit before impairment charges from home sales during thefirst quarter of 2007 compared with 2006 as a result of delivering 34 fewerhomes and reduced margins due to the continuing real estate slowdown which hasresulted in lower selling prices. The current quarter’s homebuilding grossmargin before impairment charges of 6.6% is lower than the prior period grossmargin of 16.8% and fourth quarter 2006 margin of 9.5% primarily due to salesprice reductions and the use of incentives in order to move standing inventoryand be competitive in today’s market.

For the firstquarter of 2007, gross operating loss includes an impairment charge of $4.0million related to our Beaumont project for 87 remaining homes. This impairmentcharge reflects our current expectations about selling prices and gross marginsfor the project.  As required by SFAS144, should market conditions further deteriorate in the future or other eventsoccur that indicate the carrying amount of our real estate inventories may notbe recoverable, we will reevaluate our expected cash flows from each project todetermine whether any additional impairment exists at any point in time.

The $400,000 increase in other expense (income), netduring the first quarter of 2007 compared with the first quarter of 2006primarily reflects a $200,000 reduction in interest income on short-terminvestments, a $200,000 increase

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in legal expense primarily related to the Golden State Water litigationdescribed in Note 9 of Notes to Financial Statements, and a $100,000 increasein warranty expense.

*PaymentsUnder Contractual Obligations*

We have entered into certain contractual obligationsto make future payments for items such as loans, 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 ofMarch 31, 2007 (in millions):

|                         | ** ** | ** ** | ** ** | **Payments due by period** | ** ** |
|-------------------------|------------|------------|------------|-------------------------------------------|------------|
| ** **              | ** ** | ** ** | ** ** | **Less**                                  | ** ** | ** ** | ** ** | ** ** | ** ** | **More** | ** ** |
| ** **              | ** ** | ** ** | ** ** | **than 1**                           | ** ** | **1-3** | ** ** | **4-5** | ** ** | **than 5** | ** ** |
| ** **              | ** ** | **Total**  | ** ** | **year**                                  | ** ** | **years** | ** ** | **years** | ** ** | **years** | ** ** |
| Revolving loan  (a)     |       | $          | 35.3       |                                      | $          | 3.6 |   | $ | 31.7 |   | $ | — |   | $ | — |   |
| Term loan (a)           |       | 137.6      |       | 7.5                                       |       | 80.1 |   | 50.0 |   | — |   |
| Other project  debt (a) |       | 44.8       |       | 21.1                                      |       | 23.7 |   | — |   | — |   |
| Operating leases        |       | 1.6        |       | .3                                        |       | .7 |   | .6 |   | — |   |
| Total                   |       | $          | 219.3      |                                      | $          | 32.5 |   | $ | 136.2 |   | $ | 50.6 |   | $ | — |   |

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(a)             Amountsinclude estimated interest costs which are calculated based on forecasted debtbalances and the applicable interest rate at March 31, 2007.

Our purchasecontracts which are made in the normal course of our homebuilding business forland acquisition and construction subcontracts are generally cancelable atwill. Other contractual obligations including our tax liabilities (includingunrecognized tax benefits recorded pursuant to FIN 48), accrued benefitliability for a frozen retirement plan and other accrued pensions, homewarranty reserves and contingent indemnity and environmental obligations areestimated based on various factors. Payments are not due as of a given date,but rather are dependent upon the incurrence of professional services, thelives of annuitants and other factors. The estimation process involved in thedetermination of carrying values of these obligations is inherently uncertainsince it requires estimates as to future events and contingencies. We haveprovided additional disclosure in Item 1. “Legal Proceedings” and in Note 9 toour consolidated financial statements in this Quarterly Report.

