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 June 30, 2006

OR

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

    SECURITIES EXCHANGE ACT OF 1934

Commission file number 001-31625

WILLIAM LYON HOMES

(Exact name of registrant as specified in its charter)

Delaware	33-0864902
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)
4490 Von Karman Avenue
Newport Beach, California	92660
(Address of principal executive offices)	(Zip Code)

(949) 833-3600

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year,

if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YES  x                    NO  ¨

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

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

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

YES  ¨                    NO  x

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

Class of Common Stock	Outstanding at August 1, 2006
Common stock, par value $.01	1,000

WILLIAM LYON HOMES

INDEX

	Page No.
PART I.    FINANCIAL INFORMATION
Item 1.    Financial Statements:
Consolidated Balance Sheets — June 30, 2006 (unaudited) and December 31, 2005	3
Consolidated Statements of Income — Three and Six Months Ended June 30, 2006 and 2005 (unaudited)	4
Consolidated Statement of Stockholders’ Equity — Six Months Ended June 30, 2006 (unaudited)	5
Consolidated Statements of Cash Flows — Six Months Ended June 30, 2006 and 2005 (unaudited)	6
Notes to Consolidated Financial Statements (unaudited)	7
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations	36
Item 3.    Quantitative and Qualitative Disclosures About Market Risk	56
Item 4.    Controls and Procedures	56
PART II.    OTHER INFORMATION	57
Item 1.    Legal Proceedings	57
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	59
SIGNATURES	60
EXHIBIT INDEX	61

2

PART I.    FINANCIAL INFORMATION

Item 1.    Financial Statements.

WILLIAM LYON HOMES

CONSOLIDATED BALANCE SHEETS

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

ASSETS
	June 30, 2006		December 31, 2005
	(unaudited)
Cash and cash equivalents	$	27,638	$	52,369
Receivables		41,916		143,481
Real estate inventories — Notes 2 and 3		1,590,805		1,419,248
Investments in and advances to unconsolidated joint ventures — Note 3		1,519		397
Property and equipment, less accumulated depreciation of $11,164 and $9,936 at June 30, 2006 and December 31, 2005, respectively		18,639		18,553
Deferred loan costs		11,653		12,323
Goodwill — Note 1		5,896		5,896
Other assets		39,534		38,735
	$	1,737,600	$	1,691,002
LIABILITIES AND STOCKHOLDERS’ EQUITY
Accounts payable	$	75,913	$	67,326
Accrued expenses		106,902		181,068
Notes payable		259,220		125,619
7 5/8% Senior Notes due December 15, 2012 — Note 4		150,000		150,000
10 3/4% Senior Notes due April 1, 2013 — Note 4		247,063		246,917
7 1/2% Senior Notes due February 15, 2014 — Note 4		150,000		150,000
		989,098		920,930
Minority interest in consolidated entities — Notes 2 and 3		145,279		227,178
Commitments and contingencies — Note 7
Stockholders’ equity — Note 6
Common stock, par value $.01 per share; 30,000,000 shares authorized; 8,702,067 and 8,652,067 shares issued and outstanding at June 30, 2006 and December 31, 2005, respectively; 1,275,000 shares issued and held in treasury at June 30, 2006 and December 31, 2005, respectively		87		86
Additional paid-in capital		39,137		35,404
Retained earnings		563,999		507,404
		603,223		542,894
	$	1,737,600	$	1,691,002

See accompanying notes.

3

WILLIAM LYON HOMES

CONSOLIDATED STATEMENTS OF INCOME

(in thousands except per common share amounts)

(unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
	2006			2005			2006			2005
Operating revenue
Home sales	$	406,624		$	362,123		$	714,005		$	606,779
Lots, land and other sales		1,630			45,366			1,630			47,392
		408,254			407,489			715,635			654,171
Operating costs
Cost of sales — homes		(313,655	)		(266,952	)		(543,098	)		(441,934	)
Cost of sales — lots, land and other		(2,338	)		(22,024	)		(2,768	)		(23,837	)
Sales and marketing		(16,779	)		(13,282	)		(29,903	)		(24,397	)
General and administrative		(17,832	)		(23,963	)		(36,421	)		(41,404	)
Other		(661	)		(526	)		(1,487	)		(1,208	)
		(351,265	)		(326,747	)		(613,677	)		(532,780	)
Equity in income (loss) of unconsolidated joint ventures — Note 3		(19	)		252			3,619			(159	)
Minority equity in income of consolidated entities — Note 2		(6,312	)		(5,699	)		(11,538	)		(11,959	)
Operating income		50,658			75,295			94,039			109,273
Financial advisory expenses — Note 6		(1,600	)		(2,191	)		(3,100	)		(2,191	)
Other income (expense), net		920			(212	)		2,161			(317	)
Income before provision for income taxes		49,978			72,892			93,100			106,765
Provision for income taxes — Note 1		(19,597	)		(28,792	)		(36,505	)		(42,172	)
Net income	$	30,381		$	44,100		$	56,595		$	64,593
Earnings per common share — Note 1
Basic	$	3.50		$	5.12		$	6.53		$	7.50
Diluted — Note 1				$	5.07					$	7.43

See accompanying notes.

4

WILLIAM LYON HOMES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

(Note 6)

Six Months Ended June 30, 2006

(in thousands)

(unaudited)

	Common Stock			Additional Paid-In Capital		Retained Earnings		Total
	Shares	Amount
Balance — December 31, 2005	8,652	$	86	$	35,404	$	507,404	$	542,894
Income tax benefit from unused recognized built-in losses — Note 1	—		—		3,299		—		3,299
Issuance of common stock upon exercise of stock options	50		1		434		—		435
Net income	—		—		—		56,595		56,595
Balance — June 30, 2006	8,702	$	87	$	39,137	$	563,999	$	603,223

See accompanying notes.

5

WILLIAM LYON HOMES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Six Months Ended March 31,
	2006			2005
Operating activities
Net income	$	56,595		$	64,593
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization		1,228			1,004
Equity in (income) loss of unconsolidated joint ventures		(3,619	)		159
Distributions of income from unconsolidated joint ventures		2,599			—
Minority equity in income of consolidated entities		11,538			11,959
State income tax refund credited to additional paid-in capital		10			—
Federal income tax refund credited to additional paid in capital		1,820			—
Provision for income taxes		36,505			42,172
Net changes in operating assets and liabilities:
Receivables		101,565			4,874
Real estate inventories		(164,786	)		(195,641	)
Deferred loan costs		670			715
Other assets		(9,203	)		(2,134	)
Accounts payable		8,587			14,028
Accrued expenses		(109,201	)		(77,474	)
Net cash used in operating activities		(65,692	)		(135,745	)
Investing activities
Investments in and advances to unconsolidated joint ventures		(11	)		(1,221	)
Net (contributions) distributions of capital from unconsolidated joint ventures		(91	)		3,500
Purchases of property and equipment		(1,314	)		(1,570	)
Net cash (used in) provided by investing activities		(1,416	)		709
Financing activities
Proceeds from borrowing on notes payable		1,093,543			664,747
Principal payments on notes payable		(980,567	)		(602,449	)
Minority interest (distributions) contributions, net		(71,033	)		27,323
Common stock issued for exercised stock options		434			—
Net cash provided by financing activities		42,377			89,621
Net decrease in cash and cash equivalents		(24,731	)		(45,415	)
Cash and cash equivalents — beginning of period		52,369			96,074
Cash and cash equivalents — end of period	$	27,638		$	50,659
Supplemental disclosures of cash flow information
Real estate inventories and minority interest from previously consolidated variable interest entity	$	14,000		$	—
Other assets and minority interest from previously consolidated variable interest entity	$	8,804		$	—
Issuance of notes payable for land acquisitions	$	20,625		$	11,686
Consolidation of real estate inventories and minority interests from variable interest entities	$	—		$	37,316
Income tax benefit credited to additional paid-in capital	$	1,470		$	—

See accompanying notes.

6

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Note 1 — Basis of Presentation and Significant Accounting Policies

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

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

The interim consolidated financial statements have been prepared in accordance with the Company’s customary accounting practices. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a presentation in accordance with U.S. generally accepted accounting principles have been included. Operating results for the three and six months ended June 30, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006.

The preparation of the Company’s financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of the assets and liabilities as of June 30, 2006 and December 31, 2005 and revenues and expenses for the periods presented. Accordingly, actual results could differ materially from those estimates in the near-term.

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

The consolidated financial statements include the accounts of the Company and all majority-owned and controlled subsidiaries and joint ventures, and certain joint ventures and other entities which have been determined to be variable interest entities in which the Company is considered the primary beneficiary (see Note 2). Investments in joint ventures which have not been determined to be variable interest entities in which the Company is considered the primary beneficiary are accounted for using the equity method because the Company has a 50% or less voting or economic interest (and thus such joint ventures are not controlled by the Company). The accounting policies of the joint ventures are substantially the same as those of the Company. All significant intercompany accounts and transactions have been eliminated in consolidation.

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

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

7

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

A provision for warranty costs relating to the Company’s limited warranty plans is included in cost of sales at the time the home sale is recorded. The Company generally reserves approximately one percent of the sales price of its homes against the possibility of future charges relating to its one-year limited warranty and similar potential claims. Factors that affect the Company’s warranty liability include the number of homes under warranty, historical and anticipated rates of warranty claims, and cost per claim. The Company periodically assesses the adequacy of its recorded warranty liability and adjusts the amounts as necessary. Changes in the Company’s warranty liability during the six months ended June 30 are as follows (in thousands):

	June 30,
	2006			2005
Warranty liability, beginning of period	$	20,219		$	14,308
Warranty provision during period		6,855			4,533
Warranty payments during period		(16,294	)		(8,836	)
Warranty charges related to pre-existing warranties during period		3,574			2,874
Warranty liability, end of period	$	14,354		$	12,879

At December 31, 2005, the Company has unused recognized built-in losses in the amount of $23,297,000 which are available to offset future taxable income and expire between 2009 and 2011. The utilization of these losses is limited to offset $3,883,000 of taxable income per year; however, any unused losses in any year may be carried forward for utilization in future years through 2011. The income tax benefit from the built-in losses was $3,299,000 for the six months ended June 30, 2006, and was credited to additional paid-in capital. The Company’s ability to utilize the foregoing tax benefits will depend upon the amount of its future taxable income and may be further limited under certain circumstances.

Earnings per share amounts for all periods presented conform to Financial Accounting Standards Board Statement of Financial Accounting Standards No. 128, Earnings Per Share. Basic earnings per common share for the three months ended June 30, 2006 is based on 8,676,792 weighted average shares of common stock outstanding. Basic earnings per common share for the six months ended June 30, 2006 is based on 8,664,498 weighted average shares of common stock outstanding. During the three months ended June 30, 2006, an officer and director exercised options to purchase 50,000 shares of the Company’s common stock in accordance with the William Lyon Homes 2000 Stock Incentive Plan. At June 30, 2006, all options to purchase shares of common stock had been exercised eliminating the dilutive effect of unexercised stock options on earnings per share for the three and six months ended June 30, 2006. Basic and diluted earnings per common share for the three months ended June 30, 2005 are based on 8,616,236 and 8,693,425 weighted average shares of common stock outstanding, respectively. Basic and diluted earnings per common share for the six months ended June 30, 2005 are based on 8,616,236 and 8,693,172 weighted average shares of common stock outstanding, respectively.

On June 29, 2005, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue No. 04-05, “Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights” (“EITF 04-05”). The scope of EITF 04-05 is limited to limited partnerships or similar entities (such as limited liability companies that have governing provisions that are the functional equivalent of a limited partnership) that are not variable interest entities under Interpretation No. 46 (see Note 2) and provides a new framework for addressing when a general partner in a limited partnership, or managing member in the case of a limited liability company, controls the entity. Under EITF 04-05, the Company may be required to consolidate certain investments in which the Company holds a general partner or managing member interest. EITF 04-05 was effective after June 29, 2005 for new entities

8

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

formed after such date and for existing entities for which the agreements are subsequently modified and is effective for the Company’s fiscal year beginning January 1, 2006 for all other entities. The adoption of EITF 04-05 did not have any impact on the Company’s financial statements as of June 30, 2006, since the Company already recognizes its proportionate share of joint venture earnings and losses under the equity method of accounting.

In July 2006, the Financial Accounting Standards Board (the “FASB”) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). This interpretation, among other things, creates a two step approach for evaluating uncertain tax positions. Recognition (step one) occurs when an enterprise concludes that a tax position, based solely on its technical merits, is more-likely-than-not to be sustained upon examination. Measurement (step two) determines the amount of benefit that more-likely-than-not will be realized upon settlement. Derecognition of a tax position that was previously recognized would occur when a company subsequently determines that a tax position no longer meets the more-likely-than-not threshold of being sustained. FIN 48 specifically prohibits the use of a valuation allowance as a substitute for derecognition of tax positions, and it has expanded disclosure requirements. FIN 48 is effective for fiscal years beginning after December 15, 2006, in which the impact of adoption should be accounted for as a cumulative-effect adjustment to the beginning balance of retained earnings. The Company is evaluating FIN 48 and has not yet determined the impact the adoption will have on the consolidated financial statements.

Note 2 — Consolidation of Variable Interest Entities

In January 2003, the Financial Accounting Standards Board issued Interpretation No. 46, Consolidation of Variable Interest Entities, as amended (“Interpretation No. 46”) which addresses the consolidation of variable interest entities (“VIEs”). Under Interpretation No. 46, arrangements that are not controlled through voting or similar rights are accounted for as VIEs. An enterprise is required to consolidate a VIE if it is the primary beneficiary of the VIE.

Under Interpretation No. 46, a VIE is created when (i) the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties or (ii) equity holders either (a) lack direct or indirect ability to make decisions about the entity through voting or similar rights, (b) are not obligated to absorb expected losses of the entity or (c) do not have the right to receive expected residual returns of the entity if they occur. If an entity is deemed to be a VIE, pursuant to Interpretation No. 46, an enterprise that absorbs a majority of the expected losses or residual returns of the VIE is considered the primary beneficiary and must consolidate the VIE.

