William Lyon Homes (WLH) 10-Q 2010 Q3 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 September 30, 2010

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  ¨    NO  x

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every interactive data file required to be submitted and posted pursuant to Rule 405 of Regulation S-T (section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  ¨    NO  ¨

Indicate by check mark 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	¨
Non-accelerated filer	x   (Do not check if a smaller reporting company)	Smaller reporting company	¨

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

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 November 5, 2010
Common stock, par value $.01	1,000

WILLIAM LYON HOMES

INDEX

		Page No.
PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements:
	Consolidated Balance Sheets — September 30, 2010 (unaudited) and December  31, 2009		4
	Consolidated Statements of Operations — Three and Nine Months Ended September  30, 2010 and 2009 (unaudited)		5
	Consolidated Statement of Equity — Nine Months Ended September 30, 2010 (unaudited)		6
	Consolidated Statements of Cash Flows —  Nine Months Ended September 30, 2010 and 2009 (unaudited)		7
	Notes to Consolidated Financial Statements		8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		35
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		57
Item 4.	Controls and Procedures		57
Item 4T.	Not Applicable		57
PART II. OTHER INFORMATION			58
Item 1.	Legal Proceedings		58
Item 1A.	Risk Factors		58
Item 2.	Not Applicable		58
Item 3.	Not Applicable		58
Item 4.	Not Applicable		58
Item 5.	Not Applicable		58
Item 6.	Exhibits		58
SIGNATURES			59
EXHIBIT INDEX			60

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

Actual events and results may differ materially from those expressed or forecasted in the forward-looking statements due to a number of factors. The principal factors that could cause the Company’s actual performance and future events and actions to differ materially from such forward-looking statements include, but are not limited to, worsening in general economic conditions either nationally or in regions in which the Company operates, worsening in the markets for residential housing, further decline in real estate values resulting in further impairment of the Company’s real estate assets, volatility in the banking industry and credit markets, terrorism or other hostilities involving the United States, whether an ownership change occurred which could, under certain circumstances, have resulted in the limitation of the Company’s ability to offset prior years’ taxable income with net operating losses, the uncertain impact of the prior expiration of income tax incentives for homebuyers, 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, the Company’s ability to refinance the outstanding balances of its debt obligations 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. These and other risks and uncertainties are more fully described in Item 1A. “Risk Factors” as contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009. While it is impossible to identify all such factors, factors which could cause actual results to differ materially from those estimated by the Company include, but are not limited to, those factors or conditions described under “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The Company’s past performance or past or present economic conditions in the Company’s housing markets are not indicative of future performance or conditions. Investors are urged not to place undue reliance on forward-looking statements. In addition, the Company undertakes no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of anticipated or unanticipated events or changes to projections over time unless required by federal securities law.

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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)

	September 30, 2010		December 31, 2009
	(unaudited)
ASSETS
Cash and cash equivalents — Note 6	$	71,903	$	117,587
Restricted cash		640		4,352
Receivables		13,613		16,294
Income tax refunds receivable — Note 8		—		106,989
Real estate inventories — Notes 2 and 4
Owned		621,054		523,336
Not owned		55,270		55,270
Property & equipment, less accumulated depreciation of $6,699 and $8,195 at September 30, 2010 and December 31, 2009, respectively		1,300		1,673
Deferred loan costs		13,313		14,859
Other assets		2,556		19,739
	$	779,649	$	860,099
LIABILITIES AND EQUITY
Accounts payable	$	11,828	$	11,046
Accrued expenses		49,306		45,294
Liabilities from inventories not owned — Note 9		55,270		55,270
Notes payable — Note 5		34,051		64,227
Senior Secured Term Loan due October 20, 2014 — Note 5		206,000		206,000
7 5/8% Senior Notes due December 15, 2012 — Note 5		66,704		67,204
10 3/4% Senior Notes due April 1, 2013 — Note 5		138,551		168,158
7 1/2% Senior Notes due February 15, 2014 — Note 5		77,867		84,701
		639,577		701,900
Commitments and contingencies — Note 9
Equity:
Stockholders’ equity
Common stock, par value $.01 per share; 3,000 shares authorized; 1,000 shares outstanding at September 30, 2010 and December 31, 2009, respectively		—		—
Additional paid-in capital		48,867		48,867
Retained earnings		80,698		101,733
		129,565		150,600
Non-controlling interest — Note 2		10,507		7,599
		140,072		158,199
	$	779,649	$	860,099

See accompanying notes.

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WILLIAM LYON HOMES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands)

(unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
Operating revenue
Home sales	$	73,680		$	55,785		$	180,279		$	179,741
Lots, land and other sales		—			180			17,204			7,595
Construction services — Note 1		1,573			11,248			7,625			26,623
		75,253			67,213			205,108			213,959
Operating costs
Cost of sales — homes		(62,095	)		(49,025	)		(150,252	)		(158,085	)
Cost of sales — lots, land and other — Note 4		(39	)		—			(15,612	)		(46,565	)
Impairment loss on real estate assets — Notes 4 and 6		(7,652	)		—			(7,943	)		(24,171	)
Construction services — Note 1		(1,327	)		(9,115	)		(5,248	)		(22,726	)
Sales and marketing		(5,084	)		(3,998	)		(14,486	)		(12,662	)
General and administrative		(6,688	)		(4,045	)		(18,274	)		(14,598	)
Other		(436	)		(1,940	)		(2,334	)		(4,487	)
		(83,321	)		(68,123	)		(214,149	)		(283,294	)
Equity in (loss) income of unconsolidated joint ventures		(1,080	)		532			93			(778	)
Operating loss		(9,148	)		(378	)		(8,948	)		(70,113	)
Interest expense, net of amounts capitalized		(4,511	)		(8,251	)		(17,818	)		(25,284	)
Gain on retirement of debt		5,572			—			5,572			57,973
Other income (expense), net		45			(3,091	)		(26	)		(3,813	)
Loss before benefit from income taxes		(8,042	)		(11,720	)		(21,220	)		(41,237	)
Benefit from income taxes — Note 8		—			56			65			78
Consolidated net loss		(8,042	)		(11,664	)		(21,155	)		(41,159	)
Less: Net loss (income) — non-controlling interest		29			27			120			(92	)
Net loss attributable to William Lyon Homes	$	(8,013	)	$	(11,637	)	$	(21,035	)	$	(41,251	)

See accompanying notes.

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WILLIAM LYON HOMES

CONSOLIDATED STATEMENT OF EQUITY

Nine Months Ended September 30, 2010

(in thousands)

(unaudited)

	Common Stock				Additional Paid-In Capital		Retained Earnings			Non- Controlling Interest			Total
	Shares		Amount
Balance — December 31, 2009		1	$	—	$	48,867	$	101,733		$	7,599		$	158,199
Net loss		—		—		—		(21,035	)		(120	)		(21,155	)
Cash contributions from members of consolidated entities, net		—		—		—		—			3,028			3,028
Balance — September 30, 2010		1	$	—	$	48,867	$	80,698		$	10,507		$	140,072

See accompanying notes.

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WILLIAM LYON HOMES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Nine Months Ended September 30,
	2010			2009
Operating activities
Consolidated net loss	$	(21,155	)	$	(41,159	)
Adjustments to reconcile consolidated net loss to net cash provided by operating activities:
Depreciation and amortization		309			1,339
Impairment loss on real estate assets		7,943			24,171
Equity in (income) loss of unconsolidated joint ventures		(93	)		778
Loss on disposition of fixed asset		122			3,009
Gain on retirement of debt		(5,572	)		(57,973	)
Benefit from income taxes		(65	)		(78	)
Net changes in operating assets and liabilities:
Restricted cash		3,712			(260	)
Receivables		2,681			19,243
Income tax refunds receivable		107,054			41,615
Real estate inventories — owned		(94,616	)		67,293
Deferred loan costs		2,424			1,194
Other assets		15,140			1,586
Accounts payable		782			(7,182	)
Accrued expenses		4,012			(9,678	)
Net cash provided by operating activities		22,678			43,898
Investing activities
Investments in and advances to unconsolidated joint ventures		(194	)		(194	)
Distributions of income from unconsolidated joint ventures		2,330			362
Net proceeds from sale of fixed asset		—			2,063
Purchases of property and equipment, net		(58	)		(21	)
Net cash provided by investing activities		2,078			2,210
Financing activities
Proceeds from borrowing on notes payable, net		7,870			106,961
Principal payments on notes payable		(50,070	)		(157,719	)
Net cash paid for repurchase of Senior Notes		(31,268	)		(25,424	)
Noncontrolling interest contributions (distributions), net		3,028			(4,742	)
Net cash used in financing activities		(70,440	)		(80,924	)
Net decrease in cash and cash equivalents		(45,684	)		(34,816	)
Cash and cash equivalents — beginning of period		117,587			67,017
Cash and cash equivalents — end of period	$	71,903		$	32,201
Supplemental disclosures of non-cash items:
Decrease to net real estate inventories not owned and liabilities from inventories not owned	$	—		$	24,809
Decrease to net real estate inventories not owned and non-controlling interests	$	—		$	27,684
Decrease in real estate inventories owned and notes payable	$	—		$	56,151
Increase in real estate inventories owned and seller notes payable	$	10,652		$	—
Assumption of note receivable on sale of aircraft	$	—		$	6,188

See accompanying notes

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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, 2009.

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 and nine months ended September 30, 2010 are not necessarily indicative of the results that may be expected for the year ending December 31, 2010.

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 September 30, 2010 and December 31, 2009 and revenues and expenses for the periods presented. Accordingly, actual results could differ from those estimates. The significant accounting policies using estimates include real estate inventories and cost of sales, impairment of real estate inventories, warranty reserves, loss contingencies, sales and profit recognition, income taxes, and accounting for variable interest entities. The current economic environment increases the uncertainty inherent in these estimates and assumptions.

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 ability of the Company to meet its covenants and 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 flows 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 Secured Term Loan, Senior Note obligations and other indebtedness may restrict the Company from pursuing any of these alternatives.

The Company designs, constructs and sells a wide range of homes designed to meet the specific needs of each of its markets. The Company conducts its homebuilding operations through four reportable operating segments: Southern California, Northern California, Arizona and Nevada. See Note 3 for further discussion of the Company’s homebuilding segments.

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WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

The Company accounts for construction management agreements using thePercentage of Completion Method in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 605Revenue Recognition (“ASC 605”). Under ASC 605, the Company records revenues and expenses as work on a contract progresses, and based on the percentage of costs incurred to date compared to the total estimated costs of the contract. Based on the provisions of ASC 605, the Company has recorded construction services revenues and expenses of $1.6 million and $1.3 million, respectively, for the three months ended September 30, 2010 and $11.2 million and $9.1 million, respectively for the three months ended September 30, 2009, in the accompanying consolidated statement of operations. In addition, the Company has recorded construction services revenues and expenses of $7.6 million and $5.2 million, respectively, for the nine months ended September 30, 2010 and $26.6 million and $22.7 million, respectively for the nine months ended September 30, 2009, in the accompanying consolidated statement of operations.

The Company entered into construction management agreements to build, sell and market homes. For such services, the Company receives fees (generally 3 to 5 percent of the sales price, as defined) and may, under certain circumstances, receive additional compensation if certain financial thresholds are achieved. In addition, in October 2008, the Company entered into a contract to build apartment units for a related party at a contract price of $13.5 million, which includes the Company’s contractor fee of $0.5 million. During the nine months ended September 30, 2009, the Company recorded construction services revenue of $9.2 million and expenses of $8.8 million for this project, which was completed in 2009.

The Company evaluates performance and allocates resources primarily based on the operating income (loss) of individual homebuilding projects. Operating loss is defined by the Company as operating revenue less operating costs plus equity in (loss) income of unconsolidated joint ventures. Accordingly, operating (loss) income excludes certain expenses included in the determination of net loss.

Restricted cash consists of $0.6 million of outstanding irrevocable standby letters of credit to guarantee the Company’s financial obligations under certain contractual arrangements in the normal course of business. Under the terms of the senior secured term loan disclosed in Note 5, all of the Company’s standby letters of credit are secured by cash.

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 nine months ended September 30 are as follows (in thousands):

	September 30
	2010			2009
Warranty liability, beginning of period	$	21,365		$	26,394
Warranty provision during period		1,711			1,591
Warranty payments during period		(6,951	)		(6,977	)
Warranty charges related to pre-existing warranties during period		648			997
Warranty liability, end of period	$	16,773		$	22,005

The Company follows the guidance in ASC Topic 855Subsequent Events (“ASC 855”), which provides guidance to establish general standards of accounting for and disclosures of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. ASC 855 sets forth (i) the period after the balance sheet date during which management of a reporting entity evaluates events or transactions that may occur for potential recognition or disclosure in the financial statements, (ii) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements, and (iii) the disclosures an entity should make about events or transactions that occurred after the balance sheet date.

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WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

In January 2010, the FASB issued Accounting Standards Update (“ASU”) 2010-06,Fair Value Measurements and Disclosures (Topic 820),which requires additional disclosures and clarifies some existing disclosure requirements about fair value measurement as set forth in ASC 820-10. ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The adoption in January 2010 of the additional disclosure portion of this guidance did not have a material effect on the Company’s consolidated financial statements, but resulted in additional disclosures. The Company does not expect the adoption of the later portion of this guidance to have a material effect on its consolidated financial statements.

In June 2009 and February 2010, the FASB updated certain provisions of ASC 810,Consolidation. These provisions amend the consolidation guidance applicable to variable interest entities and the definition of a variable interest entity, and require enhanced disclosures to provide more information about an enterprise’s involvement in a variable interest entity. ASC 810 also requires ongoing assessments of whether an enterprise is the primary beneficiary of a variable interest entity. These provisions under ASC 810 were effective for the Company on January 1, 2010. The adoption of this guidance did not have a material effect on the Company’s consolidated financial statements, but resulted in additional disclosures, which are reflected in Note 2 below.

Certain balances have been reclassified in order to conform to current period presentation.

Note 2 — Variable Interest Entities and Non-controlling Interests

The FASB issued guidance now codified as ASC 810,Consolidation, which addresses the consolidation of variable interest entities (“VIEs”). Under this guidance, arrangements that are not controlled through voting or similar rights are accounted for as VIEs. An enterprise is required to consolidate a VIE if it is the primary beneficiary of the VIE. The primary beneficiary is an enterprise that has the power to direct the activities of the VIE that most significantly impacts its economic performance and the obligation to absorb losses or the right to receive benefits from the VIE that could be potentially significant to the VIE.

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.

Based on the provisions of this guidance, 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, in order to determine if the Company is the primary beneficiary, the Company considers various factors including, but not limited to, voting rights, risks, involvement in the operations of the VIE, ability to make major decisions, contractual obligations including distributions of income and loss, and computations of expected losses and residual returns based on the probability of future cash flow. If the Company has been determined to be the primary beneficiary of the VIE, the assets, liabilities and operations of the VIE are consolidated with the Company’s financial statements.

Joint Ventures

Certain joint ventures have been determined to be VIEs under ASC 810 in which the Company is considered the primary beneficiary. Accordingly, the assets, liabilities and operations of these VIEs have been consolidated with the Company’s financial statements. The Company did not recognize any gain or loss on initial consolidation of the VIE since the joint ventures were previously accounted for on an unconsolidated basis using the equity method of accounting.

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. Creditors of these VIEs have no recourse against the general credit of the Company. The liabilities of each VIE are restricted to the assets of each VIE. Additionally, the creditors of the Company have no access to the assets of the VIEs. Income allocations and cash distributions to the Company are based on predetermined formulas between the Company and their 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 the joint ventures.

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WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

As of September 30, 2010, the assets and liabilities of the consolidated VIEs totaled $15.5 million and $1.2 million, respectively. In addition, the Company’s interest in the consolidated VIEs is $3.8 million and the members’ interest in the consolidated VIEs is $10.5 million, which is reported as non-controlling interest on the accompanying consolidated balance sheet.

