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EX-32.1 - CERTIFICATION OF CEO - SECTION 906 - WILLIAM LYON HOMESdex321.htm
EX-21.1 - LIST OF SUBSIDIARIES OF WILLIAM LYON HOMES - WILLIAM LYON HOMESdex211.htm
EX-12.1 - STATEMENT OF COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES - WILLIAM LYON HOMESdex121.htm
EX-31.1 - CERTIFICATION OF CEO - SECTION 302 - WILLIAM LYON HOMESdex311.htm
EX-32.2 - CERTIFICATION OF CFO - SECTION 906 - WILLIAM LYON HOMESdex322.htm
EX-31.2 - CERTIFICATION OF CFO - SECTION 302 - WILLIAM LYON HOMESdex312.htm
Table of Contents

 

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

(Mark One)

x

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2009

OR

 

¨

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission File Number 001-31625

WILLIAM LYON HOMES

(Exact name of registrant as specified in its charter)

 

Delaware   33-0864902

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

 

4490 Von Karman Avenue

Newport Beach, California

  92660
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: (949) 833-3600

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.    Yes  x    No  ¨

Indicate by check mark whether registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  ¨    NO  x.

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K.  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated Filer  ¨

  

Accelerated filer  ¨

Non-accelerated filer  x (Do not check if a smaller reporting company)

  

Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The number of shares of Common Stock outstanding as of March 5, 2010 was 1,000.

DOCUMENTS INCORPORATED BY REFERENCE

None

 

 

 


Table of Contents

WILLIAM LYON HOMES

INDEX

 

          Page No.
   PART I   

Item 1.

  

Business

   2

Item 1A.

  

Risk Factors

   12

Item 1B.

  

Unresolved Staff Comments

   20

Item 2.

  

Properties

   20

Item 3.

  

Legal Proceedings

   20

Item 4.

  

Reserved

   21
   PART II   

Item 5.

  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

   22

Item 6.

  

Selected Financial Data

   23

Item 7.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   25

Item 7A.

  

Quantitative and Qualitative Disclosures About Market Risk

   52

Item 8.

  

Financial Statements and Supplementary Data

   52

Item 9.

  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

   52

Item 9A.

  

Controls and Procedures

   52

Item 9B.

  

Other Information

   53
   PART III   

Item 10.

  

Directors, Executive Officers and Corporate Governance

   54

Item 11.

  

Executive Compensation

   57

Item 12.

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

   62

Item 13.

  

Certain Relationships and Related Transactions, and Director Independence

   62

Item 14.

  

Principal Accountant Fees and Services

   65
   PART IV   

Item 15.

  

Exhibits and Financial Statement Schedules

   66
  

Index to Financial Statements

   72

 

i


Table of Contents

NOTE ABOUT FORWARD-LOOKING STATEMENTS

Investors are cautioned that certain statements contained in this Annual Report on Form 10-K, as well as some statements by the Company in periodic press releases and some oral statements by Company officials to securities analysts during presentations about the Company are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Act”). Statements which are predictive in nature, which depend upon or refer to future events or conditions, or which include words such as “expects”, “anticipates”, “intends”, “plans”, “believes”, “estimates”, “hopes”, and similar expressions constitute forward-looking statements. In addition, any statements concerning future financial performance (including future revenues, earnings or growth rates), ongoing business strategies or prospects, and possible future Company actions, which may be provided by management are also forward-looking statements as defined in the Act. Forward-looking statements are based upon expectations and projections about future events and are subject to assumptions, risks and uncertainties about, among other things, the Company, economic and market factors and the homebuilding industry.

Actual events and results may differ materially from those expressed or forecasted in the forward-looking statements due to a number of factors. The principal factors that could cause the Company’s actual performance and future events and actions to differ materially from such forward-looking statements include, but are not limited to, worsening in general economic conditions either nationally or in regions in which the Company operates, worsening in the markets for residential housing, further decline in real estate values resulting in further impairment of the company’s real estate assets, volatility in the banking industry and credit markets, terrorism or other hostilities involving the United States, whether an ownership change occurred which could, under certain circumstances, have resulted in the limitation of the Company’s ability to offset prior years’ taxable income with net operating losses, changes in home mortgage interest rates, changes in generally accepted accounting principles or interpretations of those principles, changes in prices of homebuilding materials, labor shortages, adverse weather conditions, the occurrence of events such as landslides, soil subsidence and earthquakes that are uninsurable, not economically insurable or not subject to effective indemnification agreements, changes in governmental laws and regulations, whether the Company is able to refinance the outstanding balances of its debt obligations at their maturity, anticipated tax refunds, the timing of receipt of regulatory approvals and the opening of projects and the availability and cost of land for future growth. These and other risks and uncertainties are more fully described in Item 1A. “Risk Factors”. While it is impossible to identify all such factors, factors which could cause actual results to differ materially from those estimated by the Company include, but are not limited to, those factors or conditions described under “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The Company’s past performance or past or present economic conditions in the Company’s housing markets are not indicative of future performance or conditions. Investors are urged not to place undue reliance on forward-looking statements. In addition, the Company undertakes no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of anticipated or unanticipated events or changes to projections over time unless required by federal securities law.

 

1


Table of Contents

PART I

 

Item 1.

Business

General

William Lyon Homes, a Delaware corporation, and subsidiaries (the “Company”) are primarily engaged in the design, construction and sale of single family detached and attached homes in California, Arizona and Nevada. Since the founding of the Company’s predecessor in 1956, the Company and its joint ventures have sold over 72,000 homes. The Company conducts its homebuilding operations through four reportable operating segments (Southern California, Northern California, Arizona and Nevada). For 2009, approximately 62% of the home closings of the Company and its joint ventures were derived from its California operations. For the year ended December 31, 2009, on a consolidated basis the Company had revenues from home sales of $253.9 million and delivered 915 homes, which includes $5.6 million of revenue and 17 homes from consolidated joint ventures (see Note 2 of “Notes to Consolidated Financial Statements”).

The Company designs, constructs and sells a wide range of homes designed to meet the specific needs of each of its markets, although it primarily emphasizes sales to the entry-level and move-up home buyer markets. At December 31, 2009, the Company marketed its homes through 17 sales locations. In 2009, the average sales price for consolidated homes delivered was $277,500. Base sales prices for actively selling projects in 2009, including affordable projects, ranged from $99,000 to $1,200,000.

As of December 31, 2009, the Company and its consolidated joint ventures owned approximately 9,124 lots and had options to purchase an additional 1,206 lots. As used in this Annual Report on Form 10-K, “entitled” land has a development agreement and/or vesting tentative map, or a final recorded plat or map from the appropriate county or city government. Development agreements and vesting tentative maps generally provide for the right to develop the land in accordance with the provisions of the development agreement or vesting tentative map unless an issue arises concerning health, safety or general welfare. The Company’s sources of developed lots for its homebuilding operations are (1) development of master-planned communities, and (2) purchase of smaller projects with shorter life cycles (merchant homebuilding). The Company estimates that its current inventory of lots owned and controlled is adequate to supply its homebuilding operations at current operating levels (including future land sales) for approximately six to eight years.

The Company will continue to utilize its current inventory of lots and future land acquisitions to conduct its operating strategy which consists of: (i) focusing on high growth core markets; (ii) maintaining current cash position and improving its credit profile; (iii) acquiring strong land positions through disciplined acquisition strategies; (iv) maintaining a low cost structure; and (v) leveraging an experienced management team.

The Company had total consolidated revenues from operations of $309.2 million, $526.1 million and $1.105 billion for the years ended December 31, 2009, 2008 and 2007, respectively. Homes closed by the Company, including its joint ventures, were 915, 1,260 and 2,182 for the years ended December 31, 2009, 2008 and 2007, respectively. Including its joint ventures, the Company’s dollar amount of backlog of homes sold but not closed as of December 31, 2009, was $56.5 million, a 30% decrease from the $80.8 million as of December 31, 2008. The cancellation rate of buyers who contracted to buy a home but did not close escrow was approximately 21% during 2009 and 28% during 2008.

The Company entered into certain agreements with various affiliates to build and market homes on behalf of the affiliates. For such services, the Company receives fees and may, under certain circumstances, receive additional compensation if certain financial thresholds are achieved. The Company recorded $34.1 million of revenue on 176 delivered homes for the year ended December 31, 2009.

The Company’s operations are dependent to a significant extent on debt financing and, to a lesser extent, on joint venture financing. The Company’s principal credit sources are its Senior Secured Term Loan (more fully described in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operation – Financial Condition and Liquidity”), 7 5/8% Senior Notes, 10 3/4% Senior Notes, 7 1/2% Senior Notes (collectively the “Senior Notes”), construction notes payable, and land banking transactions. During 2009, the Company’s revolving credit facilities were a significant credit source until the facilities were repaid with the proceeds from the Senior Secured Term Loan. At December 31, 2009, the outstanding principal amount of the Secured Term Loan was $206.0 million, the outstanding principal amount of the 7 5/8% Senior Notes was $67.2 million, the outstanding principal amount of the 10 3/4% Senior Notes was $168.2 million and the outstanding principal amount of the 7 1/2% Senior Notes was $84.7 million.

On June 10, 2009, the Company’s wholly-owned subsidiary, William Lyon Homes, Inc., a California corporation (“California Lyon”), consummated a cash tender offer (the “Tender Offer”) to purchase a portion of its outstanding Senior Notes, on the terms and subject to the conditions set forth in its offer to purchase, as amended. The principal amount of

 

2


Table of Contents

Senior Notes purchased by California Lyon on settlement of the Tender Offer totaled $53.2 million, including $29.1 million of the 7 5/8% Senior Notes due 2012, $2.4 million of the 10 3/4% Senior Notes due 2013, and $21.7 million of the 7 1/2% Senior Notes due 2014. The aggregate Tender Offer consideration paid totaled $14.9 million, plus accrued interest. The net gain resulting from the Tender Offer, after closing costs, was $37.0 million.

Also, during 2009, the Company purchased, in privately negotiated transactions, a total of $103.7 million principal amount of its outstanding Senior Notes at a cost of $62.1 million, plus accrued interest. The net gain resulting from the purchase, after giving effect to amortization of related deferred loan costs was $41.1 million. At December 31, 2009, the Company had fully repaid the outstanding principal amounts under revolving credit facilities, as well as the two revolving credit facilities the Company used to fund its mortgage operations. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Financial Condition and Liquidity” and Note 6 of “Notes to Consolidated Financial Statements” for more information relating to the revolving credit facilities of the Company.

In October 2008, the Company purchased, in privately negotiated transactions, $71.9 million principal amount of its outstanding Senior Notes at a cost of $16.7 million, plus accrued interest. The net gain resulting from the purchase, after giving effect to amortization of related deferred loan costs was $54.0 million.

Beginning in 2006 and continuing into the beginning of 2009, the homebuilding industry has experienced decreased demand for housing and declining sales prices. These conditions were the result of an erosion of homebuyer confidence which was driven by increases in unemployment, limited availability of mortgage financing due to stress in the mortgage and credit markets, price instability, increasing foreclosures and increased levels of housing inventory in the market. In certain of the Company’s markets, however, the Company has experienced steadying sales absorption rates, a decrease in sales incentives and an increase in base pricing, while homebuilding costs continue to decrease. In Southern California, net new home orders per average sales location increased to 50.0 during the year ended December 31, 2009 from 30.8 for the same period in 2008. In Arizona, net new home orders per average sales location increased to 49.3 during the year ended December 31, 2009 from 45.8 for the same period in 2008. In addition, the Company’s cancellation rate decreased to 21% in the 2009 period compared to 28% in the 2008 period, particularly impacted by Southern California of 19% in the 2009 period compared to 30% in the 2008 period and Arizona of 13% in the 2009 period compared to 22% in the 2008 period. In addition, the Company is experiencing increased homebuilding gross margin percentages of 13.5% in the 2009 period compared to 6.2% in the 2008 period particularly impacted by Southern California of 15.6% in the 2009 period compared to 7.5% in the 2008 period and Northern California of 13.8% in the 2009 period compared to (2.6)% in the 2008 period.

During 2009, the Company incurred impairment losses on real estate assets amounting to $45.3 million. The impairments were primarily attributable to lower than anticipated net revenue in certain of its projects due to the effects of the economy on the homebuilding industry as described previously. At two of the Company’s projects, impairment loss was primarily attributable to an increase in interest cost allocated to the project related to the addition of the Senior Secured Term Loan at 14% interest. In addition, the Company decreased base sales prices and increased certain incentives related to the projects, which is a strategy to improve sales absorption rates. The Company was required to write-down the book value of these real estate assets in accordance with Financial Accounting Standards Board Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“Statement No. 144”), now codified as FASB ASC Topic 360, as defined in Note 5 of “Notes to Consolidated Financial Statements.”

Beginning in 2008 and into 2009, in response to the declining demand for housing in the homebuilding industry, management of the Company shifted its strategy to focus on generating positive cash flow, reducing overall debt levels and improving liquidity. Management of the Company has managed cash flow by reducing staffing to levels to support current operations, reducing inventory levels for projects near completion, identifying land opportunities (finished lots) and acquiring land in stabilizing markets, using available funds to repurchase senior notes at a discount, and evaluate the timing of reintroducing projects to the marketplace that have been temporarily suspended.

From 2007 through 2009, the Company temporarily suspended the development, sales and marketing activities at certain of its projects. The Company concluded that this strategy was necessary under the prevailing market conditions at the time and will allow the Company to market the properties at some future time when market conditions may have improved. As markets continue to improve, management continues to evaluate and analyze the market place to potentially activate temporarily suspended projects in 2010 and beyond.

The ability of the Company to meet its obligations on its indebtedness will depend to a large degree on its future performance which in turn will be subject, in part, to factors beyond its control, such as prevailing economic conditions, mortgage and other interest rates, weather, the occurrence of events such as landslides, soil subsidence and earthquakes that are uninsurable, not economically insurable or not subject to effective indemnification agreements, availability of labor and homebuilding materials, changes in governmental laws and regulations, and the availability and cost of land for future development.

 

3


Table of Contents

Additionally, as a result of tax legislation that was enacted in November 2009, the Company filed for a tax refund of approximately $101.8 million, which was received in March 2010.

The Company’s principal executive offices are located at 4490 Von Karman Avenue, Newport Beach, California 92660 and its telephone number is (949) 833-3600. The Company was incorporated in the State of Delaware on July 15, 1999.

The Company’s Markets

The Company is currently operating in four reportable operating segments: Southern California, Northern California, Arizona, and Nevada. Each of the segments has responsibility for the management of the Company’s homebuilding and development operations within its geographic boundaries.

The following table sets forth sales from real estate operations attributable to each of the Company’s homebuilding segments during the preceding three fiscal years:

 

     Total Revenue
     Year Ended December 31,
     2009    2008    2007
     (in thousands)
     (note 1)

Consolidated

        

Southern California(2)

   $ 179,282    $ 323,446    $ 780,213

Northern California(3)

     43,211      95,084      102,432

Arizona(4)

     51,215      49,187      134,153

Nevada(5)

     35,535      58,361      88,559
                    
   $ 309,243    $ 526,078    $ 1,105,357
                    

 

(1)

The Company has organized its operations into geographic segments. Each segment has a management team led by a divisional president.

 

(2)

The Southern California Segment consists of operations in Orange, Los Angeles, Riverside, San Bernardino and San Diego counties.

 

(3)

The Northern California Segment consists of operations in Contra Costa, Placer, Sacramento, San Joaquin and Santa Clara counties.

 

(4)

The Arizona Segment consists of operations in the Phoenix, Arizona metropolitan area.

 

(5)

The Nevada Segment consists of operations in the Las Vegas, Nevada metropolitan area.

For financial information concerning segments, see the “Consolidated Financial Statements” and Note 3 of “Notes to Consolidated Financial Statements.”

LAND ACQUISITION AND DEVELOPMENT

As of December 31, 2009, the Company and its consolidated joint ventures owned approximately 9,124 lots and had options to purchase an additional 1,206 lots.

The Company estimates that its current inventory of lots owned and controlled is adequate to supply its homebuilding operations at current operating levels (including future land sales) for approximately six to eight years.

The Company uses a land acquisition team, which includes members of its senior management, to manage the risks associated with land ownership and development. It is the Company’s policy that land can be purchased or sold only with the prior approval of senior management and, for land prices above certain thresholds, the board of directors. The Company’s land acquisition strategy has been to undertake projects with shorter life-cycles in order to reduce development and market risk while maintaining an inventory of owned lots sufficient for construction of homes over a two-year period. The Company’s long-term strategy consists of the following elements:

 

 

 

Completing due diligence prior to committing to acquire land;

 

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Table of Contents
 

 

Reviewing the status of entitlements and other governmental processing to mitigate zoning and other development risk;

 

 

 

Focusing on land as a component of a home’s cost structure, rather than on the land’s speculative value;

 

 

 

Limiting land acquisition size to reduce investment levels in any one project where possible;

 

 

 

Utilizing option, joint venture and other non-capital intensive structures to control land where feasible;

 

 

 

Funding land acquisitions whenever possible with non-recourse seller financing;

 

 

 

Employing centralized control of approval over all land transactions;

 

 

 

Homebuilding operations in the Southwest, particularly in the Company’s long established markets of California, Arizona and Nevada; and

 

 

 

Diversifying with respect to geography, markets and product types.

Prior to committing to the acquisition of land, the Company conducts feasibility studies covering pertinent aspects of the proposed commitment. These studies may include a variety of elements from technical aspects such as title, zoning, soil and seismic characteristics, to marketing studies that review population and employment trends, schools, transportation access, buyer profiles, sales forecasts, projected profitability, cash requirements, and assessment of political risk and other factors. Prior to acquiring land, the Company considers assumptions concerning the needs of the targeted customer and determines whether the underlying land price enables the Company to meet those needs at an affordable price. Before purchasing land, the Company attempts to project the commencement of construction and sales over a reasonable time period. The Company utilizes outside architects and consultants, under close supervision, to help review acquisitions and design products.

HOMEBUILDING AND MARKET STRATEGY

The Company currently has a wide variety of product lines which enables it to meet the specific needs of each of its markets. Although the Company primarily emphasizes sales to the entry-level and move-up home markets, it believes that a diversified product strategy enables it to best serve a wide range of buyers and adapt quickly to a variety of market conditions. In order to reduce exposure to local market conditions, the Company’s sales locations are geographically dispersed. At December 31, 2009, the Company and its joint ventures had 17 sales locations.

Because the decision as to which product to develop is based on the Company’s assessment of market conditions and the restrictions imposed by government regulations, homestyles and sizes vary from project to project. The Company’s attached housing ranges in size from 1,040 to 2,737 square feet, and the detached housing ranges from 1,077 to 4,957 square feet.

Due to the Company’s product and geographic diversification strategy, the prices of the Company’s homes also vary substantially. During 2009, base sales prices for the Company’s attached housing range from approximately $180,000 to $525,000 and base sales prices for detached housing range from approximately $99,000 to $1,200,000. On a consolidated basis, the average sales price of homes closed for the year ended December 31, 2009 was $277,500.

The Company generally standardizes and limits the number of home designs within any given product line. This standardization permits on-site mass production techniques and bulk purchasing of materials and components, thus enabling the Company to better control and sometimes reduce construction costs and home construction cycles.

The Company contracts with a number of architects and other consultants who are involved in the design process of the Company’s homes. Designs are constrained by zoning requirements, building codes, energy efficiency laws and local architectural guidelines, among other factors. Engineering, landscaping, master-planning and environmental impact analysis work are subcontracted to independent firms which are familiar with local requirements.

Substantially all construction work is done by subcontractors with the Company acting as the general contractor. The Company manages subcontractor activities with on-site supervisory employees and management control systems. The Company does not have long-term contractual commitments with its subcontractors or suppliers; instead it contracts development work by project and where possible by phase size of 8 to 20 home sites. The Company generally has been able to obtain sufficient materials and subcontractors during times of material shortages. The Company believes its relationships with its suppliers and subcontractors are in good standing.

 

5


Table of Contents

Description of Projects and Communities Under Development

The Company’s homebuilding projects usually take two to five years to develop. The following table presents project information relating to each of the Company’s homebuilding operating segments as of December 31, 2009 and only includes projects with lots owned as of December 31, 2009, lots consolidated in accordance with certain accounting principles as of December 31, 2009 or homes closed for the year ended December 31, 2009.

 

Project (County or City)

   Year of
First
Delivery
   Estimated
Number of
Homes at
Completion(1)
   Cumulative
Units Closed
as of

Dec 31, 2009
   Backlog at
Dec 31,
2009(2)(3)
   Lots Owned
as of

Dec 31,
2009(4)
   Homes Closed
for the

Year Ended
Dec 31, 2009
   Sales Price
Range(5)
SOUTHERN CALIFORNIA

San Diego County:

                    

Pasado, Del Sur

   2009    89    20    0    37    20    $ 520,000 - 575,000

Altair, Santee

   2008    85    85    0    0    54    $ 271,000 - 301,000

Carlsbad

                    

Blossom Grove

   2010    110    0    0    32    0    $ 605,000 - 690,000

Mirasol at La Costa Greens

   2010    71    0    0    71    0    $ 636,000 - 771,000

Riverside County:

                    

Corona

                    

Parkside

   2007    122    122    0    0    2    $ 436,000 - 529,000

Serafina,

   2007    314    314    0    0    60    $ 200,000 - 280,000

Bridle Creek,

   2003    264    264    0    0    5    $ 436,000 - 560,000

Savannah at Harveston Ranch,
Temecula

   2005    162    162    0    0    8    $ 257,000 - 320,000

San Bernardino County:

                    

Fontana

                    

Adelina,

   2008    109    59    25    50    41    $ 206,000 - 241,000

Rosabella

   2007    114    73    10    41    47    $ 220,000 - 255,000

Rancho Cucamonga

                    

Amador

   2007    69    60    4    9    22    $ 214,000 - 258,000

Amador (Lewis)

   2010    30    0    26    30    0    $ 214,000 - 256,000

Vintner’s Grove

                    

SFD

   2007    45    38    0    7    17    $ 345,000 - 395,000

Triplex

   2007    63    54    8    9    26    $ 220,000 - 260,000

Vintner’s Grove (Lewis)

                    

SFD

   2009    33    0    25    33    0    $ 356,000 - 408,000

Triplex

   2010    15    0    15    15    0    $ 217,000 - 256,000

Orange County:

                    

Irvine

                    

San Carlos

   2007    60    60    0    0    12    $ 310,000 - 475,000

San Carlos II

   2010    92    0    0    0    0    $ 315,000 - 470,000

Ivy

   2009    135    20    30    1    20    $ 379,000 - 457,000

Columbus Grove/Columbus Square,
Tustin:

                    

Cambridge Lane

   2007    156    156    0    0    31    $ 116,000 - 475,000

Ciara

   2007    67    67    0    0    10    $ 1,000,000 - 1,200,000

Los Angeles County:

                    

Arboreta at Rainbird, Glendora

                    

Vintage

   2008    87    53    15    34    37    $ 345,000 - 455,000

Tradition

   2008    53    53    0    0    14    $ 600,000 - 689,000

360 South Bay, Hawthorne (6):

                    

The Flats

   2010    188    0    0    188    0    $ 375,000 - 520,000

The Lofts

   2011    123    0    0    123    0    $ 370,000 - 525,000

The Rows

   2011    94    0    0    94    0    $ 515,000 - 630,000

The Courts

   2010    118    0    0    118    0    $ 470,000 - 575,000

The Gardens

   2012    102    0    0    102    0    $ 580,000 - 725,000

 

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Table of Contents

Project (County or City)

   Year of
First
Delivery
   Estimated
Number of
Homes at
Completion(1)
   Cumulative
Units Closed
as of

Dec 31, 2009
   Backlog at
Dec 31,
2009(2)(3)
   Lots Owned
as of
Dec 31,
2009(4)
   Homes Closed
for the

Year Ended
Dec 31, 2009
   Sales Price
Range(5)

Rosedale, Azusa

                    

Gardenia

   2011    147    0    0    81    0    $ 455,000 - 550,000

Sage Court

   2011    176    0    0    64    0    $ 420,000 - 515,000
                              

SOUTHERN CALIFORNIA TOTAL

   3,293    1,660    158    1,139    426   
                              
NORTHERN CALIFORNIA

Contra Costa County:

                    

Rivergate I & II, Antioch

   2006    167    167    0    0    26    $ 300,000 - 380,000

Vista Del Mar, Pittsburgh

                    

Villages

   2007    102    50    0    52    10    $ 296,000 - 354,000

Venue

   2007    132    48    0    84    7    $ 363,000 - 410,000

Vineyard

   2007    29    17    3    12    0    $ 386,000 - 430,000

Victory

   2008    25    14    0    11    1    $ 680,000 - 745,000

Placer County:

                    

Whitney Ranch, Rocklin

                    

Shady Lane

   2006    96    96    0    0    27    $ 330,000 - 350,000

Twin Oaks

   2006    92    63    3    29    26    $ 400,000 - 470,000

Sacramento County:

                    

Big Horn, Elk Grove

                    

Plaza Walk

   2005    106    106    0    0    16    $ 250,000 - 300,000

Gallery Walk

   2005    149    148    0    1    31    $ 180,000 - 230,000

Marquis at Maderia

   2010    89    0    0    89    0    $ 290,000 - 335,000

San Joaquin County:

                    

The Ranch @ Mossdale Landing

   2010    164    0    0    164    0    $ 210,000 - 245,000

Santa Clara County:

                    

9th & Taylor, San Jose

   2010    40    0    0    36    0    $ 660,000 - 660,000
                              

NORTHERN CALIFORNIA TOTAL

   1,191    709    6    478    144   
                              
ARIZONA

Maricopa County

                    

Arroyo @ Coldwater Ranch, Peoria

   2009    20    8    2    12    8    $ 132,000 - 168,000

Lehi Crossing, Mesa

   2012    928    0    0    113    0    $ 179,000 - 292,000

Rancho Mercado, Phoenix

   2013    1,826    0    0    1,826    0    $ 125,000 - 230,000

Hastings Property, Queen Creek

   2011    631    0    0    631    0    $ 183,000 - 382,000

Circle G at the Church Farm North

   2012    1,745    0    0    1,745    0    $ 111,000 - 400,000

Lyon’s Gate, Gilbert:

                    

Pride

   2006    650    434    8    216    95    $ 134,000 - 162,000

Savanna

   2006    174    172    2    2    20    $ 172,000 - 215,000

Sahara

   2006    169    166    3    3    25    $ 196,000 - 259,000

Acacia

   2007    365    141    2    224    66    $ 160,000 - 216,000

Future Products

   2011    213    0    0    213    0   
                              

ARIZONA TOTAL

      6,721    921    17    4,985    214   
                              

 

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Project (County or City)

   Year of
First
Delivery
   Estimated
Number of
Homes at
Completion(1)
   Cumulative
Units Closed
as of
Dec 31, 2009
   Backlog at
Dec 31,
2009(2)(3)
   Lots Owned
as of

Dec 31,
2009(4)
   Homes Closed
for the

Year Ended
Dec 31, 2009
   Sales Price
Range(5)
NEVADA

Clark County:

                    

Summerlin, Las Vegas

                    

Kingwood Crossing

   2006    100    100    0    0    8    $ 385,000 - 471,000

North Las Vegas

                    

The Cottages

   2004    360    316    0    44    9    $ 152,000 - 179,000

La Tierra

   2006    67    67    0    0    6    $ 230,000 - 260,000

Tierra Este

   2008    8    8    0    0    2    $ 275,000 - 305,000

Carson Ranch, Las Vegas

                    

West Series I

   2005    74    67    0    7    0    $ 395,000 - 430,000

West Series II

   2005    56    53    0    3    0    $ 406,000 - 503,000

East Series I

   2006    116    102    2    14    31    $ 265,000 - 300,000

East Series II

   2007    45    37    1    8    15    $ 299,000 - 361,000

West Park, Las Vegas

                    

Villas

   2006    95    91    4    4    11    $ 183,000 - 225,000

Courtyards

   2006    82    79    2    3    18    $ 235,000 - 275,000

Flagstone, Las Vegas

                    

Crossings

   2011    77    0    0    77    0    $ 229,000 - 264,000

Commons

   2011    37    0    0    37    0    $ 229,000 - 259,000

Rhapsody, Las Vegas

   2011    63    0    0    63    0    $ 179,000 - 209,000

The Fields at Aliente, Las Vegas

   2010    60    0    0    60    0    $ 197,000 - 225,000

Nye County:

                    

Mountain Falls, Pahrump:

                    

Cascata

   2005    147    137    0    10    0    $ 216,000 - 238,000

Tramonto

   2005    212    174    2    38    8    $ 176,000 - 211,000

Move up Product

   2011    91    0    0    91    0    $ 194,000 - 229,000

Bella Sera

   2005    129    110    0    19    4    $ 217,000 - 257,000

Cascata Ancora

   2007    118    72    2    46    16    $ 99,000 - 148,000

Entrata

   2007    99    26    0    73    3    $ 142,000 - 164,000

Future Projects

   2014    1,925    0    0    1,925    0      Various
                              

NEVADA TOTAL

   3,961    1,439    13    2,522    131   
                              

GRAND TOTALS

      15,166    4,729    194    9,124    915   
                              

 

(1)

The estimated number of homes to be built at completion is subject to change, and there can be no assurance that the Company will build these homes.