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

Supplemental consolidating financial information of the Company, specifically including information for the joint ventures and land banking arrangements consolidated under Interpretation No. 46, is presented below to

9

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

allow investors to determine the nature of assets held and the operations of the consolidated entities. Investments in consolidated entities in the financial statements of wholly-owned entities presented below use the equity method of accounting. Consolidated real estate inventories include land deposits under option agreements or land banking arrangements (excluding the consolidated land banking arrangements as previously described in this paragraph) of $58,074,000 and $77,956,000 at June 30, 2006 and December 31, 2005, respectively.

The joint ventures which have been determined to be VIEs are each engaged in homebuilding and land development activities. Certain of these joint ventures have not obtained construction financing from outside lenders, but are financing their activities through equity contributions from each of the joint venture partners. Creditors of these VIEs have no recourse against the general credit of the Company. Income allocations and cash distributions to the Company are based on predetermined formulas between the Company and the joint venturers as specified in the applicable partnership or operating agreements. The Company generally receives, after partners’ priority returns and return of partners’ capital, approximately 50% of the profits and cash flows from the joint ventures.

The Company enters into purchase agreements with various land sellers. In some instances, and as a method of acquiring land in staged takedowns, thereby minimizing the use of funds from the Company’s revolving credit facilities and other corporate financing sources and limiting the Company’s risk, the Company transfers its right in such purchase agreements to entities owned by third parties (“land banking arrangements”). These entities use equity contributions and/or incur debt to finance the acquisition and development of the lots. The entities grant the Company an option to acquire lots in staged takedowns. In consideration for this option, the Company makes a non-refundable deposit of 15% to 20% of the total purchase price. The Company is under no obligation to purchase the balance of the lots, but would forfeit remaining deposits and be subject to penalties if the lots were not purchased. The Company does not have legal title to these entities or their assets and has not guaranteed their liabilities. These land banking arrangements help the Company manage the financial and market risk associated with land holdings. As described above, Interpretation No. 46, requires the consolidation of the assets, liabilities, and operations of three of the Company’s land banking arrangements including, as of June 30, 2006, real estate inventories of $60,696,000. The Company participates in two land banking arrangements, which are not VIEs in accordance with Interpretation No. 46, and are not consolidated as of June 30, 2006 and December 31, 2005. The deposits related to these two land banking projects have been recorded in the accompanying consolidated balance sheet. The financial statements of these two entities are not consolidated with the Company’s consolidated financial statements.

Summary information with respect to the Company’s consolidated and unconsolidated land banking arrangements is as follows as of June 30, 2006 (dollars in thousands):

	Consolidated		Unconsolidated
Total number of land banking projects		3		2
Total number of lots		267		590
Total purchase price	$	84,085	$	89,221
Balance of lots still under option and not purchased:
Number of lots		201		38
Purchase price	$	60,696	$	12,746
Forfeited deposits and penalties if lots are not purchased	$	6,673	$	1,753

10

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONDENSED CONSOLIDATING BALANCE SHEET BY FORM OF OWNERSHIP

(in thousands)

	June 30, 2006
	Wholly- Owned		Variable Interest Entities Under Interpretation No. 46		Eliminating Entries			Consolidated Total
ASSETS
Cash and cash equivalents	$	17,158	$	10,480	$	—		$	27,638
Receivables		39,286		2,630		—		$	41,916
Real estate inventories		1,318,907		271,898		—		$	1,590,805
Investments in and advances to unconsolidated joint ventures		1,519		—		—			1,519
Investments in consolidated entities		79,375		—		(79,375	)		—
Other assets		75,722		—		—			75,722
Intercompany receivables		—		2,938		(2,938	)		—
	$	1,531,967	$	287,946	$	(82,313	)	$	1,737,600
LIABILITIES AND STOCKHOLDERS’ EQUITY
Accounts payable and accrued expenses	$	163,970	$	18,845	$	—		$	182,815
Notes payable		214,778		44,442		—			259,220
7 5/8% Senior Notes due December 15, 2012		150,000		—		—			150,000
10 3/4% Senior Notes due April 1, 2013		247,063		—		—			247,063
7 1/2% Senior Notes due February 15, 2014		150,000		—		—			150,000
Intercompany payables		2,933		5		(2,938	)		—
Total liabilities		928,744		63,292		(2,938	)		989,098
Minority interest in consolidated entities		—		—		145,279			145,279
Owners’ capital
William Lyon Homes		—		79,375		(79,375	)		—
Others		—		145,279		(145,279	)		—
Stockholders’ equity		603,223		—		—			603,223
	$	1,531,967	$	287,946	$	82,313		$	1,737,600

11

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONDENSED CONSOLIDATING BALANCE SHEET BY FORM OF OWNERSHIP

(in thousands)

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

12

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONDENSED CONSOLIDATING STATEMENT OF INCOME BY FORM OF OWNERSHIP

(in thousands)

	Three Months Ended June 30, 2006
	Wholly- Owned			Variable Interest Entities Under Interpretation No. 46			Elimination Entries			Consolidated Total
Operating revenue
Sales	$	345,485		$	62,769			—		$	408,254
Management fees		1,866			—			(1,866	)		—
		347,351			62,769			(1,866	)		408,254
Operating costs
Cost of sales		(269,930	)		(47,929	)		1,866			(315,993	)
Sales and marketing		(14,284	)		(2,495	)		—			(16,779	)
General and administrative		(17,828	)		(4	)		—			(17,832	)
Other		(661	)		—			—			(661	)
		(302,703	)		(50,428	)		1,866			(351,265	)
Equity in income of unconsolidated joint ventures		(19	)		—			—			(19	)
Equity in income of consolidated entities		6,117			—			(6,117	)		—
Minority equity in income of consolidated entities		—			—			(6,312	)		(6,312	)
Operating income		50,746			12,341			(12,429	)		50,658
Financial advisory expenses		(1,600	)		—			—			(1,600	)
Other income, net		832			88			—			920
Income before provision for income taxes		49,978			12,429			(12,429	)		49,978
Provision for income taxes		(19,597	)		—			—			(19,597	)
Net income	$	30,381		$	12,429		$	(12,429	)	$	30,381

13

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

CONDENSED CONSOLIDATING STATEMENT OF INCOME BY FORM OF OWNERSHIP

(in thousands)

	Three Months Ended June 30, 2005
	Wholly- Owned			Variable Interest Entities Under Interpretation No. 46			Elimination Entries			Consolidated Total
Operating revenue
Sales	$	322,748		$	84,741		$	—		$	407,489
Management fees		2,738			—			(2,738	)		—
		325,486			84,741			(2,738	)		407,489
Operating costs
Cost of sales		(225,408	)		(66,306	)		2,738			(288,976	)
Sales and marketing		(10,453	)		(2,829	)		—			(13,282	)
General and administrative		(23,963	)		—			—			(23,963	)
Other		(526	)		—			—			(526	)
		(260,350	)		(69,135	)		2,738			(326,747	)
Equity in income of unconsolidated joint ventures		252			—			—			252
Equity in income of consolidated entities		9,987			—			(9,987	)		—
Minority equity in income of consolidated entities		—			—			(5,699	)		(5,699	)
Operating income		75,375			15,606			(15,686	)		75,295
Financial advisory expenses		(2,191	)		—			—			(2,191	)
Other (expense) income, net		(292	)		80			—			(212	)
Income before provision for income taxes		72,892			15,686			(15,686	)		72,892
Provision for income taxes		(28,792	)		—			—			(28,792	)
Net income	$	44,100		$	15,686		$	(15,686	)	$	44,100

14

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONDENSED CONSOLIDATING STATEMENT OF INCOME BY FORM OF OWNERSHIP

(in thousands)

	Six Months Ended June 30, 2006
	Wholly- Owned			Variable Interest Entities Under Interpretation No. 46			Eliminating Entries			Consolidated Total
Operating revenue
Sales	$	621,055		$	94,580		$	—		$	715,635
Management fees		2,938			—			(2,938	)		—
		623,993			94,580			(2,938	)		715,635
Operating costs
Cost of sales		(479,954	)		(68,850	)		2,938			(545,866	)
Sales and marketing		(25,989	)		(3,914	)		—			(29,903	)
General and administrative		(36,398	)		(23	)		—			(36,421	)
Other		(1,487	)		—			—			(1,487	)
		(543,828	)		(72,787	)		2,938			(613,677	)
Equity in income of unconsolidated joint ventures		3,619			—			—			3,619
Equity in income of consolidated entities		10,518			—			(10,518	)		—
Minority equity in income of consolidated entities		—			—			(11,538	)		11,538
Operating income		94,302			21,793			(22,056	)		94,039
Financial advisory expenses		(3,100	)		—			—			(3,100	)
Other income (expense), net		1,898			263			—			2,161
Income before provision for income taxes		93,100			22,056			(22,056	)		93,100
Provision for income taxes		(36,505	)		—			—			(36,505	)
Net income	$	56,595		$	22,056		$	(22,056	)	$	56,595

15

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

CONDENSED CONSOLIDATING STATEMENT OF INCOME BY FORM OF OWNERSHIP

(in thousands)

	Six Months Ended June 30, 2005
	Wholly- Owned			Variable Interest Entities Under Interpretation No. 46			Eliminating Entries			Consolidated Total
Operating revenue
Sales	$	512,208		$	141,963		$	—		$	654,171
Management fees		4,651			—			(4,651	)		—
		516,859			141,963			(4,651	)		654,171
Operating costs
Cost of sales		(362,736	)		(107,686	)		4,651			(465,771	)
Sales and marketing		(19,076	)		(5,321	)		—			(24,397	)
General and administrative		(41,404	)		—			—			(41,404	)
Other		(1,208	)		—			—			(1,208	)
		(424,424	)		(113,007	)		4,651			(532,780	)
Equity in loss of unconsolidated joint ventures		(159	)		—			—			(159	)
Equity in income of consolidated entities		17,220			—			(17,220	)		—
Minority equity in income of consolidated entities		—			—			(11,959	)		(11,959	)
Operating income		109,496			28,956			(29,179	)		109,273
Financial advisory expenses		(2,191	)		—			—			(2,191	)
Other (expense) income, net		(540	)		223			—			(317	)
Income before provision for income taxes		106,765			29,179			(29,179	)		106,765
Provision for income taxes		(42,172	)		—			—			(42,172	)
Net income	$	64,593		$	29,179		$	(29,179	)	$	64,593

16

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

Note 3 — Investments in and Advances to Unconsolidated Joint Ventures

The Company and certain of its subsidiaries are general partners or members in joint ventures involved in the development and sale of residential projects. The consolidated financial statements of the Company include the accounts of the Company, all majority-owned and controlled subsidiaries and certain joint ventures which have been determined to be variable interest entities in which the Company is considered the primary beneficiary (see Note 2). The financial statements of joint ventures which have not been determined to be variable interest entities in which the Company is considered the primary beneficiary are not consolidated with the Company’s financial statements. The Company’s investments in unconsolidated joint ventures are accounted for using the equity method because the Company has a 50% or less voting or economic interest (and thus such joint ventures are not controlled by the Company). Condensed combined financial information of these unconsolidated joint ventures as of June 30, 2006 and December 31, 2005 is summarized as follows:

CONDENSED COMBINED BALANCE SHEETS

(in thousands)

	June 30, 2006		December 31, 2005
	(unaudited)
ASSETS
Cash and cash equivalents	$	3,470	$	2,580
Receivables		3,824		3,253
Real estate inventories		38,644		31,279
Investment in unconsolidated joint ventures		1,813		—
Property and equipment		1,003		956
Other assets		16		—
	$	48,770	$	38,068
LIABILITIES AND OWNERS’ CAPITAL
Accounts payable	$	6,295	$	5,127
Notes payable		39,661		32,377
Advances from William Lyon Homes		192		181
		46,148		37,685
Owners’ capital
William Lyon Homes		1,327		216
Others		1,295		167
		2,622		383
	$	48,770	$	38,068

17

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONDENSED COMBINED STATEMENTS OF INCOME

(in thousands)

	Three Months Ended June 30,						Six Months Ended June 30,
	2006			2005			2006			2005
Operating revenue
Land sales	$	—		$	—		$	10,420		$	—
Operating costs
Cost of sales — land		—			—			(7,801	)		—
General and administrative		—			(11	)		—			(14	)
Other		(369	)		(344	)		(628	)		(631	)
		(369	)		(355	)		(8,429	)		(645	)
Equity in income of unconsolidated joint ventures		210			1,927			5,002			1,396
Operating income (loss)		(159	)		1,572			6,993			751
Other income		120			—			244			—
Net income (loss)	$	(39	)	$	1,572		$	7,237		$	751
Allocation to owners
William Lyon Homes	$	(19	)	$	786		$	3,619		$	375
Others		(20	)		786			3,618			376
	$	(39	)	$	1,572		$	7,237		$	751

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

The Company is a member in an unconsolidated joint venture limited liability company formed for the purpose of acquiring and developing land in Nevada. At June 30, 2006, the unconsolidated joint venture had outstanding land acquisition and development debt of $39,661,000, of which the Company guaranteed $19,830,500. If the unconsolidated joint venture liability company were to default on its obligation to repay the debt, the Company would be obligated to pay one-half of the outstanding balance, together with one-half of the accrued but unpaid interest thereon. The current maturity date of the debt is June 30, 2007, but such maturity date may be extended under certain circumstances to June 30, 2008. The debt bears interest at prime plus one-half of one percent (0.50%) and is secured by the real estate inventories of the unconsolidated joint venture limited liability company in the book amount of $38,644,000 at June 30, 2006.