As of December 31, 2009, the assets and liabilities of the consolidated VIEs totaled $13.5 million and $2.1 million, respectively. In addition, the Company’s interest in the consolidated VIEs was $3.7 million and the members’ interest in the consolidated VIEs was $7.6 million, which is reported as non-controlling interest on the accompanying consolidated balance sheet.

Option Deposits

During the nine months ended September 30, 2009, the Company abandoned its option deposit in three of its consolidated land banking arrangements in which land purchase commitments were required. The combined deposit write-off was $37.9 million and was included in cost of sales-lots, land and other in the accompanying statement of operations. Management of the Company determined that the remaining purchase price of the lots in the arrangements were priced above market values at that time. In two of these arrangements, the Company reduced real estate inventories-not owned and the related non-controlling interest $27.7 million for the remaining purchase price of the lots, which did not affect the Company’s operating income (loss) for the period. In the other arrangement, the Company reduced real estate inventories-not owned and liabilities from inventories-not owned $9.3 million for the remaining purchase price of 51 lots, which did not affect the Company’s operating income (loss) for the period. However, during the three month period ended December 31, 2009 the Company re-evaluated the purchase price of the 51 lots under option, and after the write-off of the $9.3 million deposit, the residual value became economically viable and the Company purchased the lots.

Note 3 — Segment Information

The Company operates one principal homebuilding business. In accordance with FASB ASC Topic 280,Segment Reporting(“ASC 280”), the Company has determined that each of its operating divisions is an operating segment. Corporate is a non-operating segment.

The Company’s homebuilding operations design, construct and sell a wide range of homes designed to meet the specific needs in each of it markets. In accordance with the aggregation criteria defined by ASC 280, the Company’s homebuilding operating segments have been grouped into four reportable segments: Southern California, consisting of an operating division with operations in Orange, Los Angeles, San Bernardino and San Diego counties; Northern California, consisting of an operating division with operations in Contra Costa, Sacramento, San Joaquin, Santa Clara, Solano and Placer counties; Arizona, consisting of operations in the Phoenix, Arizona metropolitan area; and Nevada, consisting of operations in the Las Vegas, Nevada metropolitan area.

Corporate is a non-operating segment that develops and implements strategic initiatives and supports the Company’s operating divisions by centralizing key administrative functions such as finance and treasury, information technology, risk management and litigation and human resources.

- 11 -

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

Segment financial information relating to the Company’s homebuilding operations was as follows:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
	(in thousands)
Homebuilding revenues:
Southern California	$	53,795		$	27,669		$	128,816		$	95,840
Northern California		12,486			11,287			23,752			35,838
Arizona		3,565			11,611			13,689			26,257
Nevada		3,834			5,218			14,022			21,806
Total homebuilding revenues	$	73,680		$	55,785		$	180,279		$	179,741
	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
	(in thousands)
(Loss) income before benefit from income taxes:
Southern California	$	(192	)	$	(2,501	)	$	(6,068	)	$	(21,574	)
Northern California		(419	)		(415	)		2,204			(37,104	)
Arizona		(8,719	)		(1,750	)		(11,180	)		(6,293	)
Nevada		(1,684	)		(2,130	)		(3,615	)		(23,914	)
Corporate		2,972			(4,924	)		(2,561	)		47,648
Total homebuilding (loss) income before benefit from income taxes	$	(8,042	)	$	(11,720	)	$	(21,220	)	$	(41,237	)

Homebuilding pretax (loss) income includes the following pretax inventory impairment charges recorded in the following segments:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2010		2009		2010		2009
	(in thousands)
Inventory impairments
Southern California	$	—		—	$	—	$	450
Northern California		—		—		—		6,144
Arizona		7,652		—		7,943		—
Nevada		—		—		—		17,577
Total inventory impairments	$	7,652	$	—	$	7,943	$	24,171

- 12 -

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

Homebuilding pretax income (loss) includes the following pretax income (loss) on sales of lots, land and other recorded in the following segments (in thousands):

	Three Months Ended September 30, 2010
	Southern California			Northern California		Arizona		Nevada			Total
(Loss) Gain on sales of lots, land and other
Operating revenue	$	—		$	—	$	—	$	—		$	—
Operating costs		(15	)		—		—		(24	)		(39	)
(Loss) Gain on sales of lots, land and other	$	(15	)	$	—	$	—	$	(24	)	$	(39	)

	Three Months Ended September 30, 2009
	Southern California			Northern California			Arizona			Nevada			Total
Gain on sales of lots, land and other
Operating revenue	$	—		$	—		$	180		$	—		$	180
Operating costs		—			—			—			—			—
Gain on sales of lots, land and other	$	—		$	—		$	180		$	—		$	180
	Nine Months Ended September 30, 2010
	Southern California			Northern California			Arizona			Nevada			Total
(Loss) Gain on sales of lots, land and other
Operating revenue	$	—		$	17,204		$	—		$	—		$	17,204
Operating costs		(1,203	)		(14,320	)		—			(89	)		(15,612	)
(Loss) Gain on sales of lots, land and other	$	(1,203	)	$	2,884		$	—		$	(89	)	$	1,592
	Nine Months Ended September 30, 2009
	Southern California			Northern California			Arizona			Nevada			Total
Loss on sales of lots, land and other
Operating revenue	$	—		$	—		$	7,595		$	—		$	7,595
Operating costs		(9,323	)		(28,565	)		(8,677	)		—			(46,565	)
Loss on sales of lots, land and other	$	(9,323	)	$	(28,565	)	$	(1,082	)	$	—		$	(38,970	)

	September 30, 2010		December 31, 2009
	(in thousands)
Homebuilding assets:
Southern California	$	348,015	$	324,728
Northern California		66,437		38,383
Arizona		201,827		172,518
Nevada		66,000		60,764
Corporate (1)		97,370		263,706
Total homebuilding assets	$	779,649	$	860,099

(1) Comprised primarily of cash, receivables, deferred loan costs and other assets.

- 13 -

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

Note 4 — Real Estate Inventories

Real estate inventories consist of the following (in thousands):

	September 30, 2010		December 31, 2009
Inventories owned: (1)
Deposits	$	32,037	$	33,582
Land and land under development		368,880		334,877
Homes completed and under construction		165,112		100,795
Model homes		55,025		54,082
Total	$	621,054	$	523,336
Inventories not owned: (2)
Other land options contracts - land banking arrangement	$	55,270	$	55,270

(1) The Company temporarily suspended development, sales and marketing activities at certain of its projects from 2006 to 2008 which were in various stages of development. Management of the Company determined that this strategy was necessary under the market conditions at that time and would allow the Company to market the properties at some future time when market conditions may have improved. As market conditions continue to improve into 2010, management of the Company has released for sale or restarted development certain of these held projects. At September 30, 2010, the Company has incurred costs related to the remaining suspended projects of $110.5 million, of which $45.3 million is included in Land and land under development, $41.2 million is included in Homes completed and under construction and $24.0 million is included in Model homes. At December 31, 2009, the Company has incurred costs related to these certain projects of $261.9 million, of which $165.3 million is included in Land and land under development, $61.3 million is included in Homes completed and under construction and $35.3 million is included in model homes.

(2) Includes the consolidation of a land banking arrangement recorded as a product financing arrangement (See Note 9). Amounts are net of deposits.

The Company accounts for its real estate inventories (including land, construction in progress, completed inventory, including models, and inventories not owned) under FASB ASC 360Property, Plant, & Equipment(“ASC 360”).

ASC 360 requires impairment losses to be recorded on real estate inventories when indicators of impairment are present and the undiscounted cash flows estimated to be generated by real estate inventories are less than the carrying amount of such assets. Indicators of impairment include a decrease in demand for housing due to softening market conditions, competitive pricing pressures which reduce the average sales prices of homes including an increase in sales incentives offered to buyers, slowing sales absorption rates, decreases in home values in the markets in which the Company operates, significant decreases in gross margins and a decrease in project cash flows for a particular project.

For land, construction in progress, completed inventory, including model homes, and inventories not owned, the Company estimates expected cash flows at the project level by maintaining current budgets using recent historical information and current market assumptions. The Company updates project budgets and cash flows of each real estate project on a quarterly basis to determine whether the estimated remaining undiscounted future cash flows of the project are more or less than the carrying amount (net book value) of the asset. If the undiscounted cash flows are more than the net book value of the project, then there is no impairment. If the undiscounted cash flows are less than the net book value of the asset, then the asset is deemed to be impaired and is written-down to its fair value.

Fair value represents the amount at which an asset could be bought or sold in a current transaction between willing parties (i.e., other than a forced liquidation sale). Management determines the estimated fair value of each project by determining the present value of estimated future cash flows at discount rates that are commensurate with the risk of each project. The estimation process involved in determining if assets have been impaired and in the determination of fair value is inherently uncertain because it requires estimates of future revenues and costs, as well as future events and conditions. Estimates of revenues and costs are supported by the Company’s budgeting process, and are based on recent sales in backlog, pricing required to get the desired pace of sales, pricing of competitive projects, incentives offered by competitors and current estimates of costs of development and construction.

- 14 -

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

Under the provisions of ASC 360, the Company is required to make certain assumptions to estimate undiscounted future cash flows of a project, which include: (i) estimated sales prices, including sales incentives, (ii) anticipated sales absorption rates and sales volume, (iii) project costs incurred to date and the estimated future costs of the project based on the project budget and pace of construction of the homes, (iv) the carrying costs related to the time a project is actively selling until it closes the final unit in the project, and (v) alternative strategies including selling the land to a third party or temporarily suspending development of the project. Each project has different assumptions and is based on management’s assessment of the current market conditions that exist in each project location. The Company’s assumptions include moderate absorption increases in certain projects beginning in 2013. In addition, the Company has assumed some moderate reduction in sales incentives in certain projects.

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

Management assesses land deposits for impairment when estimated land values are deemed to be less than the agreed upon contract price. The Company considers changes in market conditions, the timing of land purchases, the ability to renegotiate with land sellers the terms of the land option contracts in question, the availability and best use of capital, and other factors. The Company records abandoned land deposits and related pre-acquisition costs in cost of sales-lots, land and other in the consolidated statements of operations in the period that it is abandoned. During the three and nine months ended September 30, 2010, the Company recorded $39,000 and $1,292,000 respectively, related to abandoned land deposits (not under land banking arrangements) and related pre-acquisition costs. During the nine months ended September 30, 2009, the Company recorded $37.9 million related to abandoned land deposits and related pre-acquisition costs.

The following table summarizes inventory impairments recorded during the three and nine months ended September 30, 2010 and 2009:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2010		2009		2010		2009
	(Dollars in thousands)
Inventory impairments related to:
Land under development and homes completed and under construction	$	7,652	$	—	$	7,943	$	10,818
Land held for sale or sold		—		—		—		13,353
Total inventory impairments	$	7,652		—	$	7,943	$	24,171
Number of projects impaired during the period		3		0		4		11
Number of projects assessed for impairment during the period		60		64		73		70

These charges were included in impairment loss on real estate assets in the accompanying consolidated statements of operations (See Note 3 for a detail of impairment by segment). The impairment charges recorded during the period noted above stemmed from lower home prices which were driven by increased incentives and discounts resulting from weakened demand experienced from 2006 through 2009. In 2010 in Arizona, management of the Company increased sales incentives for the purpose of adjusting to slowing absorption related to the impact on the project from increased competition from foreclosures. The Company may incur impairment on real estate inventories in the future, if the homebuilding industry experiences deteriorating market conditions or increased pricing pressure and slower absorption at certain of the Company’s projects as described above.

- 15 -

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

Note 5 — Senior Notes and Secured Indebtedness

As of September 30, 2010, the Company had the following outstanding Senior Secured Term Loan due 2014, 7 ⁵/8% Senior Notes due 2012, 10 ³/4% Senior Notes due 2013 and 7 ¹/2% Senior Notes due 2014 (in thousands):

Senior Secured Term Loan due October 20, 2014	$	206,000
7 5/8% Senior Notes due December 15, 2012		66,704
10 3/4% Senior Notes due April 1, 2013		138,551
7 1/2% Senior Notes due February 15, 2014		77,867
	$	489,122

During the nine months ended September 30, 2010, the Company purchased, in privately negotiated transactions, (i) $0.5 million principal amount of its outstanding 7 ⁵/8% Senior Notes at a cost of $0.4 million plus accrued interest, (ii) $30.0 million principal amount of its 10  ³/4% Senior Notes at a cost of $25.8 million plus accrued interest, and (iii) $6.8 million principal of its 7 ¹/2% Senior Notes at a cost of $5.1 million plus accrued interest. The net gain resulting from these purchases during the first three quarters, after giving effect to amortization of related deferred loan costs, was approximately $5.6 million.

Senior Secured Term Loan

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

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

California Lyon received the first installment of $131.0 million, which funded in October 2009, and its second installment of $75.0 million, which funded in December 2009. Under the Term Loan Agreement, California Lyon will be restricted from future borrowings, and, if necessary, will be required to repay existing borrowings, in order to maintain required loan to value ratios such that: (i) the aggregate amount of outstanding loans under the Term Loan Agreement may not exceed 60% of the aggregate value of the properties securing the facility, with valuation based on the lower of appraised value (if any) and discounted net present value of the cash flows, plus unrestricted cash, and (ii) the aggregate amount of secured debt may not exceed 60% of the aggregate value of the properties owned by California Lyon and its subsidiaries, with valuation based on the lower of appraised value (if any) and discounted net present value of the cash flows. California Lyon is currently in compliance with the above requirements following each drawdown. The net proceeds to the Company from the first installment of the term loan, after giving effect to attorney fees, loan fees and other miscellaneous costs associated with the loan transaction, and repayment of the revolving credit facilities and purchase of the senior notes was $34.6 million. A portion of the $75.0 million proceeds from the second installment were used to fund the Company’s land acquisitions in 2010.

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

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

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

- 16 -

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

The Term Loan will mature on October 20, 2014; however, in the event that any portion of the outstanding principal amounts (the “Repaid Senior Note Principal”) of the Senior Notes is repaid (whether or not at maturity), the Lenders may elect to require California Lyon to repay that portion of the outstanding Loan as bears the same ratio to the entire Loan outstanding (excluding any obligation of California Lyon with respect to the Exit fee or Make-Whole Payment) as the Repaid Senior Note Principal bears to the entire amounts then outstanding under all of the indentures. All or a portion of the Term Loan may also be accelerated upon certain other events described in the Loan Agreement. The lenders waived the requirement for such repayment in connection with the Senior Note repurchases described above and in Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The Term Loan Agreement contains covenants that limit the ability of California Lyon and the Company to, among other things: (i) incur liens; (ii) incur additional indebtedness; (iii) transfer or dispose of assets; (iv) merge, consolidate or alter their line of business; (v) guarantee obligations; (vi) engage in affiliated party transactions; (vii) declare or pay dividends or make other distributions or repurchase stock; (viii) make advances, loans or investments; (ix) repurchase debt (including under the Senior Note indentures) and (x) engage in change of control transactions.

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

In addition, under the Term Loan, the Company is required to comply with a number of covenants, the most restrictive of which require the Company to maintain:

• A tangible net worth, as defined in the agreement, of not less than $75.0 million;

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

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

• Excluded Assets of no more than $20.0 million, with “Excluded Assets” being defined generally as the sum total of certain deposit accounts, payroll accounts, unrestricted cash accounts, and the Company’s total investment in joint ventures.

The Company’s covenant compliance for the Term Loan at September 30, 2010 is detailed in the table set forth below:

Covenant and Other Requirements	Actual at September 30, 2010			Covenant Requirements at September 30, 2010
Tangible Net Worth (1)	$	126.8		³$75.0
Borrowing Base		42.0	%	£60%
Maximum Permitted Secured Indebtedness		48.0	%	£60%
Excluded Assets	$	9.4		£$20.0

(1) Tangible Net Worth was calculated based on the stated amount of equity less intangible assets of $13.3 million as of September 30, 2010.

As of and for the period ending September 30, 2010, the Company was in compliance with the covenants under this loan.