 

(2)

Backlog consists of homes sold under sales contracts that have not yet closed, and there can be no assurance that closings of sold homes will occur.

 

(3)

Of the total homes subject to pending sales contracts as of December 31, 2009, 190 represent homes completed or under construction and 4 represent homes not yet under construction.

 

(4)

Lots owned as of December 31, 2009 include lots in backlog at December 31, 2009.

 

(5)

Sales price range reflects base price only and excludes any lot premium, buyer incentive and buyer selected options, which vary from project to project.

 

(6)

All or a portion of the lots in this project are not owned as of December 31, 2009. The Company consolidated the purchase price of the lots in accordance with certain accounting principles, and considers the lots owned at December 31, 2009.

 

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Construction Services — Description of Projects and Communities Under Development

The following table presents project information relating to each of the Company’s projects that it develops, sells and markets for third parties.

 

Project (County or City)

   Year of
First
Delivery
   Estimated
Number of
Homes at
Completion
   Cumulative
Units Closed
as of

Dec 31, 2009
   Backlog at
Dec 31, 2009
   Homes Closed
for the
Year Ended
Dec 31, 2009
   Sales Price
Range(5)
SOUTHERN CALIFORNIA
Construction Management Projects

San Diego County:

                 

ORA Sunset Cove

   2008    47    47    0    26    $ 425,000 - 435,000

ORA Maybeck

   2008    74    41    31    23    $ 623,000 - 685,000

Levanto (1)

   2009    90    90    0    90      N/A

Orange County:

                 

ORA Verandas

   2008    57    49    8    37    $ 580,000 - 635,000

ORA Ainsley Park

   2010    84    0    0    0    $ 500,000 - 590,000
                         

SOUTHERN CALIFORNIA TOTAL

   352    227    39    176   
                         

 

(1)

Represents an apartment complex of 90 units that the Company was contracted to build by an affiliate of the Company. See Note 11 of “Notes to Consolidated Financial Statements” for further discussion.

Sales and Marketing

The management team responsible for a specific project develops marketing objectives, formulates pricing and sales strategies and develops advertising and public relations programs for approval of senior management. The Company makes extensive use of advertising and other promotional activities, including newspaper advertisements, brochures, radio commercials, direct mail and the placement of strategically located sign boards in the immediate areas of its developments. In addition, the Company markets all of its products through the internet via email lists and interest lists, as well as its website at www.lyonhomes.com. In general, the Company’s advertising emphasizes each project’s strengths, the quality and value of its products and its reputation in the marketplace.

The Company normally builds, decorates, furnishes and landscapes three to eight model homes for each product line and maintains on-site sales offices, which typically are open seven days a week. Management believes that model homes play a particularly important role in the Company’s marketing efforts. Consequently, the Company expends a significant amount of effort in creating an attractive atmosphere at its model homes. Interior decorations vary among the Company’s models and are carefully selected based upon the lifestyles of targeted buyers. Structural changes in design from the model homes are not generally permitted, but home buyers may select various other optional construction and design amenities.

The Company employs in-house commissioned sales personnel to sell its homes. In some cases, outside brokers are also involved in the selling of the Company’s homes, particularly in the Arizona and Nevada markets. The Company typically engages its sales personnel on a long-term, rather than a project-by-project basis, which it believes results in a more motivated sales force with an extensive knowledge of the Company’s operating policies and products. Sales personnel are trained by the Company and attend weekly meetings to be updated on the availability of financing, construction schedules and marketing and advertising plans.

The Company strives to provide a high level of customer service during the sales process and after a home is sold. The participation of the sales representatives, on-site construction supervisors and the post-closing customer service personnel, working in a team effort, is intended to foster the Company’s reputation for quality and service, and ultimately lead to enhanced customer retention and referrals.

The Company’s homes are typically sold before or during construction through sales contracts which are usually accompanied by a small cash deposit. Such sales contracts are usually subject to certain contingencies such as the buyer’s ability to qualify for financing. The cancellation rate of buyers who contracted to buy a home but did not close escrow at the Company and its joint ventures’ projects was approximately 21% during 2009. Cancellation rates are subject to a variety of factors beyond the Company’s control such as the downturn in the homebuilding industry and current economic conditions. The Company’s and its joint ventures’ inventory of completed and unsold homes was 39 homes as of December 31, 2009.

 

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Warranty

The Company provides its homebuyers with a one-year limited warranty covering workmanship and materials. The Company also provides its homebuyers with a limited warranty that covers “construction defects,” as defined in the limited warranty agreement provided to each home buyer, for the length of its legal liability for such defects (which may be up to ten years in some circumstances), as determined by the law of the state in which the Company builds. The limited warranty covering construction defects is transferable to subsequent buyers not under direct contract with the Company and requires that homebuyers agree to the definitions and procedures set forth in the warranty, including the submission of unresolved construction-related disputes to binding arbitration. The Company began providing this limited warranty at the end of 2001.

In connection with the limited warranty covering construction defects, the Company obtained an insurance policy which expires on December 31, 2010, unless amended or renewed. The Company has been informed by the insurance carrier that this insurance policy will respond to construction defect claims on homes that close during each policy period for the duration of the Company’s legal liability and that the policy will respond to potential losses relating to construction, including soil subsidence. The insurance policy provides a single policy of insurance to the Company and the subcontractors enrolled in its insurance program. As a result, the Company is no longer required to obtain proof of insurance from these subcontractors nor be named as an additional insured under their individual insurance policies. The Company still requires that subcontractors not enrolled in the insurance program provide proof of insurance and name the Company as an additional insured under their insurance policy. Furthermore, the Company generally requires that its subcontractors provide the Company with an indemnity prior to receiving payment for their work.

There can be no assurance, however, that the terms and limitations of the limited warranty will be enforceable against the homebuyers, that the Company will be able to renew its insurance coverage or renew it at reasonable rates, that the Company will not be liable for damages, the cost of repairs, and/or the expense of litigation surrounding possible construction defects, soil subsidence or building-related claims or that claims will not arise out of uninsurable events not covered by insurance and not subject to effective indemnification agreements with the Company’s subcontractors.

Sale of Lots and Land

In the ordinary course of business, the Company continually evaluates land sales and has sold, and expects that it will continue to sell, land as market and business conditions warrant. The Company may also sell both multiple lots to other builders (bulk sales) and improved individual lots for the construction of custom homes where the presence of such homes adds to the quality of the community. In addition, the Company may acquire sites with commercial, industrial and multi-family parcels which will generally be sold to third-party developers.

Customer Financing — William Lyon Mortgage

The Company seeks to assist its home buyers in obtaining financing by arranging with mortgage lenders to offer qualified buyers a variety of financing options. Substantially all home buyers utilize long-term mortgage financing to purchase a home and mortgage lenders will usually make loans only to qualified borrowers.

In March 2009, the Company entered into a joint venture operating agreement with a lending institution, in which the Company would receive approximately 50% of the earnings of the joint venture. The joint venture was created to service the Company’s homebuyers by having access to a larger mortgage portfolio provided by the lending institution. The lending institution originates conventional, FHA and VA loans.

Information Systems and Controls

The Company assigns a high priority to the development and maintenance of its budget and cost control systems and procedures. The Company’s regional offices are connected to corporate headquarters through a fully integrated accounting, financial and operational management information system. Through this system, management regularly evaluates the status of its projects in relation to budgets to determine the cause of any variances and, where appropriate, adjusts the Company’s operations to capitalize on favorable variances or to limit adverse financial impacts.

Regulation

The Company and its competitors are subject to various local, state and federal statutes, ordinances, rules and regulations concerning zoning, building design, construction and similar matters, including local regulation which imposes restrictive zoning and density requirements in order to limit the number of homes that can ultimately be built within the boundaries of a particular project. The Company and its competitors may also be subject to periodic delays or may be precluded entirely from developing in certain communities due to building moratoriums or “slow-growth” or “no-growth” initiatives that could be implemented in the future in the states in which it operates. Because the Company usually purchases

 

10


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land with entitlements, the Company believes that the moratoriums would adversely affect the Company only if they arose from unforeseen health, safety and welfare issues such as insufficient water or sewage facilities. Local and state governments also have broad discretion regarding the imposition of development fees for projects in their jurisdiction. However, these are normally locked-in when the Company receives entitlements.

The Company and its competitors are also subject to a variety of local, state and federal statutes, ordinances, rules and regulations concerning protection of health and the environment. The particular environmental laws which apply to any given community vary greatly according to the community site, the site’s environmental conditions and the present and former uses of the site. These environmental laws may result in delays, may cause the Company and its competitors to incur substantial compliance and other costs, and may prohibit or severely restrict development in certain environmentally sensitive regions or areas. The Company’s projects in California are especially susceptible to restrictive government regulations and environmental laws. However, environmental laws have not, to date, had a material adverse impact on the Company’s operations.

Duxford Escrow, Inc. is licensed and subject to regulation under the California Escrow Law. The Company’s wholly-owned subsidiary, William Lyon Homes, Inc., is licensed as a general building contractor in California, Arizona and Nevada. In addition, William Lyon Homes, Inc. holds a corporate real estate license under the California Real Estate Law.

Competition

The homebuilding industry is highly competitive, particularly in the low and medium-price range where the Company currently concentrates its activities. The Company does not believe it has a significant market position in any geographic area which it serves due to the fragmented nature of the market. A number of the Company’s competitors have larger staffs, larger marketing organizations, and substantially greater financial resources than those of the Company. However, the Company believes that it competes effectively in its existing markets as a result of its product and geographic diversity, substantial development expertise, and its reputation as a low-cost producer of quality homes. Further, the Company sometimes gains a competitive advantage in locations where changing regulations make it difficult for competitors to obtain entitlements and/or government approvals which the Company has already obtained.

Corporate Organization and Personnel

The Company has organized its operations into four geographic divisions — Southern California, Northern California, Arizona and Nevada. Each division has a management team led by a division president. Each of the Company’s operating divisions has responsibility for the Company’s homebuilding and development operations within the geographical boundaries of that division.

The Company’s executive officers and divisional presidents average more than 20 years of experience in the homebuilding and development industries within California or the Southwestern United States. The Company combines decentralized management in those aspects of its business where detailed knowledge of local market conditions is important (such as governmental processing, construction, land development and sales and marketing), with centralized management in those functions where the Company believes central control is required (such as approval of land acquisitions, financial, treasury, human resources and legal matters).

As of December 31, 2009, the Company employed 195 full-time and 4 part-time employees, including corporate staff, supervisory personnel of construction projects, maintenance crews to service completed projects, as well as persons engaged in administrative, finance and accounting, engineering, land acquisition, golf course operations, sales and marketing activities.

The Company believes that its relations with its employees have been good. Some employees of the subcontractors which the Company utilizes are unionized, but none of the Company’s employees are union members. Although there have been temporary work stoppages in the building trades in the Company’s areas of operation, none has had any material impact upon the Company’s overall operations.

Available Information

The Company’s Internet address is http://www.lyonhomes.com. The Company makes available free of charge on or through its Internet website its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after such material was electronically filed with, or furnished to, the Securities and Exchange Commission.

 

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Table of Contents

Item 1A.

Risk Factors

An investment in the Company entails the following risks and uncertainties. These risk factors should be carefully considered when evaluating any investment in the Company. Any of these risks and uncertainties could cause the actual results to differ materially from the results contemplated by the forward-looking statements set forth herein, and could otherwise have a significant adverse impact on the Company’s business, prospects, financial condition or results of operations.

HOMEBUILDING OPERATIONS

Adverse changes in general economic conditions could reduce the demand for homes and, as a result, could negatively impact the Company’s results of operations.

The homebuilding industry continues to experience uncertainty and reduced demand for new homes in certain markets, which negatively impacted the Company’s financial and operating results during the year ending December 31, 2009. Increased instability in the credit markets has contributed to the decline in demand for new housing. The conditions experienced during 2009 include, among other things: the existence of a national recession; increases in unemployment levels; continuing concerns over the effects of asset valuations on the banking system and credit markets; reduced availability of mortgage loan financing; reduced consumer confidence; the absence of home price stability; and continued declines in the value of new homes in certain markets.

If the downturn in the homebuilding and mortgage lending industries continues or intensifies, or if the national economy weakens further and the recession continues or intensifies, the Company could continue to experience declines in the market value of the Company’s inventory and demand for the Company’s homes, which could have a significant negative impact on the Company’s gross margins and financial and operating results. Additionally, if energy costs should increase, demand for the Company’s homes could be adversely impacted, and the cost of building homes may increase, both of which could have a significant negative impact on the Company’s results of operations.

Revenues and margins may continue to decrease, and results of operations may be adversely affected, as a result of declines in demand for housing and other changes in economic and business conditions.

The residential homebuilding industry is cyclical and is highly sensitive to changes in general economic conditions such as levels of employment, consumer confidence and income, availability of financing for acquisitions, construction and permanent mortgages, interest rate levels, inflation, in-migration trends and demand for housing. An important segment of the Company’s customer base consists of move-up buyers, who often purchase homes subject to contingencies related to the sale of their existing homes. The difficulties facing these buyers in selling their homes during recessionary periods may adversely affect home sales. Moreover, during such periods, the Company may need to reduce sales prices and offer greater incentives to buyers to compete for sales that may result in reduced margins. Increases in the rate of inflation could adversely affect gross margins by increasing costs and expenses. In times of high inflation, demand for housing may decline and the Company may be unable to recover increased costs through higher sales.

From 2006 and into 2009, the homebuilding industry experienced continued decreased demand for housing, which has resulted in a steady decline in new home orders, home closings, and average sales prices for the Company. The Company has reduced sales prices and offered greater incentives to buyers to compete for sales. However, in certain markets, home pricing is stabilizing, incentives are being reduced and gross margins are increasing partially due to decreased construction costs. If the decreased demand for housing continues, the Company may need to continue the trend of reducing sales prices to meet competitive and market pressures.

Disruptions in the financial markets could adversely affect demand for the Company’s products or access to capital.

The homebuilding industry can be greatly affected by macro economic factors, including changes in national, regional, and local economic conditions, as well as potential homebuyers’ perceptions of such economic factors. These factors, including employment levels, income, prices, and credit availability and interest rates affecting homeowners, can adversely affect the residential real estate market. As discussed in this and prior reports, the residential real estate market has been particularly challenging over the last several quarters. The recent disruptions in the overall economy and, in particular, the credit and financial markets, have further deteriorated this environment and could further reduce consumer income, liquidity, credit and confidence in the economy, and result in further reductions in new and existing home sales. Softness or deterioration of the credit markets or the residential real estate market could be severely harmful to the Company’s financial position and results of operations and could adversely affect the Company’s liquidity or its ability to comply with the covenants under its indentures and credit facilities. There can be no assurances that recent or future government responses to the disruptions in the financial markets will restore consumer confidence, stabilize such markets or increase liquidity and the availability of credit to consumers and businesses.

 

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Table of Contents

The Company’s level of indebtedness could adversely affect its financial condition and prevent it from fulfilling its obligations.

The Company is highly leveraged and, subject to restrictions, the Company may incur substantial additional indebtedness. The Company’s high level of indebtedness could have detrimental consequences, including the following:

 

 

 

the ability to obtain additional financing for working capital, land acquisition costs, building costs, other capital expenditures, or general corporate purposes, may be limited;

 

 

 

the Company will need to use a substantial portion of cash flow from operations to pay interest and principal on its senior secured term loan, senior notes and other indebtedness, which will reduce the funds available for other purposes;

 

 

 

the Company has a higher level of indebtedness than competitors, which may put the Company at a competitive disadvantage and reduce the Company’s flexibility in planning for, or responding to, changing conditions in the industry, including increased competition;

 

 

 

substantially all of the Company’s actively selling projects are pledged as security for the Company’s senior secured term loan and a default on the debt could result in foreclosure on the Company’s assets which could, under certain circumstances, limit or prohibit the ability to operate as a going concern; and

 

 

 

the Company will be more vulnerable to economic downturns and adverse developments in the business.

The Company’s ability to meet expenses depends on future performance, which will be affected by financial, business, economic and other factors. The Company will not be able to control many of these factors, such as economic conditions in the markets where the Company operates and pressure from competitors. The Company cannot be certain that the cash flow will be sufficient to allow it to pay principal and interest on debt, support operations, and meet other obligations. If the Company does not have the resources to meet these and other obligations, the Company may be required to refinance all or part of the existing debt, including the senior notes, sell assets or borrow more money. The Company may not be able to do so on acceptable terms, if at all. In addition, the terms of existing or future debt agreements may restrict the Company from pursuing any of these alternatives.

Interest rates and the unavailability of mortgage financing can adversely affect demand for housing.

In general, housing demand is negatively impacted by increases in interest rates and housing costs and the unavailability of mortgage financing as a result of declining customer credit quality, tightening of mortgage loan underwriting standards, or other factors. Most buyers finance their home purchases through third-party lenders providing mortgage financing. Over the last several months, many third-party lenders have significantly increased underwriting standards, and many subprime and other alternate mortgage products are no longer available in the marketplace in spite of a decrease in mortgage rates. If these trends continue and mortgage loans continue to be difficult to obtain, the ability and willingness of prospective buyers to finance home purchases or to sell their existing homes will be adversely affected, which will adversely affect the Company’s results of operations through reduced home sales revenue, gross margin and cash flow.

Changes in federal income tax laws may also affect demand for new homes. Various proposals have been publicly discussed to limit mortgage interest deductions and to limit the exclusion of gain from the sale of a principal residence. Enactment of such proposals may have an adverse effect on the homebuilding industry in general. No meaningful prediction can be made as to whether any such proposals will be enacted and, if enacted, the particular form such laws would take.

Financial condition and results of operations may be adversely affected by any decrease in the value of land inventory, as well as by the associated carrying costs.

The Company continuously acquires land for replacement and expansion of land inventory within the markets in which it builds. The risks inherent in purchasing and developing land increase as consumer demand for housing decreases. Thus, the Company may have bought and developed land on which homes cannot be profitably built and sold. The market value of land, building lots and housing inventories can fluctuate significantly as a result of changing market conditions. The Company employs measures to manage inventory risks which may not be successful. In addition, inventory carrying costs can be significant and can result in losses in a poorly performing project or market. In the event of significant changes in economic or market conditions, the Company may have to sell homes at significantly lower margins or at a loss. Further, the Company may be required to write-down the book value of certain real estate assets in accordance with U.S. generally accepted accounting principles, and some of those write-downs could be material.

 

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Table of Contents

In 2009, the Company incurred impairment losses on real estate assets in the amount of $45.3 million. The impairments were primarily attributable to slower than anticipated home sales and lower than anticipated net revenue in the impaired projects. At two of the Company’s projects, impairment loss was primarily attributable to an increase in interest cost allocated to the project related to the addition of the Senior Secured Term Loan at 14% interest. In addition, the Company decreased base sales prices and increased certain incentives related to the projects, which is a strategy to improve sales absorption rates. The Company was required to write-down the book value of certain real estate assets in accordance with FASB ASC 360, as defined in Note 5 of “Notes to Consolidated Financial Statements.” The impairment losses have a material adverse effect on the Company’s financial position. A continued slump in the housing market could result in additional writedowns. Any additional material write-downs of assets could have a material adverse effect on the Company’s financial condition and earnings.

Increases in the Company’s cancellation rate could have a negative impact on the Company’s home sales revenue and home building gross margins.

During the years ended December 31, 2009, 2008 and 2007, the Company’s cancellation rates were 21%, 28% and 33%, respectively. which can negatively impact the number of closed homes, net new home orders, home sales revenue and the Company’s results of operations, as well as the number of homes in backlog. Home order cancellations can result from a number of factors, including declines, and/or slow appreciation, in the market value of homes, increases in the supply of homes available to be purchased, increased competition, higher mortgage interest rates, homebuyers’ inability to sell their existing homes, homebuyers’ inability to obtain suitable financing, including providing sufficient down payments, and adverse changes in economic conditions. High levels of home order cancellations would have a negative impact on the Company’s home sales revenue and financial and operating results.

The Company may be unable to maintain compliance with the financial covenants contained in its Senior Secured Term Loan.

The Company’s Senior Secured Term Loan imposes restrictions on operations, limits the amount of borrowings under its other sources, and requires the Company to comply with various financial covenants. The financial covenants include a minimum net worth requirement and certain asset loan-to-value ratios. In addition, the Company pledged a significant portion of its cash to the lender.

Certain of these financial ratios could be negatively impacted by declining market conditions, reduced homebuilding gross margins, impairment losses on real estate assets and losses realized on the bulk sales of land. (See Item 7, “Management’s Discussion and Analysis of Financial Condition, Financial Condition and Liquidity, Senior Secured Term Loan” for further discussion).

There can be no assurance that the Company will remain in compliance with the financial covenants contained in the Senior Secured Term Loan if market conditions decline. If the Company is unable to comply with any one or more of these financial covenants, and is unable to obtain a waiver for the noncompliance, the Company could be notified of default incurring additional borrowings. In addition, the Company’s obligations to repay indebtedness outstanding under the Senior Secured Term Loan could be accelerated in full. Any of these events could materially impact the Company’s liquidity and ability to conduct its operations.

Difficulty in obtaining sufficient capital could result in increased costs and delays in completion of projects.

The homebuilding industry is capital intensive and requires significant up-front expenditures to acquire land and begin development. Land acquisition, development and construction activities may be adversely affected by any shortage or increased cost of financing or the unwillingness of third parties to engage in joint ventures. The Company’s current financial position may make it more difficult for the Company to obtain capital for development projects, particularly if the Company has difficulty meeting its current financial ratio covenants. Any difficulty in obtaining sufficient capital for planned development expenditures could cause project delays and any such delay could result in cost increases and may adversely affect the Company’s sales and future results of operations and cash flows.

Any difficulty in obtaining sufficient capital for planned development expenditures could cause project delays and any such delay could result in cost increases and may adversely affect the Company’s sales and future results of operations and cash flows.

 

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If land is not available at reasonable prices, the Company’s homes sales revenue and results of operations could be negatively impacted and/or the Company could be required to scale back the Company’s operations in a given market.

The Company’s operations depend on the Company’s ability to obtain land for the development of the Company’s residential communities at reasonable prices and with terms that meet the Company’s underwriting criteria. The Company’s ability to obtain land for new residential communities may be adversely affected by changes in the general availability of land, the willingness of land sellers to sell land at reasonable prices given the deterioration in market conditions, competition for available land, availability of financing to acquire land, zoning, regulations that limit housing density, and other market conditions. If the supply of land appropriate for development of residential communities continues to be limited because of these factors, or for any other reason, the number of homes that the Company’s homebuilding subsidiaries build and sell may continue to decline. Additionally, the ability of the Company to open new projects could be impacted if the Company elects not to purchase lots under option contracts. To the extent that the Company is unable to purchase land timely or enter into new contracts for the purchase of land at reasonable prices, due to the lag time between the time the Company acquires land and the time the Company begins selling homes, the Company’s home sales revenue and results of operations could be negatively impacted and/or the Company could be required to scale back the Company’s operations in a given market.