During the year ended December 31, 2003, the Company’s wholly-owned subsidiary William Lyon Homes Inc., a California corporation, (“California Lyon”), and two unaffiliated parties formed a series of limited liability companies (“Development LLCs”) for the purpose of acquiring three parcels of land totaling 236 acres in Irvine and Tustin, California (formerly part of the Tustin Marine Corps Air Station) and developing the land into 1,910 residential homesites. The Development LLCs sold its first lots during the three months ended June 30, 2005 and the remaining lots were sold in July 2005. California Lyon was required under certain specific conditions to purchase approximately one half in value of the lots and during the three months ended June 30, 2005, California Lyon purchased 165 lots from the Development LLCs, of which 102 lots were purchased through a land banking arrangement (see Note 2 for additional information regarding the Company’s land banking arrangements). In July

18

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

2005, California Lyon purchased an additional 668 lots from the Development LLCs, of which 169 lots were purchased through two land banking arrangements. California Lyon had a 12 ¹/2% indirect, minority interest in the Development LLCs and during the three months ended June 30, 2005 earned income of $1.9 million from the sale of lots by the Development LLCs of which, $0.5 million of income was deferred from the purchase of the 102 lots by California Lyon and will be recognized when the lots are sold. The Development LLCs were borrowers under a secured line of credit. Advances under the line of credit were used to pay acquisition and development costs and expenses. The line of credit is secured by deeds of trust on the real property and improvements thereon owned by the applicable Development LLCs, as well as pledges of all net sale proceeds, related contracts and other ancillary property. The maximum commitment amount under the line of credit was limited by specified agreed loan-to-value ratios. The maximum commitment amount under the line of credit was $105,000,000 and matured in September 2005. California Lyon posted letters of credit equal to approximately $19,600,000 to secure its obligations as well as the Development LLCs’ obligations to the banks under the line of credit. Further, California Lyon and the other direct and indirect members of the Development LLCs, including certain affiliates of such other members, entered into reimbursement and indemnity agreements to allocate any liability arising from each line of credit, including related guarantees and letters of credit. As of June 30, 2005 the outstanding indebtedness under the line of credit was $105,000,000. In July 2005, the $105,000,000 outstanding balance under the line of credit as of June 30, 2005 was paid in full and the related letters of credit were returned by the beneficiary in conjunction with the sale of the remaining lots by the Development LLCs as described above.

Note 4 — Senior Notes

As of June 30, 2006, the Company had the following outstanding Senior Note obligations (collectively, the “Senior Notes”) (in thousands):

7 5/8% Senior Notes due December 15, 2012	$	150,000
10 3/4% Senior Notes due April 1, 2013		247,063
7 1/2% Senior Notes due February 15, 2014		150,000
	$	547,063

7 ⁵/8% Senior Notes

On November 22, 2004, the Company’s 100% owned subsidiary, William Lyon Homes, Inc., a California corporation, (“California Lyon”) closed its offering of $150,000,000 principal amount of 7 ⁵/8% Senior Notes due December 15, 2012 (the “7 ⁵/8% Senior Notes”). The notes were sold pursuant to Rule 144A. The notes were issued at par resulting in net proceeds to the Company of approximately $148,500,000. California Lyon agreed to file a registration statement with the Securities and Exchange Commission relating to an offer to exchange the notes for publicly tradeable notes having substantially identical terms. On January 12, 2005, the Securities and Exchange Commission declared the registration statement effective and California Lyon commenced an offer to exchange any and all of its outstanding $150,000,000 aggregate principal amount of 7 ⁵/8% Senior Notes due December 15, 2012, which are not registered under the Securities Act of 1933, for a like amount of its new 7 ⁵/8% Senior Notes due December 15, 2012, which are registered under the Securities Act of 1933, upon the terms and subject to the conditions set forth in the prospectus dated January 12, 2005. The exchange offer was completed for $146,500,000 principal amount of the 7 ⁵/8% Senior Notes on February 18, 2005. The remaining $3,500,000 principal amount of the old notes remains outstanding. The terms of the new notes are identical in all material respects to those of the old notes, except for certain transfer restrictions, registration rights and liquidated damages provisions relating to the old notes. Interest on the 7 ⁵/8% Senior Notes is payable semi-annually on December 15 and June 15 of each year.

Except as set forth in the Indenture governing the 7 ⁵/8% Senior Notes, the 7 ⁵/8% Senior Notes are not redeemable prior to December 15, 2008. Thereafter, the 7 ⁵/8% Senior Notes will be redeemable at the option of

19

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

California Lyon, in whole or in part, at a redemption price equal to 100% of the principal amount plus a premium declining ratably to par, plus accrued and unpaid interest, if any. In addition, on or before December 15, 2007, California Lyon may redeem up to 35% of the aggregate principal amount of the notes with the proceeds of qualified equity offerings at a redemption price equal to 107.625% of the principal amount, plus accrued and unpaid interest, if any.

10 ³/4% Senior Notes

California Lyon filed a Registration Statement on Form S-3 with the Securities and Exchange Commission for the sale of $250,000,000 of Senior Notes due 2013 (the “10 ³/4% Senior Notes”) which became effective on March 12, 2003. The offering closed on March 17, 2003 and was fully subscribed and issued. The notes were issued at a price of 98.493% to the public, resulting in net proceeds to the Company of approximately $246,233,000. The purchase price reflected a discount to yield 11% under the effective interest method and the notes have been reflected net of the unamortized discount in the accompanying consolidated balance sheet. Interest on the 10 ³/4% Senior Notes is payable on April 1 and October 1 of each year.

Except as set forth in the Indenture governing the 10 ³/4% Senior Notes, the 10 ³/4% Senior Notes are not redeemable prior to April 1, 2008. Thereafter, the 10 ³/4% Senior Notes will be redeemable at the option of California Lyon, in whole or in part, at a redemption price equal to 100% of the principal amount plus a premium declining ratably to par, plus accrued and unpaid interest, if any. In addition, on or before April 1, 2006, California Lyon may redeem up to 35% of the aggregate principal amount of the notes with the proceeds of qualified equity offerings at a redemption price equal to 110.75% of the principal amount, plus accrued and unpaid interest, if any.

7 ¹/2% Senior Notes

On February 6, 2004, California Lyon closed its offering of $150,000,000 principal amount of 7 ¹/2% Senior Notes due 2014 (the “7 ¹/2% Senior Notes”). The notes were sold pursuant to Rule 144A and outside the United States to non-U.S. persons in reliance on Regulation S. The notes were issued at par, resulting in net proceeds to the Company of approximately $147,600,000. California Lyon agreed to file a registration statement with the Securities and Exchange Commission relating to an offer to exchange the notes for publicly tradeable notes having substantially identical terms. On July 16, 2004, the Securities and Exchange Commission declared the registration statement effective and California Lyon commenced an offer to exchange any and all of its outstanding $150,000,000 aggregate principal amount of 7 ¹/2% Senior Notes due 2014, which are not registered under the Securities Act of 1933, for a like amount of its new 7 ¹/2% Senior Notes due 2014, which are registered under the Securities act of 1933, upon the terms and subject to the conditions set forth in the prospectus dated July 16, 2004. The exchange offer was completed for the full principal amount of the 7 ¹/2% Senior Notes on August 17, 2004. The terms of the new notes are identical in all material respects to those of the old notes, except for certain transfer restrictions, registration rights and liquidated damages provisions relating to the old notes. The new notes have been listed on the New York Stock Exchange. Interest on the 7 ¹/2% Senior Notes is payable on February 15 and August 15 of each year.

Except as set forth in the Indenture governing the 7 ¹/2% Senior Notes, the 7 ¹/2% Senior Notes are not redeemable prior to February 15, 2009. Thereafter, the 7 ¹/2% Senior Notes will be redeemable at the option of California Lyon, in whole or in part, at a redemption price equal to 100% of the principal amount plus a premium declining ratably to par, plus accrued and unpaid interest, if any. In addition, on or before February 15, 2007, California Lyon may redeem up to 35% of the aggregate principal amount of the notes with the proceeds of qualified equity offerings at a redemption price equal to 107.50% of the principal amount, plus accrued and unpaid interest, if any.

*    *    *    *    *

20

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

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

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

If the Company’s consolidated tangible net worth falls below $75,000,000 for any two consecutive fiscal quarters, California Lyon will be required to make an offer to purchase up to 10% of each class of Senior Notes originally issued at a purchase price equal to 100% of the principal amount, plus accrued and unpaid interest, if any.

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

The Senior Notes Indentures contain covenants that limit the ability of Delaware Lyon and its restricted subsidiaries to, among other things: (i) incur additional indebtedness; (ii) pay dividends or make other distributions or repurchase its stock; (iii) make investments; (iv) sell assets; (v) incur liens; (vi) enter into agreements restricting the ability of Delaware Lyon’s restricted subsidiaries (other than California Lyon) to pay dividends; (vii) enter into transactions with affiliates; and (viii) consolidate, merge or sell all or substantially all of Delaware Lyon’s and California Lyon’s assets. These covenants are subject to a number of important exceptions and qualifications as described in the Senior Notes Indentures.

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

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

At June 30, 2006, the Company had approximately $214,778,000 of secured indebtedness (excluding approximately $44,441,000 of secured indebtedness of consolidated entities — see Note 2) and approximately $275,750,000 of additional secured indebtedness available to be borrowed under the Company’s credit facilities, as limited by the Company’s borrowing base formulas.

Supplemental consolidating financial information of the Company, specifically including information for California Lyon, the issuer of the 10 ³/4% Senior Notes, the 7 ¹/2% Senior Notes and the 7 ⁵/8% Senior Notes, and Delaware Lyon and the guarantor subsidiaries (which are wholly-owned) 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.

21

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONSOLIDATING BALANCE SHEET

June 30, 2006

(in thousands)

	Unconsolidated
	Delaware Lyon		California Lyon		Guarantor Subsidiaries		Non-Guarantor Subsidiaries		Eliminating Entries			Consolidated Company
ASSETS
Cash and cash equivalents	$	—	$	10,392	$	6,121	$	11,125	$	—		$	27,638
Receivables		—		15,491		23,793		2,632		—			41,916
Real estate inventories		—		1,401,452		2,100		187,253		—			1,590,805
Investments in and advances to unconsolidated joint ventures		—		1,519		—		—		—			1,519
Property and equipment, net		—		2,503		16,136		—		—			18,639
Deferred loan costs		—		11,653		—		—		—			11,653
Goodwill		—		5,896		—		—		—			5,896
Other assets		—		36,859		2,675		—		—			39,534
Investments in subsidiaries		603,223		79,798		8,502		—		(691,523	)		—
Intercompany receivables		—		1,667		143,655		2,938		(148,260	)		—
		$603,223	$	1,567,230	$	202,982	$	203,948	$	(839,783	)	$	1,737,600
LIABILITIES AND STOCKHOLDERS’ EQUITY
Accounts payable	$	—	$	56,118	$	950	$	18,845	$	—		$	75,913
Accrued expenses		—		101,252		5,430		220		—			106,902
Notes payable		—		194,166		20,612		44,442		—			259,220
7 5/8% Senior Notes		—		150,000		—		—		—			150,000
10 3/4% Senior Notes		—		247,063		—		—		—			247,063
7 1/2% Senior Notes		—		150,000		—		—		—			150,000
Intercompany payables		—		146,584		1,667		9		(148,260	)		—
Total liabilities		—		1,045,183		28,659		63,516		(148,260	)		989,098
Minority interest in consolidated entities		—		—		—		—		145,279			145,279
Stockholders’ equity		603,223		522,047		174,323		140,432		(836,802	)		603,223
	$	603,223	$	1,567,230	$	202,982	$	203,948	$	(839,783	)	$	1,737,600

22

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONSOLIDATING BALANCE SHEET

December 31, 2005

(in thousands)

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

23

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONSOLIDATING STATEMENT OF INCOME

Three Months Ended June 30, 2006

(in thousands)

	Unconsolidated
	Delaware Lyon		California Lyon			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminating Entries			Consolidated Company
Operating revenue
Sales	$	—	$	294,472		$	51,013		$	62,769		$	—		$	408,254
Management fees		—		1,866			—			—			(1,866	)		—
		—		296,338			51,013			62,769			(1,866	)		408,254
Operating costs
Cost of sales		—		(237,236	)		(32,694	)		(47,929	)		1,866			(315,993	)
Sales and marketing		—		(12,073	)		(2,211	)		(2,495	)		—			(16,779	)
General and administrative		—		(17,770	)		(58	)		(4	)		—			(17,832	)
Other		—		—			(661	)		—			—			(661	)
		—		(267,079	)		(35,624	)		(50,428	)		1,866			(351,265	)
Equity in income (loss) of unconsolidated joint ventures		—		165			(184	)		—			—			(19	)
Income from subsidiaries		30,381		20,895			—			—			(51,276	)		—
Minority equity in income of consolidated entities		—		—			—			—			(6,312	)		(6,312	)
Operating income		30,381		50,319			15,205			12,341			(57,588	)		50,658
Financial advisory expenses		—		(1,600	)		—			—			—			(1,600	)
Other income, net		—		726			104			90			—			920
Income before provision for income taxes		30,381		49,445			15,309			12,431			(57,588	)		49,978
Provision for income taxes		—		(19,597	)		—			—			—			(19,597	)
Net income	$	30,381	$	29,848		$	15,309		$	12,431		$	(57,588	)	$	30,381

24

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONSOLIDATING STATEMENT OF INCOME

Three Months Ended June 30, 2005

(in thousands)

	Unconsolidated
	Delaware Lyon		California Lyon			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminating Entries			Consolidated Company
Operating revenue
Sales	$	—	$	273,055		$	49,693		$	84,741		$	—		$	407,489
Management fees		—		2,738			—			—			(2,738	)		—
		—		275,793			49,693			84,741			(2,738	)		407,489
Operating costs
Cost of sales		—		(187,051	)		(38,357	)		(66,306	)		2,738			(288,976	)
Sales and marketing		—		(8,264	)		(2,189	)		(2,829	)		—			(13,282	)
General and administrative		—		(23,952	)		(11	)		—			—			(23,963	)
Other		—		—			(526	)		—			—			(526	)
		—		(219,267	)		(41,083	)		(69,135	)		2,738			(326,747	)
Equity in income (loss) of unconsolidated joint ventures		—		424			(172	)		—			—			252
Income (loss) from subsidiaries		44,100		17,923			(37	)		—			(61,986	)		—
Minority equity in income of consolidated entities		—		—			—			—			(5,699	)		(5,699	)
Operating income		44,100		74,873			8,401			15,606			(67,685	)		75,295
Financial advisory expenses		—		(2,191	)		—			—			—			(2,191	)
Other income (expense), net		—		63			(238	)		(37	)		—			(212	)
Income before provision for income taxes		44,100		72,745			8,163			15,569			(67,685	)		72,892
Provision for income taxes		—		(28,792	)		—			—			—			(28,792	)
Net income	$	44,100	$	43,953		$	8,163		$	15,569		$	(67,685	)	$	44,100