If market conditions deteriorate, the Company continues to incur net loss or record additional impairment, the Company’s compliance with the financial covenants contained in the Company’s Term Loan could be negatively impacted. Under these circumstances, the lenders under the Term Loan would need to provide the Company with additional covenant relief if the Company is to avoid future noncompliance with these financial covenants. If the Company is unable to obtain requested covenant relief or is unable to obtain a waiver for any covenant non-compliance, the Company’s obligation to repay indebtedness under the Term Loan and the Senior Notes could be accelerated.

- 17 -

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

The Company can give no assurance that in such an event, the Company would have, or be able to obtain, sufficient funds to pay all debt that the Company would be required to repay.

- 18 -

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

7 ⁵/8% Senior Notes

On November 22, 2004, California Lyon issued $150.0 million principal amount of 7 ⁵/8% Senior Notes due 2012 (the “7 ⁵/8% Senior Notes”), resulting in net proceeds to the Company of approximately $148.5 million. Of the initial $150.0 million, $66.7 and $67.2 million in aggregate principal amount remained as of September 30, 2010 and December 31, 2009 respectively. In August 2010, the Company repurchased, in a privately negotiated transaction, $0.5 principal amount of its outstanding 7 ⁵/8% Senior Notes at a cost of $0.4 million plus accrued interest.

Interest on the 7 ⁵/8% Senior Notes is payable semi-annually on December 15 and June 15 of each year. Based on the current outstanding principal amount of the 7 ⁵/8% Senior Notes, the Company’s semi-annual interest payments are $2.5 million.

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

10  ³/4% Senior Notes

On March 17, 2003 California Lyon issued $250.0 million of 10 ³/4% Senior Notes due 2013 (the “10 ³/4% Senior Notes”) at a price of 98.493% to the public, resulting in net proceeds to the Company of approximately $246.2 million. The purchase price reflected a discount to yield 11% under the effective interest method and the notes have been reflected net of the unaccreted discount in the consolidated balance sheet. Of the initial $250.0 million, $138.6 million and $168.2 million aggregate principal amount remained outstanding as of September 30, 2010 and December 31, 2009, respectively. In July 2010, the Company repurchased, in a privately negotiated transaction, $10.5 million principal amount of its outstanding 10 ³/4% Senior Notes at a cost of $9.0 million plus accrued interest. In August 2010, the Company repurchased, in privately negotiated transactions, $19.5 million principal amount of its outstanding 10 ³/4% Senior Notes at a cost of $16.9 million plus accrued interest.

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 $7.4 million.

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

7  ¹/2% Senior Notes

On February 6, 2004, California Lyon issued $150.0 million principal amount of 7 ¹/2% Senior Notes due 2014 (the “7 ¹/2% Senior Notes”), resulting in net proceeds to the Company of approximately $147.6 million. Of the initial $150.0 million, $77.9 and $84.8 million aggregate principal amount remained outstanding as of September 30, 2010 and December 31, 2009 respectively. In August 2010, the Company repurchased, in a privately negotiated transaction, $6.8 million principal amount of its outstanding 7 ¹/2% Senior Notes at a cost of $5.1 million plus accrued interest.

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 $2.9 million.

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

General Terms of the Senior Notes

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

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

- 19 -

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

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. However, California Lyon may reduce the principal amount of the notes to be purchased by the principal amount of all notes previously redeemed prior to the offer to purchase.

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.

As of and for the period ending September 30, 2010, the Company was in compliance with these covenants.

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

Supplemental consolidating financial information of the Company, specifically including information for California Lyon, the issuer of the 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.

Construction Notes Payable

At September 30, 2010, the Company had two construction notes payable totaling $23.4 million. One of the notes matures in July 2011 and bears interest at rates based on either LIBOR or prime with an interest rate floor of 6.5% and an outstanding principal balance of $13.9 million. Interest is calculated on the average daily balance and is paid following the end of each month.

The other construction note had a remaining balance at September 30, 2010 of $9.5 million, after giving effect to a partial prepayment of the note in the amount of $28.1 million that was made in May 2010. This note was previously due to mature in July 2010; however, in conjunction with the partial prepayment, the Company and the lender entered into a new loan agreement for the remaining outstanding principal of $10.0 million, which matures July 2015. The new loan pays interest monthly at a fixed rate of 12.5%, with quarterly principal payments of $500,000. The interest rate decreases to 10.0% when the principal balance is reduced to $7.5 million.

Seller Financing

At September 30, 2010, the Company had $10.7 million of notes payable outstanding related to a land acquisition for which seller financing was provided, which is included in notes payable in the accompanying consolidated balance sheet. The seller financing note is due at various dates through 2012 and bear interest at 7.0%. Interest is calculated on the principal balance outstanding and is accrued and paid to the seller at the time each residential unit is closed. In addition, the Company makes an annual interest payment on the outstanding principal balance related to any remaining residential units.

- 20 -

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

CONSOLIDATING BALANCE SHEET

September 30, 2010

(in thousands)

	Unconsolidated
	Delaware Lyon		California Lyon			Guarantor Subsidiaries		Non-Guarantor Subsidiaries		Eliminating Entries			Consolidated Company
ASSETS
Cash and cash equivalents	$	—	$	69,475		$	172	$	2,256	$	—		$	71,903
Restricted cash		—		640			—		—		—			640
Receivables		—		9,842			317		3,454		—			13,613
Income tax refund receivable		—		—			—		—		—			—
Real estate inventories
Owned		—		610,987			—		10,067		—			621,054
Not owned		—		55,270			—		—		—			55,270
Property and equipment, net		—		1,300			—		—		—			1,300
Deferred loan costs		—		13,313			—		—		—			13,313
Other assets		—		2,404			152		—		—			2,556
Investments in subsidiaries		129,565		3,998			—		—		(133,563	)		—
Intercompany receivables		—		—			203,588		8		(203,596	)		—
	$	129,565	$	767,229		$	204,229	$	15,785	$	(337,159	)	$	779,649
LIABILITIES AND EQUITY
Accounts payable	$	—	$	10,846		$	30	$	952	$	—		$	11,828
Accrued expenses		—		49,000			223		83		—			49,306
Liabilities from inventories not owned		—		55,270			—		—		—			55,270
Notes payable		—		34,051			—		—		—			34,051
Senior Secured Term Loan		—		206,000			—		—		—			206,000
7 5/8% Senior Notes		—		66,704			—		—		—			66,704
10 3/4% Senior Notes		—		138,551			—		—		—			138,551
7 1/2% Senior Notes		—		77,867			—		—		—			77,867
Intercompany payables		—		203,352			—		244		(203,596	)		—
Total liabilities		—		841,641			253		1,279		(203,596	)		639,577
Equity
Stockholders’ equity (deficit)		129,565		(74,412	)		203,976		14,506		(144,070	)		129,565
Non-controlling interest		—		—			—		—		10,507			10,507
	$	129,565	$	767,229		$	204,229	$	15,785	$	(337,159	)	$	779,649

- 21 -

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

CONSOLIDATING BALANCE SHEET

December 31, 2009

(in thousands)

	Unconsolidated
	Delaware Lyon		California Lyon			Guarantor Subsidiaries		Non-Guarantor Subsidiaries		Eliminating Entries			Consolidated Company
ASSETS
Cash and cash equivalents	$	—	$	115,247		$	111	$	2,229	$	—		$	117,587
Restricted cash		—		4,352			—		—		—			4,352
Receivables		—		12,599			320		3,375		—			16,294
Income tax refunds receivable		—		106,989			—		—		—			106,989
Real estate inventories
Owned		—		515,102			—		8,234		—			523,336
Not owned		—		55,270			—		—		—			55,270
Property and equipment, net		—		1,624			49		—		—			1,673
Deferred loan costs		—		14,859			—		—		—			14,859
Other assets		—		19,522			217		—		—			19,739
Investments in subsidiaries		150,600		3,978			—		—		(154,578	)		—
Intercompany receivables		—		—			204,917		—		(204,917	)		—
	$	150,600	$	849,542		$	205,614	$	13,838	$	(359,495	)	$	860,099
LIABILITIES AND EQUITY
Accounts payable	$	—	$	8,914		$	42	$	2,090	$	—		$	11,046
Accrued expenses		—		44,814			397		83		—			45,294
Liabilities from inventories not owned		—		55,270			—		—		—			55,270
Notes payable		—		64,227			—		—		—			64,227
Senior Secured Term Loan		—		206,000			—		—		—			206,000
7 5/8% Senior Notes		—		67,204			—		—		—			67,204
10 3/4% Senior Notes		—		168,158			—		—		—			168,158
7 1/2% Senior Notes		—		84,701			—		—		—			84,701
Intercompany payables		—		204,829			—		88		(204,917	)		—
Total liabilities		—		904,117			439		2,261		(204,917	)		701,900
Equity
Stockholders’ equity (deficit)		150,600		(54,575	)		205,175		11,577		(162,177	)		150,600
Non-controlling interest		—		—			—		—		7,599			7,599
	$	150,600	$	849,542		$	205,614	$	13,838	$	(359,495	)	$	860,099

- 22 -

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

CONSOLIDATING STATEMENT OF OPERATIONS

Three Months Ended September 30, 2010

(in thousands)

	Unconsolidated
	Delaware Lyon			California Lyon			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminating Entries			Consolidated Company
Operating revenue
Sales	$	—		$	67,945		$	3,565		$	2,170		$	—		$	73,680
Construction services		—			1,573			—			—			—			1,573
Management fees		—			99			—			—			(99	)		—
		—			69,617			3,565			2,170			(99	)		75,253
Operating costs
Cost of sales		—			(56,688	)		(3,617	)		(1,928	)		99			(62,134	)
Impairment loss on real estate assets		—			(7,652	)		—			—			—			(7,652	)
Construction services		—			(1,327	)		—			—			—			(1,327	)
Sales and marketing		—			(4,518	)		(295	)		(271	)		—			(5,084	)
General and administrative		—			(6,607	)		(81	)		—			—			(6,688	)
Other		—			(436	)		—			—			—			(436	)
		—			(77,228	)		(3,993	)		(2,199	)		99			(83,321	)
Equity in of unconsolidated joint ventures		—			(1,080	)		—			—			—			(1,080	)
Loss from subsidiaries		(8,013	)		(432	)		—			—			8,445			—
Operating loss		(8,013	)		(9,123	)		(428	)		(29	)		8,445			(9,148	)
Interest expense, net of amounts capitalized		—			(4,511	)		—			—			—			(4,511	)
Gain on retirement of debt		—			5,572			—			—			—			5,572
Other income (expense), net		—			106			(57	)		(4	)		—			45
Consolidated net loss		(8,013	)		(7,956	)		(485	)		(33	)		8,445			(8,042	)
Less: Net loss—non-controlling interest		—			—			—			—			29			29
Net loss attributable to William Lyon Homes	$	(8,013	)	$	(7,956	)	$	(485	)	$	(33	)	$	8,474		$	(8,013	)

- 23 -

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

CONSOLIDATING STATEMENT OF OPERATIONS

Three Months Ended September 30, 2009

(in thousands)

	Unconsolidated												Eliminating Entries			Consolidated Company
	Delaware Lyon			California Lyon			Guarantor Subsidiaries			Non- Guarantor Subsidiaries
Operating revenue
Sales	$	—		$	43,672		$	11,611		$	682		$	—		$	55,965
Construction services		—			11,248			—			—			—			11,248
Management fees		—			32			—			—			(32	)		—
		—			54,952			11,611			682			(32	)		67,213
Operating costs
Cost of sales		—			(37,177	)		(11,354	)		(526	)		32			(49,025	)
Loss on impairment of real estate assets		—			—			—			—			—			—
Construction services		—			(9,115	)		—			—			—			(9,115	)
Sales and marketing		—			(3,271	)		(651	)		(76	)		—			(3,998	)
General and administrative		—			(3,989	)		(56	)		—			—			(4,045	)
Other		—			(1,936	)		(4	)		—			—			(1,940	)
		—			(55,488	)		(12,065	)		(602	)		32			(68,123	)
Equity in income of unconsolidated joint ventures		—			532			—			—			—			532
Loss from subsidiaries		(11,637	)		(3,441	)		—			—			15,078			—
Operating (loss) income		(11,637	)		(3,445	)		(454	)		80			15,078			(378	)
Interest expense, net of amounts capitalized		—			(8,251	)		—			—			—			(8,251	)
Other income (expense), net		—			257			(3,511	)		163			—			(3,091	)
(Loss) income before benefit from income taxes		(11,637	)		(11,439	)		(3,965	)		243			15,078			(11,720	)
Benefit from income taxes		—			56			—			—			—			56
Consolidated net (loss) income		(11,637	)		(11,383	)		(3,965	)		243			15,078			(11,664	)
Less: Net loss—non-controlling interest		—			—			—			—			27			27
Net (loss) income attributable to William Lyon Homes	$	(11,637	)	$	(11,383	)	$	(3,965	)	$	243		$	15,105		$	(11,637	)

- 24 -

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

CONSOLIDATING STATEMENT OF OPERATIONS

Nine Months Ended September 30, 2010

(in thousands)

	Unconsolidated
	Delaware Lyon			California Lyon			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminating Entries			Consolidated Company
Operating revenue
Sales	$	—		$	181,624		$	13,689		$	2,170		$	—		$	197,483
Construction services		—			7,625			—			—			—			7,625
Management fees		—			99			—			—			(99	)		—
		—			189,348			13,689			2,170			(99	)		205,108
Operating costs
Cost of sales		—			(150,586	)		(13,489	)		(1,888	)		99			(165,864	)
Impairment loss on real estate assets		—			(7,943	)		—			—			—			(7,943	)
Construction services		—			(5,248	)		—			—			—			(5,248	)
Sales and marketing		—			(13,170	)		(948	)		(368	)		—			(14,486	)
General and administrative		—			(18,010	)		(243	)		(21	)		—			(18,274	)
Other		—			(2,334	)		—			—			—			(2,334	)
		—			(197,291	)		(14,680	)		(2,277	)		99			(214,149	)
Equity in income of unconsolidated joint ventures		—			93			—			—			—			93
(Loss) income from subsidiaries		(21,035	)		(978	)		12			—			22,001			—
Operating loss		(21,035	)		(8,828	)		(979	)		(107	)		22,001			(8,948	)
Interest expense, net of amounts capitalized		—			(17,818	)		—			—			—			(17,818	)
Gain on retirement of debt		—			5,572			—			—			—			5,572
Other income (expense), net		—			163			(201	)		12			—			(26	)
Loss before benefit from income taxes		(21,035	)		(20,911	)		(1,180	)		(95	)		22,001			(21,220	)
Benefit from income taxes		—			65			—			—			—			65
Consolidated net loss		(21,035	)		(20,846	)		(1,180	)		(95	)		22,001			(21,155	)
Less: Net loss—non-controlling interest		—			—			—			—			120			120
Net loss attributable to William Lyon Homes	$	(21,035	)	$	(20,846	)	$	(1,180	)	$	(95	)	$	22,121		$	(21,035	)

- 25 -

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

CONSOLIDATING STATEMENT OF OPERATIONS

Nine Months Ended September 30, 2009

(in thousands)

	Unconsolidated												Eliminating Entries			Consolidated Company
	Delaware Lyon			California Lyon			Guarantor Subsidiaries			Non-Guarantor Subsidiaries
Operating revenue
Sales	$	—		$	155,458		$	26,258		$	5,620		$	—		$	187,336
Construction services		—			26,623			—			—			—			26,623
Management fees		—			283			—			—			(283	)		—
		—			182,364			26,258			5,620			(283	)		213,959
Operating costs
Cost of sales		—			(174,864	)		(25,433	)		(4,636	)		283			(204,650	)
Impairment loss on real estate assets		—			(24,171	)		—			—			—			(24,171	)
Construction services		—			(22,726	)		—			—			—			(22,726	)
Sales and marketing		—			(10,559	)		(1,616	)		(487	)		—			(12,662	)
General and administrative		—			(14,381	)		(199	)		(18	)		—			(14,598	)
Other		—			(4,483	)		(4	)		—			—			(4,487	)
		—			(251,184	)		(27,252	)		(5,141	)		283			(283,294	)
Equity in loss of unconsolidated joint ventures		—			(778	)		—			—			—			(778	)
Loss from subsidiaries		(40,842	)		(4,457	)		—			—			45,299			—
Operating (loss) income		(40,842	)		(74,055	)		(994	)		479			45,299			(70,113	)
Interest expense, net of amounts capitalized		—			(25,284	)		—			—			—			(25,284	)
Gain on retirement of debt		—			57,973			—			—			—			57,973
Other income (expense), net		—			701			(4,632	)		118			—			(3,813	)
(Loss) income before benefit from income taxes		(40,842	)		(40,665	)		(5,626	)		597			45,299			(41,237	)
Benefit from income taxes		—			78			—			—			—			78
Consolidated net (loss) income		(40,842	)		(40,587	)		(5,626	)		597			45,299			(41,159	)
Less: Net income—non-controlling interest		—			—			—			—			(92	)		(92	)
Net (loss) income attributable to William Lyon Homes	$	(40,842	)	$	(40,587	)	$	(5,626	)	$	597		$	45,207		$	(41,251	)