**Liquidity and Capital Resources**

Year-over-yearchanges in the principal components of our liquidity and capital resources areas follows (in millions, except percentages):

|                                                  | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                       | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| Cash and cash  equivalents                       |       | 8.7                                              |       | $ | 4.6 |   |
| Short-term  investments                          |       | —                                           |       | 22.5 |   |
| Cash used in  operating activities               |       | (9.6                                             | )          | (2.8 | ) |
| Cash provided by  investing activities           |       | 1.4                                              |       | 7.7 |   |
| Cash provided by (used  in) financing activities |       | 6.3                                              |       | (8.0 | ) |
|                                                  |            |                                                  |            |  |  |  |

 

Theprincipal assets in our portfolio are residential land which must be held overan extended period of time in order to be developed to a condition that, inmanagement’s opinion, will ultimately maximize our return. Consequently, werequire significant capital to finance our real estate development andhomebuilding operations. Historically, sources of capital have included loanfacilities secured by specific projects, asset sales and available internalfunds. Our unrestricted cash and cash equivalents as of March 31, 2007aggregated $8.7 million. During the first quarter of 2007, we primarilyutilized internally generated cash to fund new construction at our homebuildingprojects other than Brightwater in order to reduce the negative arbitragebetween interest costs on project debt compared with interest income earned onshort-term investments.

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OnSeptember 15, 2006 we obtained the $100 million Senior Secured Project Revolveras a construction facility to finance infrastructure and homebuildingactivities at Brightwater as further described in Note 4 to the consolidatedfinancial statements. This loan is funding the first $100 million ofdevelopment and construction costs for the Brightwater project. Availabilityunder the $100 million Revolving Loan is subject to the applicable borrowingbase limitations and includes financial covenants which may limit the amountthat may be borrowed. The initial borrowing base value of the Brightwaterproject was determined by an independent third-party appraisal of the projecton an “as-is” basis, which was $302 million as of July 6, 2006. This appraisalreflects substantial value in excess of the book value of $142 million as ofJune 30, 2006. Outstanding advances bear interest at our option at either (i)the Alternate Base rate (“Prime”) minus 25 basis points or (ii) LIBOR plus 200basis points.

We have substantialborrowing capacity available. As of March 31, 2007, based on construction inplace, the immediately available borrowing capacity on our other project debtconstruction loan facilities is approximately $8.0 million for projects otherthan Brightwater.  The additionalfacility availability for future construction costs is $72.3 million forBrightwater and approximately $43.7 million for other projects. We repaid loanson the Rancho Santa Fe and Chandler projects in full in January and February2007, respectively. During February and April 2007, we extended the maturitydates for the loans on the Beaumont and Ontario projects to August 2007 andOctober 2007, respectively.

We are utilizinginternally generated cash and joint venture contributions to fund the Oxnardland development project. We currently expect to make aggregate additionalcapital contributions of approximately $100,000 to the Oxnard joint ventureduring the remaining nine months of 2007, bringing our total expectedinvestment in the venture to $1.9 million (see Note 9 to the consolidatedfinancial statements). During the first half of 2008, we expect to makeadditional aggregate capital contributions of approximately $650,000 to$800,000. The amount of contributions could be substantially increased if the$1.0 million note receivable is not collected as discussed above.

We believe thatour cash and cash equivalents, future real estate sales proceeds, and fundsavailable under our current credit agreements will be sufficient to meetanticipated operating and capital investment requirements and projectdevelopment costs for homebuilding projects, the Oxnard land developmentproject, and general and administrative expenses, for at least the next 12months.

We are subject tothe usual obligations associated with entering into contracts for the purchaseof land and improved homesites. The purchase of properties under thesecontracts is generally contingent upon satisfaction of certain requirements bythe sellers, including obtaining applicable property entitlements. We alsoutilize option contracts with third-party land sellers and financial entitiesas a method of acquiring land in staged takedowns and minimizing the use offunds from other corporate financing sources. These option contracts also helpto manage the financial and market risk associated with land holdings. Purchaseand option contracts generally require the payment of a non-refundable cashdeposit of 5% to 15% of the purchase price for the right to acquire lots over aspecified period of time (usually one to two years) at predetermined prices. Wehave the right at our discretion to terminate our obligations under these landpurchase and option agreements by forfeiting the cash deposit with no furtherfinancial responsibility. As of March 31, 2007, we have one consolidated landoption deposit for $25,000 which is non-refundable. In addition, ourunconsolidated Oxnard joint venture has land deposits of $2.5 million.

