William Lyon Homes (WLH) 10-Q 2006 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE 

   SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2006

OR

¨    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

    SECURITIES EXCHANGE ACT OF 1934

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	(I.R.S. Employer
incorporation or organization)	Identification No.)
4490 Von Karman Avenue
Newport Beach, California	92660
(Address of principal executive offices)	(Zip Code)

(949) 833-3600

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year,

if changed since last report)

Indicate by check mark whether the 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  x                    NO  ¨

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

Large accelerated filer  ¨                    Accelerated filer  x                    Non-accelerated filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

YES  ¨                    NO  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class of Common Stock	Outstanding at May 1, 2006
Common stock, par value $.01	8,652,067

WILLIAM LYON HOMES

INDEX

	Page No.
PART I.    FINANCIAL INFORMATION
Item 1.    Financial Statements:
Consolidated Balance Sheets — March 31, 2006 and December 31, 2005	3
Consolidated Statements of Income — Three Months Ended March 31, 2006 and 2005	4
Consolidated Statement of Stockholders’ Equity — Three Months Ended March 31, 2006	5
Consolidated Statements of Cash Flows — Three Months Ended March 31, 2006 and 2005	6
Notes to Consolidated Financial Statements	7
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations	31
Item 3.    Quantitative and Qualitative Disclosures About Market Risk	47
Item 4.    Controls and Procedures	48
PART II.    OTHER INFORMATION	49
Item 1.    Legal Proceedings	49
Item 1A. Risk Factors	50
Item 2.    Not Applicable	50
Item 3.    Not Applicable	50
Item 4.    Not Applicable	50
Item 5.    Not Applicable	50
Item 6.    Exhibits	51
SIGNATURES	52
EXHIBIT INDEX	53

2

PART I.    FINANCIAL INFORMATION

Item 1.    Financial Statements.

WILLIAM LYON HOMES

CONSOLIDATED BALANCE SHEETS

(in thousands except number of shares and par value per share)

ASSETS
	March 31, 2006		December 31, 2005
	(unaudited)
Cash and cash equivalents	$	24,994	$	52,369
Receivables		33,092		143,481
Real estate inventories — Notes 2 and 3		1,544,545		1,419,248
Investments in and advances to unconsolidated joint ventures — Note 3		1,527		397
Property and equipment, less accumulated depreciation of $10,517 and $9,936 at March 31, 2006 and December 31, 2005, respectively		18,577		18,553
Deferred loan costs		12,082		12,323
Goodwill — Note 1		5,896		5,896
Other assets		39,027		38,735
	$	1,679,740	$	1,691,002
LIABILITIES AND STOCKHOLDERS’ EQUITY
Accounts payable	$	56,067	$	67,326
Accrued expenses		119,781		181,068
Notes payable		199,959		125,619
7 5/8% Senior Notes due December 15, 2012 — Note 4		150,000		150,000
10 3/4% Senior Notes due April 1, 2013 — Note 4		246,989		246,917
7 1/2% Senior Notes due February 15, 2014 — Note 4		150,000		150,000
		922,796		920,930
Minority interest in consolidated entities — Notes 2 and 3		186,734		227,178
Stockholders’ equity — Note 6
Common stock, par value $.01 per share; 30,000,000 shares authorized; 8,652,067 shares issued and outstanding at March 31, 2006 and December 31, 2005, respectively; 1,275,000 shares issued and held in treasury at March 31, 2006 and December 31, 2005, respectively		86		86
Additional paid-in capital		36,506		35,404
Retained earnings		533,618		507,404
		570,210		542,894
	$	1,679,740	$	1,691,002

See accompanying notes.

3

WILLIAM LYON HOMES

CONSOLIDATED STATEMENTS OF INCOME

(in thousands except per common share amounts)

(unaudited)

	Three Months Ended March 31,
	2006			2005
Operating revenue
Home sales	$	307,381		$	244,656
Lots, land and other sales		—			2,026
		307,381			246,682
Operating costs
Cost of sales — homes		(229,443	)		(174,982	)
Cost of sales — lots, land and other		(430	)		(1,813	)
Sales and marketing		(13,124	)		(11,115	)
General and administrative		(18,589	)		(17,441	)
Other		(826	)		(682	)
		(262,412	)		(206,033	)
Equity in income (loss) of unconsolidated joint ventures — Note 3		3,638			(411	)
Minority equity in income of consolidated entities — Note 2		(5,226	)		(6,260	)
Operating income		43,381			33,978
Financial advisory expenses — Note 8		(1,500	)		—
Other income (loss), net		1,241			(105	)
Income before provision for income taxes		43,122			33,873
Provision for income taxes — Note 1		(16,908	)		(13,380	)
Net income	$	26,214		$	20,493
Earnings per common share — Note 1
Basic	$	3.03		$	2.38
Diluted	$	3.02		$	2.36

See accompanying notes.

4

WILLIAM LYON HOMES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

Three Months Ended March 31, 2006

(in thousands)

(unaudited)

	Common Stock			Additional Paid-In Capital		Retained Earnings		Total
	Shares	Amount
Balance — December 31, 2005	8,652	$	86	$	35,404	$	507,404	$	542,894
Income tax benefit from unused recognized built-in losses — Note 1	—		—		1,102		—		1,102
Net income	—		—		—		26,214		26,214
Balance — March 31, 2006	8,652	$	86	$	36,506	$	533,618	$	570,210

See accompanying notes.

5

WILLIAM LYON HOMES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Three Months Ended March 31,
	2006			2005
Operating activities
Net income	$	26,214		$	20,493
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization		581			523
Equity in (income) loss of unconsolidated joint ventures		(3,638	)		411
Distributions of income from unconsolidated joint ventures		2,599			—
Minority equity in income of consolidated entities		5,226			6,260
State income tax refund credited to additional paid-in capital		10			—
Provision for income taxes		16,908			13,380
Net changes in operating assets and liabilities:
Receivables		110,389			13,398
Real estate inventories		(139,225	)		(163,257	)
Deferred loan costs		241			338
Other assets		(8,696	)		(1,828	)
Accounts payable		(11,259	)		9,412
Accrued expenses		(77,103	)		(67,468	)
Net cash used in operating activities		(77,753	)		(168,338	)
Investing activities
Investments in and advances to unconsolidated joint ventures		(91	)		(1,177	)
Purchases of property and equipment		(605	)		(417	)
Net cash used in investing activities		(696	)		(1,594	)
Financing activities
Proceeds from borrowing on notes payable		569,098			357,575
Principal payments on notes payable		(494,758	)		(249,741	)
Minority interest distributions, net		(23,266	)		(347	)
Net cash provided by financing activities		51,074			107,487
Net decrease in cash and cash equivalents		(27,375	)		(62,445	)
Cash and cash equivalents — beginning of period		52,369			96,074
Cash and cash equivalents — end of period	$	24,994		$	33,629
Supplemental disclosures of cash flow information
Real estate inventories and minority interest from previously consolidated variable interest entity	$	14,000		$	—
Other assets and minority interest from previously consolidated variable interest entity	$	8,404		$	—
Income tax benefit credited to additional paid-in capital	$	1,092		$	—

See accompanying notes.

6

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Note 1 — Basis of Presentation and Significant Accounting Policies

William Lyon Homes, a Delaware corporation, and subsidiaries (the “Company”) are primarily engaged in designing, constructing and selling single family detached and attached homes in California, Arizona and Nevada.

The unaudited consolidated financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and in accordance with the rules and regulations of the Securities and Exchange Commission. The consolidated financial statements do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. The consolidated financial statements included herein should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.

The interim consolidated financial statements have been prepared in accordance with the Company’s customary accounting practices. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a presentation in accordance with U.S. generally accepted accounting principles have been included. Operating results for the three months ended March 31, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006.

The preparation of the Company’s financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of the assets and liabilities as of March 31, 2006 and December 31, 2005 and revenues and expenses for the periods presented. Accordingly, actual results could differ materially from those estimates in the near-term.

Certain reclassifications have been made to the prior year financial statements to conform to the current period presentation.

The consolidated financial statements include the accounts of the Company and all majority-owned and controlled subsidiaries and joint ventures, and certain joint ventures and other entities which have been determined to be variable interest entities in which the Company is considered the primary beneficiary (see Note 2). Investments in joint ventures which have not been determined to be variable interest entities in which the Company is considered the primary beneficiary 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). The accounting policies of the joint ventures are substantially the same as those of the Company. All significant intercompany accounts and transactions have been eliminated in consolidation.

The Company designs, constructs and sells a wide range of homes designed to meet the specific needs of each of its markets. For internal reporting purposes, the Company is organized into five geographic home building regions and its mortgage origination operation. Because each of the Company’s geographic home building regions has similar economic characteristics, housing products and class of prospective buyers, the geographic home building regions have been aggregated into a single home building segment.

The Company evaluates performance and allocates resources primarily based on the operating income of individual home building projects. Operating income is defined by the Company as operating revenue less operating costs plus equity in loss of unconsolidated joint ventures less minority equity in income of consolidated entities. Accordingly, operating income excludes certain expenses included in the determination of net income. All other segment measurements are disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.

7

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

A provision for warranty costs relating to the Company’s limited warranty plans is included in cost of sales at the time the home sale is recorded. The Company generally reserves approximately one percent of the sales price of its homes against the possibility of future charges relating to its one-year limited warranty and similar potential claims. Factors that affect the Company’s warranty liability include the number of homes under warranty, historical and anticipated rates of warranty claims, and cost per claim. The Company periodically assesses the adequacy of its recorded warranty liability and adjusts the amounts as necessary. Changes in the Company’s warranty liability during the three months ended March 31 are as follows (in thousands):

	March 31,
	2006			2005
Warranty liability, beginning of period	$	20,219		$	14,308
Warranty provision during period		3,986			2,701
Warranty settlements during period		(4,438	)		(4,230	)
Warranty liability, end of period	$	19,767		$	12,779

At December 31, 2005, the Company has unused recognized built-in losses in the amount of $23,297,000 which are available to offset future taxable income and expire between 2009 and 2011. The utilization of these losses is limited to offset $3,883,000 of taxable income per year; however, any unused losses in any year may be carried forward for utilization in future years through 2011. The income tax benefit from the built-in losses was $1,102,000 for the three months ended March 31, 2006, and was credited to additional paid-in capital. The Company’s ability to utilize the foregoing tax benefits will depend upon the amount of its future taxable income and may be further limited under certain circumstances.

Earnings per share amounts for all periods presented conform to Financial Accounting Standards Board Statement of Financial Accounting Standards No. 128,Earnings Per Share. Basic and diluted earnings per common share for the three months ended March 31, 2006 are based on 8,652,067 and 8,669,836 weighted average shares of common stock outstanding, respectively. Basic and diluted earnings per common share for the three months ended March 31, 2005 are based on 8,616,236 and 8,692,890 weighted average shares of common stock outstanding, respectively.

On June 29, 2005, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue No. 04-05, “Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights” (“EITF 04-05”). The scope of EITF 04-05 is limited to limited partnerships or similar entities (such as limited liability companies that have governing provisions that are the functional equivalent of a limited partnership) that are not variable interest entities under Interpretation No. 46 (see Note 2) and provides a new framework for addressing when a general partner in a limited partnership, or managing member in the case of a limited liability company, controls the entity. Under EITF 04-05, the Company may be required to consolidate certain investments in which the Company holds a general partner or managing member interest. EITF 04-05 was effective after June 29, 2005 for new entities formed after such date and for existing entities for which the agreements are subsequently modified and is effective for the Company’s fiscal year beginning January 1, 2006 for all other entities. The adoption of EITF 04-05 did not have any impact on the Company’s financial statements as of March 31, 2006, since the Company already recognizes its proportionate share of joint venture earnings and losses under the equity method of accounting.

Effective January 1, 2006, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”) using the

8

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

modified prospective transition method. In accordance with the modified prospective transition method, results for prior periods have not been restated. Prior to January 1, 2006, the Company accounted for all stock-based awards granted, modified or settled under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and related Interpretations.

The adoption of SFAS 123R did not have a material impact on the Company’s financial condition or results of operations for the three months ended March 31, 2006 as there were no stock-based awards for which the requisite service period had not been rendered that were accounted for under APB 25.

Note 2 — Consolidation of Variable Interest Entities

In January 2003, the Financial Accounting Standards Board issued Interpretation No. 46,Consolidation of Variable Interest Entities, as amended (“Interpretation No. 46”) which addresses the consolidation of variable interest entities (“VIEs”). Under Interpretation No. 46, 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.

Under Interpretation No. 46, a VIE is created when (i) the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties or (ii) equity holders 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 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 Interpretation No. 46, an enterprise that absorbs a majority of the expected losses or residual returns of the VIE is considered the primary beneficiary and must consolidate the VIE.

Based on the provisions of Interpretation No. 46, the Company has concluded that under certain circumstances when the Company (i) enters into option agreements for the purchase of land or lots from an entity and pays a non-refundable deposit, (ii) enters into land banking arrangements or (iii) enters into arrangements with a financial partner for the formation of joint ventures which engage in homebuilding and land development activities, a VIE may be created under condition (ii) (b) or (c) of the previous paragraph. The Company may be deemed to have provided subordinated financial support, which refers to variable interests that will absorb some or all of an entity’s expected losses if they occur. For each VIE created, the Company has computed expected losses and residual returns based on the probability of future cash flows as outlined in Interpretation No. 46. If the Company has been determined to be the primary beneficiary of the VIE, the assets, liabilities and operations of the VIE have been consolidated with the Company’s financial statements.