- 26 -

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

CONSOLIDATING STATEMENT OF CASH FLOWS

Nine Months Ended September 30, 2010

(in thousands)

	Unconsolidated
	Delaware Lyon			California Lyon			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminating Entries			Consolidated Company
Operating activities
Net loss	$	(21,035	)	$	(20,846	)	$	(1,180	)	$	(95	)	$	22,001		$	(21,155	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization		—			231			78			—			—			309
Impairment loss on real estate assets		—			7,943			—			—			—			7,943
Equity in income of unconsolidated joint ventures		—			(93	)		—			—			—			(93	)
Loss on disposition of fixed asset		—			—			122			—			—			122
Gain on retirement of debt		—			(5,572	)		—			—			—			(5,572	)
Equity in earnings of subsidiaries		21,035			978			(12	)		—			(22,001	)		—
Benefit from income taxes		—			(65	)		—			—			—			(65	)
Net changes in operating assets and liabilities:
Restricted cash		—			3,712			—			—			—			3,712
Receivables		—			2,757			3			(79	)		—			2,681
Income tax refund receivable		—			107,054			—			—			—			107,054
Real estate inventories—owned		—			(92,783	)		—			(1,833	)		—			(94,616	)
Deferred loan costs		—			2,424			—			—			—			2,424
Other assets		—			15,075			65			—			—			15,140
Accounts payable		—			1,932			(12	)		(1,138	)		—			782
Accrued expenses		—			4,186			(174	)		—			—			4,012
Net cash provided (used in) by operating activities		—			26,933			(1,110	)		(3,145	)		—			22,678
Investing activities
Net change in investment in and advances to unconsolidated joint ventures		—			2,136			—			—			—			2,136
Purchases of property and equipment		—			93			(151	)		—			—			(58	)
Investments in subsidiaries		—			(998	)		12			—			986			—
Net cash provided by (used in) investing activities		—			1,231			(139	)		—			986			2,078
Financing activities
Proceeds from borrowings on notes payable		—			7,870			—			—			—			7,870
Principal payments on notes payable		—			(50,070	)		—			—			—			(50,070	)
Net cash paid for retirement of senior notes		—			(31,268	)		—			—			—			(31,268	)
Non-controlling interest contributions, net		—			—			—			—			3,028			3,028
Advances to affiliates		—			—			(19	)		3,024			(3,005	)		—
Intercompany receivables/payables		—			(468	)		1,329			148			(1,009	)		—
Net cash (used in) provided by financing activities		—			(73,936	)		1,310			3,172			(986	)		(70,440	)
Net (decrease) increase in cash and cash equivalents		—			(45,772	)		61			27			—			(45,684	)
Cash and cash equivalents at beginning of period		—			115,247			111			2,229			—			117,587
Cash and cash equivalents at end of period	$	—		$	69,475		$	172		$	2,256		$	—		$	71,903

- 27 -

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

CONSOLIDATING STATEMENT OF CASH FLOWS

Nine Months Ended September 30, 2009

(in thousands)

	Unconsolidated
	Delaware Lyon			California Lyon			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminating Entries			Consolidated Company
Operating activities
Net (loss) income	$	(40,842	)	$	(40,587	)	$	(5,626	)	$	597		$	45,299		$	(41,159	)
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
Depreciation and amortization		—			435			904			—			—			1,339
Impairment loss on real estate assets		—			24,171			—			—			—			24,171
Equity in loss of unconsolidated joint ventures		—			778			—			—			—			778
Gain on retirement of debt		—			(57,973	)		—			—			—			(57,973	)
Loss on sale of fixed asset		—			—			3,009			—			—			3,009
Equity in earnings of subsidiaries		41,251			4,457			—			—			(45,708	)		—
Benefit from income taxes		—			(78	)		—			—			—			(78	)
Net changes in operating assets and liabilities:
Restricted cash		—			(260	)		—			—			—			(260	)
Receivables		—			(681	)		13,077			6,847			—			19,243
Income tax refund receivable		—			41,615			—			—			—			41,615
Real estate inventories—owned		—			61,949			—			5,344			—			67,293
Deferred loan costs		—			1,194			—			—			—			1,194
Other assets		—			526			1,060			—			—			1,586
Accounts payable		—			(3,412	)		(40	)		(3,730	)		—			(7,182	)
Accrued expenses		—			(9,373	)		(305	)		—			—			(9,678	)
Net cash provided by operating activities		409			22,761			12,079			9,058			(409	)		43,898
Investing activities
Net change in investment in and advances to unconsolidated joint ventures		—			168			—			—			—			168
Net proceeds from sale of fixed asset		—			—			2,063			—			—			2,063
Purchases of property and equipment		—			77			(98	)		—			—			(21	)
Investments in subsidiaries		—			71			—			—			(71	)		—
Advances to affiliates		—			(22,210	)		—			—			22,210			—
Net cash (used in) provided by investing activities		—			(21,894	)		1,965			—			22,139			2,210
Financing activities
Proceeds from borrowings on notes payable		—			95,609			11.352			—			—			106,961
Principal payments on notes payable		—			(140,098	)		(17,621	)		—			—			(157,719	)
Net cash paid for retirement of senior notes		—			(25,424	)		—			—			—			(25,424	)
Minority interest contributions, net		—			—			—			—			(4,742	)		(4,742	)
Advances to affiliates		—			—			(512	)		(9,775	)		10,287			—
Intercompany receivables/payables		(409	)		39,691			(9,957	)		(2,050	)		(27,275	)		—
Net cash used in financing activities		(409	)		(30,222	)		(16,738	)		(11,825	)		(21,730	)		(80,924	)
Net decrease in cash and cash equivalents		—			(29,355	)		(2,694	)		(2,767	)		—			(34,816	)
Cash and cash equivalents at beginning of period		—			59,285			2,898			4,834			—			67,017
Cash and cash equivalents at end of period	$	—		$	29,930		$	204		$	2,067		$	—		$	32,201

- 28 -

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

Note 6 — Fair Value of Financial Instruments

In accordance with FASB ASC Topic 820,Fair Value Measurements and Disclosures (“ASC 820”), the Company is required to disclose the estimated fair value of financial instruments. As of September 30, 2010, the Company used the following assumptions to estimate the fair value of each type of financial instrument for which it is practicable to estimate:

• Cash and Cash Equivalents — The carrying amount is a reasonable estimate of fair value. The Company’s cash balances primarily consist of short-term liquid investments and demand deposits.

• Construction Notes Payable — For certain notes, the carrying amount is a reasonable estimate of fair value because the maturities occur within one year or the loan was renegotiated during the period.

• Seller Financing — The carrying amount is a reasonable estimate of fair value because the note originated during the current period and has a short term maturity.

• Senior Secured Term Loan — The carrying amount is a reasonable estimate of fair value. The loan originated in October 2009 and due to the short time frame since the loan was funded, management of the Company believes a new loan of this type would have similar pricing, using level 3 inputs.

• Senior Notes Payable — The senior notes are traded over the counter and their fair values were based upon quotes from industry sources.

The estimated fair values of financial instruments are as follows (in thousands):

	September 30, 2010				December 31, 2009
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial assets:
Cash and cash equivalents	$	71,903	$	71,903	$	117,587	$	117,587
Financial liabilities:
Construction notes payable	$	23,399	$	23,399	$	64,227	$	42,149
Seller financing	$	10,652	$	10,652	$	—	$	—
Senior Secured Term Loan due 2014	$	206,000	$	206,000	$	206,000	$	206,000
7 5/8% Senior Notes due 2012	$	66,704	$	54,531	$	67,204	$	42,943
10 3/4% Senior Notes due 2013	$	138,551	$	117,076	$	168,158	$	120,233
7 1/2% Senior Notes due 2014	$	77,867	$	56,563	$	84,701	$	59,291

The Company has implemented the requirements of ASC 820 for the Company’s financial assets and liabilities. ASC 820 establishes a framework for measuring fair value, expands disclosures regarding fair value measurements, and defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820 requires the Company to maximize the use of observable market inputs, minimize the use of unobservable market inputs and disclose in the form of an outlined hierarchy the details of such fair value measurements. ASC 820 specifies a hierarchy of valuation techniques based on whether the inputs to a fair value measurement are considered to be observable or unobservable in a marketplace. The three levels of the hierarchy are as follows:

• Level 1 — quoted prices for identical assets or liabilities in active markets;

• Level 2 — quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; and model-derived valuations in which significant inputs and significant value drivers are observable in active markets; and

• Level 3 — valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.

- 29 -

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

Non-financial Instruments

The Company adopted ASC 820 in 2008, however, disclosure of certain non-financial portions of the statement were deferred until the 2009 reporting period. These non-financial homebuilding assets are those assets for which the Company recorded valuation adjustments during the first half of 2009 on a nonrecurring basis. See Note 4, “Real Estate Inventories” for further discussion of the valuation of real estate inventories and within “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

The following table summarizes the fair-value measurements of its non-financial assets for the nine months ended September 30, 2010:

	Fair Value Hierarchy		Fair Value at Measurement Date(1)		Impairment Charges for the Nine Months Ended September 30, 2010(1)
	(in thousands)
Land under development and homes completed and under construction(2)		Level 3	$	16,295	$	7,943

(1) Amounts represent the aggregate fair values for communities where the Company recognized noncash inventory impairment charges for the periods ending June 30, 2010 and September 30, 2010, the date that the fair value measurements were made. The carrying value for these communities may have subsequently increased or decreased from the fair value reflected due to activity that has occurred since the measurement date.

(2) In accordance with ASC 360, inventory under this caption with a carrying value of $0.9 million and $23.3 million was written down to its fair value of $0.6 million and $15.7 million at June 30, 2010 and September 30, 2010, resulting in total impairments of $0.3 million and $7.6 million for the respective periods.

The following table summarizes the fair-value measurements of its non-financial assets for the nine months ended September 30, 2009:

	Fair Value Hierarchy		Fair Value at Measurement Date(1)		Impairment Charges for the Six Months Ended June  30, 2009(1)
	(in thousands)
Land under development and homes completed and under construction(2)		Level 3	$	12,241	$	10,818
Inventory held-for-sale(3)		Level 3		7,822		13,353

(1) Amounts represent the aggregate fair values for communities where the Company recognized noncash inventory impairment charges during the period, as of March 31, 2009, the date that the fair value measurements were made. The carrying value for these communities may have subsequently increased or decreased from the fair value reflected due to activity that has occurred since the measurement date.

(2) In accordance with ASC 360, inventory under this caption with a carrying value of $23.1 million was written down to its fair value of $12.3 million at March 31, 2009, resulting in total impairments of $10.8 million for the period.

(3) In accordance with ASC 360, inventory under this caption with a carrying value of $21.2 million was written down to its fair value of $7.8 million at March 31, 2009, resulting in total impairments of $13.4 million.

Fair values determined to be level 3 include the use of internal assumptions, estimates and financial forecasts. Valuations of these items are therefore sensitive to the assumptions used. Fair values represent the Company’s best estimates as of the measurement date, based on conditions existing and information available at the date of issuance of the consolidated financial statements. Subsequent changes in conditions or information available may change assumptions and estimates, as outlined in more detail within “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Fair values determined using Level 3 inputs, were primarily based on the estimated future cash flows discounted for inherent risk associated with each asset. These discounted cash flows are impacted by: the risk-free rate of return; expected risk premium based on estimated land development; construction and delivery timelines; market risk from potential future price erosion; cost uncertainty due to development or construction cost increases; and other risks specific to the asset or conditions in the market in which the asset is located at the time the assessment is made. These factors are specific to each community and may vary among communities.

- 30 -

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

Note 7 — Related Party Transactions

On December 27, 2007, the Company sold certain land in San Diego County, California for $12.0 million in cash to a limited liability company owned indirectly by Frank T. Suryan, Jr. as Trustee for the Suryan Family Trust. Mr. Suryan is Chairman and Chief Executive Officer of Lyon Capital Ventures, a company wholly-owned by Frank T. Suryan, Jr., General William Lyon, Chairman and Chief Executive Officer of the Company, and a trust whose sole beneficiary is William H. Lyon, President and Chief Operating Officer of the Company. The Company received a report from a third-party valuation and financial advisory services firm as to the reasonableness of the sales price in the transaction. Further, the transaction was unanimously approved by all independent members of the Board of Directors. Prior to the sale, the net book value of this land (as reflected on the Company’s financial statements) was approximately $18.7 million resulting in a loss on the transaction of $6.7 million. In October 2008, in a separately negotiated transaction from the sale of the land to the Company owned indirectly by the Suryan Family Trust (the “Owner”), the Company was contracted by and for the Owner to build apartment units for a contract price of $13.5 million, which includes the Company’s contractor fee of $0.5 million. As described in Note 1, the Company accounts for this transaction based on the percentage of completion method, and recorded construction services revenue of $4.4 million and construction services costs of $4.2 million during the three months ended March 31, 2009, respectively. This project was completed during 2009 and therefore there are no comparable amounts during the three or nine months ended September 30, 2010.

For the three and nine months ended September 30, 2010, the Company incurred reimbursable on-site labor costs of $45,000 and $164,000, respectively, and for the three and nine months ended September 30, 2009, the Company incurred reimbursable on-site labor-costs of $41,000 and $153,000, respectively, for providing customer service to real estate projects developed by entities controlled by William Lyon and William H. Lyon. At September 30, 2010 and December 31, 2009, $148,000 and $58,000, respectively, was due to the Company for reimbursable on-site labor costs. In October, the Company received $104,000 of the $148,000 that was due.

The Company earned fees of $92,000 and $336,000, respectively, during the three and nine months ended September 30, 2010 with no comparable amounts in 2009, related to a Human Resources and Payroll Services contract between the Company and an entity controlled by General William Lyon and William H. Lyon of which $63,000 was due to the Company at September 30, 2010. In October, the Company received $31,500 of the $63,000 that was due.

For the three and nine months ended September 30, 2010, the Company incurred charges of $197,000 and $590,000, respectively, related to rent on its corporate office, from a trust of which William H. Lyon is the sole beneficiary. For the three and nine months ended September 30, 2009, the Company incurred charges of $197,000 and $590,000, respectively.

On September 3, 2009, Presley CMR, Inc., a California corporation (“Presley CMR”) and wholly owned subsidiary of California Lyon, entered into an Aircraft Purchase and Sale Agreement (“PSA”) with an affiliate of General William Lyon to sell the aircraft described above. The PSA provided for an aggregate purchase price for the Aircraft of $8.3 million, (which value was the appraised fair market value of the Aircraft), which consists of: (i) cash in the amount of $2.1 million to be paid at closing and (ii) a promissory note from the affiliate in the amount of $6.2 million, which is included in receivables in the accompanying consolidated balance sheet at September 30, 2010 and December 31, 2009. The closing of this sale occurred on September 9, 2009. The Company recorded a loss on the sale of the Aircraft totaling $3.0 million in 2009.

In 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. The terms of the agreement provided 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 included (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 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 $182,000 and $757,000, for the three and nine months ended September 30, 2009, respectively.