We may enter intoland development and homebuilding joint ventures from time to time as a meansof expanding our market opportunities, establishing strategic alliances,managing our risk profile and leveraging our capital base. These joint venturesmay obtain secured acquisition, development and construction financing, whichminimize the use of funds from other corporate financing sources.

*March 31,2007 Compared with December 31, 2006*

Cash used in homebuilding operations of $9.6 millionfor the first quarter of 2007 primarily reflects investments in real estateinventories and construction costs of $18.1 million plus a $2.9 milliondecrease in accounts payable, accrued and other liabilities, offset by realestate sales proceeds of $11.7 million from deliveries of 15 homes. Additionalsignificant uses of cash include repayments of project debt in excess ofborrowings of $3.1 million which we made in order to reduce the negativearbitrage between interest costs on project debt compared with interest incomeearned on short-term investments. The primary sources of cash during the quarterwere borrowings from our Senior Secured Project Revolver (“Revolver”) of $9.4million. These items, as well as other activity presented in the Statements ofCash Flows, resulted in a $1.9 million decrease in cash and cash equivalents.

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The $1.3 million decrease in deferred tax assetsprimarily reflects the $3.3 million adjustment recorded upon the adoption ofFIN 48 discussed in Note 8 of Notes to Consolidated Financial Statements,partially offset by a $2.0 million tax benefit for additional net operatinglosses generated during the first quarter of 2007.

The $1.4 million decrease in other assets primarilyreflects the receipt of $1.1 million related to cancelled and replaced projectinsurance policies.

Accounts payable and accrued liabilities decreased by$2.9 million, to a balance of $10.2 million as of March 31, 2007, primarilyreflecting payment of discretionary bonuses during the first quarter of 2007aggregating $1.2 million to employees for 2006 performance and the payment of$1.4 million in installments for insurance premiums related to our Brightwaterproject.

**Off Balance Sheet Financing**

In the ordinarycourse of business, we enter into land option contracts in order to procureland for the construction of homes. The use of such option agreements allows usto reduce the risks associated with land ownership and development; reduce ourfinancial commitments, including interest and other carrying costs; andminimize land inventories. Under such land option contracts, we will fund aspecified option deposit or earnest money deposit in consideration for theright to purchase land in the future, usually at a predeterminedprice.  Our liability is generally limited to forfeiture of thenonrefundable deposits, letters of credit and other nonrefundable amountsincurred. As of March 31, 2007, we have one consolidated land option deposit of$25,000 and no third party guarantees.

Wealso acquire land and conduct residential construction activities throughparticipation in joint ventures in which we hold less than a controllinginterest. Through joint ventures, we reduce and share our risk and also reducethe amount invested in land, while increasing our access to potential futurehome sites. The use of joint ventures also, in some instances, enables us toacquire land which we might not otherwise obtain or access on as favorableterms, without the participation of a strategic partner. While we view the useof unconsolidated joint ventures as beneficial to our homebuilding activities,we do not view them as essential to those activities.

Ourinvestment in unconsolidated joint ventures totaled $1.8 million and $1.7 atMarch 31, 2007 and December 31, 2006, respectively. These joint ventures hadtotal assets of $8.9 million and $9.5 million as of March 31, 2007 and December31, 2006, respectively, which included land deposits of $2.5 million and $2.5million, respectively. In certain instances, we may provide varying levels ofguarantees on debt of unconsolidated joint ventures. As of March 31, 2007, weprovide no guarantees on debt of unconsolidated joint ventures.

Underthe requirements of FASB Interpretation No. 46(R), “*Consolidationof Variable Interest Entities*” (“FIN 46(R)”), certain of our landoption contracts may create a variable interest for us, with the land sellerbeing identified as a VIE.  In compliancewith FIN 46(R), we analyze our land option contracts and other contractualarrangements and consider whether we should consolidate the fair value ofcertain VIEs from which we are purchasing land under option contracts. As ofMarch 31, 2007, we had no deposits with VIEs.