Adverse weather and geological conditions may increase costs, cause project delays and reduce consumer demand for housing, all of which would adversely affect the Company’s results of operations and prospects.

As a homebuilder, the Company is subject to numerous risks, many of which are beyond management’s control, including: adverse weather conditions such as droughts, floods, or wildfires, which could damage projects, cause delays in completion of projects, or reduce consumer demand for housing; shortages in labor or materials, which could delay project completion and cause increases in the prices for labor or materials, thereby affecting the Company’s sales and profitability; and landslides, soil subsidence, earthquakes and other geologic events, which could damage projects, cause delays in the completion of projects or reduce consumer demand for the Company’s projects. Many of the Company’s projects are located in California, which has experienced significant earthquake activity. In addition to directly damaging the Company’s projects, earthquakes or other geologic events could damage roads and highways providing access to those projects, thereby adversely affecting the Company’s ability to market homes in those areas and possibly increasing the costs of completion.

There are some risks of loss for which the Company may be unable to purchase insurance coverage. For example, losses associated with landslides, earthquakes and other geologic events may not be insurable and other losses, such as those arising from terrorism, may not be economically insurable. A sizeable uninsured loss could adversely affect the Company’s business, results of operations and financial condition.

The Company’s business is geographically concentrated, and sales, results of operations, financial condition and business would be negatively impacted by a decline in regional economies.

The Company presently conducts all of its business in four geographic regions: Southern California, Northern California, Arizona and Nevada. Because the Company’s operations are concentrated in these geographic areas, the economic downturn in these markets has caused housing prices and sales to decline, which has caused a material adverse effect on the Company’s business, results of operations, and financial condition.

The Company may not be able to compete effectively against competitors in the homebuilding industry.

The homebuilding industry is highly competitive. Homebuilders compete for, among other things, homebuying customers, desirable properties, financing, raw materials and skilled labor. The Company competes both with large homebuilding companies, some of which have greater financial, marketing and sales resources than the Company, and with smaller local builders. The consolidation of some homebuilding companies may create competitors that have greater financial, marketing and sales resources than the Company and thus are able to compete more effectively against the Company. In addition, there may be new entrants in the markets in which the Company currently conducts business. The Company also competes for sales with individual resales of existing homes and with available rental housing.

 

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The Company’s operating results are variable.

The Company has historically experienced, and in the future expects to continue to experience, variability in operating results on a quarterly and an annual basis. Factors expected to contribute to this variability include, among other things:

 

 

 

the timing of land acquisitions and zoning and other regulatory approvals;

 

 

 

the timing of home closings, land sales and level of sales;

 

 

 

product mix;

 

 

 

the ability to continue to acquire additional land or options thereon at acceptable terms;

 

 

 

inventory impairment charges due to market impact on sales prices;

 

 

 

the condition of the real estate market and the general economy;

 

 

 

delays in construction due to acts of God, adverse weather, reduced subcontractor availability, and strikes;

 

 

 

changes in prevailing interests rates and the availability of mortgage financing; and

 

 

 

costs of material and labor.

Many of the factors affecting the Company’s results are beyond the Company’s control and may be difficult to predict.

The Company’s success depends on key executive officers and personnel.

The Company’s success is dependent upon the efforts and abilities of its executive officers and other key employees, many of whom have significant experience in the homebuilding industry and in the Company’s divisional markets. In particular, the Company is dependent upon the services of General William Lyon, Chairman of the Board and Chief Executive Officer, and William H. Lyon, President and Chief Operating Officer, as well as the services of the division presidents and division management teams and personnel in the corporate office. The loss of the services of any of these executives or key personnel, for any reason, could have a material adverse effect upon the Company’s business, operating results and financial condition.

Construction defect, soil subsidence and other building-related claims may be asserted against the Company, and the Company may be subject to liability for such claims.

California law provides that consumers can seek redress for patent (i.e., observable) defects in new homes within three or four years (depending on the type of claim asserted) from when the defect is discovered or should have been discovered. If the defect is latent (i.e., non-observable), consumers must still seek redress within three or four years from the date when the defect is discovered or should have been discovered, but in no event later than ten years after the date of substantial completion of the work on the construction. Consumers purchasing homes in Arizona and Nevada may also be able to obtain redress under state laws for either patent or latent defects in their new homes. Although the Company has obtained insurance for construction defect and subsidence claims, the Company may still be liable for damages, the cost of repairs, and/or the expense of litigation surrounding possible claims, including claims that arise out of uninsurable events, such as landslides or earthquakes, or other circumstances not covered by insurance and not subject to effective indemnification agreements with subcontractors.

Governmental laws and regulations may increase the Company’s expenses, limit the number of homes that the Company can build or delay completion of projects.

The Company is subject to numerous local, state, federal and other statutes, ordinances, rules and regulations concerning zoning, development, building design, construction and similar matters which impose restrictive zoning and density requirements in order to limit the number of homes that can eventually be built within the boundaries of a particular area. Projects that are not entitled may be subjected to periodic delays, changes in use, less intensive development or elimination of development in certain specific areas due to government regulations. The Company may also be subject to periodic delays or may be precluded entirely from developing in certain communities due to building moratoriums or “slow-growth” or “no-growth” initiatives that could be implemented in the future in the states in which the Company operates. Local and state governments also have broad discretion regarding the imposition of development fees for projects in their jurisdiction. Projects for which the Company has received land use and development entitlements or approvals may still require a variety of other governmental approvals and permits during the development process and can also be impacted adversely by unforeseen health, safety, and welfare issues, which can further delay these projects or prevent their development. As a result, home sales could decline and costs increase, which could negatively affect the Company’s results of operations.

 

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The Company is subject to environmental laws and regulations, which may increase costs, limit the areas in which the Company can build homes and delay completion of projects.

The Company is also subject to a variety of local, state, federal and other statutes, ordinances, rules and regulations concerning the environment. The particular environmental laws which apply to any given homebuilding site vary according to the site’s location, its environmental conditions and the present and former uses of the site, as well as adjoining properties. Environmental laws and conditions may result in delays, may cause the Company to incur substantial compliance and other costs, and can prohibit or severely restrict homebuilding activity in environmentally sensitive regions or areas, which could negatively affect the Company’s results of operations. Under various environmental laws, current or former owners of real estate, as well as certain other categories of parties, may be required to investigate and clean up hazardous or toxic substances or petroleum product releases, and may be held liable to a governmental entity or to third parties for property damage and for investigation and clean up costs incurred by such parties in connection with the contamination. In addition, in those cases where an endangered species is involved, environmental rules and regulations can result in the elimination of development in identified environmentally sensitive areas.

Utility shortages or price increases could have an adverse impact on operations.

In prior years, certain areas in Northern and Southern California have experienced power shortages, including mandatory periods without electrical power, as well as significant increases in utility costs. The Company may incur additional costs and may not be able to complete construction on a timely basis if such power shortages and utility rate increases continue. Furthermore, power shortages and rate increases may adversely affect the regional economies in which the Company operates, which may reduce demand for housing. The Company’s operations may be adversely impacted if further rate increases and/or power shortages occur.

The Company’s business and results of operations are dependent on the availability and skill of subcontractors.

Substantially all construction work is done by subcontractors with the Company acting as the general contractor. Accordingly, the timing and quality of construction depends on the availability and skill of the Company’s subcontractors. While the Company has been able to obtain sufficient materials and subcontractors during times of material shortages and believes that its relationships with suppliers and subcontractors are good, the Company does not have long-term contractual commitments with any subcontractors or suppliers. The inability to contract with skilled subcontractors at reasonable costs on a timely basis could have a material adverse effect on the Company’s business and results of operations.

Increased insurance costs and reduced insurance coverages may affect the Company’s results of operations and increase the potential exposure to liability.

Recently, lawsuits have been filed against builders asserting claims of personal injury and property damage caused by the presence of mold in residential dwellings. Some of these lawsuits have resulted in substantial monetary judgments or settlements against these builders. The Company’s insurance may not cover all of the potential claims, including personal injury claims, arising from the presence of mold or such coverage may become prohibitively expensive. If the Company is unable to obtain adequate insurance coverage, a material adverse effect on business, financial condition and results of operations could result if the Company is exposed to claims arising from the presence of mold.

The cost of insurance for the Company’s operations has risen, deductibles and retentions have increased and the availability of insurance has diminished. Significant increases in the cost of insurance coverage or significant limitations on coverage could have a material adverse effect on the Company’s business, financial condition and results of operations from such increased costs or from liability for significant uninsurable or underinsured claims.

The Company is the general partner in partnership joint ventures and may be liable for joint venture obligations.

Certain of the Company’s active joint ventures are organized as limited partnerships. The Company is the general partner in some of these and may serve as the general partner in future joint ventures. As a general partner, the Company may be liable for a joint venture’s liabilities and obligations should the joint venture fail or be unable to pay these liabilities or obligations.

 

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The Company’s senior notes are unsecured, and effectively subordinated to other secured indebtedness.

The Company’s Senior Secured Term Loan and construction loans are secured by liens on the real estate under development that is financed by those loans. If the Company becomes insolvent or is liquidated, or if payment under any secured indebtedness was accelerated, the holders of the Company’s secured indebtedness would be entitled to repayment from their collateral before those assets could be used to satisfy any unsecured claims, including claims under the Company’s senior notes or any guarantees of these notes. As a result, the senior notes will be effectively subordinated to the secured indebtedness to the extent of the value of the assets securing that indebtedness, and the holders of the notes will likely recover ratably less than the secured creditors.

The guarantees of the Company’s senior notes by the Company’s subsidiaries may be avoidable as fraudulent transfers and any new guarantees may be avoidable as preferences.

The guarantees of the Company’s senior notes by the Company’s subsidiaries may be subject to review under U.S. bankruptcy law and comparable provisions of state fraudulent conveyance laws. Under these laws, if a court were to find that, at the time any subsidiary guarantor issued a guarantee of the notes:

 

 

 

it issued the guarantee to delay, hinder or defraud present or future creditors; or

 

 

 

it received less than reasonably equivalent value or fair consideration for issuing the guarantee at the time it issued the guarantee and:

 

 

 

it was insolvent or rendered insolvent by reason of issuing the guarantee; or

 

 

 

it was engaged, or about to engage, in a business or transaction for which its assets constituted unreasonably small capital to carry on its business; or

 

 

 

it intended to incur, or believed that it would incur, debts beyond its ability to pay as they mature;

then the court could avoid the obligations under the guarantee, subordinate the guarantee of the senior notes to that of the guarantor’s other debt, require holders of the senior notes to return amounts already paid under that guarantee, or take other action detrimental to holders of the senior notes and the guarantees of the senior notes.

The measures of insolvency for purposes of fraudulent transfer laws vary depending upon the law of the jurisdiction that is being applied in any proceeding to determine whether a fraudulent transfer had occurred. Generally, however, a person would be considered insolvent if, at the time it incurred the debt:

 

 

 

the present fair saleable value of its assets was less than the amount that would be required to pay its probable liability on its existing debts, including contingent liabilities, as they become absolute and mature; or

 

 

 

it could not pay its debts as they become due.

The Company cannot be sure what standard a court would use to determine whether or not a guarantor was solvent at the relevant time, or, regardless of the standard that the court uses, that the issuance of the guarantee would not be avoided or the guarantee would not be subordinated to the guarantors’ other debt. If such a case were to occur, the guarantee could also be subject to the claim that, since the guarantee was incurred for the benefit of the issuer of the senior notes, and only indirectly for the benefit of the guarantor, the obligations of the applicable guarantor were incurred for less than fair consideration.

In addition, if the Company is required to grant an additional subsidiary guarantee for the notes at a time in the future when the guarantor was insolvent, its guarantee may also be avoidable as a preference under U.S. bankruptcy law or comparable provisions of state law.

The indentures for the senior notes and the Company’s secured term loan impose significant operating and financial restrictions, which may prevent the Company from capitalizing on business opportunities and taking some corporate actions.

The indentures for the senior notes and the credit agreement governing the Company’s secured term loan impose significant operating and financial restrictions. These restrictions limit the ability of the Company and its subsidiaries, among other things, to:

 

 

 

incur additional indebtedness;

 

 

 

pay dividends or make other distributions;

 

 

 

make investments;

 

 

 

sell assets;

 

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incur liens;

 

 

 

enter into agreements restricting the Company’s subsidiaries’ ability to pay dividends;

 

 

 

enter into transactions with affiliates; and

 

 

 

consolidate, merge or sell all or substantially all of the Company’s assets.

The Company’s other debt agreements contain additional restrictions. In addition, the Company may in the future enter into other agreements governing indebtedness which impose yet additional restrictions. These restrictions may adversely affect the Company’s ability to finance future operations or capital needs or to pursue available business opportunities. A breach of any of these covenants could result in a default in respect of the related indebtedness. If a default occurs, the relevant lenders could elect to declare the indebtedness, together with accrued interest and other fees, to be immediately due and payable and proceed against any collateral securing that indebtedness.

The Company may not be able to satisfy its obligations upon a change of control.

Upon the occurrence of a “change of control,” as defined in the senior notes indentures, each holder of the senior notes will have the right to require the Company to purchase the senior notes at a price equal to 101% of the principal amount, together with any accrued and unpaid interest, to the date of purchase. The Company’s failure to purchase, or give notice of purchase of, the senior notes would be a default under the indenture, which could in turn be a default under the Company’s other indebtedness.

If this event occurs, the Company may not have enough assets to satisfy all obligations under the indentures and any other indebtedness. In order to satisfy the obligations, the Company could seek to refinance the indebtedness under the senior notes and any other indebtedness or obtain a waiver from the holders of the indebtedness. The Company may not be able to obtain a waiver or refinance the indebtedness on acceptable terms.

In addition, the definition of change of control in the indentures governing the senior notes includes a phrase relating to the sale, lease, transfer, conveyance or other disposition of “all or substantially all” of the assets of the Company and the restricted subsidiaries. Although there is a developing body of case law interpreting the phrase “substantially all,” there is no precise established definition of the phrase under applicable law. Accordingly, the ability of a holder of senior notes to require the Company to repurchase such notes as a result of a sale, lease, transfer, conveyance or other disposition of less than all of the assets of the Company and the restricted subsidiaries may be uncertain.

Moreover, under the indentures governing the senior notes, the Company could engage in certain important corporate events, including acquisitions, refinancings or other recapitalizations or highly leveraged transactions, that would not constitute a change of control under the indentures and thus would not give rise to any repurchase rights, but which could increase the amount of indebtedness outstanding at such time or otherwise affect the Company’s capital structure or credit ratings or otherwise adversely affect holders of the senior notes. Any such transaction, however, would have to comply with the operating and financial restrictions contained in the indentures governing the senior notes.

CONSTRUCTION SERVICES

Supply and labor shortages and other risks could increase costs and delay completion.

Construction services operations could be adversely affected by fluctuating prices and limited supplies of building materials as well as the cost and availability of trades personnel. These prices and supplies may be adversely affected by natural disasters and adverse weather conditions, which could cause increased costs and delays in construction that could have an adverse effect upon the Company’s construction services operations.

The Company is subject to changes in the demand for construction projects.

Individual markets can be sensitive to overall capital spending trends in the economy, financing and capital availability for real estate and competitive pressures on the availability and pricing of construction projects. These factors can result in a reduction in the supply of suitable projects, increased competition and reduced margins on construction contracts.

The timing and funding of contracts and other factors could lead to unpredictable operating results.

Construction services operations are also subject to other risks and uncertainties, including the timing of new contracts and the funding of such awards; the length of time over which construction contracts are to be performed; cancellations of, or changes in the scope of, existing contracts; and the ability to meet performance or schedule guarantees and cost overruns.

 

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REGULATORY

The Company may not be able to benefit from net operating loss (“NOL”) carryforwards.

At December 31, 2009, the Company had gross federal and state net operating loss carry forwards totaling approximately $39.2 million and $329.8 million, respectively. Federal net operating loss carry forwards will expire in 2028; state net operating loss carry forwards begin to expire in 2013. The Company will only receive tax benefits for the NOL carry forwards if there is future taxable income before the applicable NOL expiration period. The Company has fully reserved against all of its deferred tax assets, including the NOL carry forward that was carried on the Company’s financial statements, due to the possibility that the Company may not have taxable income. However, these deferred tax assets will be available to the Company if there is sufficient future taxable income.

 

Item 1B.

Unresolved Staff Comments

None.

 

Item 2.

Properties

Headquarters

The Company’s corporate headquarters are located at 4490 Von Karman Avenue, Newport Beach, California, which it leases from a trust of which William H. Lyon, a director of the Company, is the sole beneficiary. The Company leases or owns properties for its division offices and William Lyon Financial Services, but none of these properties is material to the operation of the Company’s business. For information about properties owned by the Company for use in its homebuilding activities, see Item 1.

 

Item 3.

Legal Proceedings

Litigation Arising from General Lyon’s Tender Offer

On March 17, 2006, the Company’s principal stockholder commenced a tender offer (the “Tender Offer”) to purchase all outstanding shares of the Company’s common stock not already owned by him. Initially, the price offered in the Tender was $93 per share, but it was subsequently increased to $109 per share.

Two purported class action lawsuits were filed in the Court of Chancery of the State of Delaware in and for New Castle County, purportedly on behalf of the public stockholders of the Company, challenging the Tender Offer and challenging related actions of the Company and the directors of the Company. Stephen L. Brown v. William Lyon Homes, et al., Civil Action No. 2015-N was filed on March 20, 2006, and Michael Crady, et al. v. General William Lyon, et al., Civil Action No. 2017-N was filed on March 21, 2006 (collectively, the “Delaware Complaints”). On March 21, 2006, plaintiff in the Brown action also filed a First Amended Complaint. The Delaware Complaints name the Company and the then directors of the Company as defendants. These complaints allege, among other things, that the defendants had breached their fiduciary duties owed to the plaintiffs in connection with the Tender Offer and other related corporate activities. The plaintiffs sought to enjoin the Tender Offer and, among other things, to obtain attorneys’ fees and expenses related to the litigation.

On March 24, 2006, the Delaware Chancery Court consolidated the Delaware Complaints into a single case entitled In re: William Lyon Homes Shareholder Litigation, Civil Action No. 2015-N (the “Consolidated Delaware Action”).

On April 10, 2006, the parties to the Consolidated Delaware Action executed a Memorandum of Understanding (“MOU”), detailing a proposed settlement subject to the Delaware Chancery Court’s approval. Pursuant to the MOU, General Lyon increased his offer of $93 per share to $100 per share, extended the closing date of the offer to April 21, 2006, and, on April 11, 2006, filed an amended Schedule TO. Plaintiffs in the Consolidated Delaware Action have determined that the settlement is “fair, reasonable, adequate, and in the best interests of plaintiffs and the putative Class.” A special committee of the Company’s Board of Director’s also determined that the price of $100 per share was fair to the shareholders, and recommended that the Company’s shareholders accept the revised Tender Offer and tender their shares. Thereafter, General Lyon also decided to further extend the closing date of the Tender Offer from April 21, 2006 to April 28, 2006.

 

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A purported class action lawsuit challenging the Tender Offer was also filed in the Superior Court of the State of California, County of Orange. On March 17, 2006, a complaint captioned Alaska Electrical Pension Fund v. William Lyon Homes, Inc., et al., Case No. 06-CC-00047, was filed. On April 5, 2006, plaintiff in the Alaska Electrical action filed an Amended Complaint (the “California Action”). The complaint in the California Action names the Company and the then directors of the Company as defendants and alleges, among other things, that the defendants have breached their fiduciary duties to the public stockholders. Plaintiff in the California Action also sought to enjoin the Tender Offer, and, among other things, to obtain attorneys’ fees and expenses related to the litigation.

On April 20, 2006, the California court denied the request of plaintiff in the California Action to enjoin the Tender Offer. Plaintiff filed a motion to certify a class in the California Action which was later taken off calendar, and the Company filed a motion to stay the California Action. On July 5, 2006, the California Court granted the Company’s motion to stay the California Action pending final resolution of all matters in the Delaware Action.

On April 23, 2006, the Delaware Chancery Court conditionally certified a class in the Consolidated Delaware Action. The parties to the Consolidated Delaware Action agreed to a Stipulation of Settlement, and on August 9, 2006, the Delaware Chancery Court certified a class in the Consolidated Delaware Action, approved the settlement, and dismissed the Consolidated Delaware Action with prejudice as to all defendants and the class. On February 16, 2007, plaintiff in the California Action appealed the fee award in the Consolidated Delaware Action to the Supreme Court of the State of Delaware. Thereafter, the Delaware Supreme Court remanded the matter to the Chancery Court for further proceedings and, on April 2, 2009, the Chancery Court issued its decision on remand denying the fee award sought by the California plaintiff. On April 30, 2009, the California plaintiff again appealed the fee award to the Delaware Supreme Court. On January 14, 2010, the Delaware Supreme court affirmed the order of the Chancery Court.

Other Legal Proceedings

The Company is involved in various legal proceedings, most of which relate to routine litigation and some of which are covered by insurance. In the opinion of the Company’s management, none of the uninsured claims involves claims which are material and unreserved or will have a material adverse effect on the financial condition of the Company.

 

Item 4.

Reserved

 

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PART II

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

The Company’s Common Stock was delisted from the NYSE in conjunction with the Tender Offer and Merger. The Company is now a privately held company. See Note 8 of “Notes to Consolidated Financial Statements.”

The Company has not paid any cash dividends on its Common Stock during the last three fiscal years and expects that for the foreseeable future it will follow a policy of retaining earnings in order to help finance its business. Payment of dividends is within the discretion of the Company’s Board of Directors and will depend upon the earnings, capital requirements, general economic conditions and operating and financial condition of the Company, among other factors. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Financial Condition and Liquidity” and Note 8 of “Notes to Consolidated Financial Statements.”

 

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Item 6.

Selected Financial Data

The following table sets forth certain of the Company’s historical financial data. The selected historical consolidated financial data as of December 31, 2009 and 2008 and for the years ended December 31, 2009, 2008 and 2007 have been derived from the Company’s audited consolidated financial statements and the related notes included elsewhere herein. The selected historical consolidated financial data as of December 31, 2007, 2006 and 2005 and for the years ended December 31, 2006 and 2005, has been derived from the Company’s audited financial statements for such years, which are not included herein. The selected historical consolidated financial data set forth below are not necessarily indicative of the results of future operations and should be read in conjunction with the discussion under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the historical consolidated financial statements and accompanying notes included elsewhere herein.

 

      As of and for the Year Ended December 31,  
     2009     2008     2007     2006     2005  
     (dollars in thousands)  
     (note 8)  

Statement of Operations Data:

          

Operating revenue

          

Home sales

   $ 253,874      $ 468,452      $ 1,002,549      $ 1,478,694      $ 1,745,067   

Lots, land and other sales(1)

     21,220        39,512        102,808        13,527        111,316   

Construction services(2)

     34,149        18,114                        
                                        
     309,243        526,078        1,105,357        1,492,221        1,856,383   
                                        

Operating costs

          

Cost of sales—homes

     (219,486     (439,276     (873,228     (1,160,614     (1,307,027

Cost of sales—lots, land and other(1)

     (131,640     (47,599     (205,603     (16,524     (44,774

Impairment loss on real estate assets(3)

     (45,269     (135,311     (231,120     (39,895     (4,600

Impairment loss on goodwill(4)

            (5,896                     

Construction services(2)

     (28,486     (15,431                     

Sales and marketing

     (17,636     (40,441     (66,703     (72,349     (59,422

General and administrative

     (21,027     (27,645     (37,472     (61,390     (90,045

Other

     (6,580     (4,461     (903     (6,502     (2,450
                                        
     (470,124     (716,060     (1,415,029     (1,357,274     (1,508,318
                                        

Equity in (loss) income of unconsolidated joint ventures

     (420     (3,877     304        3,242        4,301   

Operating (loss) income

     (161,301     (193,859     (309,368     138,189        352,366   

Gain on retirement of debt(5)

     78,144        54,044                        

Interest expense, net of amounts capitalized(6)

     (35,902     (24,440                     

Financial advisory expenses

                          (3,165     (2,191

Other (expense) income, net

     (3,802     579        3,744        5,599        2,176   
                                        

(Loss) income before benefit (provision) for income taxes

     (122,861     (163,676     (305,624     140,623        352,351   

Benefit(provision) for income taxes

     101,908        41,592        (32,658     (48,931     (124,149
                                        

Consolidated net (loss) income

     (20,953     (122,084     (338,282     91,692        228,202   

Less: net loss (income) – noncontrolling interest

     428        10,446        (11,126     (16,914     (37,571
                                        

Net(loss) income

   $ (20,525   $ (111,638   $ (349,408   $ 74,778      $ 190,631   
                                        

Balance Sheet Data:

          

Cash and cash equivalents

   $ 117,587      $ 67,017      $ 73,197      $ 38,732      $ 52,369   

Real estate inventories

          

Owned(3)

     523,336        754,489        1,061,660        1,431,753        1,303,476   

Not owned

     55,270        107,763        144,265        200,667        115,772   

Total assets

     860,099        1,044,843        1,375,328        1,878,595        1,691,002   

Total debt

     590,290        670,905        814,485        851,314        672,536   

Equity

     158,199        241,541        338,772        735,254        770,072   

Operating Data (including consolidated joint ventures) (unaudited):

          

Number of net new home orders

     869        1,221        1,855        2,202        3,321   

Number of homes closed

     915        1,260        2,182        2,887        3,196   

Average sales price of homes closed

   $ 278      $ 372      $ 460      $ 512      $ 546   

Cancellation rates

     21     28     33     33     16

Backlog at end of period, number of homes(7)

     194        240        279        606        1,291   

Backlog at end of period, aggregate sales value(7)

   $ 56,472      $ 80,750      $ 107,893      $ 295,505      $ 691,627   

 

(1)

On December 24, 2009, the Company consummated the sale of certain real property (comprising approximately 165 acres) in San Bernardino County, California; San Diego County California; Clark County, Nevada; and Maricopa County, Arizona, for an aggregate sales price of $13.6 million. The book value of these properties on the closing date as reflected on the consolidated balance sheet of the Company and its subsidiaries was approximately $84.2 million. The Company entered into these transactions to generate cash flow, to reduce overall debt and to re-invest the cash by purchasing land in certain of its improving markets. The best economic value to the Company of these lots was to sell them in their current condition as opposed to holding the lots and eventually building and selling homes. The Company continues to evaluate land values to determine whether to hold for development or to sell at current prices.