25

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

CONSOLIDATING STATEMENT OF INCOME

Six Months Ended June 30, 2006

(in thousands)

	Unconsolidated
	Delaware Lyon		California Lyon			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminating Entries			Consolidated Company
Operating revenue
Sales	$	—	$	528,669		$	92,386		$	94,580		$	—		$	715,635
Management fees		—		2,938			—			—			(2,938	)		—
		—		531,607			92,386			94,580			(2,938	)		715,635
Operating costs
Cost of sales		—		(420,823	)		(59,131	)		(68,850	)		2,938			(545,866	)
Sales and marketing		—		(22,123	)		(3,866	)		(3,914	)		—			(29,903	)
General and administrative		—		(36,298	)		(100	)		(23	)		—			(36,421	)
Other		—		—			(1,487	)		—			—			(1,487	)
		—		(479,244	)		(64,584	)		(72,787	)		2,938			(613,677	)
Equity in income (loss) of unconsolidated joint ventures		—		3,933			(314	)		—			—			3,619
Income from subsidiaries		56,595		37,454			(40	)		—			(94,009	)		—
Minority equity in income of consolidated entities		—		—			—			—			(11,538	)		(11,538	)
Operating income		56,595		93,750			27,448			21,793			(105,547	)		94,039
Financial advisory expenses		—		(3,100	)		—			—			—			(3,100	)
Other income, net		—		955			945			261			—			2,161
Income before provision for income taxes		56,595		91,605			28,393			22,054			(105,547	)		93,100
Provision for income taxes		—		(36,505	)		—			—			—			(36,505	)
Net income	$	56,595	$	55,100		$	28,393		$	22,054		$	(105,547	)	$	56,595

26

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

CONSOLIDATING STATEMENT OF INCOME

Six Months Ended June 30, 2005

(in thousands)

	Unconsolidated
	Delaware Lyon		California Lyon			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminating Entries			Consolidated Company
Operating revenue
Sales	$	—	$	426,316		$	85,892		$	141,963		$	—		$	654,171
Management fees		—		4,651			—			—			(4,651	)		—
		—		430,967			85,892			141,963			(4,651	)		654,171
Operating costs
Cost of sales		—		(295,657	)		(67,079	)		(107,686	)		4,651			(465,771	)
Sales and marketing		—		(15,487	)		(3,589	)		(5,321	)		—			(24,397	)
General and administrative		—		(41,261	)		(143	)		—			—			(41,404	)
Other		—		—			(1,208	)		—			—			(1,208	)
		—		(352,405	)		(72,019	)		(113,007	)		4,651			(532,780	)
Equity in income (loss) of unconsolidated joint ventures		—		157			(316	)		—			—			(159	)
Income from subsidiaries		64,593		30,297			(217	)		—			(94,673	)		—
Minority equity in income of consolidated entities		—		—			—			—			(11,959	)		(11,959	)
Operating income		64,593		109,016			13,340			28,956			(106,632	)		109,273
Financial advisory expenses		—		(2,191	)		—			—			—			(2,191	)
Other income (expense), net		—		199			(698	)		182			—			(317	)
Income before provision for income taxes		64,593		107,024			12,642			29,138			(106,632	)		106,765
Provision for income taxes		—		(42,154	)		—			(18	)		—			(42,172	)
Net income	$	64,593	$	64,870		$	12,642		$	29,120		$	(106,632	)	$	64,593

27

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONSOLIDATING STATEMENT OF CASH FLOWS

Six Months Ended June 30, 2006

(in thousands)

	Unconsolidated
	Delaware Lyon			California Lyon			Guarantor Subsidiaries			Non-Guarantor     Subsidiaries			Eliminating Entries			Consolidated Company
Operating activities
Net income	$	56,595		$	55,100		$	28,393		$	22,054		$	(105,547	)	$	56,595
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Depreciation and amortization		—			417			811			—			—			1,228
Equity in (income) loss of unconsolidated joint ventures		—			(3,933	)		314			—			—			(3,619	)
Distributions of income from unconsolidated joint ventures		—			1,599			1,000			—			—			2,599
Minority equity in income of consolidated entities		—			—			—			—			11,538			11,538
Equity in earnings of subsidiaries		(56,595	)		(37,454	)		40			—			94,009			—
State income tax refund credited to additional paid-in capital		—			10			—			—			—			10
Federal income tax refund credited to additional paid in capital		—			1,820			—			—			—			1,820
Provision for income taxes		—			36,505			—			—			—			36,505
Net changes in operating assets and liabilities:
Receivables		—			60,014			28,774			12,777			—			101,565
Intercompany receivables/payables		—			—			(30,125	)		3,654			26,471			—
Real estate inventories		—			(166,875	)		(900	)		2,989			—			(164,786	)
Deferred loan costs		—			670			—			—			—			670
Other assets		—			(8,791	)		(412	)		—			—			(9,203	)
Accounts payable		—			9,934			194			(1,541	)		—			8,587
Accrued expenses		—			(103,667	)		(820	)		(4,714	)		—			(109,201	)
Net cash (used in) provided by operating activities		—			(154,651	)		27,269			35,219			26,471			(65,692	)
Investing activities
Net change in investment in and advances to unconsolidated joint ventures		—			322			(424	)		—			—			(102	)
Purchases of property and equipment		—			(792	)		(522	)		—			—			(1,314	)
Investments in subsidiaries		—			45,910			1,790			—			(47,700	)		—
Advances to affiliates		(434	)		(33,623	)		—			—			34,057			—
Net cash (used in) provided by investing activities		(434	)		11,817			844			—			(13,643	)		(1,416	)
Financing activities
Proceeds from borrowings on notes payable		—			687,954			377,297			28,292			—			1,093,543
Principal payments on notes payable		—			(576,066	)		(404,501	)		—			—			(980,567	)
Minority interest contributions, net		—			22,404			—			(93,437	)		—			(71,033	)
Common stock issued for exercised stock options		434			—			—			—			—			434
Advances from (to) affiliates		—			—			(1,475	)		14,303			(12,828	)		—
Net cash provided by (used in) financing activities		434			134,292			(28,679	)		(50,842	)		(12,828	)		42,377
Net decrease in cash and cash equivalents		—			(8,542	)		(566	)		(15,623	)		—			(24,731	)
Cash and cash equivalents at beginning of period		—			18,934			6,687			26,748			—			52,369
Cash and cash equivalents at end of period	$	—		$	10,392		$	6,121		$	11,125		$	—		$	27,638

28

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONSOLIDATING STATEMENT OF CASH FLOWS

Six Months Ended June 30, 2005

(in thousands)

	Unconsolidated
	Delaware Lyon			California Lyon			Guarantor Subsidiaries			Non-Guarantor     Subsidiaries			Eliminating Entries			Consolidated Company
Operating activities
Net income	$	64,593		$	64,870		$	12,642		$	29,120		$	(106,632	)	$	64,593
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Depreciation and amortization		—			226			778			—			—			1,004
Equity in (income) loss of unconsolidated joint ventures		—			(157	)		316			—			—			159
Minority equity in income of consolidated entities		—			—			—			—			11,959			11,959
Equity in (earnings) loss of subsidiaries		(64,593	)		(30,297	)		217			—			94,673			—
Provision for income taxes		—			42,154			—			18			—			42,172
Net changes in operating assets and liabilities:
Receivables		—			8,391			(6,582	)		3,065			—			4,874
Intercompany receivables/payables		—			—			25			6,542			(6,567	)		—
Real estate inventories		—			(169,291	)		(965	)		(25,385	)		—			(195,641	)
Deferred loan costs		—			715			—			—			—			715
Other assets		—			(1,944	)		(190	)		—			—			(2,134	)
Accounts payable		—			15,615			245			(1,832	)		—			14,028
Accrued expenses		—			(73,692	)		627			(4,409	)		—			(77,474	)
Net cash (used in) provided by operating activities		—			(143,410	)		7,113			7,119			(6,567	)		(135,745	)
Investing activities
Net change in investment in unconsolidated joint ventures		—			2,595			(316	)		—			—			2,279
Purchases of property and equipment		—			(830	)		(740	)		—			—			(1,570	)
Investment in subsidiaries		—			45,584			2,579			—			(48,163	)		—
Advances to affiliates		—			(7,080	)		—			—			7,080			—
Net cash provided by investing activities		—			40,269			1,523			—			(41,083	)		709
Financing activities
Proceeds from borrowings on notes payable		—			472,007			192,740			—			—			664,747
Principal payments on notes payable		—			(404,373	)		(185,491	)		(12,585	)		—			(602,449	)
Minority interest contributions, net		—			—			—			27,323			—			27,323
Advances to affiliates		—			—			(16,901	)		(30,749	)		47,650			—
Net cash provided by (used in) financing activities		—			67,634			(9,652	)		(16,011	)		47,650			89,621
Net decrease in cash and cash equivalents		—			(35,507	)		(1,016	)		(8,892	)		—			(45,415	)
Cash and cash equivalents at beginning of period		—			57,420			6,170			32,484			—			96,074
Cash and cash equivalents at end of period	$	—		$	21,913		$	5,154		$	23,592		$	—		$	50,659

29

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

Note 5 — Related Party Transactions

On October 26, 2000, the Company’s Board of Directors (with Messrs. William Lyon and William H. Lyon abstaining) approved the purchase of 579 lots for a total purchase price of $12,581,000 from an entity controlled by William Lyon and William H. Lyon. The terms of the purchase agreement provide for an initial option payment of $1,000,000 and a rolling option takedown of the lots. In addition, one-half of the net profits in excess of six percent from the development are to be paid to the seller. Phased takedowns of approximately 20 lots each were anticipated to occur at periodic intervals for each of several product types through September 2004. As of December 31, 2004, all lots were purchased under this agreement. In addition, one-half of the net profits, as defined, in excess of six percent from the development are to be paid to the seller, of which $5,711,000 has been paid through June 30, 2006. This land acquisition qualified as an affiliate transaction under the Company’s 12 ¹/2% Senior Notes due July 1, 2003 Indenture dated as of June 29, 1994, as amended (“Old Indenture”). Pursuant to the terms of the Old Indenture, the Company determined that the land acquisition is on terms that are no less favorable to the Company than those that would have been obtained in a comparable transaction by the Company with an unrelated person. The Company delivered to the Trustee under the Old Indenture a resolution of the Board of Directors of the Company set forth in an Officers’ Certificate certifying that the land acquisition is on terms that are no less favorable to the Company than those that would have been obtained in a comparable transaction by the Company with an unrelated person and the land acquisition was approved by a majority of the disinterested members of the Board of Directors of the Company. Further, the Company delivered to the Trustee under the Indenture a determination of value by a real estate appraisal firm which is of regional standing in the region in which the subject property is located and is MAI certified.

For the three months ended June 30, 2006 and 2005, the Company incurred reimbursable on-site labor costs of $28,000 and $39,000, respectively, for providing customer service to real estate projects developed by entities controlled by William Lyon and William H. Lyon, of which $32,000 was due to the Company at December 31, 2005. For the six months ended June 30, 2006 and 2005, the Company incurred reimbursable on-site labor costs of $57,000 and $71,000, respectively, for providing customer service to real estate projects developed by entities controlled by William Lyon and William H. Lyon.

For each of the three month periods ended June 30, 2006 and 2005, the Company incurred charges of $189,000 related to rent on its corporate office, from a trust of which William H. Lyon is the sole beneficiary.

Effective September 1, 2004, the Company entered into an aircraft consulting and management agreement with an affiliate (the “Affiliate”) of William Lyon to operate and manage the Company’s aircraft which was placed in service effective as of September 1, 2004. The terms of the agreement provide that the Affiliate shall consult and render its advice and management services to the Company with respect to all functions necessary to the operation, maintenance and administration of the aircraft. The Company’s business plan for the aircraft includes (i) use by Company executives for traveling on Company business to the Company’s regional offices and other destinations, (ii) charter service to outside third parties and (iii) charter service to William Lyon personally. Charter services for outside third parties and William Lyon personally are contracted for at market rates. As compensation to the Affiliate for its management and consulting services under the agreement, the Company pays the Affiliate a fee equal to (i) the amount equal to 107% of compensation paid by the affiliate for the pilots supplied pursuant to the agreement, (ii) $50 per operating hour for the aircraft and (iii) $9,000 per month for hangar rent. In addition, all maintenance work, inspections and repairs performed by the Affiliate on the aircraft are charged to the Company at the Affiliate’s published rates for maintenance, inspections and repairs in effect at the time such work is completed. The total compensation paid to the Affiliate under the agreement amounted to $293,000 and $313,000 for the three months ended June 30, 2006 and 2005, respectively, and $653,000 and $492,000, for the six months ended June 30, 2006 and 2005, respectively.

30

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

Pursuant to the agreement above, the Company had earned revenue of $112,000 and $110,000 for charter services provided to William Lyon personally, for the three months ended June 30, 2006 and 2005, respectively, and $288,000 and $129,000 was due to the Company at June 30, 2006 and December 31, 2005, respectively, for charter services provided. For the six months ended June 30, 2006 and 2005, the Company had earned $191,000 and $181,000, respectively for charter services provided to General Lyon personally.

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

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

Note 6 — Tender Offer and Merger

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

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

On March 23, 2006, the Company announced that its board of directors had formed a special committee of independent directors to consider the offer by General Lyon with the assistance of outside financial and legal advisors which the special committee retained. On April 10, 2006, General Lyon announced that he would amend his tender offer for all the outstanding shares of William Lyon Homes by increasing the offer price to $100 per

31

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

share. The special committee determined that it would recommend that stockholders tender their shares in connection with the amended offer. General Lyon also extended his offer until Friday, April 21, 2006. General Lyon has also reached an agreement, subject to final court approval, to settle certain class action lawsuits that have been filed in Delaware on behalf of William Lyon Homes’ stockholders. Another class action lawsuit filed in California has been stayed by the California court.