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ITEM 3 - QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK

We utilize variable rate debt financing for acquisition, development andconstruction of homes. The interest rates on our debt approximate the currentrates available for secured real estate financing with similar terms andmaturities, and as a result, their carrying amounts approximate fair value.While changes in interest rates generally do not impact the fair market valueof the debt instrument, they do affect our earnings and cash flows. Holding ourvariable rate debt balance of $132.0 million constant as of March 31,2007, each one point percentageincrease in interest rates would result in an increase in variable rateinterest incurred for the next 12 months of approximately $1.3 million.

We are exposed tomarket risks related to fluctuations in interest rates on our outstandingvariable rate debt. Other than an interest rate swap used to manage ourexposure to changes in interest rates on $62.5 million of our variablerate-based Term Loan, we did not utilize swaps, forward or option contracts oninterest rates, or other types of derivative financial instruments as of or duringthe quarter ended March 31, 2007. We do not enter into or hold derivatives fortrading or speculative purposes.

Under the TermLoan agreement, we were required to enter into a swap agreement to hedgeagainst risks associated with fluctuating interest rates related to $62.5million of floating rate debt. On September 15, 2006 we entered into aninterest rate swap transaction to effectively fix the interest rate on $62.5million in floating rate debt at 8.015% per annum for two years. The swaptransaction terminates in September 2008. Since we do not use derivativefinancial instruments for trading purposes, the swap did not qualify for hedgeaccounting under SFAS No. 133. The fair value of the interest rate swapagreement represents the spread between the interest rate we paid and theinterest rate we would receive over the remaining life of the agreement;however, this was not considered material at March 31, 2007. The change in fairvalue of the interest rate swap agreement during the quarter ended March 31,2007 was not material to us. The counterparties to the interest rate swapagreement are financial institutions.

You should beaware that many of the statements contained in this section are forward lookingand should be read in conjunction with our disclosures under the heading “CautionaryStatement About Forward-Looking Statements.”

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ITEM 4 - EVALUATION OFDISCLOSURE CONTROLS AND PROCEDURES

*ConclusionRegarding the Effectiveness of Disclosure Controls and Procedures*

Our chiefexecutive officer and chief financial officer, with the assistance ofmanagement, evaluated the effectiveness of our disclosure controls andprocedures (as defined in Rules 13a-15(e) and 15d-15(e) under the SecuritiesExchange Act of 1934, as amended) as of the end of the period covered by thisreport (the “Evaluation Date”). Based on that evaluation, our chief executiveofficer and chief financial officer concluded that, as of the Evaluation Date,our disclosure controls and procedures were effective to ensure thatinformation required to be disclosed in our reports under the Exchange Act, isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms, and that such information is accumulated andcommunicated to management, including our chief executive officer and chieffinancial officer, as appropriate to allow timely decisions regarding requireddisclosure.

However, no matterhow well a control system is conceived and operated, it can provide onlyreasonable, not absolute, assurance that the objectives of the control systemare met. In addition, the design of a control system must reflect the fact thatthere are resource constraints and the benefits of controls must be consideredrelative to costs.  Therefore, nocost-effective control system and no evaluation of controls can provideabsolute assurance that all control issues and instances of misstatements dueto error or fraud, if any, within our company have been detected.

*Changes in Internal Controls*

There have been nochanges in our internal control over financial reporting during the threemonths ended March 31, 2007 that have materially affected, or are reasonablylikely to materially affect, our internal control over financial reporting.

PARTII - OTHER INFORMATION

ITEM1 - LEGAL PROCEEDINGS

See Notes 7 and 9 to the consolidated financialstatements above, and “Item 1 - Business - Corporate Indemnification Matters”and “Item 3 - Legal Proceedings” in our Annual Report on Form 10-K for the yearended December 31, 2006.

ITEM1A - RISK FACTORS THAT MAY AFFECT RESULTS OF OPERATIONS AND FINANCIALCONDITION

Set forth below is a discussion of the materialchanges in our risk factors as previously disclosed in Item 1A ofPart I of our Annual Report on Form 10-K for the fiscal year ended December31, 2006; however, the risks and uncertainties described in the Form 10-K arenot the only ones facing us. Other events that we do not currently anticipateor that we currently deem immaterial also may affect our results of operationsand financial condition.

The informationpresented below updates, and should be read in conjunction with, the riskfactors and other information disclosed in our December 31, 2006 Form 10-K.