Effective July 1, 2006, General William Lyon entered into a time sharing agreement (“the Agreement”) with the Company pertaining to his personal use of the aircraft. The agreement calls for General Lyon to reimburse the company for all costs incurred by the Company during his personal flights plus a surcharge on fuel consumption of two times the cost. Pursuant to the agreement, the Company had earned revenue of $0 and $53,000 for charter services provided to William Lyon personally, during the three and nine months ended September 30, 2009, respectively.

- 31 -

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

Note 8 — Income Taxes

Effective January 1, 2008, the Company and its shareholders made a revocation of the “S” corporation election. As a result of this revocation, the Company was taxed as a “C” corporation. The shareholders will not be able to elect “S” corporation status until 2013. The revocation of the “S” corporation election allowed taxable losses generated in 2008 to be carried back to the 2006 “C” corporation year. As a result of the change in tax status, the Company recorded a deferred tax asset and related income tax benefit of $41.6 million as of January 1, 2008. In January 2009, the Company received the tax refund for the amount of the deferred tax asset.

On November 6, 2009, an expanded carry back election was signed into law as part of the Worker, Homeownership, and Business Assistance Act of 2009. As a result of this legislation, the Company elected to carry back for five years the taxable losses generated in 2009. As of December 31, 2009, the Company recorded an income tax refund receivable and the related income tax benefit of $101.8 million. As of March 31, 2010, the Company received the tax refund.

The Company accounts for income taxes in accordance with FASB ASC Topic 740,Income Taxes (“ASC 740”). ASC 740 prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be considered “more-likely-than-not” to be sustained upon examination by taxing authorities. The Company has taken positions in certain taxing jurisdictions for which it is more likely than not that previously unrecognized tax benefits will be recognized. In addition, the Company has elected to recognize interest and penalties related to uncertain tax positions in the income tax provision. In accordance with the provisions of ASC 740, effective January 1, 2007, the Company recorded an income tax refund receivable of $5.7 million and recognized the associated tax benefit as an increase in additional paid-in capital. In connection therewith, the Company recorded interest receivable of $1.1 million and recognized the associated tax benefit as an increase in retained earnings. Since recording the income tax refund, the Company has received refunds and accrued additional interest, leaving approximately $5.2 million of income tax refunds and interest receivable on the consolidated balance sheet at December 31, 2009. The Company received the balance of the refunds and interest, totaling $5.2 million in the first quarter of 2010. At December 31, 2009 and September 30, 2010, the Company has no unrecognized tax benefits.

In compliance with the Company’s election to recognize interest income (expense) and penalties related to uncertain tax positions in the income tax provision, $75,000 of interest income related to the income tax refund received, recorded under the provisions of ASC 740, is included in the benefit from income taxes of $65,000 for the nine months ended September 30, 2010.

As of January 1, 2010, the Company has gross federal and state net operating loss carry forwards totaling approximately $39.2 million and $328.3 million respectively. Federal net operating loss carry forwards will expire after 2028; state net operating loss carry forwards begin to expire after 2013.

Due to the “change of ownership” provision of the Tax Reform Act of 1986, utilization of the Company’s net operating loss carry forwards may be subject to an annual limitation against taxable income in future periods. As a result of the annual limitation, a portion of these carry forwards may expire before ultimately becoming available to reduce future income tax liabilities.

The Company has federal alternative minimum tax credit carry forward of $2.7 million which do not expire.

In addition, as of January 1, 2010, the Company has unused built-in losses of $19.4 million which are available to offset future income and expire between 2010 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 2010 and 2011. The maximum cumulative unused built-in loss that may be carried forward through 2010 and 2011 is $11.5 million and $7.9 million, respectively. 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.

The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various state jurisdictions. The Company is subject to U.S. federal income tax examination for calendar tax years ending 2006 through 2009. The Company is subject to various state income tax examinations for calendar tax years ending 2005 through 2009.

- 32 -

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

Note 9 — 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.

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.

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 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, now codified as FASB ASC Topic 970-470,Real Estate – Debt, and recorded as liabilities in the Company’s consolidated balance sheet, if the amounts are fixed and determinable.

As of September 30, 2010, the Company had $0.6 million of outstanding irrevocable standby letters of credit to guarantee the Company’s financial obligations under certain contractual arrangements in the normal course of business. The standby letters of credit were secured by cash as reflected by restricted cash on the accompanying consolidated balance sheet. 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 generally have a stated term of 12 months and have varying maturities throughout 2010 and 2011, at which time the Company may be required to renew to coincide with the term of the respective arrangement.

The Company also had outstanding performance and surety bonds of $88.7 million at September 30, 2010 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.

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 Note 5 for additional information relating to the Company’s guarantee arrangements.

Land Banking Agreements

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 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 25% of the total purchase price. The Company is under no obligation to purchase the balance of the lots, but would forfeit remaining deposits and 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. ASC 810 requires the consolidation of the assets, liabilities and operations of the Company’s land banking arrangements that are VIEs, of which none existed at September 30, 2010 and December 31, 2009.

The Company participates in one land banking arrangement, which is not a VIE in accordance with ASC 810, but is consolidated in accordance with FASB ASC Topic 470,Debt(“ASC 470”). Under the provisions of ASC 470, the Company has determined it is economically compelled, based on certain factors, to purchase the land in the land banking arrangement, and therefore, must record the remaining purchase price of the land which is included in real estate inventories not owned and liabilities from inventories not owned in the accompanying balance sheet.

- 33 -

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

Consolidated real estate inventories-owned include land deposits under option agreements or land banking arrangements of $55.3 million at September 30, 2010 and December 31, 2009, respectively.

Summary information with respect to the Company’s consolidated land banking arrangements is as follows as of September 30, 2010 (dollars in thousands):

Total number of land banking projects		1
Total number of lots		625
Total purchase price	$	161,465
Balance of lots still under option and not purchased:
Number of lots		248
Purchase price	$	55,270
Forfeited deposits if lots are not purchased	$	25,234

- 34 -

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, 2009.

Results of Operations

Over the last several years, the homebuilding industry experienced decreased demand for housing, declining sales prices and decreased absorption and sales rates. Beginning in 2006 and continuing into the beginning of 2009, these conditions were the result of an erosion of homebuyer confidence which was driven by increases in unemployment, limited availability of mortgage financing due to stress in the mortgage and credit markets, price instability, increasing foreclosures and increased levels of housing inventory in the market. In the latter part of 2009 and into 2010, in certain of the Company’s markets, the Company has experienced steadying sales absorption rates, a decrease in sales incentives and an increase in base pricing, while homebuilding costs continue to decrease. However, during the three months ended September 30, 2010, the Company experienced slower absorption rates than anticipated, while the national economy recovers.

The Company’s number of net new home orders per average sales location overall decreased to 9.1 for the three months ended September 30, 2010 compared to 10.3 for the three months ended September 30, 2009. In Southern California, net new home orders per average sales location decreased to 10.7 during the three months ended September 30, 2010 from 13.3 for the same period in 2009. In Northern California, net new home orders per average sales location decreased to 6.7 in the 2010 period from 7.7 for the same period in 2009. In Arizona, net new home orders per average sales location decreased to 8.7 in the 2010 period from 17.8 for the same period in 2009. In Nevada, net new home orders per average sales location increased to 11.0 in the 2010 period from 4.0 for the same period in 2009.

The Company’s cancellation rate decreased 2% to 17% in the three months ended September 30, 2010, compared to 19% in the 2009 period, particularly impacted by Southern California’s cancellation rate of 17% in the 2010 period compared to 21% in the 2009 period and Nevada of 12% in the 2010 period compared to 22% in the 2009 period. In addition, the Company is experiencing increased homebuilding gross margin percentages of 15.7% in the three months ended September 30, 2010, compared to 12.1% in the 2009 period particularly impacted by Southern California gross margins of 16.0% in the 2010 period compared to 15.0% in the 2009 period, Northern California gross margins of 17.2% in the 2010 period compared to 12.3% in the 2009 period and Nevada gross margins of 21.4% in the 2010 period compared to 9.9% in the 2009 period.

Comparisons of Three Months Ended September 30, 2010 to September 30, 2009

On a consolidated basis, the number of net new home orders for the three months ended September 30, 2010 decreased 34% to 163 homes from 246 homes for the three months ended September 30, 2009. The number of homes closed on a consolidated basis for the three months ended September 30, 2010, decreased 15% to 192 homes from 227 homes for the three months ended September 30, 2009. On a consolidated basis, the backlog of homes sold but not closed as of September 30, 2010 was 173, down 46% from 320 homes a year earlier.

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 September 30, 2010 was $70.1 million, down 14% from $81.2 million as of September 30, 2009. The cancellation rate of buyers who contracted to buy a home but did not close escrow at the Company’s projects was 17% during the three months ended September 30, 2010 compared to 19% during the three months ended September 30, 2009. The inventory of completed and unsold homes was 67 homes as of September 30, 2010, up from 14 homes at September 30, 2009.

The average number of sales locations during the quarter ended September 30, 2010 was 18, down 25% from 24 in the comparable period a year ago.

- 35 -

The Company’s number of new home orders per average sales location decreased 12% to 9.1 for the three months ended September 30, 2010 as compared to 10.3 for the three months ended September 30, 2009. This was attributable to Southern California, which decreased from 13.3 per location at September 30, 2009 to 10.7 per location at September 30, 2010, Northern California, which decreased from 7.7 per location at September 30, 2009 to 6.7 per location at September 30, 2010, Arizona, which decreased from 17.8 per location at September 30, 2009 to 8.7 per location at September 30, 2010 offset by Nevada which increased to 11.0 per location during the 2010 period compared to 4.0 per location in the 2009 period.

	Three Months Ended September 30,						Increase (Decrease)
	2010			2009			Amount			%
Number of Net New Home Orders
Southern California		75			120			(45	)		(38	)%
Northern California		40			23			17			74	%
Arizona		26			71			(45	)		(63	)%
Nevada		22			32			(10	)		(31	)%
Total		163			246			(83	)		(34	)%
Cancellation Rate		17	%		19	%		(2	)%

Net new home orders in each segment, except Northern California, decreased period over period. In Northern California, net new home orders increased 74% from 23 in the 2009 period to 40 in the 2010 period. Arizona experienced a significant increase in homebuyer demand in 2009 with the introduction of the new home buyer federal tax credit. In addition, in the 2010 period, the Company’s Arizona projects are experiencing competition from the large number of bank foreclosures and short sales in the marketplace.

Cancellation rates decreased to 17% for the three month period ended September 30, 2010 from 19% for the three month period ended September 30, 2009. The change includes a decrease in the cancellation rate in Southern California to 17% in the 2010 period from 21% in the 2009 period, an increase in Northern California to 27% in the 2010 period from 18% in the 2009 period, a decrease in Arizona to 0% in the 2010 period from 14% in the 2009 period and a decrease in Nevada to 12% in the 2010 period from 22% in the 2009 period.

	Three Months Ended September 30,				Increase (Decrease)
	2010		2009		Amount			%
Average Number of Sales Locations
Southern California		7		9		(2	)		(22	)%
Northern California		6		3		3			100	%
Arizona		3		4		(1	)		(25	)%
Nevada		2		8		(6	)		(75	)%
Total		18		24		(6	)		(25	)%

The average number of sales locations decreased in each homebuilding segment except Northern California during the 2010 period primarily due to (i) final deliveries in a project and (ii) management’s efforts to manage cash outflows by limiting the purchase of new lots in 2008 and 2009. However, in the last half of 2009 and into 2010, the Company has purchased additional lots for new projects, some of which are open sales locations.

	September 30,				Increase (Decrease)
	2010		2009		Amount			%
Backlog (units)
Southern California		111		210		(99	)		(47	)%
Northern California		34		18		16			89	%
Arizona		15		67		(52	)		(78	)%
Nevada		13		25		(12	)		(48	)%
Total		173		320		(147	)		(46	)%

- 36 -

The Company’s backlog at September 30, 2010 decreased 46% from 320 units at September 30, 2009 to 173 units for the period ending September 30, 2010, primarily resulting from a decrease in average sales locations and a decrease in net new home orders during the period. The decrease in backlog at quarter end reflects a decrease in total net new order activity of 34% to 163 homes in the 2010 period from 246 homes in the 2009 period, and the 15% decrease in the number of homes closed to 192 in the 2010 period from 227 in the 2009 period.

	September 30				Increase (Decrease)
	2010		2009		Amount			%
	(dollars in thousands)
Backlog (dollars)
Southern California	$	53,292	$	59,664	$	(6,372	)		(11	)%
Northern California		12,231		5,497		6,734			123	%
Arizona		1,930		10,526		(8,596	)		(82	)%
Nevada		2,685		5,492		(2,807	)		(51	)%
Total	$	70,138	$	81,179	$	(11,039	)		(14	)%

The dollar amount of backlog of homes sold but not closed as of September 30, 2010 was $70.1 million, down 14% from $81.2 million as of September 30, 2009. The decrease in backlog during this period reflects a decrease in net new order activity of 34% to 163 homes in the 2010 period compared to 246 homes in the 2009 period. In addition, the dollar amount of backlog is affected by recent average sales prices for new home orders. The Company experienced an increase of 60% in the average sales price of homes in backlog to $405,400 as of September 30, 2010 compared to $253,700 as of September 30, 2009. The decrease in the dollar amount of backlog of homes sold but not closed as described above generally results in a decrease in operating revenues in the subsequent period as compared to the previous period.

In Southern California, the dollar amount of backlog decreased 11% to $53.3 million as of September 30, 2010 from $59.7 million as of September 30, 2009, which is attributable to a 38% decrease in net new home orders in Southern California to 75 homes in the 2010 period compared to 120 homes in the 2009 period, offset by a 69% increase in the average sales price of homes in backlog to $480,100 as of September 30, 2010 compared to $284,100 as of September 30, 2009. In Southern California, the cancellation rate decreased to 17% for the period ended September 30, 2010 from 21% for the period ended September 30, 2009.

In Northern California, the dollar amount of backlog increased 123% to $12.2 million as of September 30, 2010 from $5.5 million as of September 30, 2009, which is attributable to a 74% increase in net new home orders in Northern California to 40 homes in the 2010 period compared to 23 homes in the 2009 period, along with an 18% increase in the average sales price of homes in backlog to $359,800 as of September 30, 2010 compared to $305,400 as of September 30, 2009. In Northern California, the cancellation rate increased to 27% for the period ended September 30, 2010 from 18% for the period ended September 30, 2009.

In Arizona, the dollar amount of backlog decreased 82% to $1.9 million as of September 30, 2010 from $10.5 million as of September 30, 2009, which is attributable to a 63% decrease in net new home orders in Arizona to 26 homes in the 2010 period compared to 71 homes in the 2009 period, along with an 18% decrease in the average sales price of homes in backlog to $128,700 as of September 30, 2010 compared to $157,100 as of September 30, 2009. In Arizona, the cancellation rate decreased to 0% for the period ended September 30, 2010 from 14% for the period ended September 30, 2009.

In Nevada, the dollar amount of backlog decreased 51% to $2.7 million as of September 30, 2010 from $5.5 million as of September 30, 2009, which is attributable to a 31% decrease in net new home orders in Nevada to 22 homes in the 2010 period compared to 32 homes in the 2009 period, along with a 6% decrease in the average sales price of homes in backlog to $206,500 as of September 30, 2010 compared to $219,700 as of September 30, 2009. In Nevada, the cancellation rate decreased to 12% for the period ended September 30, 2010 from 22% for the period ended September 30, 2009.

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	Three Months Ended September 30,				Increase (Decrease)
	2010		2009		Amount			%
Number of Homes Closed
Southern California		123		101		22			22	%
Northern California		32		40		(8	)		(20	)%
Arizona		22		61		(39	)		(64	)%
Nevada		15		25		(10	)		(40	)%
Total		192		227		(35	)		(15	)%

During the three months ended September 30, 2010, the number of homes closed decreased 15% to 192 in the 2010 period from 227 in the 2009 period. The decrease in home closings is primarily attributable to a 64% decrease in Arizona to 22 homes closed in the 2010 period compared to 61 homes closed in the 2009 period. The increase in Southern California is primarily attributable to improved homebuyer demand in conjunction with a change in product mix. In Arizona and Nevada, the decrease is primarily attributable to the number of homes available during the period.