Supplemental consolidating financial information of the Company, specifically including information for the joint ventures and land banking arrangements consolidated under Interpretation No. 46, is presented below to allow investors to determine the nature of assets held and the operations of the consolidated entities. Investments in consolidated entities in the financial statements of wholly-owned entities presented below use the equity method of accounting. Consolidated real estate inventories include land deposits under option agreements or land banking arrangements (excluding the consolidated land banking arrangements as previously described in this paragraph) of $75,804,000 and $77,956,000 at March 31, 2006 and December 31, 2005, respectively.

The joint ventures which have been determined to be VIEs are each engaged in homebuilding and land development activities. Certain of these joint ventures have not obtained construction financing from outside lenders, but are financing their activities through equity contributions from each of the joint venture partners.

9

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

Creditors of these VIEs have no recourse against the general credit of the Company. Income allocations and cash distributions to the Company are based on predetermined formulas between the Company and the joint venturers as specified in the applicable partnership or operating agreements. The Company generally receives, after partners’ priority returns and return of partners’ capital, approximately 50% of the profits and cash flows from the joint ventures.

The Company enters into purchase agreements with various land sellers. In some instances, and as a method of acquiring land in staged takedowns, thereby minimizing the use of funds from the Company’s revolving credit facilities and 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 lots. 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 20% of the total purchase price. The Company is under no obligation to purchase the balance of the lots, but would forfeit remaining deposits and 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. As described above, Interpretation No. 46, requires the consolidation of the assets, liabilities, and operations of three of the Company’s land banking arrangements including, as of March 31, 2006, real estate inventories of $64,363,000. The Company participates in three land banking arrangements, which are not VIEs in accordance with Interpretation No. 46, and are not consolidated as of March 31, 2006 and December 31, 2005. The deposits related to the three land banking projects have been recorded in the accompanying consolidated balance sheet. The financial statements of these three entities are not consolidated with the Company’s consolidated financial statements.

Summary information with respect to the Company’s consolidated and unconsolidated land banking arrangements is as follows as of March 31, 2006 (dollars in thousands):

	Consolidated		Unconsolidated
Total number of land banking projects		3		3
Total number of lots		267		673
Total purchase price	$	84,085	$	116,821
Balance of lots still under option and not purchased:
Number of lots		217		97
Purchase price	$	64,363	$	25,458
Forfeited deposits and penalties if lots are not purchased	$	7,076	$	8,427

10

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONDENSED CONSOLIDATING BALANCE SHEET BY FORM OF OWNERSHIP

(in thousands)

	March 31, 2006
	Wholly- Owned		Variable Interest Entities Under Interpretation No. 46		Eliminating Entries			Consolidated Total
ASSETS
Cash and cash equivalents	$	16,004	$	8,990	$	—		$	24,994
Receivables		32,214		878		—			33,092
Real estate inventories		1,228,490		316,055		—			1,544,545
Investments in and advances to unconsolidated joint ventures		1,527		—		—			1,527
Investments in consolidated entities		77,701		—		(77,701	)		—
Other assets		75,582		—		—			75,582
Intercompany receivables		5,232		2,933		(8,165	)		—
	$	1,436,750	$	328,856	$	(85,866	)	$	1,679,740
LIABILITIES AND STOCKHOLDERS’ EQUITY
Accounts payable and accrued expenses	$	161,677	$	14,171	$	—		$	175,848
Notes payable		157,874		42,085		—			199,959
7 5/8% Senior Notes due December 15, 2012		150,000		—		—			150,000
10 3/4% Senior Notes due April 1, 2013		246,989		—		—			246,989
7 1/2% Senior Notes due February 15, 2014		150,000		—		—			150,000
Intercompany payables		—		8,165		(8,165	)		—
Total liabilities		866,540		64,421		(8,165	)		922,796
Minority interest in consolidated entities		—		—		186,734			186,734
Owners’ capital
William Lyon Homes		—		77,701		(77,701	)		—
Others		—		186,734		(186,734	)		—
Stockholders’ equity		570,210		—		—			570,210
	$	1,436,750	$	328,856	$	(85,866	)	$	1,679,740

11

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONDENSED CONSOLIDATING BALANCE SHEET BY FORM OF OWNERSHIP

(in thousands)

	December 31, 2005
	Wholly- Owned		Variable Interest Entities Under Interpretation No. 46		Eliminating Entries			Consolidated Total
ASSETS
Cash and cash equivalents	$	26,271	$	26,098	$	—		$	52,369
Receivables		128,074		15,407		—			143,481
Real estate inventories		1,119,127		300,121		—			1,419,248
Investments in and advances to unconsolidated joint ventures		397		—		—			397
Investments in consolidated entities		88,197		—		(88,197	)		—
Other assets		67,103		8,404		—			75,507
Intercompany receivables		—		6,583		(6,583	)		—
	$	1,429,169	$	356,613	$	(94,780	)	$	1,691,002
LIABILITIES AND STOCKHOLDERS’ EQUITY
Accounts payable and accrued expenses	$	223,306	$	25,088	$	—		$	248,394
Notes payable		109,469		16,150		—			125,619
7 5/8% Senior Notes due December 15, 2012		150,000		—		—			150,000
10 3/4% Senior Notes due April 1, 2013		246,917		—		—			246,917
7 1/2% Senior Notes due February 15, 2014		150,000		—		—			150,000
Intercompany payables		6,583		—		(6,583	)		—
Total liabilities		886,275		41,238		(6,583	)		920,930
Minority interest in consolidated entities		—		—		227,178			227,178
Owners’ capital
William Lyon Homes		—		88,197		(88,197	)		—
Others		—		227,178		(227,178	)		—
Stockholders’ equity		542,894		—		—			542,894
	$	1,429,169	$	356,613	$	(94,780	)	$	1,691,002

12

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONDENSED CONSOLIDATING STATEMENT OF INCOME BY FORM OF OWNERSHIP

(in thousands)

	Three Months Ended March 31, 2006
	Wholly- Owned			Variable Interest Entities Under Interpretation No. 46			Elimination Entries			Consolidated Total
Operating revenue
Sales	$	271,220		$	36,161		$	—		$	307,381
Management fees		1,072			—			(1,072	)		—
		272,292			36,161			(1,072	)		307,381
Operating costs
Cost of sales		(206,559	)		(24,386	)		1,072			(229,873	)
Sales and marketing		(11,469	)		(1,655	)		—			(13,124	)
General and administrative		(18,531	)		(58	)		—			(18,589	)
Other		(826	)		—			—			(826	)
		(237,385	)		(26,099	)		1,072			(262,412	)
Equity in income of unconsolidated joint ventures		3,638			—			—			3,638
Equity in income of consolidated entities		4,994			—			(4,994	)		—
Minority equity in income of consolidated entities		—			—			(5,226	)		(5,226	)
Operating income		43,539			10,062			(10,220	)		43,381
Financial advisory expenses		(1,500	)		—			—			(1,500	)
Other income, net		1,083			158			—			1,241
Income before provision for income taxes		43,122			10,220			(10,220	)		43,122
Provision for income taxes		(16,908	)		—			—			(16,908	)
Net income	$	26,214		$	10,220		$	(10,220	)	$	26,214

13

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONDENSED CONSOLIDATING STATEMENT OF INCOME BY FORM OF OWNERSHIP

(in thousands)

	Three Months Ended March 31, 2005
	Wholly- Owned			Variable Interest Entities Under Interpretation No. 46			Eliminating Entries			Consolidated Total
Operating revenue
Sales	$	189,459		$	57,223		$	—		$	246,682
Management fees		1,913			—			(1,913	)		—
		191,372			57,223			(1,913	)		246,682
Operating costs
Cost of sales		(137,327	)		(41,381	)		1,913			(176,795	)
Sales and marketing		(8,624	)		(2,491	)		—			(11,115	)
General and administrative		(17,441	)		—			—			(17,441	)
Other		(682	)		—			—			(682	)
		(164,074	)		(43,872	)		1,913			(206,033	)
Equity in loss of unconsolidated joint ventures		(411	)		—			—			(411	)
Equity in income of consolidated entities		7,234			—			(7,234	)		—
Minority equity in income of consolidated entities		—			—			(6,260	)		(6,260	)
Operating income		34,121			13,351			(13,494	)		33,978
Other (loss) income, net		(248	)		143			—			(105	)
Income before provision for income taxes		33,873			13,494			(13,494	)		33,873
Provision for income taxes		(13,380	)		—			—			(13,380	)
Net income	$	20,493		$	13,494		$	(13,494	)	$	20,493

14

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

Note 3 — Investments in and Advances to Unconsolidated 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. The consolidated financial statements of the Company include the accounts of the Company, all majority-owned and controlled subsidiaries and certain joint ventures which have been determined to be variable interest entities in which the Company is considered the primary beneficiary (see Note 2). The financial statements of joint ventures which have not been determined to be variable interest entities in which the Company is 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). Condensed combined financial information of these unconsolidated joint ventures as of March 31, 2006 and December 31, 2005 is summarized as follows:

CONDENSED COMBINED BALANCE SHEETS

(in thousands)

	March 31, 2006		December 31, 2005
	(unaudited)
ASSETS
Cash and cash equivalents	$	2,643	$	2,580
Receivables		3,597		3,253
Real estate inventories		31,339		31,279
Investment in unconsolidated joint ventures		1,593		—
Property and equipment		1,002		956
	$	40,174	$	38,068
LIABILITIES AND OWNERS’ CAPITAL
Accounts payable	$	5,992	$	5,127
Notes payable		31,450		32,377
Advances from William Lyon Homes		272		181
		37,714		37,685
Owners’ capital
William Lyon Homes		1,255		216
Others		1,205		167
		2,460		383
	$	40,174	$	38,068

15

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONDENSED COMBINED STATEMENTS OF INCOME

(in thousands)

	Three Months Ended March 31,
	2006			2005
Operating revenue
Land sales	$	10,420		$	—
Operating costs
Cost of sales — land		(7,801	)		—
General and administrative		—			(4	)
Other		(259	)		(287	)
		(8,060	)		(291	)
Equity in income (loss) of unconsolidated joint ventures		4,792			(531	)
Operating income (loss)		7,152			(822	)
Other income		124			—
Net income (loss)	$	7,276		$	(822	)
Allocation to owners
William Lyon Homes	$	3,638		$	(411	)
Others		3,638			(411	)
	$	7,276		$	(822	)

Income allocations and cash distributions to the Company are based on predetermined formulas between the Company and the joint venture partners as specified in the applicable partnership or operating agreements. The Company generally receives, after partners’ priority returns and return of partners’ capital, approximately 50% of the profits and cash flows from joint ventures.

The Company is a member in an unconsolidated joint venture limited liability company formed for the purpose of acquiring and developing land in Nevada. At March 31, 2006, the unconsolidated joint venture had outstanding land acquisition and development debt of $31,450,000, of which the Company guaranteed $15,725,000.

Note 4 — Senior Notes

As of March 31, 2006, the Company had the following outstanding Senior Note obligations (collectively, the “Senior Notes”) (in thousands):

7 5/8% Senior Notes due December 15, 2012	$	150,000
10 3/4% Senior Notes due April 1, 2013		246,989
7 1/2% Senior Notes due February 15, 2014		150,000
	$	546,989

7 ⁵/8% Senior Notes

On November 22, 2004, the Company’s 100% owned subsidiary, William Lyon Homes, Inc., a California corporation, (“California Lyon”) closed its offering of $150,000,000 principal amount of 7 ⁵/8% Senior Notes due

16

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

December 15, 2012 (the “7 ⁵/8% Senior Notes”). The notes were sold pursuant to Rule 144A. The notes were issued at par resulting in net proceeds to the Company of approximately $148,500,000. California Lyon agreed to file a registration statement with the Securities and Exchange Commission relating to an offer to exchange the notes for publicly tradeable notes having substantially identical terms. On January 12, 2005, the Securities and Exchange Commission declared the registration statement effective and California Lyon commenced an offer to exchange any and all of its outstanding $150,000,000 aggregate principal amount of 7 ⁵/8% Senior Notes due December 15, 2012, which are not registered under the Securities Act of 1933, for a like amount of its new 7 ⁵/8% Senior Notes due December 15, 2012, which are registered under the Securities Act of 1933, upon the terms and subject to the conditions set forth in the prospectus dated January 12, 2005. The exchange offer was completed for $146,500,000 principal amount of the 7 ⁵/8% Senior Notes on February 18, 2005. The remaining $3,500,000 principal amount of the old notes remains outstanding. The terms of the new notes are identical in all material respects to those of the old notes, except for certain transfer restrictions, registration rights and liquidated damages provisions relating to the old notes. Interest on the 7 ⁵/8% Senior Notes is payable semi-annually on December 15 and June 15 of each year.

Except as set forth in the Indenture governing the 7 ⁵/8% Senior Notes, the 7 ⁵/8% Senior Notes are not redeemable prior to December 15, 2008. Thereafter, the 7 ⁵/8% Senior Notes will be 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. In addition, on or before December 15, 2007, California Lyon may redeem up to 35% of the aggregate principal amount of the notes with the proceeds of qualified equity offerings at a redemption price equal to 107.625% of the principal amount, plus accrued and unpaid interest, if any.