 

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On December 26, 2007 and January 7, 2008, the Company entered into ten separate agreements with various affiliates of one of its equity partners (the “Equity Partner Agreements”). Pursuant to the Equity Partner Agreements, the Company agreed to sell to the equity partner affiliates 604 residential lots and 5 model homes in 10 communities in Orange County, San Diego County and Ventura County, California for an aggregate sales price of $90.6 million in cash. The sale of 404 of the residential lots and the 5 model homes closed on December 27, 2007 (for an aggregate consideration of approximately $65.9 million) and the remainder of the residential lots closed on January 9, 2008. Prior to the sale, the collective net book value of these lots (as reflected on the Company’s financial statements) was approximately $210.7 million, resulting in a total loss on the sales transactions of $120.1. The loss of $40.3 million related to the portion of the land sales which closed in January 2008 has been reflected in the Consolidated Statement of Operations as Impairment Loss on Real Estate Assets for the year ended December 31, 2007.

On December 27, 2007, the Company sold certain land in San Diego County, California for $12.0 million in cash to a limited liability corporation owned indirectly by Frank T. Suryan, Jr. as Trustee of the Suryan Family Trust. Mr. Suryan is Chairman and Chief Executive Officer of Lyon Capital Ventures, a company wholly owned by Frank T. Suryan, Jr., General William Lyon, Chairman and Chief Executive Officer of the Company, and two trusts whose sole beneficiary is William H. Lyon, President of the Company. The Company received a report from a third-party valuation and financial advisory services firm as to the reasonableness of the sales price in the transaction. Further, the transaction was unanimously approved by all disinterested members of the Board of Directors. Prior to the sale, the net book value of this land (as reflected on the Company’s financial statements) was approximately $18.7 million, resulting in a loss on the transaction of $6.7 million.

 

(2)

The Company accounts for construction management agreements using the Percentage of Completion Method in accordance with FASB ASC Topic 605 Revenue Recognition. Under ASC 605, the Company records revenues and expenses as work on a contract progresses, and based on the percentage of costs incurred to date compared to the total estimated costs of the contract. Based on the provisions of ASC 605, the Company has recorded construction services revenues and expenses of $34.1 million and $28.5 million, respectively for the year ended December 31, 2009 and $18.1 million and $15.4 million, respectively, for the year ended December 31, 2008, in the accompanying consolidated statement of operations. The Company entered into construction management agreements to build and market homes in 5 separate communities. For such services, the Company will receive fees (generally 5 percent of the sales price, as defined) and may, under certain circumstances, receive additional compensation if certain financial thresholds are achieved.

 

(3)

The results of operations for the years ended December 31, 2009, 2008, 2007, 2006 and 2005, include non-cash charges of $45.3 million, $135.3 million, $231.1 million, $39.9 million and $4.6 million to record impairment losses on real estate assets held by the Company at certain of its homebuilding projects. The impairments were primarily attributable to slower than anticipated home sales and lower than anticipated net revenue. At two of the Company’s projects at the end of 2009, impairment loss was primarily attributable to an increase in interest cost allocated to the project related to the addition of the Senior Secured Term Loan at 14% interest. In addition, the Company decreased base sales prices and increased certain incentives related to the projects, which is a strategy to improve sales absorption rates. As a result, the future undiscounted cash flows estimated to be generated were determined to be less than the carrying amount of the assets. Accordingly, the related real estate assets were written-down to their estimated fair value. The non-cash charges are reflected as impairment loss on real estate assets in the accompanying consolidated statements of operations. The Company accounts for its real estate inventories under FASB ASC Topic 360, Property, Plant and Equipment, which is described more fully below in the section entitled “Impairment on Real Estate Inventories.”

 

(4)

The amount paid for business acquisitions over the net fair value of assets acquired and liabilities assumed is reflected as goodwill, which is subject to FASB ASC Topic 350, Intangibles—Goodwill and Other. The Company reviewed goodwill for impairment on an annual basis or when indicators of impairment exist. Evaluating goodwill for impairment involves the determination of the fair value of the Company’s reporting units in which the Company has recorded goodwill. A reporting unit is a component of an operating segment for which discrete financial information is available and reviewed by the Company’s management on a regular basis. Inherent in the determination of fair value are judgments and assumptions, including the interpretation of current economic conditions and market valuations. Due to deterioration in market conditions, the Company recorded an impairment charge on goodwill of $5.9 million during the year ended December 31, 2008. The Company did not incur impairment charges on goodwill during the years ended December 31, 2009, 2007, 2006 and 2005.

 

(5)

On June 10, 2009, the Company’s wholly-owned subsidiary, William Lyon Homes, Inc., a California corporation (“California Lyon”), consummated a cash tender offer (the “Tender Offer”) to purchase a portion of its outstanding Senior Notes, on the terms and subject to the conditions set forth in its offer to purchase, as amended. The principal amount of Senior Notes purchased by California Lyon on settlement of the Tender Offer totaled $53.2 million, including $29.1 million of the 7  5/8% Senior Notes due 2012, $2.4 million of the 10 3/4% Senior Notes due 2013, and $21.7 million of the 7 1/2% Senior Notes due 2014. The aggregate Tender Offer consideration paid totaled $14.9 million, plus accrued interest. The net gain resulting from the Tender Offer, after closing costs, was $37.0 million.

Also, during 2009, the Company purchased, in privately negotiated transactions, a total of $103.7 million principal amount of its outstanding Senior Notes at a cost of $61.2 million, plus accrued interest. The net gain resulting from the purchases, after giving effect to amortization of related deferred loan costs was $41.1 million.

In October 2008, the Company purchased, in privately negotiated transactions, $71.9 million principal amount of its outstanding Senior Notes at a cost of $16.7 million, plus accrued interest. The net gain resulting from the purchases, after giving effect to amortization of related deferred loan costs was $54.0 million.

 

(6)

During the years ended December 31, 2009 and 2008, the Company reported interest expense, due to a decrease in real estate assets which qualify for interest capitalization during the 2009 and 2008 periods.

 

(7)

Backlog consists of homes sold under pending sales contracts that have not yet closed, some of which are subject to contingencies, including mortgage loan approval and the sale of existing homes by customers. There can be no assurance that homes sold under pending sales contracts will close. Of the total homes sold subject to pending sales contracts as of December 31, 2009, 190 represent homes completed or under construction and 4 represent homes not yet under construction. Backlog as of all dates is unaudited.

 

(8)

The FASB issued guidance now codified as FASB ASC Topic 810, Consolidation, which addresses the consolidation of variable interest entities (“VIEs”). Under this guidance, arrangements that are not controlled through voting or similar rights are accounted for as VIEs. An enterprise is required to consolidate a VIE if it is the primary beneficiary of the VIE. Accordingly, the assets, liabilities and operations of these joint ventures have been consolidated with the Company’s financial statements for the periods presented. The adoption of this guidance has not affected the Company’s consolidated net income.

 

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Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of results of operations and financial condition should be read in conjunction with the Selected Financial Data and the Consolidated Financial Statements and Notes thereto and other financial information appearing elsewhere in this Annual Report on Form 10-K. As used herein, “on a combined basis” means the total of operations in wholly-owned projects and in consolidated joint venture projects.

The Company is primarily engaged in the design, construction and sale of single family detached and attached homes in California, Arizona and Nevada. Since the founding of its predecessor in 1956, on a combined basis the Company has sold over 72,000 homes. The Company conducts its homebuilding operations through four reportable operating segments: Southern California, Northern California, Arizona and Nevada. For the year ended December 31, 2009, on a consolidated basis the Company had revenues from home sales of $253.9 million and delivered 915 homes, which includes $5.6 million of revenue and 17 delivered homes from consolidated joint ventures.

The Company and certain of its subsidiaries are general partners or members in joint ventures involved in the development and sale of residential projects. As described more fully in “Critical Accounting Policies—Variable Interest Entities” certain joint ventures have been determined to be variable interest entities in which the Company is considered the primary beneficiary. Accordingly, the assets, liabilities and operations of these joint ventures have been consolidated with the Company’s financial statements as of and for the years ended December 31, 2009 and 2008. Because the Company already recognizes its proportionate share of joint venture earnings and losses under the equity method of accounting, the adoption of the accounting for variable interest entities did not affect the Company’s consolidated net income. The financial statements of joint ventures in which the Company is not considered the primary beneficiary are not consolidated with the Company’s financial statements. The Company’s investments in unconsolidated joint ventures are accounted for using the equity method because the Company has a 50% or less voting or economic interest (and thus such joint ventures are not controlled by the Company). Income allocations and cash distributions to the Company from the unconsolidated joint ventures are based on predetermined formulas between the Company and its joint venture partners as specified in the applicable partnership or operating agreements.

The Company evaluates homebuilding assets for impairments when indicators of potential impairments are present. Indicators of potential impairment include but are not limited to a decrease in housing market values and sales absorption rates. Given the current market conditions in the homebuilding industry, the Company evaluates all homebuilding assets for impairments each quarter. Comparing the 2009 period to the 2008 period, homebuilding revenues decreased 46% to $253.9 million in the 2009 period from $468.5 million in the 2008 period, the average sales price for homes closed decreased 25% to $277,500 in the 2009 period from $371,800 in the 2008 period and net new home orders decreased 29% to 869 in the 2009 period from 1,221 in the 2008 period. During 2009, the Company recorded impairment losses on real estate assets of $45.3 million. If the Company continues to experience reduced absorption rates and reduced sales prices, the potential for additional inventory impairment will increase.

Results of Operations

Beginning in 2006 and continuing into the beginning of 2009, the homebuilding industry experienced decreased demand for housing and declining sales prices. These conditions were the result of an erosion of homebuyer confidence which was driven by increases in unemployment, limited availability of mortgage financing due to stress in the mortgage and credit markets, price instability, increasing foreclosures and increased levels of housing inventory in the market. In certain of the Company’s markets, however, the Company has experienced steadying sales absorption rates, a decrease in sales incentives and an increase in base pricing, while homebuilding costs continue to decrease. In Southern California, net new home orders per average sales location increased to 50.0 during the year ended December 31, 2009 from 30.8 for the same period in 2008. In Arizona, net new home orders per average sales location increased to 49.3 during the year ended December 31, 2009 from 45.8 for the same period in 2008. In addition, the Company’s cancellation rate decreased to 21% in the 2009 period compared to 28% in the 2008 period, particularly impacted by Southern California of 19% in the 2009 period compared to 30% in the 2008 period and Arizona of 13% in the 2009 period compared to 22% in the 2008 period. In addition, the Company experienced increased homebuilding gross margin percentages of 13.5% in the 2009 period compared to 6.2% in the 2008 period particularly impacted by Southern California gross margins of 15.6% in the 2009 period compared to 7.5% in the 2008 period and Northern California gross margins of 13.8% in the 2009 period compared to (2.6)% in the 2008 period. On November 6, 2009, the Worker, Homeownership, and Business Assistance Act of 2009 was enacted into law, which extended and expanded the current homebuyer federal tax credit until April 30, 2010. While the ultimate impact of this legislation is not yet determinable, the Company believes that it has had a modest stimulative impact on the demand for new housing in its markets. It is possible that when this tax credit expires, it could have a negative impact on the demand for new housing.

Comparisons of Years Ended December 31, 2009 and 2008

On a combined basis, the number of net new home orders for the year ended December 31, 2009 decreased 29% to 869 homes from 1,221 homes for the year ended December 31, 2008. The number of homes closed on a combined basis for the year ended December 31, 2009 decreased 27% to 915 homes from 1,260 homes for the year ended December 31, 2008. The

 

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cancellation rate of buyers who contracted to buy a home but did not close escrow at the Company’s projects was approximately 21% during 2009 and 28% during 2008. The inventory of completed and unsold homes was 39 homes as of December 31, 2009, compared to 80 homes as of December 31, 2008.

On a combined basis, the backlog of homes sold but not closed as of December 31, 2009 was 194 homes, down 19% from 240 homes as of December 31, 2008. Homes in backlog are generally closed within three to six months. The dollar amount of backlog of homes sold but not closed on a combined basis as of December 31, 2009 was $56.5 million, down 30% from $80.8 million as of December 31, 2008.

The Company’s average number of sales locations decreased for the year ended December 31, 2009 to 25, down 43% from 44 for the year ended December 31, 2008. In addition, the Company temporarily suspended the development of certain projects, which will be re-opened when management believes economic conditions stabilize. The Company’s number of new home orders per average sales location increased from 27.8 for the year ended December 31, 2008 to 34.8 for the year ended December 31, 2009.

 

     Year Ended
December 31,
    Increase (Decrease)  
     2009     2008     Amount     %  

Number of Net New Home Orders

        

Southern California

   450      586      (136   (23 )% 

Northern California

   102      238      (136   (57 )% 

Arizona

   197      183      14      8  % 

Nevada

   120      214      (94   (44 )% 
                    

Total

   869      1,221      (352   (29 )% 
                    

Cancellation Rate

   21   28   (7 )%   
                    

Three of the Company’s homebuilding segments experienced declines in net new home orders during the year ended December 31, 2009. The decrease in new home orders during the 2009 period in these three segments was attributable to a decrease in the number of sales locations. However, the Company’s Arizona segment experienced a slight increase in new home orders during this same period. This is primarily due to (i) a decrease in the cancellation rate in Arizona to 13% in 2009 from 22% in 2008 and (ii) due to the federal income tax credit for first time home buyers.

Cancellation rates during the year ended December 31, 2009 decreased to 21% in the 2009 period from 28% during the 2008 period. The decline resulted from a decrease in the cancellation rate in three of the Company’s homebuilding segments. In Southern California to 19% in the 2009 period from 30% in the 2008 period, in Northern California to 28% in the 2009 period from 29% in the 2008 period, in Arizona to 13% in the 2009 period from 22% in the 2008 period and an increase in Nevada to 30% in the 2009 period from 28% in the 2008 period. The decrease in cancellation rates, period over period, could result in continued future stabilization in certain of the homebuilding markets in which the Company operates.

 

     Year Ended
December 31,
   Increase (Decrease)  
     2009    2008    Amount     %  

Average Number of Sales Locations

          

Southern California

   9    19    (10   (53 )% 

Northern California

   4    10    (6   (60 )% 

Arizona

   4    4        

Nevada

   8    11    (3   (27 )% 
                  

Total

   25    44    (19   (43 )% 
                  

The average number of sales locations decreased in each homebuilding segment, except for Arizona, during the year ended December 31, 2009, primarily due to (i) temporarily suspending the development of certain projects throughout the Company and (ii) final deliveries in certain projects.

 

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     December 31,    Increase (Decrease)  
     2009    2008    Amount     %  

Backlog (units)

          

Southern California

   158    134    24      18

Northern California

   6    48    (42   (88 )% 

Arizona

   17    34    (17   (50 )% 

Nevada

   13    24    (11   (46 )% 
                  

Total

   194    240    (46   (19 )% 
                  

The Company’s backlog at December 31, 2009 decreased 19% from levels at December 31, 2008, primarily resulting from a decrease in the average number of sales locations, as described above, and a decrease in the number of net new home orders. The decrease in backlog during this period reflects a decrease in net new order activity of 29% to 869 homes in the 2009 period compared to 1,221 homes in the 2008 period and a decrease in number of homes closed by 27% to 915 in the 2009 period from 1,260 in the 2008 period.

 

     December 31,    Increase (Decrease)  
     2009    2008    Amount     %  

Backlog (dollars)

          

Southern California

   $ 48,681    $ 55,065    $ (6,384   (12 )% 

Northern California

     2,479      13,669      (11,190   (82 )% 

Arizona

     2,716      6,177      (3,461   (56 )% 

Nevada

     2,596      5,839      (3,243   (56 )% 
                        

Total

   $ 56,472    $ 80,750    $ (24,278   (30 )% 
                        

The dollar amount of backlog of homes sold but not closed on a combined basis as of December 31, 2009 was $56.5 million, down 30% from $80.8 million as of December 31, 2008. The significant decrease in backlog during this period reflects a decrease in net new order activity of 29% to 869 homes in the 2009 period compared to 1,221 homes in the 2008 period. In addition, the dollar amount of backlog is affected by recent average sales prices for new home orders, and the Company experienced a decrease of 13% in the average sales price of homes in backlog to $291,100 as of December 31, 2009 compared to $336,500 as of December 31, 2008. The product mix at the Company’s projects has shifted in 2009. There are no homes in backlog greater than $500,000 per unit at December 31, 2009, compared to 48 homes in backlog greater than $500,000 per unit at December 31, 2008.

In Southern California, the dollar amount of backlog decreased 12% to $48.7 million as of December 31, 2009 from $55.1 million as of December 31, 2008, which is attributable to a 23% decrease in net new home orders in Southern California to 450 homes in the 2009 period compared to 586 homes in the 2008 period, and a 25% decrease in the average sales price of homes in backlog to $308,100 as of December 31, 2009 compared to $410,900 as of December 31, 2008. In Southern California, the cancellation rate decreased to 19% for the period ended December 31, 2009 from 30% for the period ended December 31, 2008.

In Northern California, the dollar amount of backlog decreased 82% to $2.5 million as of December 31, 2009 from $13.7 million as of December 31, 2008, which is attributable to a 57% decrease in net new home orders in Northern California to 102 homes in the 2009 period compared to 238 homes in the 2008 period, and a decrease in homes in backlog to 6 homes at December 31, 2009 from 48 homes at December 31, 2008. The decrease in homes in backlog is due to a lack of open projects in the division. At December 31, 2009, Northern California had 2 open projects with 42 homes to sell. These decreases were offset by an increase of 45% in the average sales price of homes in backlog to $413,800 as of December 31, 2009 compared to $284,800 as of December 31, 2008, which is primarily due to product mix of remaining projects. In Northern California the cancellation rate decreased slightly to 28% for the period ended December 31, 2009 from 29% for the period ended December 31, 2008.

In Arizona, the dollar amount of backlog decreased 56% to $2.7 million as of December 31, 2009 from $6.2 million as of December 31, 2008, which is attributable to a 50% decrease in homes in backlog to 17 homes at December 31, 2009 from 34 homes at December 31, 2008 and to a 12% decrease of in the average sales price of homes in backlog to $159,800 as of December 31, 2009 compared to $181,700 as of December 31, 2008. In Arizona, the cancellation rate decreased to 13% for the period ended December 31, 2009 from 22% for the period ended December 31, 2008.

 

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In Nevada, the dollar amount of backlog decreased 56% to $2.6 million as of December 31, 2009 from $5.8 million as of December 31, 2008, which is attributable to a 46% decrease in homes in backlog to 13 homes at December 31, 2009 from 24 homes at December 31, 2008 and a 18% decrease in the average sales price of homes in backlog to $199,700 as of December 31, 2009 compared to $243,300 as of December 31, 2008. In Nevada, the cancellation rate increased to 30% for the period ended December 31, 2009 from 28% for the period ended December 31, 2008.

The decrease in the dollar amount of backlog of homes sold but not closed as described above generally results in a reduction in operating revenues in the subsequent period as compared to the previous period. Revenue from sales of homes decreased 46% to $253.9 million during the period ended December 31, 2009 from $468.5 million during the period ended December 31, 2008. A decrease in homebuilding revenues on a project basis is a potential indicator for impairment. If market prices and home values decrease in certain of the Company’s projects and cancellation rates increase in the future, the Company’s revenue and liquidity would likely be negatively impacted.

 

     Year Ended
December 31,
   Increase (Decrease)  
     2009    2008    Amount     %  

Number of Homes Closed

          

Southern California

   426    594    (168   (28 )% 

Northern California

   144    233    (89   (38 )% 

Arizona

   214    216    (2   (1 )% 

Nevada

   131    217    (86   (40 )% 
                  

Total

   915    1,260    (345   (27 )% 
                  

During the year ended December 31, 2009, the number of homes closed decreased 27%. The decrease was primarily driven by a decrease in the average number of sales locations to 25 in 2009 from 44 in the 2008 period and by the Company temporarily suspending the development of certain projects as discussed above.

 

     Year Ended
December 31,
   Increase (Decrease)  
     2009    2008    Amount     %  

Home Sales Revenue

          

Southern California

   $ 141,884    $ 280,611    $ (138,727   (49 )% 

Northern California

     43,211      80,292      (37,081   (46 )% 

Arizona

     39,619      49,188      (9,569   (19 )% 

Nevada

     29,160      58,361      (29,201   (50 )% 
                        

Total

   $ 253,874    $ 468,452    $ (214,578   (46 )% 
                        

The decrease in homebuilding revenue of 46% to $253.9 million during the year ended December 31, 2009 from $468.5 million during the year ended December 31, 2008 is primarily attributable to a decrease in the number of homes closed to 915 during the 2009 period from 1,260 during the 2008 period and a decrease in the average sales price of homes closed to $277,500 during the 2009 period from $371,800 during the 2008 period.

 

     Year Ended
December 31,
   Increase (Decrease)  
     2009    2008    Amount     %  

Average Sales Price of Homes Closed

          

Southern California

   $ 333,100    $ 472,400    $ (139,300   (29 )% 

Northern California

     300,100      344,600      (44,500   (13 )% 

Arizona

     185,100      227,700      (42,600   (19 )% 

Nevada

     222,600      268,900      (46,300   (17 )% 
                        

Total

   $ 277,500    $ 371,800    $ (94,300   (25 )% 
                        

 

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The average sales price of homes closed during the year ending December 31, 2009 decreased in each segment due to increased levels of sales incentives in response to lower demand for new homes and a change in product mix.

 

     Year Ended
December 31,
    Increase
(Decrease)
 
     2009     2008    

Homebuilding Gross Margin (Loss) Percentage

      

Southern California

   15.6   7.5   8.1

Northern California

   13.8   (2.6 )%    16.4

Arizona

   7.0   12.7   (5.7 )% 

Nevada

   12.2   7.0   5.2
                  

Total

   13.5   6.2   7.3
                  

Homebuilding gross margin (loss) percentage during the year ended December 31, 2009 increased to 13.5% from 6.2% during the year ended December 31, 2008 which is primarily attributable to home closings in projects where previous impairment losses had been incurred, which reduced each project’s land basis and by a decrease in the average cost per home closed of 31% from $348,600 in the 2008 period to $239,900 in the 2009 period offset by a decrease in the average sales price of homes closed of 25% from $371,800 in the 2008 period to $277,500 in the 2009 period.

Homebuilding gross margins may be negatively impacted by a weak economic environment, which includes homebuyers’ reluctance to purchase new homes, increase in foreclosure rates, tightening of mortgage loan origination requirements, high cancellation rates, which could affect our ability to maintain existing home prices and/or home sales incentive levels and continued deterioration in the demand for new homes in our markets, among other things.

Lots, Land and Other

Land sales revenue was $21.2 million during the year ended December 31, 2009, compared with $39.5 million for the year ended December 31, 2008. During 2009 and 2008, in response to the slow-down in the homebuilding industry, the Company entered into certain land sales transactions to improve its liquidity and to reduce its overall debt. On December 24, 2009, the Company consummated the sale of certain real property (comprising approximately 165 acres) in San Bernardino County, California; San Diego County, California; Clark County, Nevada; and Maricopa County, Arizona, for an aggregate sales price of $13.6 million. The aggregate book value of these properties on the closing date as reflected on the consolidated balance sheet of the Company and its subsidiaries was approximately $84.2 million. The Company entered into these land sales transactions to generate cash flow, to reduce overall debt and to re-invest the cash by purchasing land in certain of its improving markets. The Company determined that the best economic value to the Company of these lots was to sell them in their current condition as opposed to holding the lots and eventually building and selling homes. The Company continues to evaluate its options and the marketplace with respect to developing lots.

During the years ended December 31, 2009 and 2008, the Company recorded gross loss related to land sales of $(110.4) million and $(8.1) million, respectively. Included in these amounts are the write-off of land deposits and pre-acquisition costs of $37.9 million and $6.6 million, respectively, related to future projects which the Company has concluded are not currently economically viable. The write-off of land deposits and pre-acquisition costs of $37.9 million occurred during the first quarter of the year ended December 31, 2009 are attributable to projects held in three of its land banking arrangements. In the fourth quarter of 2009, for one of these land banking arrangements, the Company subsequently purchased the remaining 51 lots for the contracted price after the Company had written off the deposits that would have been included in the land basis of these lots. Management of the Company determined that the remaining purchase prices of the lots in the arrangements were priced above current market values.

Construction Services Revenue

Construction services revenue, which is all recognized in Southern California, was $34.1 million during the year ended December 31, 2009, compared with $18.1 million in the 2008 period. See Note 1 to “Notes to Consolidated Financial Statements” for further discussion.