	Three Months Ended September 30,				Increase (Decrease)
	2010		2009		Amount			%
	(dollars in thousands)
Home Sales Revenue
Southern California	$	53,795	$	27,669	$	26,126			94	%
Northern California		12,486		11,287		1,199			11	%
Arizona		3,565		11,611		(8,046	)		(69	)%
Nevada		3,834		5,218		(1,384	)		(27	)%
Total	$	73,680	$	55,785	$	17,895			32	%

The increase in homebuilding revenue of 32% to $73.7 million during the third quarter 2010 from $55.8 million during the third quarter 2009 is primarily attributable to an increase in the average sales price of homes closed to $383,800 during the 2010 period from $245,700 during the 2009 period, which included an increase in the number of homes closed with a sale price in excess of $500,000 from 1 in the 2009 period to 53 in the 2010 period due to a change in product mix.

	Three Months Ended September 30,				Increase (Decrease)
	2010		2009		Amount			%
Average Sales Price of Homes Closed
Southern California	$	437,400	$	273,900	$	163,500			60	%
Northern California		390,200		282,200		108,000			38	%
Arizona		162,000		190,300		(28,300	)		(15	)%
Nevada		255,600		208,800		46,800			22	%
Total	$	383,800	$	245,700	$	138,100			56	%

The average sales price of homes closed during the 2010 period increased in three segments and overall due primarily to a change in product mix. The number of homes closed with a sale price in excess of $500,000 was 1 in the 2009 period and 53 in the 2010 period.

	Three Months Ended September 30,						Increase (Decrease)
	2010			2009
Homebuilding Gross Margin Percentage
Southern California		16.0	%		15.0	%		1.0	%
Northern California		17.2	%		12.3	%		4.9	%
Arizona		0.6	%		6.0	%		(5.4	)%
Nevada		21.4	%		9.9	%		11.5	%
Total		15.7	%		12.1	%		3.6	%

Homebuilding gross margin percentage during the 2010 period increased to 15.7% from 12.1% during the 2009 period which is primarily attributable to a 56% increase in the average sales price of home closed of $383,800 in the 2010 period

- 38 -

from $245,700 in the 2009 period offset by an increase in the average cost per homes closed of 50% from $216,000 in the 2009 period to $323,400 in the 2010 period. The average cost increase is due primarily to a change in product mix in addition to previously recorded impairment.

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

Lots, Land and Other

During the three months ended September 30, 2009 land sales revenue was $0.2 million with no comparable amount in the 2010 period. During the period ended September 30, 2009, the Company recorded gross profit related to land sales of $0.2 million, with no comparable amount in the 2010 period.

Construction Services Revenue

Construction services revenue, which was all recorded in Southern California, was $1.6 million in the 2010 period compared with $11.2 million in the 2009 period. See Note 1 of “Notes to Consolidated Financial Statements” for further discussion.

Impairment Loss on Real Estate Assets

The Company evaluates homebuilding assets for impairment when indicators of impairments are present. Given the current market conditions in the homebuilding industry since 2008, the Company evaluates all homebuilding assets for impairments on a quarterly basis. Indicators of potential impairment include, but are not limited to, a decrease in housing market values and sales absorption rates. For the three months ended September 30, 2010, the Arizona segment recorded an impairment on real estate assets of $7.7 million with no comparable amount in the 2009 period.

The Company used discount rates in the estimated discounted cash flow assessments of a range of 21% to 25%. The rates resulted from an increase in the leverage component of our discount rate related to the interest cost on the Senior Secured Term Loan (14%).

The Company continues to evaluate land values to determine whether to hold for development or to sell at current prices, which may lead to additional impairment on real estate assets.

	Three Months Ended September 30,				Increase (Decrease)
	2010		2009		Amount			%
	(dollars in thousands)
Sales and Marketing Expenses
Homebuilding
Southern California	$	2,764	$	2,103	$	661			31	%
Northern California		1,549		801		748			93	%
Arizona		295		663		(368	)		(56	)%
Nevada		476		431		45			10	%
Total	$	5,084	$	3,998	$	1,086			27	%

Sales and marketing expense increased $1.1 million to $5.1 million in the 2010 period from $4.0 million in the 2009 period, primarily attributable to an increase in advertising expense of $1.1 million from $0.7 million in the 2009 period to $1.8 million in the 2010 period, due to opening of new model complexes and the re-introduction of projects where development was temporarily suspended.

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	Three Months Ended September 30,				Increase (Decrease)
	2010		2009		Amount		%
	(dollars in thousands)
General and Administrative Expenses
Homebuilding
Southern California	$	1,478	$	615	$	863		140	%
Northern California		742		380		362		95	%
Arizona		521		467		54		12	%
Nevada		609		514		95		18	%
Corporate		3,338		2,069		1,269		61	%
Total	$	6,688	$	4,045	$	2,643		65	%

General and administrative expenses increased $2.6 million to $6.7 million in the 2010 period from $4.0 million in the 2009 period primarily due to increases in salaries and benefits expense as well as outside services incurred in association with the Secured Term Loan.

Other Items

Other operating costs decreased to $0.4 million in the 2010 period compared to $1.9 million in the 2009 period. The decrease is due to a reduction in property tax expense incurred on projects in which development was temporarily suspended in the 2009 period, some of which were later restarted or sold.

Equity in income (loss) of unconsolidated joint ventures increased to income (loss) of $(1.1) million in the 2010 period from income of $0.5 million in the 2009 period, primarily due to a loss of $(1.9) million from the sale of a joint venture in Southern California.

During the period ending September 30, 2010, the Company purchased, in privately negotiated transactions, (i) $0.5 million principal amount of its outstanding 7 ⁵/8% Senior Notes at a cost of $0.4 million plus accrued interest, (ii) $30.0 million principal amount of its 10 ³/4% Senior Notes at a cost of $25.8 million plus accrued interest, and (iii) $6.8 million principal of its 7 ¹/2% Senior Notes at a cost of $5.1 million plus accrued interest. The net gain resulting from these purchases during the first three quarters, after giving effect to amortization of related deferred loan costs, was approximately $5.6 million. There were no Senior Note repurchases in the comparable 2009 period.

During the period ending September 30, 2010, the Company incurred interest related to its outstanding debt of $15.0 million, of which $10.5 million was capitalized, resulting in net interest expense of $4.5 million. During the period ending September 30, 2009, the Company incurred interest related to its outstanding debt of $10.8 million, of which $2.5 million was capitalized, resulting in net interest expense of $8.3 million.

	Three Months Ended September 30,						Increase (Decrease)
	2010			2009			Amount			%
	(dollars in thousands)
(Loss) Income Before Benefit from Income Taxes
Homebuilding
Southern California	$	(192	)	$	(2,501	)	$	(2,309	)		(92	)%
Northern California		(419	)		(415	)		4			1	%
Arizona		(8,719	)		(1,750	)		6,969			398	%
Nevada		(1,684	)		(2,130	)		(446	)		(21	)%
Corporate		2,972			(4,924	)		(7,896	)		(160	)%
Total	$	(8,042	)	$	(11,720	)	$	(3,678	)		31	%

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In Southern California, loss before benefit from income taxes improved 92% to a loss of $(0.2) million in the 2010 period from a loss of $(2.5) million in the 2009 period. The decrease in loss is primarily attributable to an increase in homebuilding gross margins to 16.0% in the 2010 period from 15.0% in the 2009 period.

In Northern California, income before benefit from income taxes remained constant at $(0.4) million in the 2010 period compared to $(0.4) million in the 2009 period. An increase in homebuilding gross margins to 17.2% in the 2010 period from 12.3% in the 2009 period was offset by an increase in sales and marketing expense of 93% in the 2010 period.

In Arizona, loss before benefit from income taxes increased 398% to a loss of $(8.7) million in the 2010 period from a loss of $(1.8) million in the 2009 period. The increase in loss is primarily attributable to a (i) a decrease in homebuilding revenue of $8.0 million to $3.6 million in the 2010 period from $11.6 million in the 2009 period, (ii) decrease in the average cost of homes closed to $161,100 in the 2010 period from $178,900 in the 2009 period, (iii) gain from sale of land of $0.2 million in the 2009 period with no comparable amount in the 2010 period, and (iv) impairment loss on real estate assets of $7.7 million in the 2010 period with no comparable amount in the 2009 period.

In Nevada, loss before benefit from income taxes decreased 21% to a loss of $(1.7) million in the 2010 period from a loss of $(2.1) million in the 2009 period. The decrease in loss is primarily attributable to an increase in the average sales price of homes closed to $255,600 in the 2010 period from $208,800 in the 2009 period.

The Corporate segment is a non-homebuilding segment in which the Company develops and implements strategic initiatives and supports the Company’s operating divisions by centralizing key administrative functions such as finance and treasury, information technology, tax planning, internal audit, risk management and litigation and human resources. The Company records the gain from retirement of senior notes and income tax provisions and benefits at the corporate segment. The change in (loss) income before benefit from income taxes to a gain of $3.0 million in the 2010 period from loss of $(4.9) million in the 2009 period is attributable to the Company recording a gain on retirement of debt of $5.6 million in the 2010 period with no comparable amount in the 2009 period.

Net Loss

As a result of the foregoing factors, net loss for the three months ended September 30, 2010 was $8.0 million compared to net loss for the three months ended September 30, 2009 of $11.6 million.

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Lots Owned and Controlled

The table below summarizes the Company’s lots owned and controlled as of the periods presented:

	September 30,				Increase (Decrease)
	2010		2009		Amount			%
Lots Owned
Southern California		1,061		1,415		(354	)		(25	)%
Northern California		654		377		277			73	%
Arizona		5,782		5,409		373			7	%
Nevada		2,711		2,795		(84	)		(3	)%
Total		10,208		9,996		212			2	%
Lots Controlled(1)
Southern California		370		508		(138	)		(27	)%
Northern California		298		—		298			100	%
Arizona		—		713		(713	)		(100	)%
Total		668		1,221		(553	)		(45	)%
Total Lots Owned and Controlled		10,876		11,217		(341	)		(3	)%

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

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Comparison of Nine Months Ended September 30, 2010 to September 30, 2009

On a consolidated basis, the number of net new home orders for the nine months ended September 30, 2010 decreased 23% to 536 homes from 697 homes for the nine months ended September 30, 2009. The number of homes closed on a consolidated basis for the nine months ended September 30, 2010, decreased 10% to 557 homes from 617 homes for the nine months ended September 30, 2009.

The cancellation rate of buyers who contracted to buy a home but did not close escrow at the Company’s projects was approximately 18% during the nine months ended September 30, 2010 compared to 21% during the nine months ended September 30, 2009.

The average number of sales locations during the nine months ended September 30, 2010 was 18, down 31% from 26 in the comparable period a year ago. The Company’s number of new home orders per average sales location increased to 29.8 for the nine months ended September 30, 2010 as compared to 26.8 for the nine months ended September 30, 2009.

	Nine Months Ended September 30,						Increase (Decrease)
	2010			2009			Amount			%
Number of Net New Home Orders
Southern California		307			338			(31	)		(9	)%
Northern California		91			90			1			1	%
Arizona		77			171			(94	)		(55	)%
Nevada		61			98			(37	)		(38	)%
Total		536			697			(161	)		(23	)%
Cancellation Rate		18	%		21	%		(3	)%

Three of the Company’s homebuilding segments experienced declines in net new home orders during the 2010 period. In Arizona, net new home orders decreased 55% from 171 in the 2009 period to 77 in the 2010 period. Arizona experienced a significant increase in homebuyer demand in 2009 with the introduction of the new home buyer federal tax credit. In addition, in the 2010 period, the Company’s Arizona projects are experiencing competition from the large number of bank foreclosures and short sales in the marketplace.

Cancellation rates during the 2010 period decreased to 18% from 21% during the 2009 period. The change includes a decrease in the cancellation rate in Southern California to 18% in the 2010 period from 20% in the 2009 period, in Northern California to 19% in the 2010 period from 24% in the 2009 period, in Arizona to 16% in the 2010 period from 12% in the 2009 period and in Nevada to 16% in the 2010 period from 30% in the 2009 period.

	Nine Months Ended September 30,				Increase (Decrease)
	2010		2009		Amount			%
Average Number of Sales Locations
Southern California		7		10		(3	)		(30	)%
Northern California		5		4		1			25	%
Arizona		3		4		(1	)		(25	)%
Nevada		3		8		(5	)		(63	)%
Total		18		26		(8	)		(31	)%

The average number of sales locations decreased in each homebuilding segment, except for Northern California, during the 2010 period primarily due to (i) management’s on-going efforts to manage cash outflows through, among other things, limiting the purchase of new lots and (ii) final deliveries in certain legacy projects. In 2009 and 2010, the Company has purchased additional lots for new projects, some of which are active selling communities.

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	Nine Months Ended September 30,				Increase (Decrease)
	2010		2009		Amount			%
Number of Homes Closed
Southern California		354		262		92			35	%
Northern California		63		120		(57	)		(48	)%
Arizona		79		138		(59	)		(43	)%
Nevada		61		97		(36	)		(37	)%
Total		557		617		(60	)		(10	)%

During the 2010 period, the number of homes closed decreased 10% compared to the 2009 period. In Arizona and Nevada, the decrease is primarily attributable to a decrease in the average number of sales locations to 3 each, in the 2010 period from 4 and 8, respectively, in the 2009 period. In Northern California, the decrease is attributable to the lack of available homes in the 2010 period. The number of homes in backlog at December 31, 2009 in Northern California was 6 homes. In Southern California, the increase is attributable to a change in product mix and average sales price, which decreased to $363,900 in the 2010 period compared to $365,800 in the 2009 period.

	Nine Months Ended September 30,				Increase (Decrease)
	2010		2009		Amount			%
Home Sales Revenue (dollars in thousands)
Southern California	$	128,816	$	95,840	$	32,976			34	%
Northern California		23,752		35,838		(12,086	)		(34	)%
Arizona		13,689		26,257		(12,569	)		(48	)%
Nevada		14,022		21,806		(7,783	)		(36	)%
Total	$	180,279	$	179,741	$	538			0	%

The increase in homebuilding revenue of $0.6 million to $180.3 million during the 2010 period from $179.7 million during the 2009 period is primarily attributable to an increase in the average sales price of homes closed to $323,700 during the 2010 period from $291,300 during the 2009 period offset by a decrease in the number of homes closed to 557 during the 2010 period from 617 during the 2009 period.

	Nine Months Ended September 30,				Increase (Decrease)
	2010		2009		Amount			%
Average Sales Price of Homes Closed
Southern California	$	363,900	$	365,800	$	(1,900	)		(1	)%
Northern California		377,000		298,700		78,300			26	%
Arizona		173,300		190,300		(17,000	)		(9	)%
Nevada		229,900		224,800		5,100			2	%
Total	$	323,700	$	291,300	$	32,400			11	%

The increase in the average sales price of homes closed during the 2010 period is primarily due to a change in product mix for actively selling projects as well as an increase in the number of homes closed with a sale price in excess of $500,000.

	Nine Months Ended September 30,						Increase (Decrease)
	2010			2009
Homebuilding Gross Margin Percentage
Southern California		17.0	%		13.9	%		3.1	%
Northern California		21.6	%		11.1	%		10.5	%
Arizona		4.0	%		6.6	%		(2.6	)%
Nevada		17.6	%		12.2	%		5.4	%
Total		16.7	%		12.0	%		4.7	%

- 44 -

Homebuilding gross margin percentage during the 2010 period increased to 16.7% from 12.0% during the 2009 period which is primarily attributable to an increase in the average sales price of homes closed of 11% from $291,300 in the 2009 period to $323,700 in the 2010 period. The increase also reflects improved margins from projects impaired in previous periods.