10 ³/4% Senior Notes

California Lyon filed a Registration Statement on Form S-3 with the Securities and Exchange Commission for the sale of $250,000,000 of Senior Notes due 2013 (the “10 ³/4% Senior Notes”) which became effective on March 12, 2003. The offering closed on March 17, 2003 and was fully subscribed and issued. The notes were issued at a price of 98.493% to the public, resulting in net proceeds to the Company of approximately $246,233,000. 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 accompanying consolidated balance sheet. Interest on the 10 ³/4% Senior Notes is payable on April 1 and October 1 of each year.

Except as set forth in the Indenture governing the 10 ³/4% Senior Notes, the 10 ³/4% Senior Notes are not redeemable prior to April 1, 2008. Thereafter, the 10 ³/4% Senior Notes will be 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. In addition, on or before April 1, 2006, California Lyon may redeem up to 35% of the aggregate principal amount of the notes with the proceeds of qualified equity offerings at a redemption price equal to 110.75% of the principal amount, plus accrued and unpaid interest, if any.

7 ¹/2% Senior Notes

On February 6, 2004, California Lyon closed its offering of $150,000,000 principal amount of 7 ¹/2% Senior Notes due 2014 (the “7 ¹/2% Senior Notes”). The notes were sold pursuant to Rule 144A and outside the United States to non-U.S. persons in reliance on Regulation S. The notes were issued at par, resulting in net proceeds to the Company of approximately $147,600,000. California Lyon agreed to file a registration statement with the

17

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

Securities and Exchange Commission relating to an offer to exchange the notes for publicly tradeable notes having substantially identical terms. On July 16, 2004, the Securities and Exchange Commission declared the registration statement effective and California Lyon commenced an offer to exchange any and all of its outstanding $150,000,000 aggregate principal amount of 7 ¹/2% Senior Notes due 2014, which are not registered under the Securities Act of 1933, for a like amount of its new 7 ¹/2% Senior Notes due 2014, which are registered under the Securities act of 1933, upon the terms and subject to the conditions set forth in the prospectus dated July 16, 2004. The exchange offer was completed for the full principal amount of the 7 ¹/2% Senior Notes on August 17, 2004. The terms of the new notes are identical in all material respects to those of the old notes, except for certain transfer restrictions, registration rights and liquidated damages provisions relating to the old notes. The new notes have been listed on the New York Stock Exchange. Interest on the 7 ¹/2% Senior Notes is payable on February 15 and August 15 of each year.

Except as set forth in the Indenture governing the 7 ¹/2% Senior Notes, the 7 ¹/2% Senior Notes are not redeemable prior to February 15, 2009. Thereafter, the 7 ¹/2% Senior Notes will be 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. In addition, on or before February 15, 2007, California Lyon may redeem up to 35% of the aggregate principal amount of the notes with the proceeds of qualified equity offerings at a redemption price equal to 107.50% of the principal amount, plus accrued and unpaid interest, if any.

*    *    *    *    *

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 $75,000,000 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 of such 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

18

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

agreements restricting the ability of Delaware Lyon’s 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.

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.

The net proceeds of the offerings were used to repay amounts outstanding under revolving credit facilities and other indebtedness. The remaining proceeds were used to pay fees and commissions related to the offering and for other general corporate purposes.

At March 31, 2006, the Company had approximately $157,875,000 of secured indebtedness (excluding approximately $42,084,000 of secured indebtedness of consolidated entities — see Note 2) and approximately $248,906,000 of additional secured indebtedness available to be borrowed under the Company’s credit facilities, as limited by the Company’s borrowing base formulas.

Supplemental consolidating financial information of the Company, specifically including information for California Lyon, the issuer of the 10 ³/4% Senior Notes, the 7 ¹/2% Senior Notes and the 7 ⁵/8% Senior Notes, and Delaware Lyon and the guarantor subsidiaries is presented below. Investments in subsidiaries are presented using the equity method of accounting. Separate financial statements of California Lyon and the guarantor subsidiaries are not provided, as the consolidating financial information contained herein provides a more meaningful disclosure to allow investors to determine the nature of assets held and the operations of the combined groups.

19

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONSOLIDATING BALANCE SHEET

March 31, 2006

(in thousands)

	Unconsolidated
	Delaware Lyon		California Lyon		Guarantor Subsidiaries		Non-Guarantor Subsidiaries		Eliminating Entries			Consolidated Company
ASSETS
Cash and cash equivalents	$	—	$	7,733	$	7,632	$	9,629	$	—		$	24,994
Receivables		—		11,095		21,117		880		—			33,092
Real estate inventories		—		1,315,709		2,090		226,746		—			1,544,545
Investments in and advances to unconsolidated joint ventures		—		1,527		—		—		—			1,527
Property and equipment, net		—		2,256		16,321		—		—			18,577
Deferred loan costs		—		12,082		—		—		—			12,082
Goodwill		—		5,896		—		—		—			5,896
Other assets		—		36,548		2,479		—		—			39,027
Investments in subsidiaries		570,210		78,122		8,686		—		(657,018	)		—
Intercompany receivables		—		1,667		126,406		2,933		(131,006	)		—
	$	570,210	$	1,472,635	$	184,731	$	240,188	$	(788,024	)	$	1,679,740
LIABILITIES AND STOCKHOLDERS’ EQUITY
Accounts payable	$	—	$	44,720	$	573	$	10,774	$	—		$	56,067
Accrued expenses		—		110,922		5,242		3,617		—			119,781
Notes payable		—		139,640		18,234		42,085		—			199,959
7 5/8% Senior Notes		—		150,000		—		—		—			150,000
10 3/4% Senior Notes		—		246,989		—		—		—			246,989
7 1/2% Senior Notes		—		150,000		—		—		—			150,000
Intercompany payables		—		121,174		1,667		8,165		(131,006	)		—
Total liabilities		—		963,445		25,716		64,641		(131,006	)		922,796
Minority interest in consolidated entities		—		—		—		—		186,734			186,734
Stockholders’ equity		570,210		509,190		159,015		175,547		(843,752	)		570,210
	$	570,210	$	1,472,635	$	184,731	$	240,188	$	(788,024	)	$	1,679,740

20

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONSOLIDATING BALANCE SHEET

December 31, 2005

(in thousands)

	Unconsolidated
	Delaware Lyon		California Lyon		Guarantor Subsidiaries		Non-Guarantor Subsidiaries		Eliminating Entries			Consolidated Company
ASSETS
Cash and cash equivalents	$	—	$	18,934	$	6,687	$	26,748	$	—		$	52,369
Receivables		—		75,505		52,567		15,409		—			143,481
Real estate inventories		—		1,226,916		2,090		190,242		—			1,419,248
Investments in and advances to unconsolidated joint ventures		—		397		—		—		—			397
Property and equipment, net		—		2,128		16,425		—		—			18,553
Deferred loan costs		—		12,323		—		—		—			12,323
Goodwill		—		5,896		—		—		—			5,896
Other assets		—		36,472		2,263		—		—			38,735
Investments in subsidiaries		542,894		88,254		10,332		—		(641,480	)		—
Intercompany receivables		—		1,667		113,530		6,583		(121,780	)		—
	$	542,894	$	1,468,492	$	203,894	$	238,982	$	(763,260	)	$	1,691,002
LIABILITIES AND STOCKHOLDERS’ EQUITY
Accounts payable	$	—	$	46,184	$	756	$	20,386	$	—		$	67,326
Accrued expenses		—		169,884		6,250		4,934		—			181,068
Notes payable		—		61,653		47,816		16,150		—			125,619
7 5/8% Senior Notes		—		150,000		—		—		—			150,000
10 3/4% Senior Notes		—		246,917		—		—		—			246,917
7 1/2% Senior Notes		—		150,000		—		—		—			150,000
Intercompany payables		—		120,113		1,667		—		(121,780	)		—
Total liabilities		—		944,751		56,489		41,470		(121,780	)		920,930
Minority interest in consolidated entities		—		—		—		—		227,178			227,178
Stockholders’ equity		542,894		523,741		147,405		197,512		(868,658	)		542,894
	$	542,894	$	1,468,492	$	203,894	$	238,982	$	(763,260	)	$	1,691,002

21

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONSOLIDATING STATEMENT OF INCOME

Three Months Ended March 31, 2006

(in thousands)

	Unconsolidated
	Delaware Lyon		California Lyon			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminating Entries			Consolidated Company
Operating revenue
Sales	$	—	$	229,846		$	41,374		$	36,161		$	—		$	307,381
Management fees		—		1,072			—			—			(1,072	)		—
		—		230,918			41,374			36,161			(1,072	)		307,381
Operating costs
Cost of sales		—		(180,123	)		(26,476	)		(24,346	)		1,072			(229,873	)
Sales and marketing		—		(9,814	)		(1,655	)		(1,655	)		—			(13,124	)
General and administrative		—		(18,489	)		(42	)		(58	)		—			(18,589	)
Other		—		—			(826	)		—			—			(826	)
		—		(208,426	)		(28,999	)		(26,059	)		1,072			(262,412	)
Equity in income (loss) of unconsolidated joint ventures		—		3,767			(129	)		—			—			3,638
Income from subsidiaries		26,214		17,153			—			—			(43,367	)		—
Minority equity in income of consolidated entities		—		—			—			—			(5,226	)		(5,226	)
Operating income		26,214		43,412			12,246			10,102			(48,593	)		43,381
Financial advisory expense		—		(1,500	)		—			—			—			(1,500	)
Other income, net		—		248			839			154			—			1,241
Income before provision for income taxes		26,214		42,160			13,085			10,256			(48,593	)		43,122
Provision for income taxes		—		(16,908	)		—			—			—			(16,908	)
Net income	$	26,214	$	25,252		$	13,085		$	10,256		$	(48,593	)	$	26,214

22

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONSOLIDATING STATEMENT OF INCOME

Three Months Ended March 31, 2005

(in thousands)

	Unconsolidated
	Delaware Lyon		California Lyon			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminating Entries			Consolidated Company
Operating revenue
Sales	$	—	$	153,259		$	36,200		$	57,223		$	—		$	246,682
Management fees		—		1,913			—			—			(1,913	)		—
		—		155,172			36,200			57,223			(1,913	)		246,682
Operating costs
Cost of sales		—		(108,604	)		(28,723	)		(41,381	)		1,913			(176,795	)
Sales and marketing		—		(7,218	)		(1,400	)		(2,497	)		—			(11,115	)
General and administrative		—		(17,309	)		(132	)		—			—			(17,441	)
Other		—		—			(682	)		—			—			(682	)
		—		(133,131	)		(30,937	)		(43,878	)		1,913			(206,033	)
Equity in loss of unconsolidated joint ventures		—		(268	)		(143	)		—			—			(411	)
Income (loss) from subsidiaries		20,493		12,345			(180	)		—			(32,658	)		—
Minority equity in income of consolidated entities		—		—			—			—			(6,260	)		(6,260	)
Operating income		20,493		34,118			4,940			13,345			(38,918	)		33,978
Other income (expense), net		—		161			(461	)		195			—			(105	)
Income before provision for income taxes		20,493		34,279			4,479			13,540			(38,918	)		33,873
Provision for income taxes		—		(13,362	)		—			(18	)		—			(13,380	)
Net income	$	20,493	$	20,917		$	4,479		$	13,522		$	(38,918	)	$	20,493

23

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONSOLIDATING STATEMENT OF CASH FLOWS

Three Months Ended March 31, 2006

(in thousands)

	Unconsolidated
	Delaware Lyon			California Lyon			Guarantor Subsidiaries			Non-Guarantor     Subsidiaries			Eliminating Entries			Consolidated Company
Operating activities
Net income	$	26,214		$	25,252		$	13,085		$	10,256		$	(48,593	)	$	26,214
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Depreciation and amortization		—			183			398			—			—			581
Equity in (income) loss of unconsolidated joint ventures		—			(3,767	)		129			—			—			(3,638	)
Distributions of income from unconsolidated joint ventures		—			1,599			1,000			—			—			2,599
Minority equity in income of consolidated entities		—			—			—			—			5,226			5,226
Equity in earnings of subsidiaries		(26,214	)		(17,153	)		—			—			43,367			—
State income tax refund credited to additional paid-in capital		—			10			—			—			—			10
Provision for income taxes		—			16,908			—			—			—			16,908
Net changes in operating assets and liabilities:
Receivables		—			64,410			31,450			14,529			—			110,389
Intercompany receivables/payables		—			—			(12,876	)		11,815			1,061			—
Real estate inventories		—			(101,831	)		(890	)		(36,504	)		—			(139,225	)
Deferred loan costs		—			241			—			—			—			241
Other assets		—			(8,480	)		(216	)		—			—			(8,696	)
Accounts payable		—			(1,464	)		(183	)		(9,612	)		—			(11,259	)
Accrued expenses		—			(74,778	)		(1,008	)		(1,317	)		—			(77,103	)
Net cash (used in) provided by operating activities		—			(98,870	)		30,889			(10,833	)		1,061			(77,753	)
Investing activities
Net change in investment in and advances to unconsolidated joint ventures		—			148			(239	)		—			—			(91	)
Purchases of property and equipment		—			(311	)		(294	)		—			—			(605	)
Investments in subsidiaries		—			27,285			1,646			—			(28,931	)		—
Advances to affiliates		—			(17,440	)		—			—			17,440			—
Net cash provided by investing activities		—			9,682			1,113			—			(11,491	)		(696	)
Financing activities
Proceeds from borrowings on notes payable		—			346,995			196,168			25,935			—			569,098
Principal payments on notes payable		—			(269,008	)		(225,750	)		—			—			(494,758	)
Minority interest contributions, net		—			—			—			(23,266	)		—			(23,266	)
Advances from (to) affiliates		—			—			(1,475	)		(8,955	)		10,430			—
Net cash provided by (used in) financing activities		—			77,987			(31,057	)		(6,286	)		10,430			51,074
Net (decrease) increase in cash and cash equivalents		—			(11,201	)		945			(17,119	)		—			(27,375	)
Cash and cash equivalents at beginning of period		—			18,934			6,687			26,748			—			52,369
Cash and cash equivalents at end of period	$	—		$	7,733		$	7,632		$	9,629		$	—		$	24,994