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

On May 18, 2006, General Lyon announced the completion of his tender offer to purchase all of the outstanding shares of the common stock of the Company not already owned by him for $109.00 net per share in cash. Computershare Trust Company of New York, the depositary for the offer, had advised General Lyon that an aggregate of 1,711,125 shares were tendered in the offer, including 310,652 shares that remained subject to guaranteed delivery procedures. The shares tendered in the offer, together with the shares already owned by General Lyon, The William Harwell Lyon 1987 Trust and The William Harwell Lyon Separate Property Trust, represented over 90% of the outstanding shares of the Company, which would be sufficient to enable General Lyon to effect a short-form merger with the Company under Delaware law.

On July 26, 2006, General Lyon announced that on July 25, 2006, WLH Acquisition Corp., a corporation owned by General Lyon, The William Harwell Lyon 1987 Trust and The William Harwell Lyon Separate Property Trust, was merged with and into the Company, with the Company continuing as the surviving corporation of the merger. At the effective time of the merger, each outstanding share of the Company’s common stock (except for shares owned by WLH Acquisition Corp. and by stockholders who properly exercise their appraisal rights in accordance with Delaware law) was cancelled and converted into the right to receive $109.00 per share in cash, without interest, which is the same consideration that was paid for shares of the Company in the tender offer by General Lyon. Shareholders of the Company as of the effective time of the merger were sent additional information by mail on the process for receiving the merger consideration or exercising their appraisal rights.

Prior to the completion of the merger, General Lyon and the two trusts contributed all the shares of the Company owned by them, which constituted more than 90% of the outstanding shares, to WLH Acquisition Corp. WLH Acquisition Corp. was then merged with and into the Company pursuant to the short-form merger provisions of Delaware law. Prior to the merger, the Company had cancelled and retired 1,275,000 shares of its common stock which had been repurchased and were being held in the treasury. After the merger, the Company’s capital structure consists of common stock, par value $.01 per share, 3,000 shares authorized, and 1,000 shares outstanding. The Company will continue as a privately held company, wholly owned by General Lyon and the two trusts.

The Company has incurred approximately $3,100,000 in financial advisory expenses related to the tender offer which are reflected as financial advisory expenses in the accompanying consolidated statement of income.

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

32

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

Note 7 — Commitments and Contingencies

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

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

Litigation Arising from General Lyon’s Tender Offer

As described above in Note 6—Tender Offer and Merger, on March 17, 2006, the Company’s principal stockholder commenced a tender offer (the “Tender Offer”) to purchase all outstanding shares of the Company’s common stock not already owned by him. Initially, the price offered in the Tender was $93 per share, but it has since been increased to $109 per share.

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

On March 23, 2006, the Company announced that its Board had appointed a special committee of independent directors who are not members of the Company’s management or employed by the Company (the “Special Committee”) to consider the Tender Offer. The members of the Special Committee are Harold H. Greene, Lawrence M. Higby, and Dr. Arthur Laffer. The Company also announced that the Special Committee had retained Morgan Stanley & Co. as its financial advisor and Gibson, Dunn & Crutcher LLP as its legal counsel.

33

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

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

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

On April 23, 2006, Delaware Chancery Court conditionally certified a class in the Consolidated Delaware Action. The parties to the Consolidated Delaware Action agreed to a Stipulation of Settlement, and the Delaware Chancery Court approved the settlement on August 9, 2006.

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

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

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

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

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

34

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

As of June 30, 2006, the Company had $3.1 million of outstanding irrevocable standby letters of credit to guarantee the Company’s financial obligations under certain land banking arrangements, joint venture agreements and other contractual arrangements in the normal course of business. The beneficiary may draw upon these letters of credit in the event of a contractual default by the Company relating to each respective obligation. These letters of credit have a stated term of up to two years and have varying maturities through 2007, at which time the Company may be required to renew the letters of credit to coincide with the term of the respective arrangement.

The Company also had outstanding performance and surety bonds of $271.8 million at June 30, 2006 related principally to its obligations for site improvements at various projects. The Company does not believe that draws upon these bonds, if any, will have a material effect on the Company’s financial position, results of operations or cash flows.

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

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

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

WILLIAM LYON HOMES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

The following discussion of results of operations and financial condition should be read in conjunction with the consolidated financial statements and notes thereto included in Item 1, as well as the information presented in the Annual Report on Form 10-K for the year ended December 31, 2005.

Results of Operations

Overview and Recent Results

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

	Three Months Ended June 30,
	2006									2005
	Wholly-Owned			Joint Ventures			Consolidated Total			Wholly-Owned			Joint Ventures			Consolidated Total
Selected Financial Information (dollars in thousands)
Homes closed		625			143			768			498			121			619
Home sales revenue	$	343,855		$	62,769		$	406,624		$	277,382		$	84,741		$	362,123
Cost of sales		(267,592	)		(46,063	)		(313,655	)		(203,384	)		(63,568	)		(266,952	)
Gross margin	$	76,263		$	16,706		$	92,969		$	73,998		$	21,173		$	95,171
Gross margin percentage		22.2	%		26.6	%		22.9	%		26.7	%		25.0	%		26.3	%
Number of homes closed
California		411			143			554			214			121			335
Arizona		133			—			133			171			—			171
Nevada		81			—			81			113			—			113
Total		625			143			768			498			121			619
Average sales price
California	$	639,700		$	438,900		$	587,900		$	872,900		$	700,300		$	810,500
Arizona		383,600			—			383,600			291,800			—			291,800
Nevada		369,400			—			369,400			360,000			—			360,000
Total	$	550,200		$	438,900		$	529,500		$	557,000		$	700,300		$	585,000
Number of net new home orders
California		222			82			304			532			206			738
Arizona		166			—			166			177			—			177
Nevada		80			—			80			239			—			239
Total		468			82			550			948			206			1,154
Average number of sales locations during period
California		25			6			31			19			9			28
Arizona		6			—			6			6			—			6
Nevada		12			—			12			8			—			8
Total		43			6			49			33			9			42

36

	As of June 30,
	2006						2005
	Wholly-Owned		Joint Ventures		Consolidated Total		Wholly-Owned		Joint Ventures		Consolidated Total
Backlog of homes sold but not closed at end of period
California		475		70		545		934		440		1,374
Arizona		446		—		446		521		—		521
Nevada		148		—		148		220		—		220
Total		1,069		70		1,139		1,675		440		2,115
Dollar amount of homes sold but not closed at end of period (dollars in thousands)
California	$	346,766	$	30,040	$	376,806	$	600,957	$	274,920	$	875,877
Arizona		134,627		—		134,627		172,240		—		172,240
Nevada		55,156		—		55,156		77,462		—		77,462
Total	$	536,549	$	30,040	$	566,589	$	850,659	$	274,920	$	1,125,579
Lots controlled at end of period
Owned lots
California		4,465		972		5,437		3,938		1,762		5,700
Arizona		4,333		1,738		6,071		3,812		269		4,081
Nevada		1,380		—		1,380		959		—		959
Total		10,178		2,710		12,888		8,709		2,031		10,740
Optioned lots(1)
California						3,786						3,525
Arizona						4,270						5,132
Nevada						2,122						1,489
Total						10,178						10,146
Total lots controlled
California						9,223						9,225
Arizona						10,341						9,213
Nevada						3,502						2,448
Total						23,066						20,886

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

37

	Six Months Ended June 30,
	2006									2005
	Wholly-owned			Joint Ventures			Combined Total			Wholly-owned			Joint Ventures			Combined Total
Selected Financial Information (dollars in thousands)
Homes closed		1,145			204			1,349			862			216			1,078
Home sales revenue	$	619,425		$	94,580		$	714,005		$	464,816		$	141,963		$	606,779
Cost of sales		(477,186	)		(65,912	)		(543,098	)		(338,899	)		(103,035	)		(441,934	)
Gross margin	$	142,239		$	28,668		$	170,907		$	125,917		$	38,928		$	164,845
Gross margin percentage		23.0	%		30.3	%		23.9	%		27.1	%		27.4	%		27.2	%
Number of homes closed
California		678			204			882			331			216			547
Arizona		232			—			232			297			—			297
Nevada		235			—			235			234			—			234
Total		1,145			204			1,349			862			216			1,078
Average sales price
California	$	642,800		$	463,600		$	601,300		$	870,800		$	657,200		$	786,500
Arizona		398,200			—			398,200			289,900			—			289,900
Nevada		388,200			—			388,200			386,600			—			386,600
Total	$	541,000		$	463,600		$	529,300		$	539,200		$	657,200		$	562,900
Number of net new home orders
California		530			166			696			908			411			1,319
Arizona		282			—			282			336			—			336
Nevada		219			—			219			372			—			372
Total		1,031			166			1,197			1,616			411			2,027
Average number of sales locations during period
California		25			6			31			17			9			26
Arizona		6			—			6			6			—			6
Nevada		11			—			11			8			—			8
Total		42			6			48			31			9			40

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

On a consolidated basis, the number of net new home orders for the three months ended June 30, 2006 decreased 52.3% to 550 homes from 1,154 homes for the three months ended June 30, 2005. The number of homes closed on a consolidated basis for the three months ended June 30, 2006, increased 24.1% to 768 homes from 619 homes for the three months ended June 30, 2005. On a consolidated basis, the number of net new home orders for the six months ended June 30, 2006 decreased 40.9% to 1,197 homes from 2,027 homes for the six months ended June 30, 2005. The number of homes closed on a consolidated basis for the six months ended June 30, 2006 increased 25.1% to 1,349 homes from 1,078 homes for the six months ended June 30, 2005. On a consolidated basis, the backlog of homes sold but not closed as of June 30, 2006 was 1,139, down 46.1% from 2,115 homes a year earlier, and down 16.1% from 1,357 homes at March 31, 2006.

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 June 30, 2006 was $566.6 million, down 49.7% from $1.126 billion as of June 30, 2005 and down 21.4% from $721.2 million as of March 31, 2006. The cancellation rate of buyers who contracted to buy a home but did not close escrow at the Company’s projects was approximately 32% during the three months ended June 30, 2006 compared to 13% during the three months ended June 30, 2005. The inventory of completed and unsold homes was 72 homes as of June 30, 2006.

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The average number of sales locations during the quarter ended June 30, 2006 was 49, up 17% from 42 in the comparable period a year ago, as a result of the Company’s focus begun in 2005 to increase the number of sales locations in each of its markets. The Company’s number of new home orders per average sales location decreased to 11.2 for the quarter ended June 30, 2006 as compared to 27.5 for the quarter ended June 30, 2005.

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

Comparison of Three Months Ended June 30, 2006 to June 30, 2005

Consolidated operating revenue for the three months ended June 30, 2006 was $408.3 million, a slight increase from consolidated operating revenue of $407.5 million for the three months ended June 30, 2005. Revenue from sales of wholly-owned homes increased $66.5 million, or 24.0%, to $343.9 million in the 2006 period from $277.4 million in the 2005 period. This increase was comprised of (i) an increase of $70.7 million due to an increase in the number of wholly-owned homes closed to 625 in 2006 from 498 in 2005 and (ii) a decrease of $4.2 million due to a decrease in the average sales price of wholly-owned homes closed to $550,200 in the 2006 period from $557,000 in the 2005 period. Consolidated operating revenue includes revenue from sales of joint ventures due to the adoption of Interpretation No. 46. Revenue from sales of joint venture homes decreased $21.9 million, or 25.9%, to $62.8 million in the 2006 period from $84.7 million in the 2005 period. This decrease was comprised of (i) a decrease of $37.4 million due to a decrease in the average sales price of joint venture homes closed to $438,900 in the 2006 period from $700,300 in the 2005 period and (ii) an increase of $15.5 million due to an increase in the number of joint venture homes closed to 143 in 2006 from 121 in 2005. Revenue from sales of lots, land and other was $1.6 million in the 2006 period compared with $45.4 million in the 2006 period, due to the timing of bulk sales of land in certain of the Company’s markets. The decrease in the average sales price of units closed in wholly-owned projects and in joint venture projects was due to a change in product mix.

Total operating income decreased to $50.7 million in the 2006 period from $75.3 million in the 2005 period. The excess of revenue from sales of homes over the related cost of sales (gross margin) increased by $8.2 million to $93.0 million in the 2006 period from $95.2 million in the 2005 period primarily due to an increase in the number of homes closed to 768 in the 2006 period from 619 in the 2005 period, offset by a decrease in gross margin percentages to 22.9% in the 2006 period from 26.3% in the 2005 period. The decrease in period-over-period gross margin percentage primarily reflects the close out of projects with higher average gross margin percentages in 2005 and a shift in product mix. The excess of revenue from sales of lots, land and other over the related cost of sales (gross margin) decreased to $(0.7) million in the 2006 period from $23.3 million in the 2005 period primarily due to the bulk sale of land in certain of the Company’s markets in the 2005 period with only minor transactions in the 2006 period. In addition, costs were incurred related to the abandonment and write-off of project pre-acquisition costs and land option deposits for certain of the Company’s potential projects in the 2006 period.

Sales and marketing expense increased by $3.5 million to $16.8 million in the 2006 period from $13.3 million in the 2005 period primarily due to an increase of $2.9 million in advertising costs to $6.3 million in the 2006 period from $3.4 million in the 2005 period and an increase of $0.4 million in direct selling expenses to $8.4 million in the 2006 period from $8.0 million in the 2005 period. The increase in advertising costs is attributable to the softening in the Company’s markets which began in 2005 and is continuing into 2006 which has caused the Company to aggressively increase its marketing efforts in order to compete in a market where the demand for homes has decreased significantly. The increase in direct selling expenses is caused by the increase in the number of homes closed to 768 in the 2006 period from 619 in the 2005 period. General and administrative expenses decreased by $6.1 million to $17.9 million in the 2006 period from $24.0 million in the 2005 period, primarily as a result of a decrease of $6.5 million in bonus expense to $9.5 million in the 2006 period from $16.0 million in the 2005 period due to decreased levels of pre-tax, pre-bonus income, offset by an increase of

39

$0.9 million in salaries and related benefits as a result of increased personnel levels. Selling, general and administrative expense as a percentage of home sales revenue was 8.5% in the 2006 period compared to 10.3% in the 2005 period. Other operating costs consist of operating losses realized by golf course operations at certain of the Company’s projects which increased to $0.7 million in the 2006 period compared to $0.5 million in the 2005 period. Equity in income (loss) from unconsolidated joint ventures decreased to a loss of $0.02 million in the 2006 period from income of $0.3 million in the 2005 period. Minority equity in income of consolidated entities increased to $6.3 million in the 2006 period from $5.7 million in the 2005 period, primarily due to a decrease in the number of joint venture homes closed to 143 in the 2006 period from 121 in 2005.