 

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     Year Ended
December 31,
   Increase
(Decrease)
 
     2009    2008   

Impairment Loss on Real Estate Assets

        

Land under development and homes completed and under construction

        

Southern California

   $ 19,518    $ 39,925    $ (20,407

Northern California

     6,144      24,063      (17,919

Arizona

          1,086      (1,086

Nevada

     6,254      18,100      (11,846
                      

Total

   $ 31,916    $ 83,174    $ (51,258
                      

Land held-for-sale or sold

        

Southern California

   $    $    $   

Northern California

          27,394      (27,394

Arizona

          13,170      (13,170

Nevada

     13,353      11,573      1,780   
                      

Total

     13,353      52,137      (38,784
                      

Total Impairment Loss on Real Estate Assets

   $ 45,269    $ 135,311    $ (90,042
                      

The impairment loss related to land under development and homes completed and under construction incurred during the year ended December 31, 2009, primarily resulted from decreases in home sales prices, due to increased sales incentives, and the continued deterioration in the homebuilding industry. At two of the Company’s projects, impairment loss was primarily attributable to an increase in interest cost allocated to the project related to the addition of the Senior Secured Term Loan at 14% interest. In addition, the Company decreased base sales prices and increased certain incentives related to the projects, which is a strategy to improve sales absorption rates. During the 2009 period, the Company increased the discount rates used in the estimated discounted cash flow assessments to a range of 19% to 27%. These rates resulted from an increase in the leverage component of our discount rate related to the interest cost on the Senior Secured Term Loan (14%) and a decrease in risk-related discount rates in California projects due to improving market conditions, including: (i) a decrease in the cancellation rate in Southern California to 19% in the 2009 period from 30% in the 2008 period, (ii) an increase of 8.1% in the Southern California gross margin percentage and (iii) an increase in the number of net home order per sale location from 30.8 in the 2008 period to 50.0 in the 2009 period.

The impairment loss related to land held-for-sale or sold primarily resulted from significant decreases in the fair market values of new homes being sold, as this has caused corresponding declines in the fair market values of land held by the Company. Also contributing to these impairments was the decision that the best economic value to the Company of these lots was to sell them in their current condition as opposed to holding the lots and eventually building and selling homes. The Company continues to evaluate land values to determine whether to hold for development or to sell at current prices, which may lead to additional impairment on real estate assets.

 

     Year Ended
December 31,
   Increase (Decrease)  
     2009    2008    Amount     %  

Sales and Marketing Expense

          

Homebuilding

          

Southern California

   $ 9,537    $ 23,909    $ (14,372   (60 )% 

Northern California

     3,499      8,742      (5,243   (60 )% 

Arizona

     2,350      3,265      (915   (28 )% 

Nevada

     2,250      4,525      (2,275   (50 )% 
                        

Total

   $ 17,636    $ 40,441    $ (22,805   (56 )% 
                        

Sales and marketing expense decreased $22.8 million to $17.6 million in the 2009 period from $40.4 million in the 2008 period primarily due to (i) a decrease of $3.6 million in sales model operating costs and (ii) a decrease of $9.3 million in advertising, due to the decrease in the average number of sales locations to 25 in the 2009 period from 44 in the 2008 period. In addition, direct selling expenses decreased approximately $9.6 million, including $4.9 million in sales commissions due to

 

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the reduction in units closed and reduction in revenue from home sales in 2009 as compared to 2008, a decrease of $4.0 million in commissions paid to outside brokers in 2009 as compared to 2008, and a decrease of $0.8 million in seller closing costs in 2009 as compared to 2008.

 

     Year Ended
December 31,
   Increase (Decrease)  
     2009    2008    Amount     %  

General and Administrative Expenses

          

Homebuilding

          

Southern California

   $ 3,982    $ 5,694    $ (1,712   (30 )% 

Northern California

     2,317      3,704      (1,387   (37 )% 

Arizona

     2,358      3,672      (1,314   (36 )% 

Nevada

     2,558      2,708      (150   (6 )% 

Corporate

     9,812      11,867      (2,055   (17 )% 
                        

Total

   $ 21,027    $ 27,645    $ (6,618   (24 )% 
                        

General and administrative expenses decreased $6.6 million, or 24%, in the 2009 period to $21.0 million from $27.6 million in the 2008 period primarily as a result of a decrease in salaries and benefits expense of $4.0 million and a $1.3 million decrease in bonus expense. As the number of active projects decline, the Company reduced staffing levels to support operations to 194 full time employees by the end of 2009 from 391 at the end of 2008. The bonus expense incurred in the 2008 and 2009 periods was a decision by management to award bonuses to employees in order to encourage employee retention and reward performance.

Other Items

Other operating costs increased to $6.6 million in the 2009 period compared to $4.5 million in the 2008 period. The increase is due to property tax expense incurred on projects declined in which development is temporarily suspended of $5.4 million in the 2009 period, compared with $2.0 million in the 2008 period. This increase was primarily driven by the increase in the number of projects put on hold as of December 31, 2009. In addition, operating losses realized by golf course operations decreased to $1.2 million in the 2009 period from $1.3 million in the 2008 period.

Equity in loss of unconsolidated joint ventures decreased to $0.4 million in the 2009 period from $3.9 million in the 2008 period, primarily due to (i) an impairment loss on real estate assets of $4.5 million recorded at one of the Company’s joint venture projects, of which $2.25 million was allocated to the Company and to the other member of the joint venture during the 2008 period compared with no impairment recorded during the 2009 period and (ii) a decrease in joint venture activity.

As described previously, during 2009, the Company purchased, $156.9 million principal amount of its outstanding Senior Notes at a cost of $77.0 million, plus accrued interest. The net gain resulting from the purchase, after giving effect to amortization of related deferred loan costs was $78.1 million. In October 2008, the Company purchased, in privately negotiated transactions, $71.9 million principal amount of its outstanding Senior Notes at a cost of $16.7 million, plus accrued interest. The net gain resulting from the purchase, after giving effect to amortization of related deferred loan costs was $54.0 million.

During the year ended December 31, 2009, the Company incurred interest related to its outstanding debt of $48.8 million and capitalized $12.9 million, resulting in net interest expense of $35.9 million. During the year ended December 31, 2008, the Company incurred interest related to its outstanding debt of $66.7 million and capitalized $42.3 million, resulting in net interest expense of $24.4 million. The year over year increase in net interest expense is due to a decrease in real estate assets which qualify for interest capitalization during the 2009 period.

Other loss primarily consists of the loss on the sale of fixed asset of $3.0 million in the 2009 period due to the sale of the Company’s aircraft as described more fully in Note 7 of “Notes to Consolidated Financial Statements”, with no comparable amount in the 2008 period.

The noncontrolling interest in loss of consolidated entities decreased to $0.4 million in the 2009 period compared to $10.4 million in the 2008 period, primarily due to a decrease in the number of joint venture homes closed to 17 in the 2009 period from 64 in 2008. In 2008, the noncontrolling interest in loss was attributable to impairment loss on real estate assets of $23.6 million recorded at two consolidated entities, of which $10.4 million was allocated to the minority member and $13.2 million was allocated to the Company.

 

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Table of Contents
     Year Ended
December 31,
    Increase (Decrease)  
     2009     2008     Amount     %  

(Loss) Income Before Benefit (Provision) for Income Taxes

        

Homebuilding

        

Southern California

   $ (57,716   $ (74,908   $ 17,192      (23 )% 

Northern California

     (37,853     (68,913     31,060      (45 )% 

Arizona

     (21,451     (17,746     (3,605   20

Nevada

     (70,915     (37,265     (33,650   90

Corporate

     65,074        35,256        29,818      58
                          

Total

   $ (122,861   $ (163,676   $ 40,815      25
                          

In Southern California, (loss) income before benefit (provision) for income taxes decreased 23% to $(57.7) million in the 2009 period from $(74.9) million in the 2008 period. The decrease in loss is primarily attributable to (i) a decrease in impairment loss on real estate assets to $19.5 million in the 2009 period, from $39.9 million in the 2008 period, (ii) a decrease in revenues from home sales to $141.9 million in the 2009 period, from $280.6 million in the 2008 period, (iii) loss on land sales of $24.0 million in the 2009 period compared to a loss of $6.1 million in the 2008 period, and (iv) a decrease in sales and marketing expense to $9.5 million in the 2009 period from $23.9 million in the 2008 period.

In Northern California, (loss) income before benefit (provision) for income taxes decreased 45% to $(37.9) million in the 2009 period from $(68.9) million in the 2008 period. The decrease in loss is primarily attributable to (i) a decrease in impairment loss on real estate assets to $6.1 million in the 2009 period from $51.5 million in the 2008 period, (ii) a decrease in revenues from home sales to $43.2 million in the 2009 period from $80.3 million in the 2008 period, and (iii) a decrease in sales and marketing expense to $3.5 million in the 2009 period from $8.7 million in the 2008 period.

In Arizona, (loss) income before benefit (provision) for income taxes increased to a loss of $(21.5) million in the 2009 period from a loss of $(17.8) million in the 2008 period. The change is primarily attributable to the loss on land sales of $14.0 million in the 2009 period compared to $0.8 million in the 2008 period, offset by (i) a decrease in impairment loss on real estate assets from $14.3 million in the 2008 period to zero in the 2009 period, (ii) a decrease in revenues from home sales to $39.6 million in the 2009 period from $49.2 million in the 2008 period and (iii) a decrease in sales and marketing expense to $2.4 million in the 2009 period from $3.3 million in the 2008 period.

In Nevada, (loss) income before benefit (provision) for income taxes increased 90% to $(70.9) million in the 2009 period from $(37.3) million in the 2008 period. The increase in loss is primarily attributable to (i) a loss on land sales of $43.0 million in the 2009 period with no comparable loss in the 2008 period, (ii) a decrease in impairment loss on real estate assets to $19.6 million in the 2009 period from $29.7 million in the 2008 period, (iii) a decrease in revenues from home sales to $29.2 million in the 2009 period from $58.4 million in the 2008 period and (iv) a decrease in sales and marketing expense to $2.3 million in the 2009 period from $4.5 million in the 2008 period.

The Corporate segment is a non-homebuilding segment where the Company develops and implements strategic initiatives and supports the Company’s operating divisions by centralizing key administrative functions such as finance and treasury, information technology, tax planning, internal audit, risk management and litigation and human resources. The Company records the gain from retirement of senior notes and income tax provisions and benefits at the corporate level.

Income Taxes

On November 6, 2009, an expanded carry back election was signed into law as part of the Worker, Homeownership, and Business Assistance Act of 2009. As a result of this legislation, the Company elected to carry back for five years the taxable losses generated in 2009. The Company recorded a deferred tax asset and related income tax benefit of $101.8 million. The recorded deferred tax asset reflects the anticipated tax refund for the carry back of the estimated 2009 tax loss to 2004 and 2005. As of December 31, 2009, the deferred tax asset was reclassified to income tax refunds receivable and the tax benefit was recorded as benefit from provision for income taxes in the accompanying consolidated balance sheet and statement of operations.

Net Loss

As a result of the foregoing factors, net loss for the year ended December 31, 2009 was $20.5 million compared to net loss for the year ended December 31, 2008 of $111.6 million.

 

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     December 31,    Increase (Decrease)  
     2009    2008    Amount     %  

Lots Owned and Controlled

          

Lots Owned

          

Southern California

   1,139    1,607    (468   (29 )% 

Northern California

   478    1,166    (688   (59 )% 

Arizona

   4,985    5,993    (1,008   (17 )% 

Nevada

   2,522    2,839    (317   (11 )% 
                  

Total

   9,124    11,605    (2,481   (21 )% 
                  

Lots Controlled(1)

          

Southern California

   439    406    33      8

Arizona

   767    321    446      139
                  

Total

   1,206    727    479      66
                  

Total Lots Owned and Controlled

   10,330    12,332    (2,002   (16 )% 
                  

 

(1)

Lots controlled may be purchased by the Company as consolidated projects or may be purchased by newly formed unconsolidated joint ventures.

Total lots owned and controlled has decreased 16% from 12,332 lots owned and controlled at December 31, 2008 to 10,330 lots at December 31, 2009. The decrease is primarily due to the closing of 915 homes during the 2009 period and the strategic sale of land in California during the period, offset by certain lot acquisitions during the period.

Comparisons of Years Ended December 31, 2008 and 2007

On a combined basis, the number of net new home orders for the year ended December 31, 2008 decreased 34% to 1,221 homes from 1,855 homes for the year ended December 31, 2007. The number of homes closed on a combined basis for the year ended December 31, 2008 decreased 42% to 1,260 homes from 2,182 homes for the year ended December 31, 2007. The cancellation rate of buyers who contracted to buy a home but did not close escrow at the Company’s projects was approximately 28% during 2008 and 33% during 2007. The inventory of completed and unsold homes was 80 homes as of December 31, 2008.

On a combined basis, the backlog of homes sold but not closed as of December 31, 2008 was 240 homes, down 14% from 279 homes as of December 31, 2007. Homes in backlog are generally closed within three to six months. The dollar amount of backlog of homes sold but not closed on a combined basis as of December 31, 2008 was $80.8 million, down 25% from $107.9 million as of December 31, 2007.

The Company’s average number of sales locations decreased to 44 for the year ended December 31, 2008, compared to 57 for the year ended December 31, 2007. The Company’s number of new home orders per average sales location decreased from 32.5 for the year ended December 31, 2007 to 27.8 for the year ended December 31, 2008.

 

     Year Ended
December 31,
    Increase (Decrease)  
     2008     2007     Amount     %  

Number of Net New Home Orders

        

Southern California

   586      1,069      (483   (45 %) 

Northern California

   238      256      (18   (7 %) 

Arizona

   183      296      (113   (38 %) 

Nevada

   214      234      (20   (9 %) 
                    

Total

   1,221      1,855      (634   (34 %) 
                    

Cancellation Rate

   28   33   (5 )%   
                    

Each of the Company’s homebuilding segments experienced declines in net new home orders during the year ended December 31, 2008 and most notably in Southern California and Arizona. Net new home orders during the year ended December 31, 2008 in each of the Company’s segments were negatively impacted by the unstable economic conditions and continued down-turn in the homebuilding industry in the 2008 period. Net new home orders during the twelve months ended December 31, 2008 decreased 34% on a consolidated basis, mostly due to the decline in housing demand as discussed previously.

 

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Cancellation rates during the year ended December 31, 2008 decreased to 28% in the 2008 period from 33% during the 2007 period. The decline resulted from a decrease in the cancellation rate in Southern California to 30% in the 2008 period from 31% in the 2007 period, in Northern California to 29% in the 2008 period from 38% in the 2007 period, in Arizona to 22% in the 2008 period from 33% in the 2007 period and in Nevada to 28% in the 2008 period from 33% in the 2007 period. Although the cancellation rates declined in each operating segment, the rates continue to reflect the impact of the uncertain economic conditions and the lack of homebuyer confidence is consistent in all markets.

 

     Year Ended
December 31,
   Increase (Decrease)  
     2008    2007    Amount     %  

Average Number of Sales Locations

          

Southern California

   19    29    (10   (34 )% 

Northern California

   10    13    (3   (23 )% 

Arizona

   4    5    (1   (20 )% 

Nevada

   11    10    1      10
                  

Total

   44    57    (13   (23 )% 
                  

The average number of sales locations decreased in each homebuilding segment during the year ended December 31, 2008, primarily due to (i) management’s on-going efforts to manage cash outflows through, among other things, limiting the purchase of new lots, (ii) temporarily suspending the development of thirteen projects throughout the Company and (iii) the close-out of projects.

 

     December 31,    Increase (Decrease)  
     2008    2007    Amount     %  

Backlog (units)

          

Southern California

   134    142    (8   (6 )% 

Northern California

   48    43    5      12

Arizona

   34    67    (33   (49 )% 

Nevada

   24    27    (3   (11 )% 
                  

Total

   240    279    (39   (14 )% 
                  

The Company’s backlog at December 31, 2008 decreased 14% from levels at December 31, 2007, primarily resulting from a deterioration in demand for new homes. The decrease in backlog during this period reflects a decrease in net new order activity of 34% to 1,221 homes in the 2008 period compared to 1,855 homes in the 2007 period and a decrease in number of homes closed by 42% to 1,260 in the 2008 period from 2,182 in the 2007 period.

 

     December 31,    Increase (Decrease)  
     2008    2007    Amount     %  

Backlog (dollars)

          

Southern California

   $ 55,065    $ 71,792    $ (16,727   (23 )% 

Northern California

     13,669      13,674      (5  

Arizona

     6,177      15,627      (9,450   (61 )% 

Nevada

     5,839      6,800      (961   (14 )% 
                        

Total

   $ 80,750    $ 107,893    $ (27,143   (25 )% 
                        

The dollar amount of backlog of homes sold but not closed on a combined basis as of December 31, 2008 was $80.8 million, down 25% from $107.9 million as of December 31, 2007. The significant decrease in backlog during this period reflects a decrease in net new order activity of 34% to 1,221 homes in the 2008 period compared to 1,855 homes in the 2007 period. In addition, the dollar amount of backlog is affected by recent average sales prices for new home orders, and the Company experienced a decrease of 13% in the average sales price of homes in backlog to $336,500 as of December 31, 2008 compared to $386,700 as of December 31, 2007. An increase in the Company’s cancellation rates generally has an adverse effect on the Company’s backlog.

 

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In Southern California, the dollar amount of backlog decreased 23% to $55.1 million as of December 31, 2008 from $71.8 million as of December 31, 2007, which is attributable to a decrease of 45% in net new home orders in Southern California to 586 homes in the 2008 period compared to 1,069 homes in the 2007 period, and a decrease of 19% in the average sales price of homes in backlog to $410,900 as of December 31, 2008 compared to $505,600 as of December 31, 2007. In Southern California, the cancellation rate decreased to 30% for the period ended December 31, 2008 from 31% for the period ended December 31, 2007.

In Northern California, the dollar amount of backlog was unchanged at $13.7 million as of December 31, 2008 and $13.7 million as of December 31, 2007, which is attributable to a (i) decrease of 7% in net new home orders in Northern California to 238 homes in the 2008 period compared to 256 homes in the 2007 period, (ii) a decrease of 10% in the average sales price of homes in backlog to $284,800 as of December 31, 2008 compared to $318,000 as of December 31, 2007 and (iii) an increase in homes in backlog to 48 homes at December 31, 2008 from 43 homes at December 31, 2007. In Northern California the cancellation rate decreased to 29% for the period ended December 31, 2008 from 38% for the period ended December 31, 2007.

In Arizona, the dollar amount of backlog decreased 61% to $6.2 million as of December 31, 2008 from $15.6 million as of December 31, 2007, which is attributable to a decrease of 38% in net new home orders in Arizona to 183 homes in the 2008 period compared to 296 homes in the 2007 period, and a decrease of 22% in the average sales price of homes in backlog to $181,700 as of December 31, 2008 compared to $233,200 as of December 31, 2007. In Arizona, the cancellation rate decreased to 22% for the period ended December 31, 2008 from 33% for the period ended December 31, 2007.

In Nevada, the dollar amount of backlog decreased 14% to $5.8 million as of December 31, 2008 from $6.8 million as of December 31, 2007, which is attributable to a decrease of 9% in net new home orders in Nevada to 214 homes in the 2008 period compared to 234 homes in the 2007 period, and a decrease of 3% in the average sales price of homes in backlog to $243,300 as of December 31, 2008 compared to $251,900 as of December 31, 2007. In Nevada, the cancellation rate decreased to 28% for the period ended December 31, 2008 from 33% for the period ended December 31, 2007.

The decrease in the dollar amount of backlog of homes sold but not closed as described above generally results in a reduction in operating revenues in the subsequent period as compared to the previous period. Revenue from sales of homes decreased 53% to $468.5 million during the period ended December 31, 2008 from $1.002 billion during the period ended December 31, 2007. A decrease in homebuilding revenues on a project basis is a potential indicator for impairment. If current market prices and home values continue to decrease and cancellation rates increase in the future, the Company’s revenue and liquidity would likely be negatively impacted, and the Company may be required to assess its homebuilding assets for further impairment.

 

     Year Ended
December 31,
   Increase (Decrease)  
     2008    2007    Amount     %  

Number of Homes Closed

          

Southern California

   594    1,242    (648   (52 )% 

Northern California

   233    253    (20   (8 )% 

Arizona

   216    420    (204   (49 )% 

Nevada

   217    267    (50   (19 )% 
                  

Total

   1,260    2,182    (922   (42 )% 
                  

During the year ended December 31, 2008, the number of homes closed decreased 42%, with the largest decrease in the Southern California and Arizona segments. The number of homes closed during the year was impacted by the uncertain economic conditions and continued down-turn in the homebuilding industry.

 

     Year Ended
December 31,
   Increase (Decrease)  
     2008    2007    Amount     %  

Home Sales Revenue

          

Southern California

   $ 280,611    $ 696,655    $ (416,044   (60 )% 

Northern California

     80,292      102,432      (22,140   (22 )% 

Arizona

     49,188      114,903      (65,715   (57 )% 

Nevada

     58,361      88,559      (30,198   (34 )% 
                        

Total

   $ 468,452    $ 1,002,549    $ (534,097   (53 )% 
                        

 

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The decrease in homebuilding revenue of 53% to $468.5 million during the year ended December 31, 2008 from $1.002 billion during the year ended December 31, 2007 is primarily attributable to a decrease in the number of homes closed to 1,260 during the 2008 period from 2,182 during the 2007 period and a decrease in the average sales price of homes closed to $371,800 during the 2008 period from $459,500 during the 2007 period.

 

     Year Ended
December 31,
   Increase (Decrease)  
     2008    2007    Amount     %  

Average Sales Price of Homes Closed

          

Southern California

   $ 472,400    $ 560,900    $ (88,500   (16 )% 

Northern California

     344,600      404,900      (60,300   (15 )% 

Arizona

     227,700      273,600      (45,900   (17 )% 

Nevada

     268,900      331,700      (62,800   (19 )% 
                        

Total

   $ 371,800    $ 459,500    $ (87,700   (19 )% 
                        

The average sales price of homes closed during the year ending December 31, 2008 decreased in each segment due to increased levels of sales incentives in response to lower demand for new homes, increased levels of competition, and increased home foreclosure levels.

 

     Year Ended
December 31,
    Increase
(Decrease)
 
     2008     2007    

Homebuilding Gross Margin Percentage

      

Southern California

   7.5   11.5   (4.0 )% 

Northern California

   (2.6 )%    11.0   (13.6 )% 

Arizona

   12.7   24.6   (11.9 )% 

Nevada

   7.0   10.6   (3.6 )% 
                  

Total

   6.2   12.9   (6.7 )% 
                  

Homebuilding gross margin percentage during the year ended December 31, 2008 decreased to 6.2% from 12.9% during the year ended December 31, 2007 which is primarily attributable to a decrease in the average sales price of homes closed of 19% from $459,500 in the 2007 period to $371,800 in the 2008 period offset by a 13% decrease in the average cost per home closed to $349,000 in the 2008 period from $400,000 in the 2007 period.

Homebuilding gross margins may be negatively impacted by a weak economic environment, which includes homebuyers’ reluctance to purchase new homes, increase in foreclosure rates, tightening of mortgage loan origination requirements, continued high cancellation rates, which could affect our ability to maintain existing home prices and/or home sales incentive levels and continued deterioration in the demand for new homes in our markets, among other things.

Lots, Land and Other

Land sales revenue was $39.5 million during the year ended December 31, 2008, compared with $102.8 million for the year ended December 31, 2007. During 2007 and 2008, in response to the slow-down in the homebuilding industry, the Company entered into certain land sales transactions to improve its liquidity and to reduce its overall debt. On December 26, 2007 and January 7, 2008, the Company entered into separate agreements with various affiliates of one of its joint venture equity partners (the “Equity Partner Agreements”). Pursuant to the Equity Partner Agreements, the Company agreed to sell to the affiliates 604 residential lots and 5 model homes in 10 communities in Orange County, San Diego County and Ventura County, California for an aggregate purchase price of $90.6 million in cash. The purchase and sale of 404 of the residential lots and the 5 model homes closed on December 27, 2007 (for an aggregate consideration of approximately $65.9 million) and the remainder of the residential lots closed on January 9, 2008. During the years ended December 31, 2008 and 2007, the Company recorded gross (loss) related to land sales of $(8.1) million and $(102.8) million, respectively. Included in these amounts are the write-off of land deposits and pre-acquisition costs of $6.6 million and $19.8 million, respectively, related to future projects which the Company has concluded are not currently economically viable.

Construction Services Revenue

Construction services revenue, which is all recorded in Southern California, was $18.1 million in the 2008 period with no comparable amount in the 2007 period. See Note 1 to “Notes to Consolidated Financial Statements” for further discussion.

 

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Table of Contents
     Year Ended
December 31,
   Increase
(Decrease)
 
     2008    2007   

Impairment Loss on Real Estate Assets

        

Land under development and homes completed and under construction

        

Southern California

   $ 39,925    $ 105,480    $ (65,555

Northern California

     24,063      35,653      (11,590

Arizona

     1,086           1,086   

Nevada

     18,100      43,586      (25,486
                      

Total

   $ 83,174    $ 184,719    $ (101,545
                      

Land Held-for-Sale or Sold

        

Southern California

   $    $ 41,145    $ (41,145

Northern California

     27,394      5,256      22,138   

Arizona

     13,170           13,170   

Nevada

     11,573           11,573   
                      

Total

     52,137      46,401      5,736   
                      

Total Impairment Loss on Real Estate Assets

   $ 135,311    $ 231,120    $ (95,809
                      

The impairment loss related to land under development and homes completed and under construction incurred during the year ended December 31, 2008, primarily resulted from decreases in home sales prices, due to increased sales incentives, and the continued deterioration in the homebuilding industry. In addition, during the 2008 period, the Company increased the discount rates used in the estimated discounted cash flow assessments from a range of 14% to 20% to a range of 17% to 23%. This change resulted from an increase in risks and uncertainties in the homebuilding industry due to the on-going deterioration in the market value of land and homes as well as homebuyer confidence in the economy.

The impairment loss related to land held-for-sale or sold primarily resulted from significant decreases in the fair market values of new homes being sold, as this has caused corresponding declines in the fair market values of land held by the Company. Also contributing to these impairments was the decision that the best economic value to the Company of these lots was to sell them in their current condition as opposed to holding the lots and eventually building and selling homes. The Company continues to evaluate land values to determine whether to hold for development or to sell at current prices, which may lead to additional impairment on real estate assets.