As previouslydisclosed in a risk factor contained in our December 31, 2006 Form 10-K, inrecent periods we reported declines in the volume of homes sold, which reflectcontinued deteriorating market conditions in the homebuilding industry and suchdeterioration is expected to continue in the future. These trends became morepronounced during the quarter ended March 31, 2007, and we experienced asignificant decline in sales orders in all of the principal areas in which weare currently selling homes. We attribute these developments to, among otherthings, a decline in homebuyer demand due to lower consumer confidence in theconsumer real estate market, recent problems in the subprime mortgage market,decreases in the affordability of homes in the Inland Empire and Lancastermarkets, increased inventory of new and used homes for sale, and pricingpressures resulting from the imbalance between supply and demand in the InlandEmpire and Lancaster markets. These developments have had and may continue tohave a material adverse effect on our results of operations. During the quarterended March 31, 2007, we recorded $4.0 million of impairments to realestate inventories at our 87 remaining home project in Beaumont, California dueto challenging market conditions. If market conditions do not improve in futureperiods, we may decide not to pursue development and

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construction inadditional areas, and the value of existing land holdings may continue todecline, which could lead to further write-offs for land impairments.

The following newrisk factor is added to Item 1A of the December 31, 2006 Form 10-K:

***If any taxing authorities are successful in asserting taxpositions that are contrary to our positions, our income tax provision andother tax reserves may be insufficient.***

In order todetermine our provision for income taxes and for our reserves for federal,state, local and other taxes we must use significant judgment and there may bematters for which the ultimate tax outcome is uncertain. Therefore, noassurance can be given that the final tax authority review will not bematerially different than that which is reflected in our income tax provisionand other tax reserves. Any adverse differences could have a material adverseeffect on our income tax provision or benefits, or other tax reserves, in theperiod in which such determination is made and, consequently, on our net incomefor such period. To provide for potential tax exposures, we maintain reservesfor tax contingencies based on reasonable estimates of our potential exposurewith respect to the tax liabilities that may result from such audits. However,if the reserves are insufficient upon completion of any audit process, therecould be an adverse impact on our financial position and results of operations.

ITEM6 - EXHIBITS
| 10.1 | Extension and Modification of Employment Agreement  between the Registrant and Mr. Raymond J. Pacini, dated as of April 30, 2007.                               |
|------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.2 | Extension and Modification of Employment Agreement  between the Registrant and Ms. Sandra G. Sciutto, dated as of April 30, 2007.                               |
| 10.3 | Extension and Modification of Employment Agreement  between the Registrant and Mr. Michael J. Rafferty, dated as of April 30,  2007.                            |
| 10.4 | Extension and Modification of Employment Agreement  between the Registrant and Mr. John W. Marshall, dated as of April 30, 2007.                                |
| 10.5 | Extension and Modification of Employment Agreement  between the Registrant and Mr. Ed Mountford, dated as of April 30, 2007.                                    |
| 31.1 | Section 302 Certificate of Raymond J. Pacini, Chief  Executive Officer of California Coastal Communities, Inc.                                                  |
| 31.2 | Section 302 Certificate of Sandra G. Sciutto, Chief  Financial Officer of California Coastal Communities, Inc.                                                  |
| 32.1 | Section 906 Certificate of Raymond J. Pacini, Chief  Executive Officer and Sandra G. Sciutto, Chief Financial Officer of  California Coastal Communities, Inc.* |

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*              Thesecertifications are being furnished solely to accompany this report pursuant to18 U.S.C. Section 1350, and are not being filed for purposes of Section 18 ofthe Securities Exchange Act of 1934, as amended, and are not to be incorporatedby reference into any filing of the Company, whether made before or after thedate hereof, regardless of any general 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 9, 2007 | CALIFORNIA COASTAL COMMUNITIES, INC. |
|-------------------|--------------------------------------|
|              |                                 |
|              | By:                                  | */s/ Sandra G. Sciutto* | * * |
|              |                                 | SANDRA G. SCIUTTO |
|              |                                 | Senior Vice President and |
|              |                                 | Chief Financial Officer |

 

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