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

Lots, Land and Other

Land sales revenue was $17.2 million during the 2010 period, related to an opportunistic land sale in Northern California, compared with $7.6 million during the 2009 period, which was primarily a land sale in Arizona. During the nine months ended September 30, 2010 and 2009, the Company recorded gross profit (loss) related to land sales of $1.6 million and $(39.0) million, respectively. Included in these amounts are the write-off of land deposits and pre-acquisition costs of $1.2 million and $37.9 million, respectively, related to future projects which the Company has concluded are not currently economically viable. The write-off of land deposits and pre-acquisition costs of $37.9 million recorded during the nine months ended September 30, 2009 are attributable to projects held in three of its land banking arrangements. Management of the Company determined that the remaining purchase prices of the lots in the arrangements were priced above current market values.

Construction Services Revenue

Construction services revenue, which was all recorded in Southern California, was $7.6 million in the 2010 period, compared to $26.6 million in the 2009 period. See Note 1 of “Notes to Consolidated Financial Statements” for further discussion.

	Nine Months Ended September 30,				Increase (Decrease)
	2010		2009
Impairment Loss on Real Estate Assets (dollars in thousands)
Land under development and homes completed and under construction
Southern California	$	—	$	450	$	(450	)
Northern California		—		6,144		(6,144	)
Arizona		7,943		—		7,943
Nevada		—		4,224		(4,224	)
Total	$	7,943	$	10,818	$	(2,875	)
Land Held-for-Sale or Sold
Nevada	$	—	$	13,353	$	(13,353	)
Total		—		13,353		(13,353	)
Total Impairment Loss on Real Estate Assets	$	7,943	$	24,171	$	(16,228	)

The Company evaluates homebuilding assets for impairments when indicators of potential impairments are present. Given the current market conditions in the homebuilding industry, the Company evaluates all homebuilding assets for impairments each quarter. Indicators of potential impairment include, but are not limited to, a decrease in housing market values and sales absorption rates.

The impairment loss related to land under development and homes completed and under construction incurred during the nine months ended September 30, 2009, primarily resulted from decreases in home sales prices, due to increased sales incentives, and the continued deterioration in the homebuilding industry. In addition, during the 2009 period, the Company used discount rates in the estimated discounted cash flow assessments of 21% to 25%. The rates resulted from an increase in the leverage component of our discount rate related to the interest cost on the Senior Secured Term Loan (14%).

The impairment loss related to land held-for-sale or sold in the 2009 period primarily resulted from significant decreases in the fair market values of new homes being sold, as this has caused corresponding declines in the fair market values of land held by the Company. Also contributing to this impairment was the decision that the best economic value to the Company of these lots was to sell them in their current condition as opposed to holding the lots and eventually building and selling homes. The Company continues to evaluate land values to determine whether to hold for development or to sell at current prices, which may lead to additional impairment on real estate assets.

- 45 -

	Nine Months Ended September 30,				Increase (Decrease)
	2010		2009		Amount			%
Sales and Marketing Expenses (dollars in thousands)
Homebuilding
Southern California	$	9,289	$	6,464	$	2,825			44%
Northern California		2,906		2,841		65			2%
Arizona		947		1,647		(700	)		(43)%
Nevada		1,344		1,710		(366	)		(21)%
Total	$	14,486	$	12,662	$	1,824			14%

Sales and marketing expense increased $1.8 million to $14.5 million in the 2010 period from $12.7 million in the 2009 period primarily due to (i) an increase of $3.1 million in advertising costs due to opening of new model complexes and the re-introduction of projects where development was temporarily suspended, offset by (ii) a decrease in direct selling expenses of approximately $0.9 million which was primarily a reduction in outside broker commissions paid due to the decrease in units closed of 23% as compared to 2009.

	Nine Months Ended September 30,				Increase (Decrease)
	2010		2009		Amount			%
General and Administrative Expenses (dollars in thousands)
Homebuilding
Southern California	$	3,392	$	2,847	$	545			19%
Northern California		1,974		1,620		354			22%
Arizona		1,621		1,582		39			2%
Nevada		1,614		1,749		(135	)		(8)%
Corporate		9,673		6,800		2,873			42%
Total	$	18,274	$	14,598	$	3,676			25%

General and administrative expenses increased $3.7 million, or 25%, in the 2010 period to $18.3 million from $14.6 million in the 2009 period primarily due to outside services incurred in association with the Secured Term Loan and increase in salaries and accrued bonuses.

Other Items

Other operating costs decreased to $2.3 million in the 2010 period compared to $4.5 million in the 2009 period. The decrease is due to a reduction in property tax expense incurred on projects in which development was temporarily suspended in the 2009 period, some of which were later restarted or sold.

Equity in income (loss) of unconsolidated joint ventures increased to income of $0.1 million in the 2010 period from a loss of $(0.8) million in the 2009 period primarily due to a $0.7 million increase in income from a mortgage company venture.

In the 2010 period, the Company purchased in privately negotiated transactions, $37.3 million principal amount of its outstanding Senior Notes at a cost of $31.3 million, plus accrued interest. The net gain resulting from the purchase, after giving effect to amortization of related deferred loan costs was $5.6 million. In the 2009 period, the Company purchased in a tender offer and in privately negotiated transactions, $84.4 million principal amount of its outstanding Senior Notes at a cost of $25.3 million, plus accrued interest. The net gain resulting from the purchase, after giving effect to amortization of related deferred loan costs was $58.0 million.

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During the 2010 period, the Company incurred interest related to its outstanding debt of $47.0 million, of which $29.2 million was capitalized, resulting in net interest expense of $17.8 million, compared to interest incurred of $35.4 million, of which $10.1 million was capitalized, resulting in net interest expense of $25.3 million in the 2009 period.

Other loss in the 2009 period primarily consists of the loss on the sale of fixed asset of $3.0 million due to the sale of the Company’s airplane as described in Note 7 of “Notes to Consolidated Financial Statements”, with no comparable amount in the 2010 period.

	Nine Months Ended September 30,						Increase (Decrease)
	2010			2009			Amount			%
(Loss) Income Before Benefit from Income Taxes (dollars in thousands)
Homebuilding
Southern California	$	(6,068	)	$	(21,574	)	$	(15,506	)		(72)%
Northern California		2,204			(37,104	)		(39,308	)		(106)%
Arizona		(11,180	)		(6,293	)		4,887			78%
Nevada		(3,615	)		(23,914	)		(20,299	)		(85)%
Corporate		(2,561	)		47,648			50,209			(105)%
Total	$	(21,220	)	$	(41,237	)	$	(20,017	)		(49)%

In Southern California, loss before benefit from income taxes decreased 72% to $(6.1) million in the 2010 period from $(21.6) million in the 2009 period. The decrease in loss is primarily attributable to a $4.4 million increase in gross margin in the 2010 period, a reduction in write-off of land deposits and pre-acquisition costs from $9.3 million in the 2009 period with no comparable amount in the 2010 period and a decrease in impairment from $0.5 million in the 2009 period with no comparable amount in the 2010 period.

In Northern California, income (loss) before benefit from income taxes improved to $2.2 million in the 2010 period compared to a loss of $(37.1) million in the 2009 period. The decrease in loss is primarily attributable to (i) an increase in gross margin to $5.1 million in the 2010 period from $4.0 million in the 2009 period and (ii) the abandonment of land deposits and pre-acquisition costs at certain of the Company’s projects of $28.6 million in the 2009 period with a negligible amount in the 2010 period, and (iii) impairment loss on real estate assets of $6.1 million in the 2009 period with no comparable amount in the 2010 period.

In Arizona, loss before benefit from income taxes increased to a loss of $(11.2) million in the 2010 period from loss of $(6.3) million in the 2009 period. The change is primarily attributable to (i) impairment loss on real estate assets of $7.9 million in the 2010 period with no comparable amount in the 2009 period, (ii) a land sale in the 2009 period that resulted in a $(1.4) million loss with no comparable amount in the 2010 period, along with (iii) a decrease in sales and marketing expense to $0.9 million in the 2010 period from $1.6 million in the 2009 period.

In Nevada, loss before benefit from income taxes decreased 85% to $(3.6) million in the 2010 period from $(23.9) million in the 2009 period. The decrease in loss is primarily attributable to (i) a decrease in impairment loss on real estate assets of $17.6 million in the 2009 period with no comparable amount in the 2010 period, along with (ii) a decrease in sales and marketing expense to $1.3 million in the 2010 period from $1.7 million in the 2009 period.

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

Income Taxes

Effective January 1, 2008, the Company’s stockholders made a revocation of the “S” corporation election. As a result of this revocation, the Company was taxed as a “C” corporation. The shareholders will not be able to elect “S” corporation status until 2013. The revocation of the “S” corporation election allowed taxable losses generated in 2008 to be carried back to the 2006 “C” corporation year. As a result of the change in tax status, the Company recorded a deferred tax asset and related income tax benefit of $41.6 million as of January 1, 2008. In January 2009, the Company received the tax refund for the amount of the deferred tax asset.

On November 6, 2009, an expanded carry back election was signed into law as part of the Worker, Homeownership, and Business Assistance Act of 2009. As a result of this legislation, the Company elected to carry back for five years the

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taxable losses generated in 2009. As of December 31, 2009, the Company recorded an income tax refund receivable and the related income tax benefit of $101.8 million. The Company received the tax refund during the first quarter of 2010.

Net Loss

As a result of the foregoing factors, net loss for the nine months ended September 30, 2010 was $21.0 million compared to net loss for the nine months ended September 30, 2009 of $41.3 million.

Financial Condition and Liquidity

The Company provides for its ongoing cash requirements principally from internally generated funds from the sales of real estate, outside borrowings and by forming new joint ventures with venture partners that provide a substantial portion of the capital required for certain projects. The Company currently has outstanding a Senior Secured Term Loan due 2014, 7 ⁵/8% Senior Notes due 2012, 10 ³/4% Senior Notes due 2013 and 7 ¹/2% Senior Notes due 2014. The Company has financed, and may in the future finance again, certain projects and land acquisitions with construction loans secured by real estate inventories, seller provided financing and land banking transactions. The Company believes that its cash on hand, 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).

The Company’s strategy is to continue to generate positive cash flow from existing assets to repay outstanding indebtedness for the purpose of de-levering the Company and reducing interest costs. In addition, the Company intends to acquire new land that will fill the pipeline for future projects and increase our community count.

In conjunction with that strategy, in 2007 and 2008, the Company suspended development, sales and marketing activities at certain of its projects which were in the early stages of development. The Company concluded that this strategy was necessary under the prevailing market conditions at that time. As market conditions have continued to improve, the Company has released for sale, or re-started development of certain of these suspended projects in the first half of 2010. The Company will continue to analyze the viability of re-introducing the remaining suspended projects into their respective markets.

During the nine months ended September 30, 2010, the Company received a federal income tax refund of approximately $41.6 million and repaid $50.1 million of notes payable and retired $37.3 million in senior notes at a cost of $31.3 million. The Company’s cash balance at September 30, 2010 was $71.9.

As discussed more fully below, in October 2009, the Company entered into a Senior Secured Term Loan in the amount of $206.0 million. The Company used a portion of the net proceeds to fully repay the outstanding balances on its revolving credit facilities during the fourth quarter of 2009. As of December 31, 2009, the revolving credit facilities have been retired.

There is no assurance, however, that future cash flows will be sufficient to meet the Company’s future capital needs, in which case the Company may need to raise additional capital. The amount and types of indebtedness that the Company may incur may be limited by the terms of the indentures and credit or other agreements governing the Company’s Senior Note obligations, Senior Secured Term Loan and other indebtedness.

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 and other indebtedness may restrict the Company from pursuing any of these alternatives.

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Senior Secured Term Loan

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

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

California Lyon received the first installment of $131.0 million, which funded in October 2009, and its second installment of $75.0 million, which funded in December 2009. The net proceeds to the Company from the first installment of the term loan, after giving effect to attorney fees, loan fees and other miscellaneous costs associated with the loan transaction, and repayment of the revolving credit facilities and purchase of the senior notes was $34.6 million. A portion of the $75.0 million proceeds from the second installment were used to fund the Company’s land acquisitions in 2010.

Under the Term Loan Agreement, California Lyon will be required to repay existing borrowings, in order to maintain required loan to value ratios such that: (i) the aggregate amount of outstanding loans under the Term Loan Agreement may not exceed 60% of the aggregate value of the properties securing the facility, with valuation based on the lower of appraised value (if any) and discounted net present value of the cash flows, plus unrestricted cash, and (ii) the aggregate amount of secured debt may not exceed 60% of the aggregate value of the properties owned by California Lyon and its subsidiaries, with valuation based on the lower of appraised value (if any) and discounted net present value of the cash flows. California Lyon is currently in compliance with the above requirements.

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

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

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

The Term Loan will mature on October 20, 2014; however, in the event that any portion of the outstanding principal amounts (the “Repaid Senior Note Principal”) of the Senior Notes is repaid (whether or not at maturity), the Lenders may elect to require California Lyon to repay that portion of the outstanding Loan as bears the same ratio to the entire Loan outstanding (excluding any obligation of California Lyon with respect to the Exit fee or Make-Whole Payment) as the Repaid Senior Note Principal bears to the entire amounts then outstanding under all of the indentures. All or a portion of the Term Loan may also be accelerated upon certain other events described in the Loan Agreement. The lenders waived the requirement for such repayment in connection with the Senior Note repurchases described in Note 10 and in Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The Term Loan Agreement contains covenants that limit the ability of California Lyon and the Company to, among other things: (i) incur liens; (ii) incur additional indebtedness; (iii) transfer or dispose of assets; (iv) merge, consolidate or alter their line of business; (v) guarantee obligations; (vi) engage in affiliated party transactions; (vii) declare or pay dividends or make other distributions or repurchase stock; (viii) make advances, loans or investments; (ix) repurchase debt (including under the Senior Note indentures) and (x) engage in change of control transactions.

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

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In addition, under the Term Loan, the Company is required to comply with a number of covenants, the most restrictive of which require the Company to maintain:

• A tangible net worth, as defined, of not less than $75.0 million;

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

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

• Excluded Assets of no more than $20.0 million, with “Excluded Assets” being defined generally as the sum total of certain deposit accounts, payroll accounts, unrestricted cash accounts, and the Company’s total investment in joint ventures.

The Company’s covenant compliance for the Term Loan at September 30, 2010 is detailed in the table set forth below:

Covenant and Other Requirements	Actual at September 30, 2010			Covenant Requirements at September 30, 2010
Tangible Net Worth (1)	$	126.8		³$75.0
Borrowing Base		42.0	%	£60%
Maximum Permitted Secured Indebtedness		48.0	%	£60%
Excluded Assets	$	9.4		£$20.0

(1) Tangible Net Worth was calculated based on the stated amount of equity less intangible assets of $13.3 million as of September 30, 2010.

As of and for the period ending September 30, 2010, the Company was in compliance with the covenants under this loan.

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

7 ⁵/8% Senior Notes

On November 22, 2004, California Lyon issued $150.0 million principal amount of 7 ⁵/8% Senior Notes due 2012 (the “7 ⁵/8% Senior Notes”), resulting in net proceeds to the Company of approximately $148.5 million. Of the initial $150.0 million, $66.7 and $67.2 million in aggregate principal amount remained as of September 30, 2010 and December 31, 2009, respectively. In August 2010, the Company repurchased, in a privately negotiated transaction, $0.5 principal amount of its outstanding 7 ⁵/8% Senior Notes at a cost of $0.4 million plus accrued interest.

Interest on the 7 ⁵/8% Senior Notes is payable semi-annually on December 15 and June 15 of each year. Based on the current outstanding principal amount of the 7 ⁵/8% Senior Notes, the Company’s semi-annual interest payments are $2.5 million.

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

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10  ³/4% Senior Notes

On March 17, 2003 California Lyon issued $250.0 million of 10 ³/4% Senior Notes due 2013 (the “10 ³/4% Senior Notes”) at a price of 98.493% to the public, resulting in net proceeds to the Company of approximately $246.2 million. The purchase price reflected a discount to yield 11% under the effective interest method and the notes have been reflected net of the unaccreted discount in the consolidated balance sheet. Of the initial $250.0 million, $138.6 million and $168.2 million aggregate principal amount remained outstanding as of September 30, 2010 and December 31, 2009, respectively. In July 2010, the Company repurchased, in a privately negotiated transaction, $10.5 million principal amount of its outstanding 10 ³/4% Senior Notes at a cost of $9.0 million plus accrued interest. In August 2010, the Company repurchased, in privately negotiated transactions, $19.5 million principal amount of its outstanding 10 ³/4% Senior Notes at a cost of $16.9 million plus accrued interest.