The Company incurred financial advisory expenses of $1.6 million in the 2006 period compared with $2.2 million in the 2005 period due to the tender offer described in “Item 2—Tender Offer and Merger”.

Total interest incurred increased to $20.6 million in the 2006 period from $17.3 million in the 2005 period, primarily as a result of an increase in the average principal balance of debt outstanding and an increase in interest rates. All interest incurred was capitalized in the 2006 and 2005 periods.

As a result of the factors outlined above, net income decreased to $30.4 million in the 2006 period from $44.1 million in the 2005 period.

Comparison of Six Months Ended June 30, 2006 to June 30, 2005

Consolidated operating revenue for the six months ended June 30, 2006 was $715.6 million, an increase of $61.4 million, or 9.4%, from consolidated operating revenue of $654.2 million for the six months ended June 30, 2005. Revenue from sales of wholly-owned homes increased $154.6 million, or 33.3%, to $619.4 million in the 2006 period from $464.8 million in the 2005 period. This increase was comprised of (i) an increase of $152.6 million due to an increase in the number of wholly-owned homes closed to 1,145 in 2006 from 862 in 2005 and (ii) an increase of $2.0 million due to an increase in the average sales price of wholly-owned homes closed to $541,000 in the 2006 period from $539,200 in the 2005 period. Consolidated operating revenue includes revenue from sales of joint ventures due to the adoption of Interpretation No. 46. Revenue from sales of joint venture homes decreased $47.4 million, or 33.4%, to $94.6 million in the 2006 period from $142.0 million in the 2005 period. This decrease was comprised of (i) a decrease of $39.5 million due to a decrease in the average sales price of joint venture homes closed to $463,600 in the 2006 period from $657,200 in the 2005 period and (ii) a decrease of $7.9 million due to a decrease in the number of joint venture homes closed to 204 in 2006 from 216 in 2005. Revenue from sales of lots, land and other was $1.6 million in the 2006 period compared with $47.4 million in the 2006 period, due to the timing of bulk sales of land in certain of the Company’s markets. The decrease in the average sales price of units closed in wholly-owned projects and in joint venture projects was due to a change in product mix.

Total operating income decreased to $94.0 million in the 2006 period from $109.3 million in the 2005 period. The excess of revenue from sales of homes over the related cost of sales (gross margin) increased by $6.1 million to $170.9 million in the 2006 period from $164.8 million in the 2005 period primarily due to an increase in the number of homes closed to 1,349 in the 2006 period from 1,078 in the 2005 period, offset by a decrease in gross margin percentages to 23.9% in the 2006 period from 27.2% in the 2005 period. The decrease in period-over-period gross margin percentage primarily reflects the close out of projects with higher average gross margin percentages in 2005 and a shift in product mix. The excess of revenue from sales of lots, land and other over the related cost of sales (gross margin) decreased to $(1.1) million in the 2006 period from $23.6 million in the 2005 period primarily due to the bulk sale of land in certain of the Company’s markets in the 2005 period with only minor transactions in the 2006 period. In addition, costs were incurred related to the abandonment and write-off of project pre-acquisition costs and land option deposits for certain of the Company’s potential projects in the 2006 period.

Sales and marketing expense increased by $5.5 million to $29.9 million in the 2006 period from $24.4 million in the 2005 period primarily due to an increase of $4.0 million in advertising costs to $10.7 million in the 2006 period from $6.7 million in the 2005 period and an increase of $1.2 million in direct selling expenses to

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$15.1 million in the 2006 period from $13.9 million in the 2005 period. The increase in advertising costs is attributable to the softening in the Company’s markets which began in 2005 and is continuing into 2006 which has caused the Company to aggressively increase its marketing efforts in order to compete in a market where the demand for homes has decreased significantly. The increase in direct selling expenses is caused by the increase in the number of homes closed to 1,349 in the 2006 period from 1,078 in the 2005 period. General and administrative expenses decreased by $5.0 million to $36.4 million in the 2006 period from $41.4 million in the 2005 period, primarily as a result of a decrease of $5.7 million in bonus expense to $17.7 million in the 2006 period from $23.4 million in the 2005 period due to decreased levels of pre-tax, pre-bonus income, offset by an increase of $1.8 million in salaries and related benefits as a result of increased personnel levels. Selling, general and administrative expense as a percentage of home sales revenue was 9.3% in the 2006 period compared to 10.8% in the 2005 period. Other operating costs consist of operating losses realized by golf course operations at certain of the Company’s projects which increased to $1.5 million in the 2006 period compared to $1.2 million in the 2005 period. Equity in income (loss) from unconsolidated joint ventures increased to income of $3.6 million in the 2006 period from a loss of $0.2 million in the 2005 period. Minority equity in income of consolidated entities increased to $11.5 million in the 2006 period from $12.0 million in the 2005 period, primarily due to a decrease in the number of joint venture homes closed to 204 in the 2006 period from 216 in 2005.

The Company incurred financial advisory expenses of $3.1 million in the 2006 period compared with $2.2 million in the 2005 period due to the tender offer described in “Item 2—Tender Offer and Merger”.

Total interest incurred increased to $39.2 million in the 2006 period from $32.5 million in the 2005 period, primarily as a result of an increase in the average principal balance of debt outstanding and an increase in interest rates. All interest incurred was capitalized in the 2006 and 2005 periods.

As a result of the factors outlined above, net income decreased to $56.6 million in the 2006 period from $64.6 million in the 2005 period.

Financial Condition and Liquidity

The Company provides for its ongoing cash requirements principally from internally generated funds from the sales of real estate, outside borrowings and by forming new joint ventures with venture partners that provide a substantial portion of the capital required for certain projects. The Company currently has outstanding 7 ⁵/8% Senior Notes due 2012, 10 ³/4% Senior Notes due 2013 and 7 ¹/2% Senior Notes due 2014 and maintains secured revolving credit facilities (“Revolving Credit Facilities”). The Company has financed, and may in the future finance, certain projects and land acquisitions with construction loans secured by real estate inventories, seller provided financing and land banking transactions. The Company believes that its current borrowing capacity and increases reasonably available to it, cash on hand and anticipated net cash flows from operations are and will be sufficient to meet its current and reasonably anticipated liquidity needs on both a near-term and long-term basis (and in any event for the next twelve months) for funds to build homes, run its day-to-day operations, acquire land and capital assets and fund its mortgage operations. There is no assurance, however, that future cash flows will be sufficient to meet the Company’s future capital needs. The amount and types of indebtedness that the Company may incur may be limited by the terms of the indentures and credit or other agreements governing the Company’s senior note obligations, revolving credit facilities and other indebtedness.

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

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The Company cannot be certain that its cash flow will be sufficient to allow it to pay principal and interest on its debt, support its operations and meet its other obligations. If the Company is not able to meet those obligations, it may be required to refinance all or part of its existing debt, sell assets or borrow more money. The Company may not be able to do so on terms acceptable to it, if at all. In addition, the terms of existing or future indentures and credit or other agreements governing the Company’s senior note obligations, revolving credit facilities and other indebtedness may restrict the Company from pursuing any of these alternatives.

7 ⁵/8% Senior Notes

On November 22, 2004, the Company’s 100% owned subsidiary, William Lyon Homes, Inc., a California corporation, (“California Lyon”) closed its offering of $150.0 million principal amount of 7 ⁵/8% Senior Notes due 2012 (the “7 ⁵/8% Senior Notes”). The notes were sold pursuant to Rule 144A. The notes were issued at par resulting in net proceeds to the Company of approximately $148.5 million. California Lyon agreed to file a registration statement with the Securities and Exchange Commission relating to an offer to exchange the notes for publicly tradeable notes having substantially identical terms. On January 12, 2005, the Securities and Exchange Commission declared the registration statement effective and California Lyon commenced an offer to exchange any and all of its outstanding $150.0 million aggregate principal amount of 7 ⁵/8% Senior Notes due 2012, which are not registered under the Securities Act of 1933, for a like amount of its new 7 ⁵/8% Senior Notes due 2012, which are registered under the Securities Act of 1933, upon the terms and subject to the conditions set forth in the prospectus dated January 12, 2005. The exchange offer was completed for $146.5 million principal amount of the 7 ⁵/8% Senior Notes on February 18, 2005. The remaining $3.5 million principal amount of the old notes remains outstanding. The terms of the new notes are identical in all material respects to those of the old notes, except for certain transfer restrictions, registration rights and liquidated damages provisions relating to the old notes. Interest on the 7 ⁵/8% Senior Notes is payable semi-annually on December 15 and June 15 of each year. Based on the current outstanding principal amount of the 7 ⁵/8% Senior Notes, the Company’s semi-annual interest payments are $5.7 million.

Except as set forth in the Indenture governing the 7 ⁵/8% Senior Notes, the 7 ⁵/8% Senior Notes are not redeemable prior to December 15, 2008. Thereafter, the 7 ⁵/8% Senior Notes will be redeemable at the option of California Lyon, in whole or in part, at a redemption price equal to 100% of the principal amount plus a premium declining ratably to par, plus accrued and unpaid interest, if any. In addition, on or before December 15, 2007, California Lyon may redeem up to 35% of the aggregate principal amount of the notes with the proceeds of qualified equity offerings at a redemption price equal to 107.625% of the principal amount, plus accrued and unpaid interest, if any.

10 ³/4% Senior Notes

California Lyon filed a Registration Statement on Form S-3 with the Securities and Exchange Commission for the sale of $250.0 million of Senior Notes due 2013 (the “10 ³/4% Senior Notes”) which became effective on March 12, 2003. The offering closed on March 17, 2003 and was fully subscribed and issued. The notes were issued at a price of 98.493% to the public, resulting in net proceeds to the Company of approximately $246.2 million. The purchase price reflected a discount to yield 11% under the effective interest method and the notes have been reflected net of the unamortized discount in the accompanying consolidated balance sheet. Interest on the 10 ³/4% Senior Notes is payable on April 1 and October 1 of each year. Based on the current outstanding principal amount of the 10 ³/4% Senior Notes, the Company’s semi-annual interest payments are $13.4 million.

Except as set forth in the Indenture governing the 10 ³/4% Senior Notes, the 10 ³/4% Senior Notes are not redeemable prior to April 1, 2008. Thereafter, the 10 ³/4% Senior Notes will be redeemable at the option of California Lyon, in whole or in part, at a redemption price equal to 100% of the principal amount plus a premium declining ratably to par, plus accrued and unpaid interest, if any. In addition, on or before April 1, 2006, California Lyon may redeem up to 35% of the aggregate principal amount of the notes with the proceeds of qualified equity offerings at a redemption price equal to 110.75% of the principal amount, plus accrued and unpaid interest, if any.

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7 ¹/2% Senior Notes

On February 6, 2004, California Lyon closed its offering of $150.0 million principal amount of 7 ¹/2% Senior Notes due 2014 (the “7 ¹/2% Senior Notes”). The notes were sold pursuant to Rule 144A and outside the United States to non-U.S. persons in reliance on Regulation S. The notes were issued at par, resulting in net proceeds to the Company of approximately $147.6 million. California Lyon agreed to file a registration statement with the Securities and Exchange Commission relating to an offer to exchange the notes for publicly tradeable notes having substantially identical terms. On July 16, 2004, the Securities and Exchange Commission declared the registration statement effective and California Lyon commenced an offer to exchange any and all of its outstanding $150.0 million aggregate principal amount of 7 ¹/2% Senior Notes due 2014, which are not registered under the Securities Act of 1933, for a like amount of its new 7 ¹/2% Senior Notes due 2014, which are registered under the Securities act of 1933, upon the terms and subject to the conditions set forth in the prospectus dated July 16, 2004. The exchange offer was completed for the full principal amount of the 7 ¹/2% Senior Notes on August 17, 2004. The terms of the new notes are identical in all material respects to those of the old notes, except for certain transfer restrictions, registration rights and liquidated damages provisions relating to the old notes. The new notes have been listed on the New York Stock Exchange. Interest on the 7 ¹/2% Senior Notes is payable on February 15 and August 15 of each year. Based on the current outstanding principal amount of 7 ¹/2% Senior Notes, the Company’s semi-annual interest payments are $5.6 million.

Except as set forth in the Indenture governing the 7 ¹/2% Senior Notes, the 7 ¹/2% Senior Notes are not redeemable prior to February 15, 2009. Thereafter, the 7 ¹/2% Senior Notes will be redeemable at the option of California Lyon, in whole or in part, at a redemption price equal to 100% of the principal amount plus a premium declining ratably to par, plus accrued and unpaid interest, if any. In addition, on or before February 15, 2007, California Lyon may redeem up to 35% of the aggregate principal amount of the notes with the proceeds of qualified equity offerings at a redemption price equal to 107.50% of the principal amount, plus accrued and unpaid interest, if any.

*  *  *  *  *

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

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

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

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

The Senior Notes Indentures contain covenants that limit the ability of Delaware Lyon and its restricted subsidiaries to, among other things: (i) incur additional indebtedness; (ii) pay dividends or make other

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distributions or repurchase its stock; (iii) make investments; (iv) sell assets; (v) incur liens; (vi) enter into agreements restricting the ability of Delaware Lyon’s restricted subsidiaries (other than California Lyon) to pay dividends; (vii) enter into transactions with affiliates; and (viii) consolidate, merge or sell all or substantially all of Delaware Lyon’s and California Lyon’s assets. These covenants are subject to a number of important exceptions and qualifications as described in the Senior Notes Indentures.