 

     Year Ended
December 31,
   Increase (Decrease)  
     2008    2007    Amount     %  

Sales and Marketing Expenses

          

Homebuilding

          

Southern California

   $ 23,909    $ 40,165    $ (16,256   (40 )% 

Northern California

     8,742      11,650      (2,908   (25 )% 

Arizona

     3,265      8,074      (4,809   (60 )% 

Nevada

     4,525      6,814      (2,289   (34 )% 
                        

Total

   $ 40,441    $ 66,703    $ (26,262   (39 )% 
                        

Sales and marketing expense decreased $26.3 million to $40.4 million in the 2008 period from $66.7 million in the 2007 period primarily due to (i) a decrease of $2.3 million in sales model operating costs and (ii) a decrease of $9.6 million in advertising, due to the decrease in the number of models and a decrease in the average number of sales locations to 44 in the 2008 period from 57 in the 2007 period. In addition, direct selling expenses decreased approximately $14.4 million, including $3.5 million in sales commissions due to the reduction in units closed and reduction in revenue from home sales in 2008 as compared to 2007 and a decrease of $7.9 million in commissions paid to outside brokers in 2008 as compared to 2007.

 

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     Year Ended
December 31,
   Increase (Decrease)  
     2008    2007    Amount     %  

General and Administrative Expenses

          

Homebuilding

          

Southern California

   $ 5,694    $ 8,841    $ (3,147   (36 )% 

Northern California

     3,704      5,677      (1,973   (35 )% 

Arizona

     3,672      4,904      (1,232   (25 )% 

Nevada

     2,708      3,854      (1,146   (30 )% 

Corporate

     11,867      14,196      (2,329   (16 )% 
                        

Total

   $ 27,645    $ 37,472    $ (9,827   (26 )% 
                        

General and administrative expenses decreased $9.8 million, or 26%, in the 2008 period to $27.6 million from $37.5 million in the 2007 period primarily as a result of a decrease in salaries and benefits expense of $11.8 million, offset by an increase in bonus expense of $1.4 million. As the number of active projects and the number of sales orders continues to decline, the Company has reduced staffing levels to support current operations. The bonus expense incurred in the 2008 period was a decision by management to award bonuses to employees in order to encourage employee retention, which was determined on a subjective basis.

Other Items

Other operating costs increased to $4.5 million in the 2008 period compared to $0.9 million in the 2007 period. The increase is due to property tax expense incurred on projects in which development is temporarily suspended of $2.0 million in the 2008 period, with no comparable amount in the 2007 period. In addition, operating losses realized by golf course operations increased to $1.3 million in the 2008 period from $0.9 million in the 2007 period.

Equity in loss of unconsolidated joint ventures increased to $3.9 million in the 2008 period from $0.3 million in the 2007 period, primarily due to an impairment loss on real estate assets of $4.5 million recorded at one of the Company’s joint venture projects, of which $2.25 million was allocated to the Company and to the other member of the joint venture.

Noncontrolling interest in loss (income) of consolidated entities decreased to noncontrolling interest in loss of $10.4 million in the 2008 period compared to noncontrolling interest in income of $(11.1) million in the 2007 period, primarily due to a decrease in the number of joint venture homes closed to 64 in the 2008 period from 219 in 2007. The noncontrolling interest in loss was attributable to impairment loss on real estate assets of $23.6 million recorded at two consolidated entities, of which $10.4 million was allocated to the minority member and $13.2 million was allocated to the Company.

In October 2008, the Company purchased, in privately negotiated transactions, $71.9 million principal amount of its outstanding Senior Notes at a cost of $16.7 million, plus accrued interest. The net gain resulting from the purchase, after giving effect to amortization of related deferred loan costs was $54.0 million.

During the year ended December 31, 2008, the Company incurred interest related to its outstanding debt of $66.7 million and capitalized $42.3 million, resulting in net interest expense of $24.4 million, with no comparable amount in the 2007 period, due to a decrease in real estate assets which qualify for interest capitalization during the 2008 period.

 

     Year Ended
December 31,
    Increase (Decrease)  
     2008     2007     Amount     %  

(Loss) Income Before Benefit (Provision) for Income Taxes

        

Homebuilding

        

Southern California

   $ (74,908   $ (212,597   $ 137,689      65

Northern California

     (68,913     (51,418     (17,495   (34 )% 

Arizona

     (17,846     21,158        (39,004   (184 )% 

Nevada

     (37,265     (45,918     8,653      19

Corporate

     35,256        (16,849     52,105      309
                          

Total

   $ (163,676   $ (305,624   $ 141,948      46
                          

 

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In Southern California, (loss) income before benefit (provision) for income taxes decreased 65% to $(74.9) million in the 2008 period from $(212.6) million in the 2007 period. The decrease in loss is primarily attributable to (i) a decrease in impairment loss on real estate assets to $39.9 million in the 2008 period, from $146.6 million in the 2007 period, (ii) a decrease in revenues from home sales to $280.6 million in the 2008 period, from $696.7 million in the 2007 period, (iii) a decrease in sales and marketing expense to $23.9 million in the 2008 period from $40.2 million in the 2007 period and (iv) a decrease in general and administrative expenses to $5.7 million in the 2008 period from $8.8 million in the 2007 period.

In Northern California, (loss) income before benefit (provision) for income taxes increased 34% to $(68.9) million in the 2008 period from $(51.4) million in the 2007 period. The increase in loss is primarily attributable to (i) an increase in impairment loss on real estate assets to $51.5 million in the 2008 period from $40.9 million in the 2007 period, (ii) a decrease in revenues from home sales to $80.3 million in the 2008 period from $102.4 million in the 2007 period, (iii) a decrease in sales and marketing expense to $8.7 million in the 2008 period from $11.7 million in the 2007 period and (iv) a decrease in general and administrative expenses to $3.7 million in the 2008 period from $5.7 million in the 2007 period.

In Arizona, (loss) income before benefit (provision) for income taxes decreased to a loss of $(17.8) million in the 2008 period from income of $21.2 million in the 2007 period. The change is primarily attributable to (i) an increase in impairment loss on real estate assets to $14.3 million in the 2008 period with no comparable amount in the 2007 period, (ii) a decrease in revenues from home sales to $49.2 million in the 2008 period from $114.9 million in the 2007 period, offset by (i) a decrease in sales and marketing expense to $3.3 million in the 2008 period from $8.1 million in the 2007 period, and (ii) a 25% decrease in general and administrative expense to $3.7 million in the 2008 period compared to $4.9 million in the 2007 period.

In Nevada, (loss) income before benefit (provision) for income taxes decreased 19% to $(37.3) million in the 2008 period from $(45.9) million in the 2007 period. The decrease in loss is primarily attributable to (i) a decrease in impairment loss on real estate assets to $29.7 million in the 2008 period from $43.6 million in the 2007 period, (ii) a decrease in revenues from home sales to $58.4 million in the 2008 period from $88.6 million in the 2007 period, (iii) a decrease in sales and marketing expense to $4.5 million in the 2008 period from $6.8 million in the 2007 period and (iv) a decrease in general and administrative expense to $2.7 million in the 2008 period from $3.9 million in the 2007 period.

Income Taxes

Effective January 1, 2008, the Company and its shareholders made a revocation of the “S” corporation election. As a result of this revocation, the Company will be taxed as a “C” corporation. The shareholders will not be able to elect “S” corporation status for at least five years. The revocation of the “S” corporation election will allow taxable losses generated in 2008 to be carried back to the 2006 “C” corporation year. As a result of the change in tax status, the Company recorded a deferred tax asset and related income tax benefit of $41.6 million as of January 1, 2008. The recorded deferred tax asset reflects the anticipated tax refund for the carry back of the estimated 2008 tax loss to 2006. In January 2009, the Company received a tax refund for the amount of the deferred tax asset and related tax benefit. As of and during the year ended December 31, 2008, the deferred tax asset was reclassified to income tax refunds receivable and the tax benefit was recorded as benefit from provision for income taxes in the accompanying consolidated balance sheet and statement of operations.

Effective January 1, 2007, the Company made an election in accordance with federal and state regulations to be taxed as an “S” corporation rather than a “C” corporation. Under this election, the Company’s taxable income flows through to and is reported on the personal tax returns of its shareholders. The shareholders are responsible for paying the appropriate taxes based on this election. The Company does not pay any federal taxes under this election and is only required to pay certain state taxes based on a rate of approximately 1.5% of taxable income. As a result of this election, the Company’s provision for income taxes for the year ended December 31, 2007 includes a reduction of deferred tax assets of $31.9 million due to the elimination of any future tax benefit by the Company from such assets. In addition, the provision reflects a valuation allowance of $0.8 million.

Net Loss

As a result of the foregoing factors, net loss for the year ended December 31, 2008 was $111.6 million compared to net loss for the year ended December 31, 2007 of $349.4 million.

 

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     December 31,    Increase (Decrease)  
     2008    2007    Amount     %  

Lots Owned and Controlled

          

Lots Owned

          

Southern California

   1,607    2,579    (972   (38 )% 

Northern California

   1,166    1,763    (597   (34 )% 

Arizona

   5,993    6,226    (233   (4 )% 

Nevada

   2,839    3,056    (217   (7 )% 
                  

Total

   11,605    13,624    (2,019   (15 )% 
                  

Lots Controlled(1)

          

Southern California

   406    534    (128   (24 )% 

Arizona

   321    303    18      6
                  

Total

   727    837    (110   (13 )% 
                  

Total Lots Owned and Controlled

   12,332    14,461    (2,129   (15 )% 
                  

 

(1)

Lots controlled may be purchased by the Company as consolidated projects or may be purchased by newly formed unconsolidated joint ventures.

Total lots owned and controlled has decreased 15% from 14,461 lots owned and controlled at December 31, 2007 to 12,332 lots at December 31, 2008. The decrease is primarily due to the closing of 1,260 homes during the 2008 period and the strategic sale of land in California during the period, offset by certain lot acquisitions during the period. The Company has implemented a strategy to limit the number of new land acquisitions due to the uncertainty regarding future demand for new homes.

Financial Condition and Liquidity

The Company provides for its ongoing cash requirements principally from internally generated funds from the sales of real estate, outside borrowings and by forming new joint ventures with venture partners that provide a substantial portion of the capital required for certain projects. The Company currently has outstanding a 14% Senior Secured Term Loan due 2014, 7 5/8% Senior Notes due 2012, 10 3/4% Senior Notes due 2013 and 7 1 /2% Senior Notes due 2014. The Company has financed, and may in the future finance, certain projects and land acquisitions with construction loans secured by real estate inventories, seller provided financing and land banking transactions. The Company believes that its cash on hand, income tax refund received in 2010, and anticipated net cash flows from operations are and will be sufficient to meet its current and reasonably anticipated liquidity needs on both a near-term and long-term basis (and in any event for the next twelve months) for funds to build homes and run its day-to-day operations.

Beginning in 2006 and continuing into the beginning of 2009, the homebuilding industry has experienced decreased demand for housing and declining sales prices. These conditions were the result of an erosion of homebuyer confidence which was driven by increases in unemployment, limited availability of mortgage financing due to stress in the mortgage and credit markets, price instability, increasing foreclosures and increased levels of housing inventory in the market. In certain of the Company’s markets, however, the Company has experienced steadying sales absorption rates, a decrease in sales incentives and an increase in base pricing, while homebuilding costs continue to decrease. In Southern California, net new home orders per average sales location increased to 50.0 during the year ended December 31, 2009 from 30.8 for the same period in 2008. In Arizona, net new home orders per average sales location increased to 49.3 during the year ended December 31, 2009 from 45.8 for the same period in 2008. In addition, the Company’s cancellation rate decreased to 21% in the 2009 period compared to 28% in the 2008 period, particularly impacted by Southern California of 19% in the 2009 period compared to 30% in the 2008 period and Arizona of 13% in the 2009 period compared to 22% in the 2008 period. In addition, the Company is experiencing increased homebuilding gross margin percentages of 13.5% in the 2009 period compared to 6.2% in the 2008 period particularly impacted by Southern California of 15.6% in the 2009 period compared to 7.5% in the 2008 period and Northern California of 13.8% in the 2009 period compared to (2.6)% in the 2008 period.

In response to the declining demand for housing in the homebuilding industry, and the resulting decrease in homebuilding revenues of 46% from the year ended December 31, 2008 to the year ended December 31, 2009, the management of the Company shifted its strategy to focus on generating positive cash flow, reducing overall debt levels and improving liquidity. The management of the Company intends to manage cash flow by reducing inventory levels and expenditures for temporarily suspended projects. For the year ended December 31, 2009, the Company generated $12.9 million of cash flows from operations and repaid a net $74.3 million of notes payable. In addition, the Company repurchased $156.9 million of principal outstanding Senior Notes for a net purchase price of $77.0 million, plus accrued interest. The net gain resulting from the purchase, after giving effect to amortization of related deferred loan costs was $78.1 million. This repurchase will reduce future interest payments by approximately $13.4 million per year.

 

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Further, the Company received a federal income tax refund of approximately $41.6 million in January 2009 as a result of the carryback of estimated 2008 tax losses to 2006. Then on November 6, 2009, Congress enacted legislation that allows net operating losses realized in either tax year 2008 or 2009 to be carried back up to five years. Based upon this new legislation, the Company has recorded a federal income tax refund of approximately $101.9 million.

As discussed more fully below, in October 2009, the Company entered into a Senior Secured Term Loan in the amount of $206.0 million of which $131.0 million funded on October 20, 2009 and an additional $75.0 million was received on December 24, 2009. The Company used a portion of the net proceeds to fully repay the outstanding balances on its Revolving Credit Facilities during the fourth quarter of 2009. As of December 31, 2009, the Revolving Credit Facilities have been retired and there are no available borrowings on the Company’s Revolving Credit Facilities.

There is no assurance, however, that future cash flows will be sufficient to meet the Company’s future capital needs. The amount and types of indebtedness that the Company may incur may be limited by the terms of the indentures and credit or other agreements governing the Company’s senior note obligations, senior secured term loan and other indebtedness.

In 2008, the Company suspended development, sales and marketing activities at certain of its projects which are in the early stages of development. The Company has concluded that this strategy was necessary under the prevailing market conditions and believes that it will allow the Company to market the properties at some future time when market conditions may have improved. As markets continue to improve, management continues to evaluate and analyze the market place to potentially activate temporarily suspended projects in 2010 and beyond.

The ability of the Company to meet its obligations on its indebtedness will depend to a large degree on its future performance which in turn will be subject, in part, to factors beyond its control, such as prevailing economic conditions, either nationally or in regions in which the Company operates, the outbreak of war or other hostilities involving the United States, mortgage and other interest rates, changes in prices of homebuilding materials, weather, the occurrence of events such as landslides, soil subsidence and earthquakes that are uninsurable, not economically insurable or not subject to effective indemnification agreements, availability of labor and homebuilding materials, changes in governmental laws and regulations, the timing of receipt of regulatory approvals and the opening of projects, and the availability and cost of land for future development. The Company cannot be certain that its cash flow will be sufficient to allow it to pay principal and interest on its debt, support its operations and meet its other obligations. If the Company is not able to meet those obligations, it may be required to refinance all or part of its existing debt, sell assets or borrow more money. The Company may not be able to do so on terms acceptable to it, if at all. In addition, the terms of existing or future indentures and credit or other agreements governing the Company’s Senior Note obligations, revolving credit facilities and other indebtedness may restrict the Company from pursuing any of these alternatives.

Senior Secured Term Loan

William Lyon Homes, Inc., a California corporation (“California Lyon”) and wholly-owned subsidiary of William Lyon Homes is a party to a Senior Secured Term Loan Agreement (the “Term Loan Agreement”), dated October 20, 2009, with COLFIN WLH Funding, LLC, as Administrative Agent (“Admin Agent”), COLFIN WLH Funding, LLC, as Initial Lender and Lead Arranger (“COLFIN”) and the other Lenders who may become assignees of COLFIN (collectively, with COLFIN, the “Lenders”).

The Term Loan Agreement provides for a first lien secured loan of $206.0 million (the “Term Loan”), secured by substantially all of the assets of California Lyon, the Company (excluding stock in California Lyon) and certain wholly-owned subsidiaries. The Term Loan is guaranteed by the Company.

California Lyon received the first installment of $131.0 million, which funded in October 2009, and its second installment of $75.0 million, which funded in December 2009. Under the Term Loan Agreement, California Lyon will be restricted from future borrowings, and, if necessary, will be required to repay existing borrowings, in order to maintain required loan to value ratios such that: (i) the aggregate amount of outstanding loans under the Term Loan Agreement may not exceed 60% of the aggregate value of the properties securing the facility, with valuation based on the lower of appraised value (if any) and discounted net present value of the cash flows, and (ii) the aggregate amount of secured debt may not exceed 60% of the aggregate value of the properties owned by California Lyon and its subsidiaries, with valuation based on the lower of appraised value (if any) and discounted net present value of the cash flows and the second installment. California Lyon is currently in compliance with the above requirements following each drawdown. The net proceeds to the Company

 

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from the first installment of the Term Loan, after giving effect to attorney fees, loan fees and other miscellaneous costs associated with the loan transaction, and repayment of the revolving credit facilities and purchase of the Senior Notes as described in Note 6 to “Notes to Consolidated Financial Statements”, was $34.6 million. A portion of the $75.0 million proceeds from the second installment were used to fund additional land acquisitions in 2009 and 2010.

The Term Loan bears interest at a rate of 14.0%. However, California Lyon has also agreed that, upon any repayment of any portion of the principal amount under the Term Loan (whether or not at maturity), California Lyon will also pay an exit fee equal to the difference (if positive) between (x) the interest that would have been accrued and been then payable on the repaid portion if the interest rate under the Term Loan Agreement were 15.625% and (y) the internal rate of return realized by the Lenders on such repaid portion, taking into account all cash amounts actually received by the Lenders with respect thereto other than any make whole payments described below.

Based on the current outstanding balance of the Term Loan, interest payments are $28.8 million annually.

On any voluntary prepayment of any portion of the Term Loan, California Lyon will be required to make a “make whole payment” equal to an amount, if positive, of the present value of all future payments of interest which would become due with respect to such prepaid amount from the date of prepayment thereof through and including the maturity date, discounted at a rate of 14%.

The Term Loan will mature on October 20, 2014; however, in the event that any portion of the outstanding principal amounts (the “Repaid Senior Note Principal”) of the Senior Notes is repaid (whether or not at maturity), the Lenders may elect to require California Lyon to repay that portion of the outstanding loan as bears the same ratio to the entire Term Loan outstanding as the Repaid Senior Note Principal bears to the entire amounts then outstanding under all of the indentures. All or a portion of the Term Loan may also be accelerated upon certain other events described in the Term Loan Agreement. The lenders waived the requirement for such repayment in connection with the Senior Note repurchases described above.

The Term Loan Agreement requires the Company to maintain a Minimum Tangible Net Worth (as defined therein) of at least $75.0 million. The Term Loan Agreement also contains covenants that limit the ability of California Lyon and the Company to, without prior approval from Lenders, among other things: (i) incur liens; (ii) incur additional indebtedness; (iii) transfer or dispose of assets; (iv) merge, consolidate or alter their line of business; (v) guarantee obligations; (vi) engage in affiliated party transactions; (vii) declare or pay dividends or make other distributions or repurchase stock; (viii) make advances, loans or investments; (ix) repurchase debt (including under the Senior Note indentures) and (x) engage in change of control transactions.

The Term Loan Agreement contains customary events of default, including, without limitation, failure to pay when due amounts in respect of the loan or otherwise under the Term Loan Agreement; failure to comply with certain agreements or covenants contained in the Term Loan Agreement for a period of 10 days (or, in some cases, 30 days) after the administrative agent’s notice of such non-compliance; acceleration of more than $10.0 million of certain other indebtedness; and certain insolvency and bankruptcy events.

Under the Senior Secured Term Loan, the Company is required to comply with a number of covenants, the most restrictive of which require Delaware Lyon to maintain:

 

 

 

A tangible net worth, as defined, of at least $75.0 million;

 

 

 

A minimum borrowing base such that the indebtedness under the Term Loan does not exceed 60% of the Borrowing Base, with the “Borrowing Base” being calculated as (1) the discounted cash flows of each project securing the loan (collateral value), plus (2) restricted cash and (3) escrow proceeds receivable, as defined;

 

 

 

Total secured indebtedness (including the indebtedness under the Term Loan and under all other Construction Notes payable) less than or equal to the Maximum Permitted Secured Indebtedness under the Term Loan Agreement (which is generally 60% of the total secured debt collateral value as calculated under the Term Loan Agreement, which value generally does not include cash assets); and

 

 

 

Excluded Assets of no more than $25.0 Million, with “Excluded Assets” being defined generally as the sum total of certain deposit accounts, payroll accounts, unrestricted cash accounts, and the Company’s total investment in joint ventures.

 

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The Company’s covenant compliance for the Term Loan at December 31, 2009 is detailed in the table set forth below (dollars in millions):

 

Covenant and Other Requirements

   Actual at
December 31,
2009
    Covenant
Requirements at
December 31,
2009

Tangible Net Worth (1)

   $ 143.3      > $75.0

Ratio of Term Loan to Borrowing Base

     47.5   < 60%  

Secured Indebtedness (as a percentage of collateral value) (2)

     71.8   < 60%  

Excluded Assets (3)

   $ 25.3      < $25.0

 

(1)

Tangible Net Worth was calculated based on the stated amount of equity less intangible assets of $14.9 million as of December 31, 2009.

 

(2)

The Company did not meet this covenant requirement at December 31, 2009, due to the land sales that occurred in December 2009, since the proceeds had not been reapplied to eligible collateral by that date. The Company received prior approval from the lender to enter into the land sale transactions, whereby both the lender and the Company were aware of the collateral value that would be lost by selling the underlying assets. The terms of the Secured Term Loan Agreement include a “Notice of Default” provision whereby the Company is not in Default until the lender notifies the Company of an event of default. The lender has confirmed that it will not serve the Company a Notice of Default. The Company expects this calculation to be less than 60% by March 31, 2010.

 

(3)

The terms of the Secured Term Loan Agreement include a 30-day period to allow the Company to cure items of possible default. This calculation has been cured as of January 30, 2010, by reducing the balance in one of the unrestricted cash accounts.

As of and for the year ending December 31, 2009, the Company is not in default with the covenants under this loan.

If market conditions deteriorate, the financial covenants contained in the Company’s Term Loan will continue to be negatively impacted. Under these circumstances, the lenders under the Term Loan would need to provide the Company with additional covenant relief if the Company is to avoid future noncompliance with these financial covenants. If the Company is unable to obtain requested covenant relief or is unable to obtain a waiver for any covenant non-compliance, the Company’s obligation to repay indebtedness under the Term Loan and the Senior Notes could be accelerated. The Company can give no assurance that in such an event, the Company would have, or be able to obtain, sufficient funds to pay all debt that the Company would be required to repay.

Senior Notes

October 2009 Senior Note Repurchases

On October 23, 2009, California Lyon repurchased, in a privately negotiated transaction using the proceeds of the initial installment under the Loan Agreement, (i) $23.3 million principal amount of its outstanding 10 3/4% Senior Notes at a cost of $16.3 million plus accrued interest, (ii) $31.6 million principal amount of its outstanding 7 5/8% Senior Notes at a cost of $22.1 million plus accrued interest, and (iii) $17.6 million principal amount of its outstanding 7 1/2% Senior Notes at a cost of $12.3 million plus accrued interest. The Lenders have permitted this repurchase and have waived their right to require any prepayment of the Term Loan in connection therewith. The net gain resulting from these purchases, after giving effect to amortization of related deferred loan costs and other fees, was approximately $20.5 million.

After giving effect to these Senior Note repurchases, in addition to all prior Senior Note repurchases, California Lyon now has the following principal amounts of Senior Notes outstanding (in thousands):

 

     December 31,
2009

7 5/8% Senior Notes due December 15, 2012

   $ 67,204

10 3/4% Senior Notes due April 1, 2013

     168,158

7 1/2% Senior Notes due February 15, 2014

     84,701
      
   $ 320,063
      

7 5/8% Senior Notes

On November 22, 2004, California Lyon issued $150.0 million principal amount of 7 5/8% Senior Notes due 2012 (the “7 5/8% Senior Notes”), resulting in net proceeds to the Company of approximately $148.5 million. Of the initial $150.0 million, $67.2 million in aggregate principal amount remained as of December 31, 2009 and the date hereof.

 

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Interest on the 7 5/8% Senior Notes is payable semi-annually on December 15 and June 15 of each year. Based on the current outstanding principal amount of the 7 5/8% Senior Notes, the Company’s semi-annual interest payments are $2.6 million.

The 7 5/8% Senior Notes are redeemable at the option of California Lyon, in whole or in part, at a redemption price equal to 100% of the principal amount plus a premium declining ratably to par, plus accrued and unpaid interest, if any.

10 3/4% Senior Notes

On March 17, 2003 California Lyon issued $250.0 million of 10 3/4% Senior Notes due 2013 (the “10 3/4% Senior Notes”) at a price of 98.493% to the public, resulting in net proceeds to the Company of approximately $246.2 million. The purchase price reflected a discount to yield 11% under the effective interest method and the notes have been reflected net of the unamortized discount in the consolidated balance sheet. Of the initial $250.0 million, $168.2 million aggregate principal amount remained outstanding as of December 31, 2009 and the date hereof.

Interest on the 10 3/4% Senior Notes is payable on April 1 and October 1 of each year. Based on the current outstanding principal amount of the 10 3/4% Senior Notes, the Company’s semi-annual interest payments are $9.0 million.

The 10 3/4% Senior Notes are redeemable at the option of California Lyon, in whole or in part, at a redemption price equal to 100% of the principal amount plus a premium declining ratably to par, plus accrued and unpaid interest, if any.

7 1/2% Senior Notes

On February 6, 2004, California Lyon issued $150.0 million principal amount of 7 1/2% Senior Notes due 2014 (the “7 1/2% Senior Notes”), resulting in net proceeds to the Company of approximately $147.6 million. Of the initial $150.0 million, $84.7 million aggregate principal amount remained outstanding as of December 31, 2009 and the date hereof.

Interest on the 7 1/2% Senior Notes is payable on February 15 and August 15 of each year. Based on the current outstanding principal amount of 7 1/2% Senior Notes the Company’s semi-annual interest payments are $3.2 million.