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 $7.4 million.

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

7  ¹/2% Senior Notes

On February 6, 2004, California Lyon issued $150.0 million principal amount of 7 ¹/2% Senior Notes due 2014 (the “7 ¹/2% Senior Notes”), resulting in net proceeds to the Company of approximately $147.6 million. Of the initial $150.0 million, $77.9 and $84.8 million aggregate principal amount remained outstanding as of September 30, 2010 and December 31, 2009, respectively. In August 2010, the Company repurchased, in a privately negotiated transaction, $6.8 million principal amount of its outstanding 7 ¹/2% Senior Notes at a cost of $5.1 million plus accrued interest.

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 $2.9 million.

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

General Terms of the Senior Notes

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

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

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

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.

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As of and for the period ending September 30, 2010, the Company was in compliance with these covenants.

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

Supplemental consolidating financial information of the Company, specifically including information for California Lyon, the issuer of the 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.

Construction Notes Payable

At September 30, 2010, the Company had two construction notes payable totaling $23.4 million. One of the notes matures in July 2011 and bears interest at rates based on either LIBOR or prime with an interest rate floor of 6.5% and an outstanding principal balance of $13.9 million. Interest is calculated on the average daily balance and is paid following the end of each month.

The other construction note had a remaining balance at September 30, 2010 of $9.5 million, after giving effect to a partial prepayment of the note in the amount of $28.1million that was made in May 2010. This note was previously due to mature in July 2010; however, in conjunction with the partial prepayment, the Company and the lender entered into a new loan agreement for the remaining outstanding principal of $10.0 million, which matures July 2015. The new loan pays interest monthly at a fixed rate of 12.5%, with quarterly principal payments of $500,000. The interest rate decreases to 10.0% when the principal balance is reduced to $7.5 million.

Seller Financing

At September 30, 2010, the Company had $10.7 million of notes payable outstanding related to a land acquisition for which seller financing was provided, which is included in notes payable in the accompanying consolidated balance sheet. The seller financing note is due at various dates through 2012 and bear interest at 7.0%. Interest is calculated on the principal balance outstanding and is accrued and paid to the seller at the time each residential unit is closed. In addition, the Company makes an annual interest payment on the outstanding principal balance related to any remaining residential units.

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 25% of the total purchase price. The Company is under no obligation to purchase the balance of the lots, but would forfeit remaining deposits and 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. ASC 810 requires the consolidation of the assets, liabilities and operations of the Company’s land banking arrangements that are VIEs, of which none existed at September 30, 2010.

The Company participates in one land banking arrangement, which is not a VIE in accordance with ASC 810, but is consolidated in accordance with FASB ASC Topic 470,Debt(“ASC 470”). Under the provisions of ASC 470, the Company has determined it is economically compelled, based on certain factors, to purchase the land in the land banking arrangement, and therefore, must record the remaining purchase price of the land which is included in real estate inventories not owned and liabilities from inventories not owned in the accompanying balance sheet.

Consolidated real estate inventories-owned include land deposits under option agreements or land banking arrangements of $55.3 million at September 30, 2010 and December 31, 2009, respectively.

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Summary information with respect to the Company’s consolidated land banking arrangements is as follows as of September 30, 2010 (dollars in thousands):

Total number of land banking projects		1
Total number of lots		625
Total purchase price	$	161,465
Balance of lots still under option and not purchased:
Number of lots		248
Purchase price	$	55,270
Forfeited deposits if lots are not purchased	$	25,234

During the three months ended March 31, 2009, the Company abandoned its option deposit in three of its land banking arrangements in which land purchase commitments are required. Management of the Company determined that the remaining purchase prices of the lots in the arrangements were priced above current market values. In two of these arrangements, the Company reduced real estate inventories-not owned and the related non-controlling interest by $27.7 million for the remaining investment in this project. In the other arrangement, the Company reduced real estate inventories-not owned and liabilities from inventories-not owned by $9.3 million for the remaining investment in this project. The impact of these transactions is reflected in the accompanying consolidated financial statements as of the period ending September 30, 2009.

See Notes 4 and 9 of “Notes to Consolidated Financial Statements” for further discussion of the Company’s land banking arrangements.

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 Note 2 of “Notes to Consolidated Financial Statements”, in accordance with FASB ASC 810 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. 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.

In conjunction with the Company’s strategy to cease operations at William Lyon Financial Services, in which it discontinued originating and funding homebuyer mortgage loans, in March 2009, the Company entered into a joint venture operating agreement with a lending institution. The Company receives 50% of the profits and cash flows from the venture. The joint venture was created to service the Company’s homebuyers by having access to a larger mortgage portfolio with the lending institution.

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 Nine Months Ended September 30, 2010 to Nine Months Ended September 30, 2009

Net cash provided by operating activities decreased to $22.7 million in the 2010 period from $43.9 million in the 2009 period. The change was primarily as a result of (i) an increase in real estate inventories-owned of $94.6 million in the 2010 period compared to an decrease of $67.3 million in the 2009 period, (ii) a decrease in receivables of $2.7 million in the 2010 period compared to a decrease of $19.2 million in the 2009 period, (iii) a decrease in income tax refunds receivable of $107.0 million in the 2010 period compared with $41.6 million in the 2009 period, (iv) impairment loss on real estate assets $24.2 million in the 2009 period compared to $7.9 million in the 2010 period, (v) gain on retirement of debt of $5.6 million in the 2010 period compared with gain on retirement of debt of $58.0 million in the 2009 period, and (vi) consolidated net loss of $21.2 million in the 2010 period compared to consolidated net loss of $41.2 million in the 2009 period. The increase in the income tax benefit was the result of the legislation enacted in November 2009 which allows net operating losses realized in either tax year 2008 or 2009 to be carried back up to five years. As a result of the new legislation the Company recorded an income tax refund receivable and federal income tax benefit of $101.8 million for the year ended December 31, 2009, which the Company received in the first quarter of 2010.

The decrease in impairment loss on real estate assets is described in “Results of Operations” above. The gain on retirement of debt is attributable to the Senior Note repurchase transactions that occurred during 2010 and 2009 and is described in more detail in Note 5 of “Notes to Consolidated Financial Statements.” The difference between the benefit from income taxes in the 2010 period and the benefit for income taxes in the 2009 period is described in detail in Note 8 of “Notes to Consolidated Financial Statements.”

Net cash provided by (used in) investing activities decreased to $2.1 million in the 2010 period from $2.2 million in the 2009 period. The change was primarily a result of a decrease in net proceeds from the sale of fixed assets of $2.1 million in the 2009 period with no comparable amount in the 2010 period, offset by an increase in distributions of income from unconsolidated joint ventures of $2.3 million in the 2010 period compared to $0.4 million in the 2009 period.

Net cash used in financing activities decreased to $70.4 million in the 2010 period from $80.9 million in the 2009 period, primarily as a result of the decrease in cash paid in principal payments on notes payable of $50.1 million in the 2010 period compared to $157.7 million in the 2009 period and the decrease in proceeds on borrowings to $7.9 million in the 2010 period compared to $107.0 million in the 2009 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 and 9 of “Notes 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, 2009.

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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 for each of the Company’s homebuilding divisions.

Project (County or City)	Year of First Delivery		Estimated Number of Homes at Completion (1)		Cumulative Units Closed as of Sept 30, 2010		Backlog at Sept  30, 2010 (2) (3)		Lots Owned as of Sept 30, 2010(4)		Homes Closed for the Year Ended Sept 30, 2010		Sales Price Range(5)
SOUTHERN CALIFORNIA
San Diego County:
San Diego
Pasado Del Sur		2009		25		20		0		5		0	$	523,000 - 570,000
Pasado Del Sur II		2010		64		27		15		37		27	$	523,000 - 570,000
Carlsbad
Blossom Grove		2010		110		11		5		21		11	$	530,000 - 600,000
Mirasol at La Costa Greens		2010		71		6		6		65		6	$	641,000 -700,000
San Bernardino County:
Fontana
Adelina		2008		109		109		0		0		50	$	208,000 - 241,000
Rosabella		2007		114		112		2		2		39	$	225,000 - 260,000
Rancho Cucamonga
Amador		2007		69		69		0		0		9	$	214,000 - 258,000
Amador (Lewis)		2010		30		30		0		0		30	$	212,000 - 252,000
Vintner’s Grove:
Sollara SFD		2007		45		45		0		0		7	$	358,000 - 408,000
Canela Triplex		2007		63		63		0		0		9	$	220,000 - 260,000
Vintner’s Grove (Lewis)
Sollara SFD		2009		33		33		0		0		33	$	350,000 - 405,000
Canela Triplex		2010		15		15		0		0		15	$	217,000 - 256,000
Orange County:
Irvine
San Carlos II		2010		92		0		15		92		0	$	310,000 - 470,000
Ivy		2009		135		84		25		51		64	$	375,000 - 454,000
Santa Ana
Canopy Lane		2011		38		0		0		38		0	$	515,000 - 580,000
Los Angeles County:
Glendora
Arboreta at Rainbird
Vintage		2008		87		87		0		0		34	$	349,000 - 457,000
Hawthorne
360 South Bay (6):
The Flats		2010		188		0		29		188		0	$	375,000 - 540,000
The Lofts		2011		123		0		0		123		0	$	525,000 - 775,000
The Rows		2011		94		0		0		94		0	$	700,000 - 810,000
The Courts		2010		118		20		14		98		20	$	470,000 - 580,000
The Gardens		2012		102		0		0		102		0	$	755,000 - 980,000
Azusa
Rosedale:
Gardenia		2011		147		0		0		81		0	$	455,000 - 550,000
Sage Court		2011		176		0		0		64		0	$	420,000 - 515,000
SOUTHERN CALIFORNIA TOTAL				2,048		731		111		1,061		354
NORTHERN CALIFORNIA
Contra Costa County:
Pittsburgh
Vista Del Mar
Villages		2007		102		50		0		52		0	$	296,000 - 355,000
Venue		2007		132		54		6		78		6	$	330,000 - 365,000
Vineyard		2007		29		29		0		0		12	$	386,000 - 430,000
Victory		2008		25		14		0		11		0	$	680,000 - 745,000
Antioch
Waterford		2011		130		0		0		130		0	$	265,000 - 310,000
Placer County:
Whitney Ranch, Rocklin
Twin Oaks		2006		92		84		5		8		21	$	400,000 - 470,000
Sacramento County:
Elk Grove
Big Horn
Gallery Walk		2005		149		149		0		0		1	$	180,000 - 230,000
Magnolia Lane (Maderia)		2010		90		2		6		88		2	$	250,000 - 300,000
San Joaquin County:
The Ranch @ Mossdale Landing, Lathrop		2010		168		16		6		152		16	$	205,000 - 250,000
Santa Clara County:
The Gardens, San Jose		2010		40		5		3		35		5	$	595,000 - 600,000
Solano County:
Enclave at Paradise Valley, Fairfield		2010		100		0		8		100		0	$	340,000 - 410,000
NORTHERN CALIFORNIA TOTAL				1,057		403		34		654		63

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Project (County or City)	Year of First Delivery		Estimated Number of Homes at Completion (1)		Cumulative Units Closed as of Sept 30, 2010		Backlog at Sept  30, 2010 (2) (3)		Lots Owned as of Sept 30, 2010(4)		Homes Closed for the Year Ended Sept 30, 2010		Sales Price Range(5)
ARIZONA
Maricopa County
Queen Creek
Hastings Property		2011		631		0		0		631		0	$	115,900 - 382,000
Church Farms North		2013		1,820		0		0		1,820		0	$	113,000 - 399,900
Arroyo @ Coldwater Ranch, Peoria		2009		20		15		2		5		7	$	132,000 - 168,000
Lehi Crossing, Mesa		2012		914		0		0		914		0	$	199,900 - 464,900
Rancho Mercado, Phoenix		2013		1,826		0		0		1,826		0	$	110,900 - 316,900
Lyon’s Gate, Gilbert:
Pride		2006		650		469		8		181		35	$	121,000 - 148,000
Savanna		2006		174		174		0		0		2	$	172,000 - 215,000
Sahara		2006		169		169		0		0		3	$	196,000 - 259,000
Acacia		2007		365		173		5		192		32	$	157,000 - 200,000
Future Products		2013		213		0		0		213		0
ARIZONA TOTAL				6,782		1,000		15		5,782		79
NEVADA
Clark County:
North Las Vegas
The Cottages		2004		360		316		0		44		0	$	152,000 - 179,000
Serenity Ridge		2011		88		0		0		88		0	$	380,000 - 455,000
Tularosa at Mountain’s Edge		2011		140		0		0		140		0	$	190,000 - 240,000
Las Vegas
Carson Ranch
West Series I		2005		74		70		2		4		3	$	220,000 - 255,000
West Series II		2005		56		55		0		1		2	$	406,000 - 503,000
East Series I		2006		116		114		1		2		12	$	219,000 - 254,000
East Series II		2007		45		45		0		0		8	$	246,000 - 305,000
West Park
Villas		2006		107		95		5		12		4	$	155,000 - 185,000
Courtyards		2006		92		82		5		10		3	$	177,000 - 214,000
Flagstone
Crossings		2011		77		0		0		77		0	$	268,000 - 304,000
Commons		2011		37		0		0		37		0	$	232,000 - 260,000
Rhapsody		2011		63		0		0		63		0	$	179,000 - 201,000
The Fields at Aliente		2011		60		0		0		60		0	$	212,000 - 246,000
Nye County:
Pahrump
Mountain Falls
Cascata		2005		142		142		0		0		5	$	216,000 - 238,000
Tramonto		2005		212		181		0		31		7	$	176,000 - 211,000
Bella Sera		2005		129		119		0		10		9	$	217,000 - 257,000
Cascata Ancora		2007		80		80		0		0		8	$	99,000 - 148,000
Entrata		2007		26		26		0		0		0	$	142,000 - 164,000
Series I		2011		116		0		0		116		0	$	117,000 - 148,000
Series II		2011		91		0		0		91		0	$	194,000 - 229,000
Future Projects		2011		1,925		0		0		1,925		0
NEVADA TOTAL				4,036		1,325		13		2,711		61
GRAND TOTALS				13,923		3,459		173		10,208		557

(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 September 30, 2010, all 173 represent homes completed or under construction.

(4) Lots owned as of September 30, 2010 include lots in backlog at September 30, 2010.

(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 September 30, 2010. The Company consolidated the purchase price of the lots in accordance with Interpretation No. 46, and considers the lots owned at September 30, 2010.

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Income Taxes

See Note 8 of “Notes to Consolidated Financial Statements” for a description of the Company’s income taxes.

Related Party Transactions

See Note 7 of “Notes to Consolidated Financial Statements” for a description of the Company’s transactions with related parties.

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, 2009, 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. We believe that there have been no significant changes to our critical accounting policies during the three and six months ended June 30, 2010, as compared to those we disclosed in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2009, except for the following accounting policies that were updated as a result of the implementation of certain new provisions of ASC 810.

Recently Issued Accounting Standards

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

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The Company’s Annual Report on Form 10-K for the year ended December 31, 2009, 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, 2009.

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.

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

Changes in Internal Control over Financial Reporting. There have been no significant changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f)) under the Securities Exchange Act of 1934, as amended) that occurred during the 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.

Item 4T.

Not Applicable

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WILLIAM LYON HOMES

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

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

Item 1A. Risk Factors

The Company’s Annual Report on Form 10-K for the year ended December 31, 2009, 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 the filing of the Annual Report on Form 10-K for the year ended December 31, 2009.

Items2,3,4 and 5

Not applicable.

Item 6. Exhibits

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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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: November 5, 2010	By:	/S/    COLIN T. SEVERN
		Colin T. Severn
		Vice President, Chief Financial Officer, Corporate Secretary (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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