24

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONSOLIDATING STATEMENT OF CASH FLOWS

Three Months Ended March 31, 2005

(in thousands)

	Unconsolidated
	Delaware Lyon			California Lyon			Guarantor Subsidiaries			Non-Guarantor     Subsidiaries			Eliminating Entries			Consolidated Company
Operating activities
Net income	$	20,493		$	20,917		$	4,479		$	13,522		$	(38,918	)	$	20,493
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Depreciation and amortization		—			113			410			—			—			523
Equity in loss of unconsolidated joint ventures		—			268			143			—			—			411
Minority equity in income of consolidated entities		—			—			—			—			6,260			6,260
Equity in (earnings) loss of subsidiaries		(20,493	)		(12,345	)		180			—			32,658			—
Provision for income taxes		—			13,362			—			18			—			13,380
Net changes in operating assets and liabilities:
Receivables		—			5,372			3,660			4,366			—			13,398
Intercompany receivables/payables		—			—			7,366			1,196			(8,562	)		—
Real estate inventories		—			(163,279	)		(39	)		61			—			(163,257	)
Deferred loan costs		—			338			—			—			—			338
Other assets		—			(2,019	)		191			—			—			(1,828	)
Accounts payable		—			9,839			139			(566	)		—			9,412
Accrued expenses		—			(57,555	)		(291	)		(9,622	)		—			(67,468	)
Net cash (used in) provided by operating activities		—			(184,989	)		16,238			8,975			(8,562	)		(168,338	)
Investing activities
Net change in investment in unconsolidated joint ventures		—			(1,034	)		(143	)		—			—			(1,177	)
Purchases of property and equipment		—			(242	)		(175	)		—			—			(417	)
Investment in subsidiaries		—			28,145			4,998			—			(33,143	)		—
Advances from affiliates		—			1,352			—			—			(1,352	)		—
Net cash provided by (used in) investing activities		—			28,221			4,680			—			(34,495	)		(1,594	)
Financing activities
Proceeds from borrowings on notes payable		—			279,353			78,222			—			—			357,575
Principal payments on notes payable		—			(165,236	)		(81,108	)		(3,397	)		—			(249,741	)
Minority interest (distributions) contributions, net		—			(1,699	)		—			1,352			—			(347	)
Advances to affiliates		—			—			(19,995	)		(23,062	)		43,057			—
Net cash provided by (used in) financing activities		—			112,418			(22,881	)		(25,107	)		43,057			107,487
Net decrease in cash and cash equivalents		—			(44,350	)		(1,963	)		(16,132	)		—			(62,445	)
Cash and cash equivalents at beginning of period		—			57,420			6,170			32,484			—			96,074
Cash and cash equivalents at end of period	$	—		$	13,070		$	4,207		$	16,352		$	—		$	33,629

25

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

Note 5 — Related Party Transactions

On October 26, 2000, the Company’s Board of Directors (with Messrs. William Lyon and William H. Lyon abstaining) approved the purchase of 579 lots for a total purchase price of $12,581,000 from an entity controlled by William Lyon and William H. Lyon. The terms of the purchase agreement provide for an initial option payment of $1,000,000 and a rolling option takedown of the lots. In addition, one-half of the net profits in excess of six percent from the development are to be paid to the seller. Phased takedowns of approximately 20 lots each were anticipated to occur at periodic intervals for each of several product types through September 2004. As of December 31, 2004, all lots were purchased under this agreement. In addition, one-half of the net profits, as defined, in excess of six percent from the development are to be paid to the seller, of which $5,711,000 has been paid through March 31, 2006. This land acquisition qualified as an affiliate transaction under the Company’s 12 ¹/2% Senior Notes due July 1, 2003 Indenture dated as of June 29, 1994, as amended (“Old Indenture”). Pursuant to the terms of the Old Indenture, the Company determined that the land acquisition is on terms that are no less favorable to the Company than those that would have been obtained in a comparable transaction by the Company with an unrelated person. The Company delivered to the Trustee under the Old Indenture a resolution of the Board of Directors of the Company set forth in an Officers’ Certificate certifying that the land acquisition is on terms that are no less favorable to the Company than those that would have been obtained in a comparable transaction by the Company with an unrelated person and the land acquisition was approved by a majority of the disinterested members of the Board of Directors of the Company. Further, the Company delivered to the Trustee under the Indenture a determination of value by a real estate appraisal firm which is of regional standing in the region in which the subject property is located and is MAI certified.

For the three months ended March 31, 2006 and 2005, the Company incurred reimbursable on-site labor costs of $29,000 and $33,000, respectively, for providing customer service to real estate projects developed by entities controlled by William Lyon and William H. Lyon, and $5,000 and $32,000 was due to the Company at March 31, 2006 and December 31, 2005, respectively, for reimbursable on-site labor costs.

For each of the three month periods ended March 31, 2006 and 2005, the Company incurred charges of $189,000 related to rent on its corporate office, from a trust of which William H. Lyon is the sole beneficiary.

Effective September 1, 2004, the Company entered into an aircraft consulting and management agreement with an affiliate (the “Affiliate”) of William Lyon to operate and manage the Company’s aircraft which was placed in service effective as of September 1, 2004. The terms of the agreement provide that the Affiliate shall consult and render its advice and management services to the Company with respect to all functions necessary to the operation, maintenance and administration of the aircraft. The Company’s business plan for the aircraft includes (i) use by Company executives for traveling on Company business to the Company’s divisional offices and other destinations, (ii) charter service to outside third parties and (iii) charter service to William Lyon personally. Charter services for outside third parties and William Lyon personally are contracted for at market rates. As compensation to the Affiliate for its management and consulting services under the agreement, the Company pays the Affiliate a fee equal to (i) the amount equal to 107% of compensation paid by the affiliate for the pilots supplied pursuant to the agreement, (ii) $50 per operating hour for the aircraft and (iii) $9,000 per month for hangar rent. In addition, all maintenance work, inspections and repairs performed by the Affiliate on the aircraft are charged to the Company at the Affiliate’s published rates for maintenance, inspections and repairs in effect at the time such work is completed. The total compensation paid to the Affiliate under the agreement amounted to $361,000 and $179,000 for the three months ended March 31, 2006 and 2005, respectively.

Pursuant to the agreement above, the Company had earned revenue of $79,000 and $71,000 for charter services provided to William Lyon personally, for the three months ended March 31, 2006 and 2005,

26

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

respectively, and $176,000 and $129,000 was due to the Company at March 31, 2006 and December 31, 2005, respectively, for charter services provided.

The Company and one of the Company’s directors, Alex Meruelo, are parties to an agreement pursuant to which Mr. Meruelo is eligible to receive a finder’s fee based upon the cash distributions received by a subsidiary of the Company from a joint venture development project relating to a portion of the Fort Ord military base in Monterey County, California. The joint venture development project resulted from Mr. Meruelo’s introduction of the Company to Woodman Development Company, LLC (“Woodman”) and the subsequent formation of East Garrison Partners I, LLC (“EGP”) as a joint venture between Woodman and Lyon East Garrison Company I, LLC (“EGC”). The finder’s fee will equal 5% of all net cash distributions distributed by EGP to EGC with respect to EGC’s existing 50% interest in EGP that are in excess of distributions with respect to certain deficit advances, deficit preferred returns, returns of capital and preferred returns on unreturned capital. The calculation of the finder’s fee will be based on net cash distributions received from EGP on land sales and will not be determined on the basis of any revenues, profits or distributions received from any affiliate of EGC for the construction and sale or leasing of residential or commercial buildings on such lots. Mr. Meruelo is not obligated to perform any services for EGC other than the introduction to Woodman.

The Company offers home mortgage loans to its employees and directors through its mortgage company subsidiary, William Lyon Financial Services. These loans are made in the ordinary course of business and on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons. These loans do not involve more than the normal risk of collectibility or present other unfavorable features and are sold to investors typically within 7 to 15 days.

Note 6 — Stockholders’ Equity

On November 12, 2004 the Company’s Board of Directors approved an increase in the size of the Company’s previously announced stock repurchase program to 3,000,000 shares of its common stock (including any shares previously repurchased by the Company under the program). Under the program, as originally adopted in September 2001, the Company could repurchase 20% of its then outstanding shares of common stock or approximately 2,000,000 shares. Under the plan, the stock will be purchased from time to time in privately negotiated transactions or the open market in compliance with Securities and Exchange Commission Rule 10b-18, subject to market conditions, applicable legal requirements and other factors. The timing and amounts of any purchases will be as determined by the Company’s management from time to time or may be suspended at any time or from time to time without prior notice, depending on market conditions and other factors they deem relevant. The repurchased shares may be held as treasury stock and used for general corporate purposes or cancelled. As of March 31, 2006, 1,218,400 shares of common stock had been purchased for $26,750,000 and retired under this program and 1,275,000 shares of common stock had been purchased for $81,001,000 and held in treasury. No shares were purchased under this program during the three months ended March 31, 2006 and 2005.

Note 7 — Commitments and Contingencies

The Company’s commitments and contingent liabilities include the usual obligations incurred by real estate developers in the normal course of business. In the opinion of management, these matters will not have a material effect on the Company’s consolidated financial position, results of operations or cash flows.

Duxford Title Reinsurance Company, a wholly-owned subsidiary of the Company, provides title reinsurance to unrelated title insurers directly issuing title policies on homes sold by the Company in California, Nevada and Arizona. In February 2005, Duxford Title Reinsurance Company was notified by its title insurers that as a result

27

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

of current investigations by several state insurance regulators into the large number of captive reinsurance arrangements existing in the title insurance industry, the title insurers were suspending and/or terminating their current captive reinsurance agreements with Duxford Title Reinsurance Company pending final determination from the appropriate regulatory bodies as to their permissibility or necessary modification to assure compliance with applicable law. In April 2005, in response to a subpoena issued by the California Insurance Commissioner, the Company testified in connection with the Commissioner’s investigation of captive reinsurance arrangements, including testimony that in many instances, the Company pays for the title insurance being issued. The Company has not had any further communication to date from the California Insurance Commissioner or any other state insurance regulator about this matter and does not believe that the resolution of this matter will have a material effect on the Company’s financial position, results of operations or cash flows. In November 2005, the Company was notified that the United States Department of Housing and Urban Development had instituted a formal Federal investigation of the Company in connection with its participation in captive title reinsurance arrangements. The Company intends to fully cooperate with the Department in its investigation and does not believe that the resolution of this matter will have a material effect on the Company’s financial position, results of operations or cash flows.

Litigation Arising from General Lyon’s Tender Offer

As described above in Part I, Item 2 under the caption “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 has since been 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, andMichael 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 theBrown action also filed a First Amended Complaint. The Delaware Complaints name the Company and the directors of the Company as defendants. These complaints allege, among other things, that the defendants have 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 23, 2006, the Company announced that its Board had appointed a special committee of independent directors who are not members of the Company’s management or employed by the Company (the “Special Committee”) to consider the Tender Offer. The members of the Special Committee are Harold H. Greene, Lawrence M. Higby, and Dr. Arthur Laffer. The Company also announced that the Special Committee had retained Morgan Stanley & Co. as its financial advisor and Gibson, Dunn & Crutcher LLP as its legal counsel.

On March 24, 2006, the Delaware Chancery Court consolidated the Delaware Complaints into a single case entitledIn 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

28

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

Consolidated Delaware Action have determined that the settlement is “fair, reasonable, adequate, and in the best interests of plaintiffs and the putative Class.” The Special Committee 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.

On April 23, 2006, Delaware Chancery Court conditionally certified a class in the Consolidated Delaware Action. The parties to the Consolidated Delaware Action are negotiating a Stipulation of Settlement, and expect that the Delaware Chancery Court will soon schedule a settlement hearing to evaluate the settlement.

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 captionedAlaska Electrical Pension Fund v. William Lyon Homes, Inc., et al., Case No. 06-CC-00047, was filed. On April 5, 2006, plaintiff in theAlaska Electrical action filed an Amended Complaint (the “California Action”). The complaint in the California Action names the Company and the 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 has filed a motion to certify a class in the California Action, and the Company has filed a motion to stay the California Action. Both motions are currently scheduled for hearing on May 11, 2006.