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

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

At June 30, 2006, the Company had approximately $214.8 million of secured indebtedness, (excluding approximately $44.4 million of secured indebtedness of consolidated entities) and approximately $275.8 million of additional secured indebtedness available to be borrowed under the Company’s credit facilities, as limited by the Company’s borrowing base formulas.

Revolving Credit Facilities

As of June 30, 2006, the Company has six revolving credit facilities which have an aggregate maximum loan commitment of $510.0 million, (including one facility of $150.0 million, one of $100.0 million, one of $90.0 million, one of $70.0 million and two of $50.0 million each), and mature at various dates through 2008. In addition, in July 2006 the Company entered into an additional revolving credit facility agreement with another lender in the amount of $50.0 million. After giving effect to this new facility, the Company’s aggregate maximum loan commitment under the seven revolving credit facilities will be $560.0 million. The revolving credit facilities have similar characteristics. The Company may borrow amounts, subject to applicable borrowing base and concentration limitations, as defined. During the last year of the term of each facility, the commitment amount will decrease ratably until the commitment under each facility is reduced to zero by the final maturity date, as defined in each respective agreement.

Availability under each credit facility is subject not only to the maximum amount committed under the respective facility, but also to both various borrowing base and concentration limitations. The borrowing base limits lender advances to certain agreed percentages of asset value. The allowed percentage generally increases as the asset progresses from land under development to residence subject to contract of sale. Advances for each type of collateral become due in whole or in part, subject to possible re-borrowing, and/or the collateral becomes excluded from the borrowing base, after a specified period or earlier upon sale. Concentration limitations further restrict availability under the credit facilities. The effect of these borrowing base and concentration limitations essentially is to mandate minimum levels of the Company’s investment in a project, with higher percentages of investment required at earlier phases of a project, and with greater absolute dollar amounts of investment required as a project progresses. Each revolving credit facility is secured by deeds of trust on the real property and improvements thereon owned by the Company in the subdivision project(s) approved by the respective lender, as well as pledges of all net sale proceeds, related contracts and other ancillary property. Also, each credit facility includes financial covenants, which may limit the amount that may be borrowed thereunder. Outstanding advances bear interest at various rates, which approximate the prime rate. As of June 30, 2006, $162.9 million was outstanding under these credit facilities, with a weighted-average interest rate of 7.635%, and the undrawn availability was $275.8 million as limited by the borrowing base formulas. Interest on the revolving credit facilities is calculated on the average, outstanding daily balance and is paid following the end of each month. During the three and six months ended June 30, 2006, the Company borrowed $341.0 million and $688.0 million and repaid $307.1 million and $575.0 million, respectively under these facilities. The maximum amount outstanding was $201.1 million and the weighted average borrowings were $120.0 million during the six months ended June 30, 2006. Interest incurred on the revolving credit facilities for the three and six months ended June 30, 2006 was $3.9 million and $5.4 million, respectively. The Company routinely makes borrowings under

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its revolving credit facilities in the ordinary course of business within the maximum aggregate loan commitment amounts to fund its operations, including its land acquisition and home building activities, and repays such borrowings, as required by the credit facilities, with the net sales proceeds of sales of the real property, including homes, which secure the applicable credit facility.

Under the revolving credit facilities, the Company is required to comply with a number of covenants, the most restrictive of which require Delaware Lyon to maintain:

• A tangible net worth, as defined, of $200.0 million, adjusted upwards quarterly by 50% of Delaware Lyon’s quarterly net income after June 30, 2004;

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

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

As of and for the period ending June 30, 2006, the Company is in compliance with these covenants.

Construction Notes Payable

At June 30, 2006, the Company had construction notes payable on certain consolidated entities amounting to $44.4 million. The construction notes have various maturity dates and bear interest at rates ranging from 3% to prime plus 2.0% at June 30, 2006. Interest is calculated on the average daily balance and is paid following the end of each month.

Seller Financing

At June 30, 2006, the Company had $31.3 million of notes payable outstanding related to land acquisitions for which seller financing was provided. The seller financing notes are due at various dates through March 2008 and bear interest at rates ranging from 9.0% to 12.0% at June 30, 2006. Interest is calculated on the average principal balance outstanding and is accrued and paid when the financing is repaid.

Revolving Mortgage Warehouse Credit Facilities

The Company, through its mortgage subsidiary and one of its unconsolidated joint ventures, has entered into two revolving mortgage warehouse credit facilities with banks to fund its mortgage origination operations. The original credit facility, which matures in May 2007, provides for revolving loans of up to $30.0 million outstanding, $20.0 million of which is committed (lender obligated to lend if stated conditions are satisfied) and $10.0 million is not committed (lender advances are optional even if stated conditions are otherwise satisfied). However, as in the past the Company expects the maturity to be extended by the lender at each maturity date for an additional year. The Company’s mortgage subsidiary and one of its unconsolidated joint ventures entered into an additional $50.0 million credit facility which matures in November 2006. However, as in the past the Company expects the maturity to be extended by the lender at each maturity date for an additional year. Mortgage loans are generally held for a short period of time and are typically sold to investors within 7 to 15 days following funding. The facilities are secured by substantially all of the assets of each of the borrowers, including the mortgage loans held for sale, all rights of each of the borrowers with respect to contractual obligations of third party investors to purchase such mortgage loans, and all proceeds of sale of such mortgage loans. The facilities, which have LIBOR based pricing, also contain certain financial covenants requiring the borrowers to maintain minimum tangible net worth, leverage, profitability and liquidity. These facilities are non-recourse and are not guaranteed by the Company. At June 30, 2006 the outstanding balance under these facilities was $20.6 million.

Land Banking Arrangements

The Company enters into purchase agreements with various land sellers. In some instances, and as a method of acquiring land in staged takedowns, thereby minimizing the use of funds from the Company’s revolving credit

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facilities and other corporate financing sources and limiting the Company’s risk, the Company transfers its right in such purchase agreements to entities owned by third parties (land banking arrangements). These entities use equity contributions and/or incur debt to finance the acquisition and development of the lots. The entities grant the Company an option to acquire lots in staged takedowns. In consideration for this option, the Company makes a non-refundable deposit of 15% to 20% of the total purchase price. Additionally, the Company may be subject to other penalties if lots are not acquired. The Company is under no obligation to purchase the balance of the lots, but would forfeit remaining deposits and be subject to penalties if the lots were not purchased. The Company does not have legal title to these entities or their assets and has not guaranteed their liabilities. These land banking arrangements help the Company manage the financial and market risk associated with land holdings. The use of these land banking arrangements is dependent on, among other things, the availability of capital to the option provider, general housing market conditions and geographic preferences. As described in Note 2 of “Notes to Consolidated Financial Statements”, Interpretation No. 46, requires the consolidation of the assets, liabilities and operations of three of the Company’s land banking arrangements including, as of March 31, 2006, real estate inventories of $60.1 million. The Company participates in two land banking arrangements, which are not VIEs in accordance with Interpretation No. 46, and are not consolidated as of June 30, 2006 and December 31, 2005. The deposits related to these two land banking projects have been recorded in the accompanying consolidated balance sheet. Summary information with respect to the Company’s consolidated and unconsolidated land banking arrangements is as follows as of June 30, 2006 (dollars in thousands):

	Consolidated		Unconsolidated
Total number of land banking projects		3		2
Total number of lots		267		590
Total purchase price	$	84,085	$	89,221
Balance of lots still under option and not purchased:
Number of lots		201		38
Purchase price	$	60,696	$	12,746
Forfeited deposits and penalties if lots were not purchased	$	6,673	$	1,753

Joint Venture Financing

The Company and certain of its subsidiaries are general partners or members in joint ventures involved in the development and sale of residential projects. As described more fully in “Recently Issued Accounting Standards”, in accordance with Interpretation No. 46 certain joint ventures have been determined to be variable interest entities in which the Company is considered the primary beneficiary. Accordingly, the assets, liabilities and operations of these joint ventures have been consolidated with the Company’s financial statements. The financial statements of joint ventures in which the Company is not considered the primary beneficiary are not consolidated with the Company’s financial statements. The Company’s investments in unconsolidated joint ventures are accounted for using the equity method because the Company has a 50% or less voting or economic interest (and thus such joint ventures are not controlled by the Company). Income allocations and cash distributions to the Company from the unconsolidated joint ventures are based on predetermined formulas between the Company and its joint venture partners as specified in the applicable partnership or operating agreements. The Company generally receives, after partners’ priority returns and returns of partners’ capital, approximately 50% of the profits and cash flows from joint ventures. See Note 2 of “Notes to Consolidated Financial Statements” for condensed combined financial information for the joint ventures whose financial statements have been consolidated with the Company’s financial statements. See Note 3 of “Notes to Consolidated Financial Statements” for condensed combined financial information for the unconsolidated joint ventures. Based upon current estimates, substantially all future development and construction costs incurred by the joint ventures will be funded by the venture partners or from the proceeds of construction financing obtained by the joint ventures.

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As of June 30, 2006, the Company’s investment in and advances to unconsolidated joint ventures was $1.5 million and the venture partners’ investment in such joint ventures was $1.3 million. As of June 30, 2006, these joint ventures had obtained financing from construction lenders which amounted to $39.7 million of outstanding indebtedness.

Assessment District Bonds

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

Cash Flows — Comparison of Six Months Ended June 30, 2006 to Six Months Ended June 30, 2005

Net cash used in operating activities decreased to $65.7 million in the 2006 period from $135.7 million in the 2005 period. The change was primarily as a result of (i) decreased expenditures in real estate inventories to $164.8 million in the 2006 period from $195.6 million in the 2005 period, (ii) an increase in net changes in accrued expenses to a decrease of $109.2 million in the 2006 period from a decrease of $77.5 million in the 2005 period, (iii) an increase in net changes in receivables to an increase of $101.6 million in the 2006 period from an increase of $4.9 million in the 2005 period, (iv) a decrease in provision for income taxes to $36.5 million in the 2006 period from $42.2 million in the 2005 period and (v) a decrease in net income to $56.6 million in the 2006 period from $64.6 million in the 2005 period. The decrease in real estate inventories is primarily attributable to a decrease in land acquisitions during the 2006 period. The softening in the Company’s markets which began in 2005 and is continuing into 2006 has decreased the amount of land acquisitions by the Company during the 2006 period. The increase in net changes in accrued expenses is primarily attributable to a net decrease in income taxes payable of $30.0 million during the 2006 period from a balance of $35.5 million as of December 31, 2005 compared to $5.5 million as of June 30, 2006 and a net decrease in accrued bonus expense of $38.5 million during the 2006 period, from a balance of $71.8 million as of December 31, 2005 compared to $33.3 million as of June 30, 2006. Comparatively, during the 2005 period, the net decrease in income taxes payable was $13.3 million in the 2005 period, from a balance of $31.0 million as of December 31, 2004 compared to a balance of $17.7 million as of June 30, 2005 and a net decrease in accrued bonus expense of $22.3 million from a balance of $59.6 million as of December 31, 2004 compared to a balance of $37.3 million as of June 30, 2005. The changes identified above during the first six months of the periods ending June 30, 2006 and 2005 are recurring in nature and are attributable to the timing of bonus payments and estimated income tax payments made, offset by normal accruals for the period. The increase in net changes in receivables is attributable to a decrease in escrow proceeds receivable of $76.3 million during the 2006 period, from a balance of $84.3 million as of December 31, 2005 to a balance of $8.1 million as of June 30, 2006 compared to a net decrease of $3.9 million during the 2005 period, from a balance of $15.0 million as of December 31, 2004 to a balance of $11.1 million as of June 30, 2005. The large balance as of December 31, 2005 and 2004 was temporary in nature and primarily due to a significant increase in the number of homes closed in the last five days of the year to 254 in 2005 from 157 in 2004 where the homes had closed escrow but the Company had not yet received the funds from the escrow and title companies. The entire balance of escrow proceeds receivable at December 31, 2005 and 2004 was collected within the first few days of the following period. The remaining increase in the change in receivables is primarily attributable to a net decrease in first trust deed mortgage notes receivables of $27.2 million during the 2006 period to $20.6 million as of June 30, 2006 from $47.8 million as of December 31, 2005 compared to a net increase of $7.3 million during the 2005 period to $16.6 million as of June 30, 2005 from 9.3 million as of December 31, 2004. This increase was also attributable to the significant increase in the number of homes closed in the last week of the year in 2005 as compared to 2004 as described above. Substantially all of the balance of first trust deed mortgage notes receivables was collected in the first few days of January 2006 and 2005 when the loans were sold to third party investors.

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The successful issuance of the 10 ³/4% Senior Notes in 2003 and the 7 ¹/2% Senior Notes and 7 ⁵/8% Senior Notes in 2004, offset by the repayment of the 12 ¹/2% Senior Notes, provided the Company with increased financial resources. The risks inherent in purchasing and developing land increase as consumer demand for housing decreases. Thus, the Company may have bought and developed land on which it cannot profitably build and sell homes. The market value of land, building lots and housing inventories can fluctuate significantly as a result of changing market conditions. In addition, inventory carrying costs can be significant and can result in losses in a poorly performing project or market. In the event of significant changes in economic or market conditions, the Company may have to sell homes at significantly lower margins or at a loss.

Net cash (used in) provided by investing activities decreased to a use of $1.4 million in the 2006 period from a source of $0.7 million in the 2005 period. The change was primarily as a result of a decrease in net investments in and advances to unconsolidated joint ventures to $0.01 million in the 2006 period from $1.2 million in the 2005 period and a decrease in (contributions) distributions of capital from unconsolidated joint ventures to a contribution of $0.1 million in the 2006 period from a distributions of $3.5 million in the 2005 period.

Net cash provided by financing activities decreased to $42.4 million in the 2006 period from $89.6 million in the 2005 period, primarily as a result of minority interest distributions of $71.0 million in the 2006 period compared to minority interest contributions of $27.3 million in the 2005 period and a decrease in net borrowings on notes payable to $113.0 million in the 2006 period from $62.3 million in the 2005 period.

Off-Balance Sheet Arrangements

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

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Description of Projects

The Company’s homebuilding projects usually take two to five years to develop. The following table presents project information relating to each of the Company’s homebuilding regions.