The 7 1/2% Senior Notes are redeemable at the option of California Lyon, in whole or in part, at a redemption price equal to 100% of the principal amount plus a premium declining ratably to par, plus accrued and unpaid interest, if any.

General Terms of the Senior Notes

The 7 5 /8% Senior Notes, the 10 3/ 4% Senior Notes and the 7 1/2 % Senior Notes (collectively, the “Senior Notes”) are senior unsecured obligations of California Lyon and are unconditionally guaranteed on a senior unsecured basis by William Lyon Homes, a Delaware corporation (“Delaware Lyon”), which is the parent company of California Lyon, and all of Delaware Lyon’s existing and certain of its future restricted subsidiaries. The Senior Notes and the guarantees rank senior to all of the Company’s and the guarantors’ debt that is expressly subordinated to the Senior Notes and the guarantees, but are effectively subordinated to all of the Company’s and the guarantors’ senior secured indebtedness to the extent of the value of the assets securing that indebtedness.

Upon a change of control as described in the respective Indentures governing the Senior Notes (the “Senior Notes Indentures”), California Lyon will be required to offer to purchase the Senior Notes at a purchase price equal to 101% of the principal amount, plus accrued and unpaid interest, if any.

If the Company’s consolidated tangible net worth falls below $75.0 million for any two consecutive fiscal quarters, California Lyon will be required to make an offer to purchase up to 10% of each class of Senior Notes originally issued at a purchase price equal to 100% of the principal amount, plus accrued and unpaid interest, if any.

California Lyon is 100% owned by Delaware Lyon. Each subsidiary guarantor is 100% owned by California Lyon or Delaware Lyon. All guarantees of the Senior Notes are full and unconditional and all guarantees are joint and several. There are no significant restrictions on the ability of Delaware Lyon or any guarantor to obtain funds from subsidiaries by dividend or loan.

The Senior Notes Indentures contain covenants that limit the ability of Delaware Lyon and its restricted subsidiaries to, among other things: (i) incur additional indebtedness; (ii) pay dividends or make other distributions or repurchase its stock; (iii) make investments; (iv) sell assets; (v) incur liens; (vi) enter into agreements restricting the ability of Delaware Lyon’s

 

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restricted subsidiaries (other than California Lyon) to pay dividends; (vii) enter into transactions with affiliates; and (viii) consolidate, merge or sell all or substantially all of Delaware Lyon’s and California Lyon’s assets. These covenants are subject to a number of important exceptions and qualifications as described in the Senior Notes Indentures.

As of and for the year ending December 31, 2009 the Company was in compliance with these covenants.

The foregoing summary is not a complete description of the Senior Notes and is qualified in its entirety by reference to the Senior Notes Indentures.

Revolving Credit Facilities

As discussed previously, on October 20, 2009, the Company entered into a Senior Secured Term Loan Agreement with COLFIN WLH Funding, LLC, and used a portion of the net proceeds to fully repay the Revolving Credit Facilities. As of December 31, 2009, the Revolving Credit Facilities have been retired and there are no available borrowings.

Construction Notes Payable

At December 31, 2009, the Company had construction notes payable amounting to $64.2 million, including $18.9 million on certain consolidated entities. The construction notes have various maturity dates through 2017 and bear interest at rates ranging from prime plus 0.25% to prime plus 1.0% at December 31, 2009. Interest is calculated on the average daily balance and is paid following the end of each month.

The Company is the sole member of Lyon East Garrison Company I, LLC which is a member with Woodman Development Company, LLC (the “Members”) in East Garrison Partners I, LLC (the “LLC”). The LLC had a non-recourse construction note payable secured by the underlying land parcel, with an outstanding balance of $56.2 million as of June 30, 2009 related to the acquisition and development of real estate in Monterey County, California. In addition to the non-recourse construction note payable, the Company and affiliates of the other Member entered into a completion guaranty.

Based on general economic conditions at the time, the Members of the LLC and the construction note lender determined to temporarily suspend further entitlement and development of the project, at which time it was agreed that certain site improvements would be completed in order to prepare and protect the site for a delay of approximately two years. The Company and affiliates of the other Member of the LLC concluded that the completion of these site improvements satisfied the obligation under the completion guaranty.

The lender agreed to fund the site improvements under the guaranty; however the lender stopped funding for the improvements, which left the LLC with unpaid invoices. During this same period, the LLC received several letters from the lender alleging default under the construction loan agreement which the Members contended were invalid based on previous discussions. In addition, under the terms of the construction loan agreement, the LLC was required to reduce the loan commitment from $75.0 million to $35.0 million by January 31, 2009, which required a $21.2 million pay down.

The LLC did not make the required pay down on January 31, 2009 and was in default under the construction loan agreement. In September 2009, the lender under the construction note payable sold the note to a third party, at which time the new holder of the note foreclosed on the property owned by the LLC. The lender and the LLC waived all construction guaranties and obligations under the construction note payable.

Land Banking Arrangements

As a method of acquiring land in staged takedowns, thereby minimizing the use of funds from the Company’s available cash or other corporate financing sources and limiting the Company’s risk, the Company transfers its right in such purchase agreements to entities owned by third parties (“land banking arrangements”). These entities use equity contributions and/or incur debt to finance the acquisition and development of the land being purchased. The entities grant the Company an option to acquire lots in staged takedowns. In consideration for this option, the Company makes a non-refundable deposit of 15% to 25% of the total purchase price. The Company is under no obligation to purchase the balance of the lots, but would forfeit remaining deposits and could be subject to penalties if the lots were not purchased. The Company does not have legal title to these entities or their assets and has not guaranteed their liabilities. These land banking arrangements help the Company manage the financial and market risk associated with land holdings. The use of these land banking arrangements is dependent on, among other things, the availability of capital to the option provider, general housing market conditions and geographic preferences.

In addition, the Company participates in one land banking arrangement, which is not a VIE in accordance with FASB ASC 810, but is consolidated in accordance with FASB ASC Topic 470, Debt. Under the provisions of FASB ASC 470, the Company has determined it is economically compelled, based on certain factors, to purchase the land in the land banking arrangements. Therefore, the Company has recorded the remaining purchase price of the land of $55.3 million, which is included in real estate inventories not owned and liabilities from inventories not owned in the accompanying balance sheet as of December 31, 2009.

 

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Summary information with respect to the Company’s land banking arrangements is as follows as of December 31, 2009 (dollars in thousands):

 

Total number of land banking projects

     1
      

Total number of lots

     625
      

Total purchase price

   $ 161,465
      

Balance of lots still under option and not purchased:

  

Number of lots

     236
      

Purchase price

   $ 55,270
      

Forfeited deposits if lots are not purchased

   $ 25,234
      

Joint Venture Financing

The Company and certain of its subsidiaries are general partners or members in joint ventures involved in the development and sale of residential projects. As described more fully in Critical Accounting Policies—Variable Interest Entities, certain joint ventures have been determined to be variable interest entities in which the Company is considered the primary beneficiary. Accordingly, the assets, liabilities and operations of these joint ventures have been consolidated with the Company’s financial statements as of and for the years ended December 31, 2009 and 2008. Because the Company already recognizes its proportionate share of joint venture earnings and losses under the equity method of accounting, the adoption of FASB ASC 810, did not affect the Company’s consolidated net income. The financial statements of joint ventures in which the Company is not considered the primary beneficiary are not consolidated with the Company’s financial statements. The Company’s investments in unconsolidated joint ventures are accounted for using the equity method because the Company has a 50% or less voting or economic interest (and thus such joint ventures are not controlled by the Company). See Note 2 of “Notes to Consolidated Financial Statements” for condensed combined financial information for the joint ventures whose financial statements have been consolidated with the Company’s financial statements. Based upon current estimates, substantially all future development and construction costs incurred by the joint ventures will be funded by the venture partners or from the proceeds of construction financing obtained by the joint ventures.

As of December 31, 2009, the Company’s investment in and advances to unconsolidated joint ventures was $1.7 million and the venture partners’ investment in such joint ventures was $1.7 million. As of December 31, 2009, these joint ventures had repaid all financing from construction lenders.

Assessment District Bonds

In some jurisdictions in which the Company develops and constructs property, assessment district bonds are issued by municipalities to finance major infrastructure improvements and fees. Such financing has been an important part of financing master-planned communities due to the long-term nature of the financing, favorable interest rates when compared to the Company’s other sources of funds and the fact that the bonds are sold, administered and collected by the relevant government entity. As a landowner benefited by the improvements, the Company is responsible for the assessments on its land. When the Company’s homes or other properties are sold, the assessments are either prepaid or the buyers assume the responsibility for the related assessments. See Note 12 of “Notes to Consolidated Financial Statements.”

Cash Flows — Comparison of Years Ended December 31, 2009 and 2008

Net cash provided by operating activities decreased to $12.9 million in the 2009 period from $80.4 million in the 2008 period. The decrease was primarily as a result of (i) a decrease in impairment loss on real estate assets of $90.0 million to $45.3 million in the 2009 period compared to $135.3 million in the 2008 period, (ii) gain on retirement of debt of $78.1 million in the 2009 period compared to $54.0 million in the 2008 period, (iii) income tax benefit of $101.9 million in the 2009 period compared to income tax benefit of $41.6 million in the 2008 period, and (iv) net loss of $21.0 million in the 2009 period compared to $122.1 million in the 2008 period. The increase in the income tax benefit was the result of the legislation enacted in November 2009 which allows net operating losses realized in either tax year 2008 or 2009 to be carried back up to five years. As a result of the new legislation the Company recorded a federal income tax benefit of $101.9 million for the year ended December 31, 2009, which the Company anticipates receiving in the first quarter of 2010.

 

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The decrease in impairment loss on real estate assets is described in “Results of Operations” above. The gain on retirement of debt is attributable to the Senior Note repurchase transactions that occurred during 2009. The details of the transactions are more fully detailed above. The difference between the benefit from income taxes in the 2009 period and the benefit for income taxes in the 2008 period is described in detail in Note 10 to “Notes to Consolidated Financial Statements.”

Net cash provided by (used in) investing activities increased to a source of $2.7 million in the 2009 period from a use of $3.3 million in the 2008 period. The change was primarily as a result of the (i) proceeds from the sale of the Company aircraft of $2.1 million in the 2009 period, as more fully described in Note 11 to the “Notes to Consolidated Financial Statements” and (ii) a decrease in investments in and advances to unconsolidated joint ventures of $0.2 million in the 2009 period compared to $3.0 million in the 2008 period.

Net cash provided by (used in) financing activities increased to a source of $35.0 million in the 2009 period from a use of $83.3 million in the 2008 period, primarily as a result of the net proceeds received from the issuance of the Senior Secured Term Loan of $193.9 million in the 2009 period with no comparable amount in the 2008 period, offset by an increase in the net cash paid for the repurchase of Senior Notes of $77.0 million in the 2009 period, compared to $16.7 million in the 2008 period.

Cash Flows — Comparison of Years Ended December 31, 2008 and 2007

Net cash provided by operating activities decreased to $80.4 million in the 2008 period from $134.5 million in the 2007 period. The decrease was primarily as a result of (i) a decrease in impairment loss on real estate assets of $95.8 million to $135.3 million in the 2008 period compared to $231.1 million in the 2007 period, (ii) minority equity in loss of $(10.4) million in the 2008 period compared to minority equity in income of $11.1 million in the 2007 period, (iii) gain on retirement of debt of $54.0 million in the 2008 period with no comparable amount in the 2007 period, (iv) income tax benefit of $41.6 million in the 2008 period compared to income tax provision of $32.7 million in the 2007 period, (v) an increase in receivables of $9.6 million in the 2008 period compared to an increase in receivables of $81.4 million in the 2007 period and (vi) net loss of $111.6 million in the 2008 period compared to $349.4 million in the 2007 period.

The decrease in impairment loss on real estate assets is described in “Results of Operations” above. The decrease in minority equity in (loss) income is primarily attributable to a decrease in the number of consolidated joint venture homes closed to 64 homes in the 2008 period from 219 in the 2007 period and an impairment charge on real estate assets in one of the Company’s consolidated joint ventures. In conjunction with the impairment charge, the minority loss allocation was approximately $10.0 million. The gain on retirement of debt is attributable to the repurchase transaction that occurred in October 2008. The details of the transaction are more fully detailed above. The difference between the benefit from income taxes in the 2008 period and the provision for income taxes in the 2007 period are described in detail in Note 11 to “Notes to Consolidated Financial Statements.”

The decrease in receivables is attributable to a decrease in escrow proceeds receivable of $10.6 million during the 2008 period from a balance of $19.2 million as of December 31, 2007 to a balance of $8.6 million as of December 31, 2008, compared to a decrease of $28.1 million during the 2007 period, from a balance of $47.3 million as of December 31, 2006 to a balance of $19.2 million as of December 31, 2007. The large balance as of December 31, 2007 and 2006 was temporary in nature and primarily due to a significant number of homes closed in the last five days of the year of 122 in 2007 and 192 in 2006 where the homes had closed escrow but the Company had not yet received the funds from the escrow and title companies. The entire balance of escrow proceeds receivable at December 31, 2007 and 2006 was collected within the first few days of the following period.

Net cash provided by (used in) investing activities decreased to a use of $3.3 million in the 2008 period from $8.3 million in the 2007 period. The change was primarily a result of a decrease in investments in and advances to unconsolidated joint ventures of $3.0 million in the 2008 period compared to $7.1 million in the 2007 period.

Net cash provided by (used in) financing activities decreased to a use of $83.3 million in the 2008 period from $91.8 million in the 2007 period, primarily as a result of minority interest contributions of $1.0 million in the 2008 period compared to distributions of $26.1 million in the 2007 period, offset by a net payments on notes payable of $67.6 million in the 2008 period compared to $65.7 million in the 2007 period.

Off-Balance Sheet Arrangements

The Company enters into certain off-balance sheet arrangements including joint venture financing, option agreements, land banking arrangements and variable interests in consolidated and unconsolidated entities. These arrangements are more fully described above and in Notes 2, 6 and 12 of “Notes to Consolidated Financial Statements.”

 

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Contractual Obligations

The Company’s contractual obligations consisted of the following at December 31, 2009 (in thousands):

 

          Payments due by period
     Total (1)    Less than
1 year
(2010)
   1-3 years
(2011-2012)
   3-5 years
(2013-2014)
   More than
5 years
(2015 and
beyond)

Other notes payable

   $ 59,761    $ 38,174    $ 19,629    $ 139    $ 1,819

Senior Secured Term Loan

     343,855      28,840      57,680      257,335     

Senior Notes(2)

     421,697      29,674      126,348      265,675     

Operating leases

     6,305      2,914      3,194      197     

Purchase obligations

              

Land purchases and option commitments(3)

     160,970      62,132      98,838          

Surety Bonds

     109,426      107,156      2,270          

Project commitments(4)

     112,365      85,130      18,157      9,078     
                                  

Total

   $ 1,214,379    $ 354,020    $ 326,116    $ 532,424    $ 1,819
                                  

 

(1)

The summary of contractual obligations above includes interest on all interest-bearing obligations. Interest on all fixed rate interest-bearing obligations is based on the stated rate and is calculated to the stated maturity date. Interest on all variable rate interest bearing obligations is based on the rates effective as of December 31, 2009 and is calculated to the stated maturity date.

 

(2)

Includes 7 5/8% Senior Notes, 10 3/4% Senior Notes and 7 1/2% Senior Notes combined.

 

(3)

Represents the Company’s obligations in land purchases, lot option agreements and land banking arrangements. If the Company does not purchase the land under contract, it will forfeit its non-refundable deposit related to the land.

 

(4)

Represents the Company’s homebuilding project purchase commitments for developing and building homes in the ordinary course of business.

Inflation

The Company’s revenues and profitability may be affected by increased inflation rates and other general economic conditions. In periods of high inflation, demand for the Company’s homes may be reduced by increases in mortgage interest rates. Further, the Company’s profits will be affected by its ability to recover through higher sales prices increases in the costs of land, construction, labor and administrative expenses. The Company’s ability to raise prices at such times will depend upon demand and other competitive factors.

Critical Accounting Policies

The Company’s financial statements have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and costs and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments, including those which impact its most critical accounting policies. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. Management believes that the following accounting policies are among the most important to a portrayal of the Company’s financial condition and results of operations and require among the most difficult, subjective or complex judgments:

 

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Real Estate Inventories and Cost of Sales

Real estate inventories are carried at cost net of impairment losses, if any. Real estate inventories consist primarily of deposits to purchase land, raw land, lots under development, homes under construction, completed homes and model homes of real estate projects. All direct and indirect land costs, offsite and onsite improvements and applicable interest and other carrying charges are capitalized to real estate projects during periods when the project is under development. Land, offsite costs and all other common costs are allocated to land parcels benefited based upon relative fair values before construction. Onsite construction costs and related carrying charges (principally interest and property taxes) are allocated to the individual homes within a phase based upon the relative sales value of the homes. The estimation process involved in determining relative fair values and sales values is inherently uncertain because it involves estimates of current market values for land parcels before construction as well as future sales values of individual homes within a phase. The Company’s estimate of future sales values is supported by the Company’s budgeting process. The estimate of future sales values is inherently uncertain because it requires estimates of current market conditions as well as future market events and conditions. Additionally, in determining the allocation of costs to a particular land parcel or individual home, the Company relies on project budgets that are based on a variety of assumptions, including assumptions about construction schedules and future costs to be incurred. It is possible that actual results could differ from budgeted amounts for various reasons, including construction delays, increases in costs which have not yet been committed, or unforeseen issues encountered during construction that fall outside the scope of contracts obtained. While the actual results for a particular construction project are accurately reported over time, a variance between the budget and actual costs could result in the understatement or overstatement of costs and a related impact on gross margins in a specific reporting period. To reduce the potential for such distortion, the Company has set forth procedures which have been applied by the Company on a consistent basis, including assessing and revising project budgets on a monthly basis, obtaining commitments from subcontractors and vendors for future costs to be incurred, reviewing the adequacy of warranty accruals and historical warranty claims experience, and utilizing the most recent information available to estimate costs. The variances between budget and actual amounts identified by the Company have historically not had a material impact on its consolidated results of operations. Management believes that the Company’s policies provide for reasonably dependable estimates to be used in the calculation and reporting of costs. The Company relieves its accumulated real estate inventories through cost of sales by the budgeted amount of cost of homes sold, as described more fully below in the section entitled “Sales and Profit Recognition.”

Impairment of Real Estate Inventories

The Company accounts for its real estate inventories in accordance with FASB ASC Topic 360, Property, Plant & Equipment. ASC Topic 360 requires impairment losses to be recorded on real estate inventories when indicators of impairment are present and the undiscounted cash flows estimated to be generated by real estate inventories are less than the carrying amount of such assets. Indicators of impairment include a decrease in demand for housing due to softening market conditions, competitive pricing pressures which reduce the average sales price of homes, which includes sales incentives for homebuyers, slowing sales absorption rates, a decrease in home values in the markets in which the Company operates, significant decreases in gross margins and a decrease in project cash flows for a particular project.

For land and land under development, homes completed and under construction and model homes, the Company estimates expected cash flows at the project level by maintaining current budgets using recent historical information and current market assumptions. The Company updates project budgets and cash flows of each real estate project on a quarterly basis to determine whether the estimated remaining undiscounted future cash flows of the project are more or less than the carrying amount (net book value) of the asset. If the undiscounted cash flows are more than the net book value of the project, then there is no impairment. If the undiscounted cash flows are less than the net book value of the asset, then the asset is deemed to be impaired and is written-down to its fair value.

Fair value represents the amount at which an asset could be bought or sold in a current transaction between willing parties (i.e., other than a forced or liquidation sale). Management determines the estimated fair value of each project by determining the present value of estimated future cash flows at discount rates that are commensurate with the risk of each project. The estimation process involved in determining if assets have been impaired and in the determination of fair value is inherently uncertain because it requires estimates of future revenues and costs, current market yields as well as future events and conditions. As described more fully above in the section entitled “Real Estate Inventories and Cost of Sales”, estimates of revenues and costs are supported by the Company’s budgeting process.

Under FASB ASC Topic 360, the Company is required to make certain assumptions to estimate undiscounted future cash flows of a project, which include: (i) estimated sales prices, including sales incentives, (ii) anticipated sales absorption rates and sales volume, (iii) project costs incurred to date and the estimated future costs of the project based on the project budget, (iv) the carrying costs related to the time a project is actively selling until it closes the final unit in the project, and (v) alternative strategies including selling the land to a third party or temporarily suspending development on the project. Each

 

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project has different assumptions and is based on management’s assessment of the current market conditions that exist in each project location. Interest incurred allocated to each project is included in future cash flows at effective borrowing rates of 9% for the reporting periods ending March 31, June 30 and September 30 and 11% as of December 31, 2009, and 7% for the 2008 period, which would yield discount rates of 19% to 27% for the 2009 period and 17% to 23% for the 2008 period. Interest allocated to each project for cash flows in 2010 and beyond is 11.25% due to the increase in cost of capital from the Senior Secured Term Loan.

The assumptions and judgments used by the Company in the estimation process to determine the future undiscounted cash flows of a project and its fair value are inherently uncertain and require a substantial degree of judgment. The realization of the Company’s real estate inventories is dependent upon future uncertain events and market conditions. Due to the subjective nature of the estimates and assumptions used in determining the future cash flows of a project, the continued decline in the current housing market, the uncertainty in the banking and credit markets, actual results could differ materially from current estimates.

These estimates are dependent on specific market or sub-market conditions for each subdivision. While the Company considers available information to determine what it believes to be its best estimates as of the end of a reporting period, these estimates are subject to change in future reporting periods as facts and circumstances change. Local market-specific conditions that may impact these estimates for a subdivision include:

 

 

 

historical subdivision results, and actual operating profit, base selling prices and home sales incentives;

 

 

 

forecasted operating profit for homes in backlog;

 

 

 

the intensity of competition within a market or sub-market, including publicly available home sales prices and home sales incentives offered by our competitors;

 

 

 

increased levels of home foreclosures;

 

 

 

the current sales pace for active subdivisions;

 

 

 

subdivision specific attributes, such as location, availability of lots in the sub-market, desirability and uniqueness of subdivision location and the size and style of homes currently being offered;

 

 

 

changes by management in the sales strategy of a given subdivision; and

 

 

 

current local market economic and demographic conditions and related trends and forecasts.

These and other local market-specific conditions that may be present are considered by personnel in the Company’s homebuilding divisions as they prepare or update the forecasted assumptions for each subdivision. Quantitative and qualitative factors other than home sales prices could significantly impact the potential for future impairments. The sales objectives can differ among subdivisions, even within a given sub-market. For example, facts and circumstances in a given subdivision may lead the Company to price its homes with the objective of yielding a higher sales absorption pace, while facts and circumstances in another subdivision may lead the Company to price its homes to minimize deterioration in home gross margins, even though this could result in a slower sales absorption pace. Furthermore, the key assumptions included in estimated future undiscounted cash flows may be interrelated. For example, a decrease in estimated base sales price or an increase in home sales incentives may result in a corresponding increase in sales absorption pace. Additionally, a decrease in the average sales price of homes to be sold and closed in future reporting periods for one subdivision that has not been generating what management believes to be an adequate sales absorption pace may impact the estimated cash flow assumptions of a nearby subdivision. Changes in key assumptions, including estimated construction and land development costs, absorption pace, selling strategies or discount rates could materially impact future cash flow and fair value estimates. Due to the number of possible scenarios that would result from various changes in these factors, the Company does not believe it is possible to develop a sensitivity analysis with a level of precision that would be meaningful to an investor.

Management assesses land deposits for impairment when estimated land values are deemed to be less than the agreed upon contract price. The Company considers changes in market conditions, the timing of land purchases, the ability to renegotiate with land sellers the terms of the land option contract in question, the availability and best use of capital, and other factors. If land values are determined to be less than the contract price, the future project will not be purchased. The Company records abandoned land deposits and related pre-acquisition costs to cost of sales-land in the consolidated statement of operations in the period that it is abandoned.

 

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The following table summarizes inventory impairment charges recorded during the years ended December 31, 2009, 2008, and 2007:

 

     Year Ended December 31,
     2009    2008    2007
     (Dollars in thousands)

Inventory impairment charges related to:

        

Land under development and homes completed and under construction

   $ 31,916    $ 83,174    $ 184,719

Land held for sale or sold

     13,353      52,137      46,401
                    

Total inventory impairment charges

   $ 45,269    $ 135,311    $ 231,120
                    

Number of projects impaired during the year

     13      41      42
                    

Number of projects assessed for impairment during the year

     67      84      84
                    

These charges were included in impairment loss on real estate assets in the accompanying consolidated statements of operations (See Note 3—Notes to Consolidated Financial Statement for a detail of impairment by segment). At two of the Company’s projects, impairment loss was primarily attributable to an increase in interest cost allocated to the project related to the addition of the Senior Secured Term Loan at 14% interest. In addition, the Company decreased base sales prices and increased certain incentives related to the projects, which is a strategy to improve sales absorption rates. The impairment charges recorded during the periods noted above stemmed from lower home prices which were driven by increased incentives and discounts resulting from weakened demand experienced during 2007 through 2009. The Company may incur further impairment on real estate inventories in the future, if the homebuilding industry continues to experience the deteriorating market conditions identified above. In addition, the Company may incur impairments in the future if it is unable to hold its temporarily suspended projects until market conditions improve.

Sales and Profit Recognition

A sale is recorded and profit recognized when a sale is consummated, the buyer’s initial and continuing investments are adequate, any receivables are not subject to future subordination, and the usual risks and rewards of ownership have been transferred to the buyer in accordance with the provisions of FASB ASC Topic 976-605-25, Real Estate. When it is determined that the earnings process is not complete, profit is deferred for recognition in future periods. The profit recorded by the Company is based on the calculation of cost of sales which is dependent on the Company’s allocation of costs which is described in more detail above in the section entitled “Real Estate Inventories and Cost of Sales.”