The Company is a defendant in various lawsuits related to its normal business activities. In the opinion of management, disposition of the various lawsuits will have no material effect on the consolidated financial statements of the Company.

See Note 2 for information relating to the Company’s land banking arrangements.

In some jurisdictions in which the Company develops and constructs property, assessment district bonds are issued by municipalities to finance major infrastructure improvements. As a land owner benefited by these improvements, the Company is responsible for the assessments on its land. When properties are sold, the assessments are either prepaid or the buyers assume the responsibility for the related assessments. Assessment district bonds issued after May 21, 1992 are accounted for under the provisions of Statement 91-10, “Accounting for Special Assessment and Tax Increment Financing Entities” issued by the Emerging Issues Task Force of the Financial Accounting Standards Board on May 21, 1992, and recorded as liabilities in the Company’s consolidated balance sheet, if the amounts are fixed and determinable.

As of March 31, 2006, the Company had $4.5 million of outstanding irrevocable standby letters of credit to guarantee the Company’s financial obligations under certain land banking arrangements, joint venture agreements and other contractual arrangements in the normal course of business. The beneficiary may draw upon these letters of credit in the event of a contractual default by the Company relating to each respective obligation. These letters of credit have a stated term of up to two years and have varying maturities through 2007, at which time the Company may be required to renew the letters of credit to coincide with the term of the respective arrangement.

The Company also had outstanding performance and surety bonds of $264.2 million at March 31, 2006 related principally to its obligations for site improvements at various projects. The Company does not believe that draws upon these bonds, if any, will have a material effect on the Company’s financial position, results of operations or cash flows.

29

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

The Company has provided unsecured environmental indemnities to certain lenders, joint venture partners and land sellers. In each case, the Company has performed due diligence on the potential environmental risks, including obtaining an independent environmental review from outside environmental consultants. These indemnities obligate the Company to reimburse the guaranteed parties for damages related to environmental matters. There is no term or damage limitation on these indemnities; however, if an environmental matter arises, the Company could have recourse against other previous owners.

See Notes 3 and 4 for additional information relating to the Company’s guarantee arrangements.

Note 8 — Tender Offer

On March 17, 2006, General William Lyon, Chairman of the Board and Chief Executive Officer of the Company announced that he commenced an offer to purchase all outstanding shares of common stock of William Lyon Homes not already owned by him for $93.00 per share in cash. The expiration date for the tender offer at the time of the offer was Thursday, April 13, 2006, unless the offer were extended.

The offer is subject to the non-waivable condition that there shall have been validly tendered and not withdrawn before the offer expires at least a majority of the outstanding shares not owned by General Lyon, The William Harwell Lyon 1987 Trust, The William Harwell Lyon Separate Property Trust or the officers and directors of William Lyon Homes immediately before the commencement of the offer. The offer is also subject to the receipt by General Lyon of the proceeds under his financing commitment from Lehman Commercial Paper Inc. and Lehman Brothers Inc. The offer is also subject to other terms and conditions as set forth in the tender offer materials filed with the Securities and Exchange Commission and being distributed to William Lyon Homes stockholders, and was initially subject to the further condition that sufficient shares are tendered in the offer such that the tendered shares, together with the shares already directly or indirectly owned by General Lyon and the trusts, would represent at least 90% of the shares outstanding upon expiration of the offer.

On March 23, 2006, the Company announced that its board of directors had formed a special committee of independent directors to consider the offer by General Lyon with the assistance of outside financial and legal advisors which the special committee retained. On April 10, 2006, General Lyon announced that he would amend his tender offer for all the outstanding shares of William Lyon Homes by increasing the offer price to $100 per share. The special committee determined that it would recommend that stockholders tender their shares in connection with the amended offer. General Lyon also extended his offer until Friday, April 21, 2006. General Lyon has also reached an agreement in principle, subject to court approval, to settle certain class action lawsuits that have been filed in Delaware on behalf of William Lyon Homes’ stockholders. Another class action lawsuit filed in California remains pending.

On April 24, 2006, General Lyon announced that he was extending his tender offer for all outstanding shares of William Lyon Homes not owned by him through April 28, 2006, and that he would waive the 90% condition to the offer. On May 1, 2006, General Lyon announced that he was further extending the tender offer through May 12, 2006, and that he was further amending the tender offer by increasing the offer price to $109 per share. All other terms and conditions of the offer remain the same, as set forth in the tender offer materials disseminated by General Lyon.

The Company estimates that it will incur approximately $3,100,000 in financial advisory expenses related to the tender offer, of which $1,500,000 was incurred during the three months ended March 31, 2006, and is reflected as financial advisory expenses in the accompanying consolidated statement of income.

See Note 7 for information on certain lawsuits which have been filed relating to General Lyon’s proposal.

30

Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

WILLIAM LYON HOMES

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 consolidated financial statements and notes thereto included in Item 1, as well as the information presented in the Annual Report on Form 10-K for the year ended December 31, 2005.

Results of Operations

Overview and Recent Results

Selected financial and operating information for the Company including its wholly-owned projects and joint ventures as of and for the periods presented is as follows:

	Three Months Ended March 31,
	2006									2005
	Wholly-Owned			Joint Ventures			Consolidated Total			Wholly-Owned			Joint Ventures			Consolidated Total
Selected Financial Information (dollars in thousands)
Homes closed		516			65			581			364			95			459
Home sales revenue	$	271,220		$	36,161		$	307,381		$	187,433		$	57,223		$	244,656
Cost of sales		(206,129	)		(23,314	)		(229,443	)		(135,514	)		(39,468	)		(174,982	)
Gross margin	$	65,091		$	12,847		$	77,938		$	51,919		$	17,755		$	69,674
Gross margin percentage		24.0	%		35.5	%		25.4	%		27.7	%		31.0	%		28.5	%
Number of homes closed
California		263			65			328			117			95			212
Arizona		99			—			99			126			—			126
Nevada		154			—			154			121			—			121
Total		516			65			581			364			95			459
Average sales price
California	$	640,800		$	556,300		$	624,100		$	867,100		$	602,400		$	748,500
Arizona		417,900			—			417,900			287,300			—			287,300
Nevada		398,100			—			398,100			411,400			—			411,400
Total	$	525,600		$	556,300		$	529,100		$	514,900		$	602,400		$	533,000
Number of net new home orders
California		296			96			392			376			205			581
Arizona		116			—			116			159			—			159
Nevada		139			—			139			133			—			133
Total		551			96			647			668			205			873
Average number of sales locations during period
California		24			7			31			15			9			24
Arizona		6			—			6			6			—			6
Nevada		11			—			11			8			—			8
Total		41			7			48			29			9			38

31

	As of March 31,
	2006						2005
	Wholly-Owned		Joint Ventures		Consolidated Total		Wholly-Owned		Joint Ventures		Consolidated Total
Backlog of homes sold but not closed at end of period
California		641		154		795		616		355		971
Arizona		413		—		413		515		—		515
Nevada		149		—		149		94		—		94
Total		1,203		154		1,357		1,225		355		1,580
Dollar amount of homes sold but not closed at end of period (dollars in thousands)
California	$	459,291	$	77,222	$	536,513	$	453,105	$	224,482	$	677,587
Arizona		133,658		—		133,658		157,306		—		157,306
Nevada		51,012		—		51,012		36,299		—		36,299
Total	$	643,961	$	77,222	$	721,183	$	646,710	$	224,482	$	871,192
Lots controlled at end of period
Owned lots
California		4,237		1,225		5,462		3,716		1,350		5,066
Arizona		2,721		1,738		4,459		3,766		—		3,766
Nevada		1,460		—		1,460		1,072		—		1,072
Total		8,418		2,963		11,381		8,554		1,350		9,904
Optioned lots(1)
California						4,101						4,060
Arizona						6,012						5,421
Nevada						2,137						1,272
Total						12,250						10,753
Total lots controlled
California						9,563						9,126
Arizona						10,471						9,187
Nevada						3,597						2,344
Total						23,631						20,657

(1) Optioned lots may be purchased by the Company as wholly-owned projects or may be purchased by newly formed joint ventures.

During the last half of the fourth quarter of 2005, the Company began to experience some slowing in new orders in many of its markets, increases in cancellation rates and increasing pricing pressures from several of its competitors who initiated aggressive incentive and discounting programs. This softening in the Company’s markets is continuing into 2006.

On a consolidated basis, the number of net new home orders for the three months ended March 31, 2006 decreased 25.9% to 647 homes from 873 homes for the three months ended March 31, 2005. The number of homes closed on a consolidated basis for the three months ended March 31, 2006, increased 26.6% to 581 homes from 459 homes for the three months ended March 31, 2005. On a consolidated basis, the backlog of homes sold but not closed as of March 31, 2006 was 1,357, down 14.1% from 1,580 homes a year earlier, and up 5.1% from 1,291 homes at December 31, 2005.

Homes in backlog are generally closed within three to six months. The dollar amount of backlog of homes sold but not closed on a consolidated basis as of March 31, 2006 was $721.2 million, down 17.2% from $871.1 million as of March 31, 2005 and up 4.3% from $691.6 million as of December 31, 2005. 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 the three months ended March 31, 2006 compared to 12% during the three months ended March 31, 2005. The inventory of completed and unsold homes was 72 homes as of March 31, 2006.

32

The average number of sales locations during the quarter ended March 31, 2006 was 48, up 26% from 38 in the comparable period a year ago, as a result of the Company’s focus begun in 2005 to increase the number of sales locations in each of its markets. The Company’s number of new home orders per average sales location decreased to 13.5 for the quarter ended March 31, 2006 as compared to 23.0 for the quarter ended March 31, 2005.

In general, housing demand is adversely affected by increases in interest rates and housing prices. Interest rates, the length of time that assets remain in inventory, and the proportion of inventory that is financed affect the Company’s interest cost. If the Company is unable to raise sales prices sufficiently to compensate for higher costs or if mortgage interest rates increase significantly, affecting prospective buyers’ ability to adequately finance home purchases, the Company’s sales, gross margins and operating results may be adversely impacted.

Comparison of Three Months Ended March 31, 2006 to March 31, 2005

Consolidated operating revenue for the three months ended March 31, 2006 was $307.4 million, an increase of $60.7 million, or 25.0%, from consolidated operating revenue of $246.7 million for the three months ended March 31, 2005. Revenue from sales of wholly-owned homes increased $83.8 million, or 44.7%, to $271.2 million in the 2006 period from $187.4 million in the 2005 period. The increase was primarily due to an increase in the number of wholly-owned homes closed to 516 in the 2006 period from 364 in the 2005 period and a slight increase in the average sales price of wholly-owned homes to $525,600 in the 2006 period from $514,900 in the 2005 period. Consolidated operating revenue includes revenue from sales of joint ventures due to the adoption of Interpretation No. 46. Revenue from sales of joint venture homes decreased $21.0 million, or 36.7%, to $36.2 million in the 2006 period from $57.2 million in the 2005 period, primarily due to a decrease in the number of joint venture homes closed to 65 in the 2006 period from 95 in the 2005 period and a decrease in the average sales price of joint venture homes to $556,300 in the 2006 period from $602,400 in the 2005 period. Revenue from sales of lots, land and other was $2.0 million in the 2005 period with no comparable amount in the 2006 period, due to the bulk sale of land in certain of the Company’s markets in the 2005 period. The increase in the average sales price of units closed in wholly-owned projects was due to price appreciation and the decrease in the average sales price of units closed in joint venture projects was due to a change in product mix.

Total operating income increased to $43.4 million in the 2006 period from $34.0 million in the 2005 period. The excess of revenue from sales of homes over the related cost of sales (gross margin) increased by $8.2 million to $77.9 million in the 2006 period from $69.7 million in the 2005 period primarily due to an increase in the number of homes closed to 581 in the 2006 period from 459 in the 2005 period, offset by a decrease in gross margin percentages to 25.4% in the 2006 period from 28.5% in the 2005 period. The decrease in period-over-period gross margin percentage primarily reflects the close out of projects with higher average gross margin percentages and a shift in product mix. The excess of revenue from sales of lots, land and other over the related cost of sales (gross margin) decreased to $(0.4) million in the 2006 period from $0.2 million in the 2005 period primarily due to the bulk sale of land in certain of the Company’s markets in the 2005 period with no comparable transaction in the 2006 period. In addition, costs were incurred related to the abandonment and write-off of project pre-acquisition costs and land option deposits for one of the Company’s potential projects in the 2006 period.

Sales and marketing expense increased by $2.0 million to $13.1 million in the 2006 period from $11.1 million in the 2005 period primarily due to an increase in developer marketing fees paid to the land sellers in certain of the communities in which the Company builds to $1.5 million in the 2006 period from $1.1 million in the 2005 period and an increase in direct selling expenses to $6.7 million in the 2006 period from $5.9 million in the 2005 period. General and administrative expenses increased by $1.2 million to $18.6 million in the 2006 period from $17.4 million in the 2005 period, primarily as a result of an increase in bonus expense to $8.2 million in the 2006 period from $7.4 million in the 2005 period due to higher levels of pre-tax, pre-bonus income. Selling, general and administrative expense as a percentage of home sales revenue was 10.3% in the 2006 period compared to 11.7% in the 2005 period. Other operating costs consist of operating losses realized by golf course operations at certain of the Company’s projects which increased to $0.8 million in the 2006 period compared to $0.7 million in the 2005 period. Equity in income (loss) from unconsolidated joint ventures increased to income of $3.6 million in the 2006 period from a loss of $0.4 million in the 2005 period. Minority

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equity in income of consolidated entities decreased to $5.2 million in the 2006 period from $6.3 million in the 2005 period, primarily due to a decrease in the number of joint venture homes closed to 65 in the 2006 period from 95 in 2005.

The Company incurred financial advisory expenses of $1.5 million in the 2006 period with no comparable amount in the 2005 period due to the tender offer described in “Item 2—Tender Offer”.

Total interest incurred increased to $18.7 million in the 2006 period from $15.2 million in the 2005 period, primarily as a result of an increase in the average principal balance of debt outstanding and an increase in interest rates. All interest incurred was capitalized in the 2006 and 2005 periods.

As a result of the factors outlined above, net income increased to $26.2 million in the 2006 period from $20.5 million in the 2005 period.

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 7 ⁵/8% Senior Notes due 2012, 10 ³/4% Senior Notes due 2013 and 7 ¹/2% Senior Notes due 2014 and maintains secured revolving credit facilities (“Revolving Credit Facilities”). 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 current borrowing capacity and increases reasonably available to it, cash on hand 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, run its day-to-day operations, acquire land and capital assets and fund its mortgage operations. 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, revolving credit facilities and other indebtedness.

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.

7 ⁵/8% Senior Notes

On November 22, 2004, the Company’s 100% owned subsidiary, William Lyon Homes, Inc., a California corporation, (“California Lyon”) closed its offering of $150.0 million principal amount of 7 ⁵/8% Senior Notes due 2012 (the “7 ⁵/8% Senior Notes”). The notes were sold pursuant to Rule 144A. The notes were issued at par resulting in net proceeds to the Company of approximately $148.5 million. California Lyon agreed to file a

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registration statement with the Securities and Exchange Commission relating to an offer to exchange the notes for publicly tradeable notes having substantially identical terms. On January 12, 2005, the Securities and Exchange Commission declared the registration statement effective and California Lyon commenced an offer to exchange any and all of its outstanding $150.0 million aggregate principal amount of 7 ⁵/8% Senior Notes due 2012, which are not registered under the Securities Act of 1933, for a like amount of its new 7 ⁵/8% Senior Notes due 2012, which are registered under the Securities Act of 1933, upon the terms and subject to the conditions set forth in the prospectus dated January 12, 2005. The exchange offer was completed for $146.5 million principal amount of the 7 ⁵/8% Senior Notes on February 18, 2005. The remaining $3.5 million principal amount of the old notes remains outstanding. The terms of the new notes are identical in all material respects to those of the old notes, except for certain transfer restrictions, registration rights and liquidated damages provisions relating to the old notes. 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 $5.7 million.

Except as set forth in the Indenture governing the 7 ⁵/8% Senior Notes, the 7 ⁵/8% Senior Notes are not redeemable prior to December 15, 2008. Thereafter, the 7 ⁵/8% Senior Notes will be 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. In addition, on or before December 15, 2007, California Lyon may redeem up to 35% of the aggregate principal amount of the notes with the proceeds of qualified equity offerings at a redemption price equal to 107.625% of the principal amount, plus accrued and unpaid interest, if any.

10 ³/4% Senior Notes

California Lyon filed a Registration Statement on Form S-3 with the Securities and Exchange Commission for the sale of $250.0 million of Senior Notes due 2013 (the “10 ³/4% Senior Notes”) which became effective on March 12, 2003. The offering closed on March 17, 2003 and was fully subscribed and issued. The notes were issued 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 accompanying consolidated balance sheet. 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 $13.4 million.

Except as set forth in the Indenture governing the 10 ³/4% Senior Notes, the 10 ³/4% Senior Notes are not redeemable prior to April 1, 2008. Thereafter, the 10 ³/4% Senior Notes will be 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. In addition, on or before April 1, 2006, California Lyon may redeem up to 35% of the aggregate principal amount of the notes with the proceeds of qualified equity offerings at a redemption price equal to 110.75% of the principal amount, plus accrued and unpaid interest, if any.

7 ¹/2% Senior Notes

On February 6, 2004, California Lyon closed its offering of $150.0 million principal amount of 7 ¹/2% Senior Notes due 2014 (the “7 ¹/2% Senior Notes”). The notes were sold pursuant to Rule 144A and outside the United States to non-U.S. persons in reliance on Regulation S. The notes were issued at par, resulting in net proceeds to the Company of approximately $147.6 million. California Lyon agreed to file a registration statement with the Securities and Exchange Commission relating to an offer to exchange the notes for publicly tradeable notes having substantially identical terms. On July 16, 2004, the Securities and Exchange Commission declared the registration statement effective and California Lyon commenced an offer to exchange any and all of its outstanding $150.0 million aggregate principal amount of 7 ¹/2% Senior Notes due 2014, which are not registered under the Securities Act of 1933, for a like amount of its new 7 ¹/2% Senior Notes due 2014, which are registered

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under the Securities act of 1933, upon the terms and subject to the conditions set forth in the prospectus dated July 16, 2004. The exchange offer was completed for the full principal amount of the 7 ¹/2% Senior Notes on August 17, 2004. The terms of the new notes are identical in all material respects to those of the old notes, except for certain transfer restrictions, registration rights and liquidated damages provisions relating to the old notes. The new notes have been listed on the New York Stock Exchange. 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 $5.6 million.

Except as set forth in the Indenture governing the 7 ¹/2% Senior Notes, the 7 ¹/2% Senior Notes are not redeemable prior to February 15, 2009. Thereafter, the 7 ¹/2% Senior Notes will be 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. In addition, on or before February 15, 2007, California Lyon may redeem up to 35% of the aggregate principal amount of the notes with the proceeds of qualified equity offerings at a redemption price equal to 107.50% of the principal amount, plus accrued and unpaid interest, if any.

*  *  *  *  *

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 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.

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.

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The net proceeds of the offerings were used to repay amounts outstanding under revolving credit facilities and other indebtedness. The remaining proceeds were used to pay fees and commissions related to the offering and for other general corporate purposes.

At March 31, 2006, the Company had approximately $157.9 million of secured indebtedness, (excluding approximately $42.1 million of secured indebtedness of consolidated entities) and approximately $248.9 million of additional secured indebtedness available to be borrowed under the Company’s credit facilities, as limited by the Company’s borrowing base formulas.

Revolving Credit Facilities

As of March 31, 2006, the Company has six revolving credit facilities which have an aggregate maximum loan commitment of $510.0 million, (including one facility of $150.0 million, one of $100.0 million, one of $90.0 million, one of $70.0 million and two of $50.0 million each), and mature at various dates through 2008. The revolving credit facilities have similar characteristics. The Company may borrow amounts, subject to applicable borrowing base and concentration limitations, as defined. During the last year of the term of each facility, the commitment amount will decrease ratably until the commitment under each facility is reduced to zero by the final maturity date, as defined in each respective agreement.

Availability under each credit facility is subject not only to the maximum amount committed under the respective facility, but also to both various borrowing base and concentration limitations. The borrowing base limits lender advances to certain agreed percentages of asset value. The allowed percentage generally increases as the asset progresses from land under development to residence subject to contract of sale. Advances for each type of collateral become due in whole or in part, subject to possible re-borrowing, and/or the collateral becomes excluded from the borrowing base, after a specified period or earlier upon sale. Concentration limitations further restrict availability under the credit facilities. The effect of these borrowing base and concentration limitations essentially is to mandate minimum levels of the Company’s investment in a project, with higher percentages of investment required at earlier phases of a project, and with greater absolute dollar amounts of investment required as a project progresses. Each revolving credit facility is secured by deeds of trust on the real property and improvements thereon owned by the Company in the subdivision project(s) approved by the respective lender, as well as pledges of all net sale proceeds, related contracts and other ancillary property. Also, each credit facility includes financial covenants, which may limit the amount that may be borrowed thereunder. Outstanding advances bear interest at various rates, which approximate the prime rate. As of March 31, 2006, $129.0 million was outstanding under these credit facilities, with a weighted-average interest rate of 7.262%, and the undrawn availability was $248.9 million as limited by the borrowing base formulas. Interest on the revolving credit facilities is calculated on the average, outstanding daily balance and is paid following the end of each month. During the three months ended March 31, 2006, the Company borrowed $347.0 million and repaid $268.0 million under these facilities. The maximum amount outstanding was $129.0 million and the weighted average borrowings were $71.6 million during the three months ended March 31, 2006. Interest incurred on the revolving credit facilities for the three months ended March 31, 2006 was $1.4 million. The Company routinely makes borrowings under its revolving credit facilities in the ordinary course of business within the maximum aggregate loan commitment amounts to fund its operations, including its land acquisition and home building activities, and repays such borrowings, as required by the credit facilities, with the net sales proceeds of sales of the real property, including homes, which secure the applicable credit facility.

Under the revolving credit facilities, 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 $200.0 million, adjusted upwards quarterly by 50% of Delaware Lyon’s quarterly net income after June 30, 2004;

• A ratio of total liabilities to tangible net worth, each as defined, of less than 3.25 to 1; and

• Minimum liquidity, as defined, of at least $10.0 million.

As of and for the period ending March 31, 2006, the Company is in compliance with these covenants.

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Construction Notes Payable

At March 31, 2006, the Company had construction notes payable on certain consolidated entities amounting to $42.1 million. The construction notes have various maturity dates and bear interest at rates ranging from 3% to prime plus 2.0% at March 31, 2006. Interest is calculated on the average daily balance and is paid following the end of each month.

Seller Financing

At March 31, 2006, the Company had $10.7 million of notes payable outstanding related to land acquisitions for which seller financing was provided. The seller financing notes are due at various dates through December 2007 and bear interest at rates ranging from 9.0% to 12.0% at March 31, 2006. Interest is calculated on the average principal balance outstanding and is accrued and paid when the financing is repaid.

Revolving Mortgage Warehouse Credit Facilities

The Company, through its mortgage subsidiary and one of its unconsolidated joint ventures, has entered into two revolving mortgage warehouse credit facilities with banks to fund its mortgage origination operations. The original credit facility, which matures in May 2006, provides for revolving loans of up to $30.0 million outstanding, $20.0 million of which is committed (lender obligated to lend if stated conditions are satisfied) and $10.0 million is not committed (lender advances are optional even if stated conditions are otherwise satisfied). However, as in the past the Company expects the maturity to be extended by the lender at each maturity date for an additional year. In August 2003, the Company’s mortgage subsidiary and one of its unconsolidated joint ventures entered into an additional $10.0 million credit facility which matures in October 2006. In October 2005, the additional credit facility was increased to $50.0 million. However, as in the past the Company expects the maturity to be extended by the lender at each maturity date for an additional year. Mortgage loans are generally held for a short period of time and are typically sold to investors within 7 to 15 days following funding. The facilities are secured by substantially all of the assets of each of the borrowers, including the mortgage loans held for sale, all rights of each of the borrowers with respect to contractual obligations of third party investors to purchase such mortgage loans, and all proceeds of sale of such mortgage loans. The facilities, which have LIBOR based pricing, also contain certain financial covenants requiring the borrowers to maintain minimum tangible net worth, leverage, profitability and liquidity. These facilities are non-recourse and are not guaranteed by the Company. At March 31, 2006 the outstanding balance under these facilities was $18.2 million.

Land Banking Arrangements

The Company enters into purchase agreements with various land sellers. In some instances, and as a method of acquiring land in staged takedowns, thereby minimizing the use of funds from the Company’s revolving credit facilities and 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 lots. 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 20% of the total purchase price. Additionally, the Company may be subject to other penalties if lots are not acquired. The Company is under no obligation to purchase the balance of the lots, but would forfeit remaining deposits and 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. As described in Note 2 of “Notes to Consolidated Financial Statements”, Interpretation No. 46, requires the consolidation of the assets, liabilities and operations of three of the Company’s land banking arrangements including, as of March 31, 2006, real estate inventories of $64.4 million. The Company participates in three land banking arrangements, which are not VIEs

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in accordance with Interpretation No. 46, and are not consolidated as of March 31, 2006 and December 31, 2005. The deposits related to the three land banking projects have been recorded in the accompanying consolidated balance sheet. Summary information with respect to the Company’s consolidated and unconsolidated land banking arrangements is as follows as of March 31, 2006 (dollars in thousands):

	Consolidated		Unconsolidated
Total number of land banking projects		3		3
Total number of lots		267		673
Total purchase price	$	84,085	$	116,821
Balance of lots still under option and not purchased:
Number of lots		217		97
Purchase price	$	64,363	$	25,458
Forfeited deposits and penalties if lots were not purchased	$	7,076	$	8,427

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 “Recently Issued Accounting Standards”, in accordance with Interpretation No. 46 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. 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 generally receives, after partners’ priority returns and returns of partners’ capital, approximately 50% of the profits and cash flows from joint ventures. 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. See Note 3 of “Notes to Consolidated Financial Statements” for condensed combined financial information for the unconsolidated joint ventures. 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 March 31, 2006, the Company’s investment in and advances to unconsolidated joint ventures was $1.5 million and the venture partners’ investment in such joint ventures was $1.2 million. As of March 31, 2006, these joint ventures had obtained financing from construction lenders which amounted to $31.5 million of outstanding indebtedness.

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.