Variable Interest Entities

Certain land purchase contracts and lot option contracts are accounted for in accordance with FASB ASC Topic 810, Consolidation. In addition, all joint ventures are reviewed and analyzed under this guidance to determine whether or not these arrangements are accounted for under the principles of ASC 810 or other accounting rules. Under ASC 810, a variable interest entity (“VIE”) is created when (i) the equity investment at risk in the entity is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties or (ii) the entity’s equity holders as a group either (a) lack direct or indirect ability to make decisions about the entity through voting or similar rights, (b) are not obligated to absorb expected losses of the entity if they occur or (c) do not have the right to receive expected residual returns of the entity if they occur. If an entity is deemed to be a VIE pursuant to this guidance, the enterprise that absorbs a majority of the expected losses, receives a majority of the entity’s expected residual returns, or both, is considered the primary beneficiary and must consolidate the VIE. Expected losses and residual returns for VIEs are calculated based on the probability of estimated future cash flows as defined in FASB ASC 810. Based on the provisions of ASC 810, whenever the Company enters into a land purchase contract or an option contract for land or lots with an entity and makes a non-refundable deposit, or enters into a joint venture, a VIE may be created and the arrangement is evaluated under this guidance. In order to (i) evaluate whether the equity investment at risk is not sufficient to permit the entity to finance its activities without additional financial support from other parties, (ii) calculate expected losses, expected residual returns and the probability of estimated future cash flows, and (iii) determine whether the Company is the primary beneficiary, the Company must exercise significant judgment regarding the interpretation of the terms of the underlying agreements in light of ASC 810 and make assumptions regarding future events that may or may not occur. The terms of these agreements are subject to various interpretations and the assumptions used by the Company are inherently uncertain. The use by the Company of different interpretations and/or assumptions could affect the Company’s evaluation as to whether or not land purchase contracts, lot option contracts or joint ventures are VIEs and whether or not the Company is the primary beneficiary of the VIE.

 

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The Company’s critical accounting policies are more fully described in Note 1 of the “Notes to Consolidated Financial Statements.”

Related Party Transactions

See Item 13 and Note 10 of the “Notes to Consolidated Financial Statements” for a description of the Company’s transactions with related parties.

Recently Issued Accounting Standards

See Note 1 of “Notes to Consolidated Financial Statements” for a description of the recently issued accounting standards.

 

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

The Company’s exposure to market risk for changes in interest rates relates to the Company’s floating rate debt with a total outstanding balance at December 31, 2009 of $57.0 million where the interest rate is variable based upon certain bank reference or prime rates. The average prime rate during the year ended December 31, 2009 was 3.25%. If variable interest rates were to increase by 10%, the estimated impact on the Company’s consolidated financial statements would be an increase to loss before benefit from income taxes of $0.4 million, based on amounts outstanding and rates in effect during the year ended December 31, 2009, but would increase capitalized interest by approximately $0.1 million which would be amortized to cost of sales as home closings occur.

 

Item 8.

Financial Statements and Supplementary Data

The consolidated financial statements of William Lyon Homes and the reports of the independent registered public accounting firm, listed under Item 15, are submitted as a separate section of this report beginning on page 86 and are incorporated herein by reference.

 

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.

 

Item 9A.

Controls and Procedures

Evaluation of Disclosure Controls and Procedures. An evaluation was performed under the supervision and with the participation of the Company’s management, including its principal executive officer and principal financial officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended). Based on that evaluation, the Company’s principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures were effective at the reasonable assurance levels as of the end of the period covered by the Annual Report on Form 10-K for the period ending December 31, 2009. Although the Company’s disclosure controls and procedures have been designed to provide reasonable assurance of achieving their objectives, there can be no assurance that such disclosure controls and procedures will always achieve their stated goals under all circumstances.

A material weakness is a deficiency, or a combination of deficiencies in internal control over financial reporting, that creates a more than remote likelihood that a material misstatement of interim or annual financial statements will not be prevented or detected on a timely basis. Management has concluded that the following material weakness existed at December 31, 2008.

During the year ended December 31, 2008, the Company reviewed all of its homebuilding projects and land held for development for indicators of impairment, both of which are included in real estate inventories on the Company’s consolidated balance sheets. Under the provisions of FASB ASC 360, the Company is required to make certain assumptions to estimate undiscounted future cash flows of a project, which include: (i) estimated sales prices, including sales incentives, (ii) anticipated sales absorption rates and sales volume, (iii) project costs incurred to date and the estimated future costs of the project based on the project budget, and (iv) the carrying costs related to the time a project is actively selling until it closes the final unit in the project, and (v) alternative strategies including selling the land to a third party or temporarily suspending development of the project. Each project has different assumptions and is based on management’s assessment of the current market conditions that exist in each project location.

 

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At December 31, 2008 controls over the financial reporting process for the validity of assumptions used for the estimated sales price on two projects were not effective. This resulted in a significant additional impairment adjustment to the Company’s consolidated financial statements at December 31, 2008. Specifically, controls were not effective to ensure accounting estimates based on these estimated sales prices were appropriately reviewed, analyzed and challenged by management on a timely basis. This adjustment was appropriately reflected in the Consolidated Financial Statements in the Annual Report on Form 10-K for the year ending December 31, 2008.

In June 2009, the Company implemented new procedures to address the material weakness on impairment losses on real estate assets. The Company added a weighting factor to add statistical analysis to the subjectivity related to comparable pricing data in new home pricing, which was appropriately reviewed, analyzed and challenged by management on a timely basis. The enhanced controls were tested in the three month periods ending September 30, 2009 and December 31, 2009. The Company concluded that, as of December 31, 2009, the enhanced controls implemented were effective in the remediation of the material weakness.

Management’s Annual Report on Internal Control over Financial Reporting. The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting and has designed internal controls and procedures to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements and related notes in accordance with generally accepted accounting principles. Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2009. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on that assessment, our management concluded that, the Company maintained effective internal control over financial reporting as of December 31, 2009.

Changes in Internal Control over Financial Reporting. There have been no significant changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f)) under the Securities Exchange Act of 1934, as amended) that occurred during the Company’s fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

This annual report does not include an audit report of the Company’s registered public accounting firm regarding internal control over financial reporting. The Company’s internal controls were not subject to audit by the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.

 

Item 9B.

Other Information

None.

 

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PART III

 

Item 10.

Directors, Executive Officers and Corporate Governance

Information Regarding the Directors of William Lyon Homes

The following table lists the Directors of the Company and provides their respective ages and current positions with the Company as of March 5, 2010. Each director holds office until the Company’s next Annual Meeting and until his successor is duly elected and qualified. Except as described below, there are no family relationships between any director or executive officer and any other director or executive officer of William Lyon Homes. Biographical information for each Director is provided below.

 

Name

   Age   

Position

General William Lyon

   86   

Chairman of the Board of Directors and Chief

Executive Officer

William H. Lyon

   36   

Director, President and Chief Operating Officer

Douglas K. Ammerman (a, b, c)

   58   

Director

Harold H. Greene (a, b, c)

   71   

Director

Gary H. Hunt (a, b, c)

   61   

Director

Alex Meruelo (a, b, c)

   47   

Director

 

(a)

Member of the Audit Committee

 

(b)

Member of the Compensation Committee

 

(c)

Member of the Nominating and Corporate Governance Committee

GENERAL WILLIAM LYON was elected director and Chairman of the Board of the The Presley Companies, the predecessor of the Company, in 1987 and has served in that capacity since November 1999. General Lyon is the Company’s Chief Executive Officer. General Lyon also served as the Chairman of the Board, President and Chief Executive Officer of the former William Lyon Homes, which sold substantially all of its assets to the Company in 1999 and subsequently changed its name to Corporate Enterprises, Inc. In recognition of his distinguished career in real estate development, General Lyon was elected to the California Building Industry Foundation Hall of Fame in 1985. General Lyon is a retired USAF Major General and was Chief of the Air Force Reserve from 1975 to 1979. General Lyon is a director of Fidelity Financial Services, Inc. and is Chairman of the Board of Directors of Commercial Bank of California.

WILLIAM H. LYON, President and Chief Operating Officer, son of General William Lyon, worked full time with the former William Lyon Homes from November 1997 through November 1999 as an assistant project manager, has been employed by the Company since November 1999 and has been a member of the board of directors since January 25, 2000. Since joining the Company, Mr. Lyon has been employed as an assistant project manager and project manager and has participated in a training program designed to expose him to the many facets of real estate development. From February 2003 until February 2005, he served as the Company’s Director of Corporate Affairs. In February 2005, he was appointed Vice President and Chief Administrative Officer of the Company. Effective on March 1, 2007, Mr. Lyon was appointed as Executive Vice President and Chief Administrative Officer. Effective on March 18, 2009, Mr. Lyon was appointed as President and Chief Operating Officer of the Company. Mr. Lyon is a member of the Board of Directors of Commercial Bank of California. Mr. Lyon received a dual B.S. in Industrial Engineering and Product Design from Stanford University in 1997.

DOUGLAS K. AMMERMAN was appointed to the Board of Directors on February 27, 2007. Mr. Ammerman’s business career includes almost three decades of service with KPMG, independent public accountants, until his retirement in 2002. He was the Managing Partner of the Orange County office and was a National Partner in Charge — Tax. He is a certified public accountant (inactive). Since 2005, Mr. Ammerman has served as a member of the Board of Directors of Fidelity National Financial (a company listed on the New York Stock Exchange), where he also serves as Chairman of the Audit Committee. Also, since 2005, he has been a member of the Board of Directors of Quiksilver (a company listed on the New York Stock Exchange), where he also serves as Chairman of the Audit Committee, a member of the Compensation Committee and a member of the Nominating and Corporate Governance Committee. He also is a member of the Board of Directors of El Pollo Loco, where he also serves as Chairman of the Audit Committee. Mr. Ammerman has served as a director of The Pacific Club for twelve years and is a past president. He also has served as a director of the UCI Foundation for fourteen years.

 

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HAROLD H. GREENE joined the board of directors on October 17, 2005. Mr. Greene is a 40-year veteran of the commercial and residential real estate lending industry. He most recently served as the Managing Director for Bank of America’s California Commercial Real Estate Division from 1998 to 2001 where he was responsible for lending to commercial real estate developers in California and managed an investment portfolio of approximately $2.6 billion. From 1990 to 1998, Mr. Greene was the Executive Vice President of SeaFirst Bank in Seattle, Washington and prior to that he served as the Vice Chairman of MetroBank from 1989 to 1990 and in various positions, including Senior Vice President in charge of the Asset Based Finance Group, with Union Bank, where he worked for 27 years. Mr. Greene currently serves as a director of Gary’s and Company (men’s clothing retailer) and as a director and member of the audit committee of Paladin Realty Income Properties, Inc. (real estate investments). From September 2007 until December 2009, he also served as a director and member of the audit committee and the corporate governance committee of Grubb & Ellis (real estate management).

GARY H. HUNT joined the board of directors on October 17, 2005. He has more than three decades of experience in government, business, major land use planning and development, as well as governmental and political affairs. Since 2001, Mr. Hunt has been the Managing Partner of California Strategies, LLC, a strategic consulting firm, in Newport Beach, California with eight offices throughout California. He was also formerly the Executive Vice President and a member of the Board of Directors and the Executive Committee of The Irvine Company, a real estate developer, for which Mr. Hunt worked for 24 years. Mr. Hunt’s career also includes staff and appointed positions with the California State Legislature, U.S. House of Representatives, California Governor Ronald Reagan, and President George W. Bush. He currently serves as Chairman of the California Bay Delta Authority. He also currently serves as a director of Glenair Inc., a manufacturer of electrical connector accessories and as Chairman of the Board of Advisors of Kennecott Land Company, a real estate land developer in Utah. From September 2007 until December 2009, he also served as a director of Grubb & Ellis.

ALEX MERUELO has invested extensively in residential and commercial real estate throughout Southern California since 1987, primarily in Hispanic neighborhoods. Mr. Meruelo currently is the President and Chief Executive Officer of Meruelo Enterprises, Inc., Cantamar Property Management, Inc. and La Pizza Loca, Inc. Mr. Meruelo currently owns and manages over 1,000 residential units and over 20 retail units and has overseen over 15 developments. Mr. Meruelo established La Pizza Loca, a fast food pizza restaurant, in 1986 and which now has over 50 franchised and company owned restaurants serving Latino communities throughout Southern California. Since 1999, Mr. Meruelo has focused his endeavors on the construction industry and, through Meruelo Enterprises, owns a number of established Southern California utility construction contractors including Herman Weissker, Inc., Doty Bros. Equipment Company and Tidwell Excavating. He has been a member of the board of directors since May 10, 2004. Mr. Meruelo is also a member of the board of directors and chairman of the audit committee of Commercial Bank of California.

Audit Committee. The Company has a standing Audit Committee, which is chaired by Mr. Harold H. Greene and consists of Messrs. Greene, Ammerman, Hunt and Meruelo. The Board has determined that all committee members are independent and financially literate under the standards established by the Securities and Exchange Commission (the “SEC”). The Board has determined that Mr. Greene is an “audit committee financial expert” as defined by the SEC.

Board Structure. General William Lyon, Chairman of the Board and Chief Executive Officer of the Company is also the majority shareholder, beneficially owning 944 shares of the 1,000 outstanding shares of Company common stock. The Company’s securities are not registered on any national security exchange, and the Company is not otherwise required to file public reports under the rules and regulation of the Securities and Exchange Commission, but is a voluntary filer under the terms of its Senior Notes Indentures (as previously defined). However, as noted below under “—Director Independence”, the Company maintains a majority of independent directors as determined under the Rules of the New York Stock Exchange.

Given General Lyon’s long standing association with the Company, his controlling interest in the Company and his extensive knowledge of and experience with the home building industry, the Board of Directors believes that General Lyon’s service as both Chairman of the Board and Chief Executive Officer is in the best interest of the Company and its security holders. General Lyon possesses detailed and in-depth knowledge of the home building industry and the issues facing the Company and is thus best positioned to develop agendas that ensure that the Board’s time and attention are focused on the most critical matters. His combined role enables decisive leadership, ensures clear accountability, and enhances the Company’s ability to communicate its message and strategy clearly and consistently to the Company’s security holders and employees.

Although the Company believes that the combination of the Chairman and Chief Executive Officer roles is appropriate in the current circumstances, the Company has not established this approach as a policy.

The Company strives to compose the Board of directors with a collection of individuals who bring a variety of complementary skills which, as a group, will possess the appropriate skills and experience to oversee the Company’s business. Accordingly, although diversity may be a consideration in the selection of Board members, the Company and the Board of Directors do not have a formal policy with regard to the consideration of diversity in identifying director nominees.

        Risk Oversight. The Board is actively involved in oversight of risks that could affect the Company. The Board satisfies this responsibility through full reports by each committee chair (principally, the Audit Committee chair) regarding such committee’s considerations and actions, as well as through regular reports directly from the officers responsible for oversight of particular risks within the Company.

The Audit Committee is primarily responsible for overseeing the risk management function at the Company on behalf of the Board. In carrying out its responsibilities, the Audit Committee works closely with management. The Audit Committee meets at least quarterly with members of management and, among things, receives an update on management’s assessment of risk exposures (including risks related to liquidity, credit, and operations, among others). The Audit Committee chair provides periodic reports on risk management to the full Board.

In addition to the Audit Committee, the other committees of the Board consider the risks within their areas of responsibility. For example, the Compensation Committee considers the risks that may be implicated by the Company’s executive compensation programs. The Company does not believe that risks relating to its compensation policies and practices are reasonably likely to have a material adverse effect on the Company.

Information Regarding Executive Officers of William Lyon Homes

The executive officers of the Company are chosen annually by the Board of Directors and each holds office until his or her successor is chosen and qualified or until his or her death, resignation or removal. There are no family relationships between any director or executive officer and any other director or executive officer of the Company, except for William Lyon and William H. Lyon, who are father and son. The following table lists the Company’s executive officers and provides their respective ages as of March 5, 2010 and their current positions.

 

Name

   Age   

Position

General William Lyon

   86   

Chairman of the Board of Directors and Chief Executive Officer

William H. Lyon

   36   

President and Chief Operating Officer

Matthew R. Zaist

   35   

Executive Vice President

Mary J. Connelly

   58   

Senior Vice President and Nevada Division President

W. Thomas Hickcox

   57   

Senior Vice President and Arizona Division President

Richard S. Robinson

   63   

Senior Vice President — Finance

Colin T. Severn

   38   

Vice President, Chief Financial Officer and Corporate Secretary

Brian W. Doyle

   46   

Vice President and Southern California Division President

Gary L.Galindo

   46   

Vice President and Northern California Division President

Cynthia E. Hardgrave

   61   

Vice President — Tax and Internal Audit

Officers serve at the discretion of the Board of Directors, subject to rights, if any, under contracts of employment. See “Employment Contracts” in Part III, Item 11. Biographical information for General Lyon and Mr. William H. Lyon is provided above. See “Information Regarding the Directors of William Lyon Homes.”

 

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MATTHEW R. ZAIST, Executive Vice President, joined William Lyon Homes in 2000 as the Company’s CIO. Since joining the Company, Mr. Zaist has served in a number of operational roles including Corporate Vice President - Business Development & Operations. Prior to that Mr. Zaist served as Project Manager and Director of Land Acquisition for the Company’s Southern California Region. In his current role, Mr. Zaist assists William H. Lyon with the overall management of the operations of the Company, is responsible for all new real estate acquisitions, while also serving as a member of the Company’s Land Committee. Mr. Zaist was appointed Executive Vice President in January 2010. Prior to joining William Lyon Homes, Mr. Zaist was a principal with American Management Systems (now CGI) in their State & Local Government practice. Mr. Zaist holds a B.S. from Rensselaer Polytechnic Institute.

MARY J. CONNELLY, Senior Vice President and Nevada Division President, joined The Presley Companies in May 1995, after eight years’ association with Gateway Development, six of which were served as Managing Partner in Nevada. Ms. Connelly was Vice President — Finance for the Company’s San Diego Division from 1985 to 1987, and she has more than 25 years experience in the real estate development and homebuilding industry.

W. THOMAS HICKCOX, Senior Vice President and Arizona Division President, joined the Company in May 2000. Mr. Hickcox was previously President of Continental Homes in Phoenix, Arizona, with 16 years of service at that company. Mr. Hickcox has more than 25 years experience in the real estate development and homebuilding industry.

RICHARD S. ROBINSON, Senior Vice President — Finance, joined the Company in 1999 when it acquired substantially all of the assets of the former William Lyon Homes, where Mr. Robinson had served since May 1997 as Senior Vice President, and as Vice President — Treasurer and other administrative positions at The William Lyon Company or one of its subsidiaries or affiliates since his hire in June 1979. His experience in residential real estate development and homebuilding finance totals more than 30 years.

COLIN T. SEVERN, Vice President, Chief Financial Officer and Corporate Secretary joined the Company in December 2003, and served in the role of Financial Controller until April 3, 2009. Since April 3, 2009, Mr. Severn served as Vice President, Corporate Controller and Corporate Secretary until his promotion to Chief Financial Officer by approval of the board of directors of the Company on August 11, 2009. Mr. Severn is a member of the Company’s Land Committee. Mr. Severn is a CPA (inactive) and has more than 14 years of experience in real estate accounting and finance, including positions with the public accounting firm of Ernst & Young LLP, Irvine Apartment Communities and Standard Pacific Homes. Mr. Severn holds a B.A in Business Administration with concentrations in Accounting and Finance from California State University, Fullerton.

BRIAN W. DOYLE, Vice President and Southern California Division President, joined the Company in 1999 when it acquired substantially all of the assets of the former William Lyon Homes, where Mr. Doyle had served as Director of Sales and Marketing for the Southern California Division after his hire in November 1997. In January 2006, Mr. Doyle became Vice President and Division Manager for the San Diego Division. In January 2008, Mr. Doyle became Division President for the San Diego/Inland Division. In February 2009, Mr. Doyle became the Southern California Division President. Mr. Doyle has more than 10 years experience in the real estate development and homebuilding industry.

GARY L. GALINDO, Vice President and Northern California Division President, joined the Company in 2003 as Director of Land Acquisition for the Northern California Division. In January 2006, Mr. Galindo became Vice President and Division Manager for the Sacramento Division. In January 2008, Mr. Galindo became the Northern California Division President. Mr. Galindo has more than 10 years experience in the real estate development and homebuilding industry.

CYNTHIA E. HARDGRAVE, Vice President — Tax and Internal Audit, joined the Company in 1999 when it acquired substantially all of the assets of the former William Lyon Homes, where Ms. Hardgrave had served in various tax management positions since her hire in July 1989. Ms. Hardgrave is a CPA and has more than 25 years experience in real estate tax and audit.

Section 16(a) Beneficial Ownership Reporting Compliance

During 2009, the Company had no class of equity securities registered under Section 12 of the Securities Exchange Act of 1934. Accordingly, no reports were required to be filed during or with respect to the year ended December 31, 2009 on Form 3, Form 4 and Form 5 by the Company’s directors, officers and 10% stockholders.

Code of Ethics

The Board has adopted a Code of Business Conduct and Ethics (the “Code of Ethics”) that is applicable to all directors, employees, and officers of the Company. The Code of Ethics constitutes the Company’s “code of ethics” within the meaning

 

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of Section 406 of the Sarbanes-Oxley Act. The Company intends to disclose future amendments to certain provisions of the Code of Ethics, or waivers of such provisions applicable to the Company’s directors and executive officers, on the Company’s website at www.lyonhomes.com.

The Code of Ethics is available on the Company’s website at www.lyonhomes.com. In addition, printed copies of the Code of Ethics are available upon written request to Investor Relations, William Lyon Homes, 4490 Von Karman Avenue, Newport Beach, California 92660.

 

Item 11.

Executive Compensation

Compensation Discussion and Analysis

Attracting, retaining, and motivating well-qualified executives is essential to the success of any company. This is particularly the case with the Company, as the homebuilding industry is highly competitive and is subject to market fluctuations beyond the Company’s control. The goals of the Company’s compensation program are to provide significant rewards for successful performance, and to encourage retention of top executives who may have attractive opportunities at other companies. At the same time, the Company tries to keep its selling, general and administrative (“SG&A”) costs at competitive levels when compared with other major homebuilders.

The Company’s compensation decisions are made by the Compensation Committee, which is composed entirely of independent outside members of the Company’s Board of Directors. The Compensation Committee receives recommendations from the Company’s senior executives and consults with outside independent compensation consultants as it deems appropriate. The Compensation Committee and its consultants also consider publicly-available information on the executive compensation of other major homebuilders. Members of the Company’s executive team are involved in the compensation process by assembling data to present to the Compensation Committee and, if necessary, working with the outside independent compensation consultants to give them the information necessary to enable them to complete their reports.

Internal Revenue Code Section 162(m) generally disallows a tax deduction to reporting companies for compensation over $1,000,000 paid to each of the Company’s chief executive officer and the four other most highly compensated officers, except for compensation that is “performance based.” Because the Company no longer has a class of publicly-traded equity securities outstanding, the Company is no longer subject to Section 162(m), and therefore it is not a factor in the Company’s compensation decisions.

Elements of Compensation

Salary

The Company’s Compensation Committee generally reviews the base salary of the Company’s named executive officers annually. In view of the Company’s desire to reward performance and loyalty while keeping SG&A costs competitive, the Company does not regard salary as the principal component of the compensation of its named executive officers. The Company believes that the salaries of its named executive officers are very conservative when compared with the salaries paid by other major homebuilders to similar officers.

Bonuses

Near the beginning of each year, the Compensation Committee sets objective performance criteria for the bonuses of named executive officers for that year. Although the Compensation Committee sets the objective performance criteria at the beginning of each year, in practice the objective performance criteria have been essentially the same for the past several years. The Company believes that the virtual uniformity of the objective performance criteria over the past several years has helped to reward productivity and loyalty by stabilizing the goalposts for bonuses over changing economic times. The objective performance criteria which the Compensation Committee has selected correlate each named executive officer’s bonus directly to the Company’s consolidated pre-tax, pre-bonus income (or, in the case of a division president, to his division’s pre-tax, pre-bonus income), thereby directly rewarding performance.

The Company believes that the bonus plan for its named executive officers is similar to the bonus plans at other major homebuilders. Application of the objective performance criteria can produce large bonuses in the event that the Company has (or the relevant division has) high pre-tax, pre-bonus income. The Company believes that large bonuses for its named executive officers are appropriate if the Company has (or the relevant division has) high pre-tax, pre-bonus income, particularly because in recent years the Company has not awarded any options or other equity compensation.

 

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A named executive officer’s right to receive a bonus is conditioned on his being actively employed by the Company on the date of payment, except in the case of retirement, death or disability. Bonuses for a particular year will be paid out over two years, with 75% paid following the determination of the bonus, and 25% paid one year later, again conditioned on continued employment to the date of payment, except in the case of retirement, death or disability. These provisions help insure the loyalty and continued service of the Company’s named executive officers.

The Compensation Committee retains the discretion to increase the bonus of a named executive officer in the event of an extraordinary performance, or decrease it in the case of a substandard performance, and may make this determination on the basis of objective or subjective criteria, including, but not limited to, the pay levels of executives at other major homebuilders. In practice, the Compensation Committee has seldom exercised this discretion in recent years.

Summary Compensation Table

The following table summarizes the annual and long-term compensation during 2009, 2008 and 2007 of the Company’s Principal Executive Officer, Principal Financial Officer and the three additional most highly compensated executive officers whose annual salaries and bonuses exceeded $100,000 in total during the fiscal year ended December 31, 2009 (collectively, the “Named Executive Officers”).

 

Name and Principal Position

   Year    Salary
($)(1)
   Bonus
($)(2)(3)
   Stock
Awards
($)
   Option
Awards
($)
   Non-Equity
Incentive Plan
Compensation
($)(1)(2)(3)
   Change in
Pension Value
and
Nonqualified
Deferred
Compensation
Earnings ($)
   All Other
Compensation
($)(4)
   Total ($)

General William Lyon

Chairman of the Board and Chief

Executive Officer (Principal

    Executive Officer)

   2009

2008

2007