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Cash Flows — Comparison of Three Months Ended March 31, 2006 to Three Months Ended March 31, 2005

Net cash used in operating activities decreased to $77.8 million in the 2006 period from $168.3 million in the 2005 period. The change was primarily as a result of (i) decreased expenditures in real estate inventories to $139.2 million in the 2006 period from $163.3 million in the 2005 period, (ii) an increase in net changes in accrued expenses to $77.1 million in the 2006 period from $67.5 million in the 2005 period, due to an increase in bonuses and income taxes paid in the 2006 period compared to the 2005 period and (iii) an increase in net income. The successful issuance of the 10 ³/4% Senior Notes in 2003 and the 7 ¹/2% Senior Notes and 7 ⁵/8% Senior Notes in 2004, offset by the repayment of the 12 ¹/2% Senior Notes, provided the Company with increased financial resources. 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 it cannot profitably build and sell homes. The market value of land, building lots and housing inventories can fluctuate significantly as a result of changing market conditions. 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.

Net cash used in investing activities decreased to $0.7 million in the 2006 period from $1.6 million in the 2005 period. The change was primarily as a result of a decrease in net cash paid to investments in unconsolidated joint ventures to $0.1 million in the 2006 period from $1.2 million in the 2005 period.

Net cash provided by financing activities decreased to $51.1 million in the 2006 period from $107.5 million in the 2005 period, primarily as a result of minority interest distributions of $23.3 million in the 2006 period compared to $0.3 million in the 2005 period and a decrease in net borrowings on notes payable to $74.3 million in the 2006 period from $107.8 million in the 2005 period.

Off-Balance Sheet Arrangements

The Company enters into certain off-balance sheet arrangements including joint venture financing, option arrangements, land banking arrangements and variable interests in consolidated and unconsolidated entities. These arrangements are more fully described above and in Notes 2, 3 and 7 to Consolidated Financial Statements. In addition, the Company is party to certain contractual obligations, including land purchases and project commitments, which are detailed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.

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Description of Projects

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 divisions.

Project (County) Product	Year of First Delivery	Estimated Number of Homes at Completion(1)	Units Closed as of March 31, 2006	Backlog at March 31, 2006(2)(3)	Lots Owned as of March 31, 2006	Homes Closed for the Three Months Ended March 31, 2006	Sales Price Range(5)
SOUTHERN CALIFORNIA COASTAL REGION
ORANGE COUNTY DIVISION
Wholly-Owned:
Mirador at Talega, San Clemente	2004	76	66	10	10	13	$1,115,000—1,270,000
Ambridge at Quail Hill, Irvine	2004	128	120	8	8	0	$500,000—570,000
Lombard Court, Irvine	2005	150	106	41	44	37	$445,000—633,000
Garland Park, Irvine	2005	166	102	42	64	2	$579,000—717,000
Seacove at the Waterfront, Huntington Beach	2004	106	106	0	0	8	$802,000—995,000
Floralisa, San Juan Capistrano	2005	80	18	29	62	8	$1,310,000—1,410,000
Estrella Rosa, San Juan Capistrano	2006	40	0	20	40	0	$1,675,000—1,725,000
Amarante II, Ladera Ranch	2006	18	0	18	18	0	$1,046,000—1,130,000
Bellataire II, Ladera Ranch	2006	23	0	23	23	0	$1,180,000—1,220,000
Tamarisk, Irvine	2005	113	89	24	24	25	$555,000—610,000
Columbus Grove, Irvine:
Lantana(6)	2006	102	0	26	102	0	$900,000—1,015,000
Kensington	2006	63	0	11	63	0	$740,000—850,000
Clarendon	2007	102	0	0	102	0	$289,000—714,000
Astoria(6)	2007	102	0	0	98	0	$1,015,000—1,185,000
Mirabella	2007	60	0	0	60	0	$723,000—858,000
Cambridge Lane	2007	156	0	0	156	0	$396,000—457,000
Ainsley Park	2007	84	0	0	84	0	$644,000—719,000
Ciara(6)	2007	67	0	0	67	0	$1,210,000—1,560,000
Verandas	2007	97	0	0	97	0	$729,000—847,000
Total Wholly-Owned		1,733	607	252	1,122	93
Joint Ventures:
Amarante, Ladera Ranch	2005	53	48	5	5	4	$965,000—1,060,000
Bellataire, Ladera Ranch	2005	52	43	9	9	0	$1,220,000—1,260,000
Total Joint Ventures		105	91	14	14	4
TOTAL ORANGE COUNTY		1,838	698	266	1,136	97
LOS ANGELES DIVISION
Wholly-Owned:
Meridian Hills, Moorpark:
Ashford	2006	113	0	0	113	0	$806,000—1,015,000
Marquis	2006	135	0	0	135	0	$895,000—1,129,000
Brighton (Affordable)	2007	17	0	0	17	0	$105,000—272,000
TOTAL LOS ANGELES		265	0	0	265	0
SAN DIEGO DIVISION
Wholly-Owned:
Promenade North, San Diego	2006	137	0	6	137	0	$444,000—510,000
Alcala at Del Sur, San Diego	2005	83	0	16	71	0	$770,000—792,000
Altair, Santee	2007	85	0	0	85	0	$444,000—505,000
Maybeck, San Diego	2006	120	0	0	93	0	$800,000—845,000
Sunset Cove, San Diego	2006	77	0	0	77	0	$528,000—558,000
Total Wholly-Owned:		502	0	22	463	0
Joint Ventures:
Ravenna, San Diego	2005	199	77	43	122	29	$471,000—510,000
Amante, San Diego	2005	127	77	9	50	12	$561,000—631,000
Treviso, San Diego	2005	186	52	17	134	17	$386,000—526,000
Belleza at San Miguel Village, Chula Vista	2005	195	125	14	70	3	$360,000—444,000
Total Joint Ventures:		707	331	83	376	61
TOTAL SAN DIEGO		1,209	331	105	839	61

41

Project (County) Product		Year of First Delivery	Estimated Number of Homes at Completion(1)	Units Closed as of March 31, 2006	Backlog at March 31, 2006(2)(3)	Lots Owned as of March 31, 2006	Homes Closed for the Three Months Ended March 31, 2006	Sales Price Range(5)
SOUTHERN CALIFORNIA COASTAL REGION COMBINED TOTAL
Wholly-Owned			2,500	607	274	1,850	93
Joint Ventures			812	422	97	390	65
	��
			3,312	1,029	371	2,240	158
NORTHERN CALIFORNIA REGION
BAY AREA/CENTRAL VALLEY DIVISION
Wholly-Owned:
Contra Costa County
Seagate at Bayside, Hercules		2005	96	38	18	58	10	$594,000—727,000
Wavecrest at Bayside, Hercules		2005	76	52	17	24	14	$724,000—776,000
Rivergate Laurels, Antioch		2005	72	72	0	0	3	$548,000—658,000
Rivergate II, Antioch		2006	95	4	14	91	4	$548,000—658,000
San Joaquin County
Seasons, Stockton		2005	145	101	22	44	18	$553,000—613,000
Santa Clara County
Baton Rouge, San Jose		2005	91	59	15	32	14	$536,000—661,000
Stanislaus County
Falling Leaf, Modesto
Trails		2006	100	0	0	100	0	$400,000—460,000
Groves		2006	131	0	0	131	0	$390,000—425,000
Meadows		2006	83	0	0	83	0	$450,000—520,000
Total Wholly-Owned			889	326	86	563	63
Joint Ventures:
Contra Costa County
Alves Ranch, Pittsburgh		2006	533	0	0	533	0	$326,000—691,000
Total Joint Ventures:			533	0	0	533	0
TOTAL BAY AREA/CENTRAL VALLEY			1,422	326	86	1,096	63
SACRAMENTO DIVISION
Wholly-Owned:
San Joaquin County
Ironwood II, Lathrop		2003	88	85	0	3	0	$276,000—317,000
Ironwood III, Lathrop		2005	109	79	2	30	8	$467,000—529,000
Placer County
Twin Oaks at Whitney Ranch Rocklin		2006	92	0	6	92	0	$634,000—666,000
Sacramento County
Verona at Anatolia, Rancho Cordova		2005	79	14	11	65	5	$460,000—505,000
Fair Oaks(6)		2007	189	0	0	189	0	$399,000—417,000
Total Wholly-Owned:			557	178	19	379	13
Joint Ventures:
Placer County
Shady Lane at Whitney Ranch Rocklin		2006	96	0	9	96	0	$443,000—453,000
Sacramento County
Big Horn, Elk Grove
Plaza Walk		2005	106	21	17	85	0	$359,000—419,000
Gallery Walk		2005	149	28	31	121	0	$230,000—356,000
Total Joint Ventures			351	49	57	302	0
TOTAL SACRAMENTO			908	227	76	681	13
NORTHERN CALIFORNIA REGION COMBINED TOTAL
Wholly-Owned			1,446	504	105	942	76
Joint Ventures			884	49	57	835	0
			2,330	553	162	1,777	76

42

Project (County) Product	Year of First Delivery	Estimated Number of Homes at Completion(1)	Units Closed as of March 31, 2006	Backlog at March 31, 2006(2)(3)	Lots Owned as of March 31, 2006	Homes Closed for the Three Months Ended March 31, 2006	Sales Price Range(5)
INLAND EMPIRE REGION
Wholly-Owned:
Riverside County
Heartland, North Corona
Homestead	2005	109	70	29	39	26	$598,000��670,000
Almont	2006	91	14	58	77	14	$487,000—555,000
Vander Stelt, Corona	2007	122	0	0	122	0	$575,000—675,000
Kasbergen/Serafina, North Corona	2007	314	0	0	314	0	$306,000—406,000
Bridle Creek, Corona	2003	274	174	6	100	2	$648,000—740,000
Sequoia at Wolf Creek, Temecula	2005	125	35	15	90	21	$389,000—438,000
Savannah at Harveston Ranch, Temecula	2005	162	0	50	162	0	$328,000—380,000
San Bernardino County
The Peaks at Citrus Heights, Fontana	2005	150	80	32	70	8	$605,000—665,000
Adelina, Fontana(6)	2007	109	0	0	109	0	$340,000—400,000
Chapman Heights, Yucaipa:
Braeburn	2005	113	31	12	37	12	$562,000—602,000
Crofton	2005	140	23	47	85	3	$437,000—466,000
Westland	2005	79	37	13	42	8	$498,000—521,000
Vista Bella	2006	108	0	0	108	0	$300,000—325,000
Redcort	2006	90	0	0	90	0	$330,000—356,000
INLAND EMPIRE REGION COMBINED TOTAL		1,986	464	262	1,445	94
ARIZONA REGION
Wholly-Owned:
Maricopa County
Gateway Crossing, Gilbert
Oakcrest	2003	236	236	0	0	1	$252,000—320,000
Woodridge	2003	165	165	0	0	1	$292,000—355,000
Sonoran Foothills, Phoenix
Desert Crown	2004	124	107	7	17	22	$441,000—544,000
Desert Sierra	2004	212	142	62	70	21	$249,000—307,000
Copper Canyon Ranch, Surprise
Rancho Vistas	2004	212	202	10	10	9	$490,000—600,000
Sunset Point	2004	282	159	83	123	28	$282,000—379,000
El Sendero Hills	2004	188	119	52	69	17	$377,000—470,000
Talavera, Phoenix	2006	134	0	33	134	0	$255,000—326,000
Coldwater Ranch, Maricopa County	2007	368	0	0	368	0	$209,000—277,000
Collin’s Creek, Phoenix	2007	126	0	0	126	0	$237,000—245,000
Rancho Mercado—Inn Suites Phoenix	2009	1,906	0	0	233	0	$231,000—300,000
Lyon’s Gate, Gilbert:
Pride	2006	548	0	83	548	0	$232,000—256,000
Savanna	2006	174	0	40	174	0	$248,000—344,000
Sahara	2006	169	0	43	169	0	$318,000—407,000
Future Products	2007	680	0	0	680	0
Total Wholly-Owned:		5,524	1,130	413	2,721	99
Joint Ventures:
Maricopa County
Hastings Property, Queen Creek	2007	822	0	0	822	0	$250,000—300,000
Church Farm, Queen Creek	2009	1,700	0	0	916	0	$250,000—318,000
Total Joint Ventures:		2,522	0	0	1,738	0
ARIZONA REGION TOTAL		8,046	1,130	413	4,459	99

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Project (County) Product	Year of First Delivery	Estimated Number of Homes at Completion(1)	Units Closed as of March 31, 2006	Backlog at March 31, 2006(2)(3)	Lots Owned as of March 31, 2006	Homes Closed for the Three Months Ended March 31, 2006	Sales Price Range(5)
NEVADA REGION
Wholly-Owned:
Clark County
Summerlin, Las Vegas
Granada	2004	144	118	9	26	13	$446,000—511,000
The Lyon Collection	2005	79	51	9	28	18	$624,000—659,000
Kingwood	2006	100	0	9	100	0	$430,000—516,000
North Las Vegas
The Classics	2003	227	220	1	7	0	$290,000—315,000
The Cottages	2004	360	224	27	136	15	$231,000—261,000
La Tierra	2006	67	0	15	67	0	$315,000—345,000
Goldfield	2006	134	0	0	125	0	$301,000—326,000
Carson Ranch, Las Vegas
West Series I	2005	71	66	1	5	24	$395,000—430,000
West Series II	2005	59	14	3	45	13	$456,000—511,000
East Series I	2007	104	0	9	104	0	$400,000—435,000
East Series II	2006	57	0	0	57	0	$395,000—430,000
West Park, Las Vegas
Villas	2006	191	0	1	191	0	$363,000—405,000
Courtyards	2006	113	0	1	113	0	$395,000—445,000
Tropical & Jones, Las Vegas	2006	49	0	0	49	0	$395,000—430,000
1/2 Acre Assemblage, Las Vegas	2007	138	0	0	138	0	$593,000—661,000
Mountain Falls, Pahrump:
Cascata	2005	147	78	35	69	24	$213,000—235,000
Tramonto	2005	212	94	19	118	28	$261,000—276,000
Bella Sera	2005	129	47	10	82	19	$322,000—362,000
NEVADA REGION TOTAL		2,381	912	149	1,460	154
GRAND TOTALS:
Wholly-Owned		13,837	3,617	1,203	8,418	516
Joint Ventures		4,218	471	154	2,963	65
		18,055	4,088	1,357	11,381	581

(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 March 31, 2006, 1,269 represent homes completed or under construction and 88 represent homes not yet under construction.

(4) Lots owned as of March 31, 2006 include lots in backlog at March 31, 2006.

(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 March 31, 2006. The Company consolidated the purchase price of the lots in accordance with Interpretation No. 46, and considers the lots owned at March 31, 2006.

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Net Operating Loss Carryforwards

At December 31, 2005, the Company has unused recognized built-in losses in the amount of $23.3 million which are available to offset future income and expire between 2009 and 2011. The utilization of these losses is limited to $3.9 million of taxable income per year; however, any unused losses in any year may be carried forward for utilization in future years through 2011. The Company’s ability to utilize the foregoing tax benefits will depend upon the amount of its future taxable income and may be limited under certain circumstances.

Neither the amount of the net operating loss carryforwards nor the amount of limitation on such carryforwards claimed by the Company has been audited or otherwise validated by the Internal Revenue Service, and it could challenge either amount the Company has calculated. It is possible that legislation or regulations will be adopted that would limit the Company’s ability to use the tax benefits associated with the current tax net operating loss carryforwards.

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.

Related Party Transactions

See Note 5 of the Notes to Consolidated Financial Statements for a description of the Company’s transactions with related parties.

Tender Offer

On March 17, 2006, General William Lyon, Chairman of the Board and Chief Executive Officer of the Company announced that he commenced an offer to purchase all outstanding shares of common stock of William Lyon Homes not already owned by him for $93.00 per share in cash. The expiration date for the tender offer at the time of the offer was Thursday, April 13, 2006, unless the offer were extended.

The offer is subject to the non-waivable condition that there shall have been validly tendered and not withdrawn before the offer expires at least a majority of the outstanding shares not owned by General Lyon, The William Harwell Lyon 1987 Trust, The William Harwell Lyon Separate Property Trust or the officers and directors of William Lyon Homes immediately before the commencement of the offer. The offer is also subject to the receipt by General Lyon of the proceeds under his financing commitment from Lehman Commercial Paper Inc. and Lehman Brothers Inc. The offer is also subject to other terms and conditions as set forth in the tender offer materials filed with the Securities and Exchange Commission and being distributed to William Lyon Homes stockholders, and was initially subject to the further condition that sufficient shares are tendered in the offer such that the tendered shares, together with the shares already directly or indirectly owned by General Lyon and the trusts, would represent at least 90% of the shares outstanding upon expiration of the offer.

On March 23, 2006, the Company announced that its board of directors had formed a special committee of independent directors to consider the offer by General Lyon with the assistance of outside financial and legal advisors which the special committee retained. On April 10, 2006, General Lyon announced that he would amend his tender offer for all the outstanding shares of William Lyon Homes by increasing the offer price to $100 per share. The special committee determined that it would recommend that stockholders tender their shares in connection with the amended offer. General Lyon also extended his offer until Friday, April 21, 2006. General Lyon has also reached an agreement in principle, subject to court approval, to settle certain class action lawsuits that have been filed in Delaware on behalf of William Lyon Homes’ stockholders. Another class action lawsuit filed in California remains pending.

45

On April 24, 2006, General Lyon announced that he was extending his tender offer for all outstanding shares of William Lyon Homes not owned by him through April 28, 2006, and that he would waive the 90% condition to the offer. On May 1, 2006, General Lyon announced that he was further extending the tender offer through May 12, 2006, and that he was further amending the tender offer by increasing the offer price to $109 per share. All other terms and conditions of the offer remain the same, as set forth in the tender offer materials disseminated by General Lyon.

The Company estimates that it will incur approximately $3,100,000 in financial advisory expenses related to the tender offer, of which $1,500,000 was incurred during the three months ended March 31, 2006, and is reflected as financial advisory expenses in the accompanying consolidated statement of income.

Board of Directors

On January 17, 2006, the Board of Directors of the Company appointed Lawrence M. Higby as an additional independent director to the Board of Directors. As a result of this appointment and the associated Board committee assignments of the previously appointed and elected directors, the Company has regained compliance with the listing requirements of the NYSE, including a majority of independent directors on the Board and the requisite composition of the Nominating and Corporate Governance Committee and the Audit Committee.

Critical Accounting Polices

The Company’s financial statements have been prepared in accordance with accounting principles generally accepted in the United States. 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. As disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, the Company’s most critical accounting policies are real estate inventories and cost of sales; impairment of real estate inventories; sales and profit recognition; and variable interest entities. Since December 31, 2005, there have been no changes in the Company’s most critical accounting policies and no material changes in the assumptions and estimates used by management.

Recently Issued Accounting Standards

On June 29, 2005, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue No. 04-05, “Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights” (“EITF 04-05”). The scope of EITF 04-05 is limited to limited partnerships or similar entities (such as limited liability companies that have governing provisions that are the functional equivalent of a limited partnership) that are not variable interest entities under Interpretation No. 46 and provides a new framework for addressing when a general partner in a limited partnership, or managing member in the case of a limited liability company, controls the entity. Under EITF 04-05, the Company may be required to consolidate certain investments in which the Company holds a general partner or managing member interest. EITF 04-05 was effective after June 29, 2005 for new entities formed after such date and for existing entities for which the agreements are subsequently modified and is effective for the Company’s fiscal year beginning January 1, 2006 for all other entities. The adoption of EITF 04-05 did not have any impact on the Company’s financial statements as of March 31, 2006, since the Company already recognizes its proportionate share of joint venture earnings and losses under the equity method of accounting.

Effective January 1, 2006, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”) using the

46

modified prospective transition method. In accordance with the modified prospective transition method, results for prior periods have not been restated. Prior to January 1, 2006, the Company accounted for all stock-based awards granted, modified or settled under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and related Interpretations.

The adoption of SFAS 123R did not have a material impact on the Company’s financial condition or results of operations for the three months ended March 31, 2006 as there were no stock-based awards for which the requisite service period had not been rendered that were accounted for under APB 25.

Forward-Looking Statements

Investors are cautioned that certain statements contained in this Quarterly Report on Form 10-Q, as well as some statements by the Company in periodic press releases and some oral statements by Company officials to securities analysts and stockholders 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, changes in general economic conditions either nationally or in regions in which the Company operates, 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 obligation at their maturity, the timing of receipt of regulatory approvals and the opening of projects and the availability and cost of land for future growth. While it is impossible to identify all such factors, additional 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” and in the Company’s other filings with the Securities and Exchange Commission. 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.

Item 3.    Quantitative and Qualitative Disclosures About Market Risk

The Company’s Annual Report on Form 10-K for the year ended December 31, 2005, includes detailed disclosure about quantitative and qualitative disclosures about market risk. Quantitative and qualitative disclosures about market risk have not materially changed since December 31, 2005.

47

Item 4.    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 as of the end of the period covered by this Quarterly Report. 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.

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 period covered by this Quarterly Report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

48

WILLIAM LYON HOMES

PART II.    OTHER INFORMATION

Item 1.    Legal Proceedings

Captive Title Reinsurance Investigation

Duxford Title Reinsurance Company, a wholly-owned subsidiary of the Company, provides title reinsurance to unrelated title insurers directly issuing title policies on homes sold by the Company in California, Nevada and Arizona. In February 2005, Duxford Title Reinsurance Company was notified by its title insurers that as a result of current investigations by several state insurance regulators into the large number of captive reinsurance arrangements existing in the title insurance industry, the title insurers were suspending and/or terminating their current captive reinsurance agreements with Duxford Title Reinsurance Company pending final determination from the appropriate regulatory bodies as to their permissibility or necessary modification to assure compliance with applicable law. In April 2005, in response to a subpoena issued by the California Insurance Commissioner, the Company testified in connection with the Commissioner’s investigation of captive reinsurance arrangements, including testimony that in many instances, the Company pays for the title insurance being issued. The Company has not had any further communication to date from the California Insurance Commissioner or any other state insurance regulator about this matter and does not believe that the resolution of this matter will have a material effect on the Company’s financial position, results of operations or cash flows. In November 2005, the Company was notified that the United States Department of Housing and Urban Development had instituted a formal Federal investigation of the Company in connection with its participation in captive title reinsurance arrangements. The Company intends to fully cooperate with the Department in its investigation and does not believe that the resolution of this matter will have a material effect on the Company’s financial position, results of operations or cash flows.

Litigation Arising from General Lyon’s Tender Offer

As described above in Part I, Item 2 under the caption “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 has since been 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, andMichael 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 theBrown action also filed a First Amended Complaint. The Delaware Complaints name the Company and the directors of the Company as defendants. These complaints allege, among other things, that the defendants have 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 23, 2006, the Company announced that its Board had appointed a special committee of independent directors who are not members of the Company’s management or employed by the Company (the “Special Committee”) to consider the Tender Offer. The members of the Special Committee are Harold H. Greene, Lawrence M. Higby, and Dr. Arthur Laffer. The Company also announced that the Special Committee had retained Morgan Stanley & Co. as its financial advisor and Gibson, Dunn & Crutcher LLP as its legal counsel.

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

49

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.” The Special Committee 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.

On April 23, 2006, Delaware Chancery Court conditionally certified a class in the Consolidated Delaware Action. The parties to the Consolidated Delaware Action are negotiating a Stipulation of Settlement, and expect that the Delaware Chancery Court will soon schedule a settlement hearing to evaluate the settlement.

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 captionedAlaska Electrical Pension Fund v. William Lyon Homes, Inc., et al., Case No. 06-CC-00047, was filed. On April 5, 2006, plaintiff in theAlaska Electrical action filed an Amended Complaint (the “California Action”). The complaint in the California Action names the Company and the 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 has filed a motion to certify a class in the California Action, and the Company has filed a motion to stay the California Action. Both motions are currently scheduled for hearing on May 11, 2006.

Item 1A.    Risk Factors

The Company’s Annual Report on Form 10-K for the year ended December 31, 2005, includes detailed disclosure about risk factors which should be carefully considered when evaluating any investment in the Company. Risk factors have not materially changed since December 31, 2005 except as described in the following paragraph.

As described above in Part I. Item 2 under the caption “Tender Offer”, the Company’s principal stockholder has commenced a tender offer to purchase all outstanding shares of the Company’s stock not already owned by him. An investor in the Company’s stock should give careful consideration to the risks and uncertainties as to whether or not this tender offer will be successful. If the principal stockholder were to withdraw his tender offer or if the conditions of his offer are not met, the market price of the Company’s stock could decline significantly. In addition, in the event that the Tender Offer is successful and General Lyon is able to acquire sufficient shares to allow him to cause the contemplated follow-on merger pursuant to Section 253 of the General Corporation Law of the State of Delaware, as described in his Offer to Purchase, stockholders who did not tender their shares in the Tender Offer will nonetheless not hold equity in the surviving corporation, since their shares in the Company will have been converted in the merger into the right to receive cash in an amount per share equal to the tender offer price.

Items 2, 3, 4 and 5.

Not applicable.

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Item 6.    Exhibits

Exhibit No.	Description
10.1	Revolving Line of Credit Agreement dated as of March 8, 2006 by and between William Lyon Homes, Inc., a California corporation, and Comerica Bank (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on April 3, 2006)
31.1	Certification of Chief Executive Officer Pursuant to Section 302 of The Sarbanes-Oxley Act of 2002
31.2	Certification of Chief Financial Officer Pursuant to Section 302 of The Sarbanes-Oxley Act of 2002
32.1	Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002
32.2	Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002

51

WILLIAM LYON HOMES

SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	WILLIAM LYON HOMES Registrant
Date:  May 5, 2006	By:	/s/    MICHAEL D. GRUBBS
		MICHAEL D. GRUBBS Senior Vice President, Chief Financial Officer and Treasurer (Principal Financial Officer)
Date:  May 5, 2006	By:	/s/    W. DOUGLASS HARRIS
		W. DOUGLASS HARRIS Vice President, Corporate Controller (Principal Accounting Officer)

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EXHIBIT INDEX

Exhibit No.	Description
31.1	Certification of Chief Executive Officer Pursuant to Section 302 of The Sarbanes-Oxley Act of 2002
31.2	Certification of Chief Financial Officer Pursuant to Section 302 of The Sarbanes-Oxley Act of 2002
32.1	Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002
32.2	Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002

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