Project (County) Product	Year of First Delivery	Estimated Number of Homes at Completion(1)	Units Closed as of June 30, 2006	Backlog at June 30, 2006(2)(3)	Lots Owned as of June 30, 2006	Homes Closed for the Period Ended June 30, 2006	Sales Price Range(5)
SOUTHERN CALIFORNIA COASTAL REGION
ORANGE COUNTY DIVISION
Wholly-Owned:
Mirador at Talega, San Clemente	2004	76	75	1	1	22	$1,115,00—1,270,000
Ambridge at Quail Hill, Irvine	2004	128	128	0	0	8	$500,000—570,000
Lombard Court, Irvine	2005	150	128	22	22	59	$445,000—633,000
Garland Park, Irvine	2005	166	130	29	36	30	$579,000—717,000
Seacove at the Waterfront, Huntington Beach	2004	106	106	0	0	8	$802,000—995,000
Floralisa, San Juan Capistrano	2005	80	35	14	45	25	$1,310,000—1,410,000
Estrella Rosa, San Juan Capistrano	2006	40	0	19	40	0	$1,675,000—1,725,000
Amarante, Ladera Ranch	2005	53	48	5	5	4	$880,000—1,060,000
Amarante II, Ladera Ranch	2006	18	1	16	17	1	$1,056,000—1,140,000
Bellataire, Ladera Ranch	2005	52	43	9	9	0	$1,220,000—1,260,000
Bellataire II, Ladera Ranch	2006	23	1	22	22	1	$1,195,000—1,230,000
Tamarisk, Irvine	2005	113	107	6	6	43	$555,000—610,000
Portola Springs, Irvine	2007	152	0	0	20	0	$455,000—615,000
Alora, San Clemente	2007	49	0	0	17	0	$1,285,000—1,410,000
Columbus Grove, Irvine:
Lantana(6)	2006	102	16	12	102	16	$900,000—1,015,000
Kensington	2006	63	0	27	63	0	$740,000—850,000
Clarendon	2007	102	0	0	102	0	$289,000—660,000
Astoria(6)	2007	102	0	0	98	0	$975,000—1,120,000
Kensington II	2007	60	0	0	60	0	$740,000—850,000
Cambridge Lane	2007	156	0	0	156	0	$94,000—490,000
Ainsley Park	2007	84	0	0	84	0	$690,000—810,000
Ciara(6)	2007	67	0	0	67	0	$1,225,000—1,375,000
Verandas	2007	97	0	0	97	0	$730,000—850,000
TOTAL ORANGE COUNTY DIVISION		2,039	818	182	1,069	217
LOS ANGELES DIVISION
Wholly-Owned:
Meridian Hills, Moorpark:
Ashford	2006	113	0	0	113	0	$850,000—975,000
Marquis	2006	135	0	0	135	0	$890,000—1,080,000
Brighton (Affordable)	2007	17	0	0	17	0	$105,000—272,000
TOTAL LOS ANGELES		265	0	0	265	0
SAN DIEGO DIVISION
Wholly-Owned:
Promenade North, San Diego	2006	168	0	7	168	0	$444,000—515,000
Alcala at Del Sur, San Diego	2005	83	5	19	78	5	$772,000—795,000
Altair, Santee	2008	85	0	0	85	0	$444,000—505,000
Maybeck, San Diego	2006	120	0	0	112	0	$803,000—875,000
Sunset Cove, San Diego	2007	77	0	0	77	0	$583,000—618,000
Total Wholly-Owned:		533	5	26	520	5
Joint Ventures:
Ravenna, San Diego	2005	199	122	22	77	74	$471,000—513,000

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Project (County) Product	Year of First Delivery	Estimated Number of Homes at Completion(1)	Units Closed as of June 30, 2006	Backlog at June 30, 2006(2)(3)	Lots Owned as of June 30, 2006	Homes Closed for the Period Ended June 30, 2006	Sales Price Range(5)
Amante, San Diego	2005	127	90	9	37	25	$561,000—631,000
Treviso, San Diego	2005	186	75	7	111	40	$386,000—526,000
Belleza at San Miguel Village, Chula Vista	2005	195	154	13	41	32	$360,000—440,000
Total Joint Ventures		707	441	51	266	171
TOTAL SAN DIEGO		1,240	446	77	786	176
SOUTHERN CALIFORNIA COASTAL REGION COMBINED TOTAL
Wholly-Owned		2,837	823	208	1,854	222
Joint Ventures		707	441	51	266	171
		3,544	1,264	259	2,120	393
NORTHERN CALIFORNIA REGION
BAY AREA/CENTRAL VALLEY DIVISION
Wholly-Owned:
Contra Costa County
Seagate at Bayside, Hercules	2005	96	54	14	42	26	$594,000—727,000
Wavecrest at Bayside, Hercules	2005	76	65	10	11	27	$724,000—776,000
Rivergate Laurels, Antioch	2005	69	69	0	0	0	$548,000—658,000
Rivergate II, Antioch	2006	98	15	11	83	15	$538,000—653,000
San Joaquin County
Seasons, Stockton	2005	145	117	10	28	34	$553,000—613,000
Santa Clara County
Baton Rouge, San Jose	2005	91	79	12	12	34	$536,000—661,000
Stanislaus County
Falling Leaf, Modesto
Trails	2006	100	0	0	100	0	$390,000—450,000
Groves	2006	131	0	0	131	0	$380,000—415,000
Meadows	2006	83	0	2	83	0	$455,000—520,000
Total Wholly-Owned		889	399	59	490	136
Joint Ventures:
Contra Costa County
Vista Del Mar, Pittsburgh
Villages	2007	102	0	0	102	0	$298,000—524,000
Venue	2007	132	0	0	132	0	$353,000—658,000
Vineyard	2007	162	0	0	162	0	$686,000—741,000
Victory	2007	125	0	0	125	0	$706,000—806,000
Estates Custom Lots	2007	12	0	0	12	0	$144,000—400,000
Total Joint Ventures		533	0	0	533	0
TOTAL BAY AREA/CENTRAL VALLEY		1,422	399	59	1,023	136
SACRAMENTO DIVISION
Wholly-Owned:
San Joaquin County
Ironwood II, Lathrop	2003	88	85	0	3	0	$276,000—317,000
Ironwood III, Lathrop	2005	109	81	17	28	10	$487,000—571,000
Placer County
Shady Lane at Whitney Ranch Rocklin	2006	96	6	12	90	6	$443,000—465,000
Twin Oaks at Whitney Ranch Rocklin	2006	92	0	6	92	0	$634,000—666,000
Sacramento County
Verona at Anatolia, Rancho Cordova	2005	79	28	4	51	19	$500,000—525,000
Fair Oaks(6)	2007	189	0	0	189	0	$399,000—417,000
Total Wholly-Owned		653	200	39	453	35

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Project (County) Product	Year of First Delivery	Estimated Number of Homes at Completion(1)	Units Closed as of June 30, 2006	Backlog at June 30, 2006(2)(3)	Lots Owned as of June 30, 2006	Homes Closed for the Period Ended June 30, 2006	Sales Price Range(5)
Joint Ventures:
Sacramento County
Big Horn, Elk Grove
Plaza Walk	2005	106	37	4	69	16	$359,000—419,000
Gallery Walk	2005	149	45	15	104	17	$230,000—361,000
Total Joint Ventures		255	82	19	173	33
TOTAL SACRAMENTO		908	282	58	626	68
NORTHERN CALIFORNIA REGION COMBINED TOTAL
Wholly-Owned		1,542	599	98	943	171
Joint Ventures		788	82	19	706	33
		2,330	681	117	1,649	204
INLAND EMPIRE REGION
Wholly-Owned:
Riverside County
Heartland, North Corona
Homestead	2005	109	94	8	15	50	$578,000—645,000
Almont	2006	91	46	30	45	46	$492,000—568,000
Parkside/Vander Stelt, Corona	2007	309	0	4	122	0	$578,000—678,000
Kasbergen/Serafina, North Corona	2007	314	0	0	314	0	$311,000—411,000
Bridle Creek, Corona	2003	274	174	12	100	2	$693,000—870,000
Sequoia at Wolf Creek, Temecula	2005	125	61	11	64	47	$392,000—438,000
Savannah at Harveston Ranch, Temecula	2005	162	17	48	145	17	$334,000—386,000
San Bernardino County
The Peaks at Citrus Heights, Fontana	2005	150	113	11	37	41	$605,000—665,000
Adelina, Fontana(6)	2007	109	0	0	109	0	$340,000—400,000
Rosabella, Fontana	2007	114	0	0	114	0	$405,000—440,000
Amador, Rancho Cucamonga	2007	99	0	0	99	0	$375,000—447,000
Vintner’s Grove, Rancho Cucamonga
SFD	2008	78	0	0	78	0	$535,000—625,000
Triplex	2008	78	0	0	78	0	$405,000—475,000
Chapman Heights, Yucaipa:
Braeburn	2005	113	44	13	37	25	$569,000—609,000
Crofton	2005	140	51	26	89	31	$443,000—473,000
Westland	2005	79	55	6	24	26	$498,000—521,000
Vista Bella	2006	108	0	0	108	0	$300,000—325,000
Redcort	2006	90	0	0	90	0	$330,000—356,000
INLAND EMPIRE REGION COMBINED TOTAL		2,542	655	169	1,668	285
ARIZONA REGION
Wholly-Owned:
Maricopa County
Gateway Crossing, Gilbert
Oakcrest	2003	236	236	0	0	1	$252,000—320,000
Woodridge	2003	165	165	0	0	1	$292,000—355,000
Sonoran Foothills, Phoenix
Desert Crown	2004	124	118	2	6	33	$441,000—544,000
Desert Sierra	2004	212	176	32	36	55	$249,000—307,000
Copper Canyon Ranch, Surprise
Rancho Vistas	2004	212	209	2	3	16	$490,000—600,000
Sunset Point	2004	282	184	58	98	53	$287,000—383,000
El Sendero Hills	2004	188	146	23	42	44	$377,000—470,000
Talavera, Phoenix	2006	134	3	81	131	3	$256,000—332,000
Coldwater Ranch, Maricopa County	2008	368	0	0	368	0	$199,000—267,000

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Project (County) Product	Year of First Delivery	Estimated Number of Homes at Completion(1)	Units Closed as of June 30, 2006	Backlog at June 30, 2006(2)(3)	Lots Owned as of June 30, 2006	Homes Closed for the Period Ended June 30, 2006	Sales Price Range(5)
Collin’s Creek, Phoenix	2007	126	0	0	126	0	$237,000—245,000
Lehi Crossing, Mesa	2008	805	0	0	113	0
Rancho Mercado, Phoenix	2009	1,865	0	0	1,865	0	$216,000—295,000
Lyon’s Gate, Gilbert:
Pride	2006	548	14	122	534	14	$232,000—256,000
Savanna	2006	174	8	61	166	8	$249,000—344,000
Sahara	2006	169	4	65	165	4	$195,000—340,000
Future Products	2007	680	0	0	680	0
Total Wholly-Owned		6,288	1,263	446	4,333	232
Joint Ventures:
Maricopa County
Hastings Property, Queen Creek	2008	822	0	0	822	0	$199,000—290,000
Church Farm North, Queen Creek	2008	1,744	0	0	916	0	$259,000—402,000
Total Joint Ventures		2,566	0	0	1,738	0
ARIZONA REGION TOTAL		8,854	1,263	446	6,071	232
NEVADA REGION
Wholly-Owned:
Clark County
Summerlin, Las Vegas
Granada	2004	144	127	7	17	22	$446,000—511,000
The Lyon Collection	2005	79	57	10	22	24	$624,000—659,000
Kingwood	2006	100	6	14	94	6	$435,000—521,000
North Las Vegas
The Classics	2003	227	220	3	7	0	$290,000—315,000
The Cottages	2004	360	236	20	124	27	$232,000—262,000
La Tierra	2006	67	8	14	59	8	$315,000—345,000
Tierra Este	2007	126	0	0	126	0	$324,000—355,000
Carson Ranch, Las Vegas
West Series I	2005	71	67	0	4	25	$395,000—430,000
West Series II	2005	59	17	6	42	16	$456,000—511,000
East Series I	2007	103	0	17	103	0	$405,000—440,000
East Series II	2006	58	0	0	58	0	$470,000—518,000
West Park, Las Vegas
Villas	2006	191	0	0	191	0	$333,000—375,000
Courtyards	2006	113	0	6	113	0	$395,000—445,000
Mesa Canyon, Las Vegas	2008	49	0	0	49	0	$429,000—467,000
The Lyon Estates, Las Vegas	2008	138	0	0	138	0	$635,000—700,000
Mountain Falls, Pahrump:
Cascata	2005	147	93	28	54	39	$216,000—238,000
Tramonto	2005	212	108	15	104	42	$266,000—301,000
Bella Sera	2005	129	54	8	75	26	$322,000—362,000
NEVADA REGION TOTAL		2,373	993	148	1,380	235
GRAND TOTALS:
Wholly-Owned		15,582	4,333	1,069	10,178	1,145
Joint Ventures		4,061	523	70	2,710	204
		19,643	4,856	1,139	12,888	1,349

(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 June 30, 2006, 1,083 represent homes completed or under construction and 56 represent homes not yet under construction.

(4) Lots owned as of June 30, 2006 include lots in backlog at June 30, 2006.

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

(6) All or a portion of the lots in this project are not owned as of June 30, 2006. The Company consolidated the purchase price of the lots in accordance with Interpretation No. 46, and considers the lots owned at June 30, 2006.

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Net Operating Loss Carryforwards

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

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

Inflation

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

Related Party Transactions

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

Tender Offer and Merger

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

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

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

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

On May 18, 2006, General Lyon announced the completion of his tender offer to purchase all of the outstanding shares of the common stock of the Company not already owned by him for $109.00 net per share in cash. Computershare Trust Company of New York, the depositary for the offer, had advised General Lyon that an aggregate of 1,711,125 shares were tendered in the offer, including 310,652 shares that remained subject to guaranteed delivery procedures. The shares tendered in the offer, together with the shares already owned by General Lyon, The William Harwell Lyon 1987 Trust and The William Harwell Lyon Separate Property Trust, represented over 90% of the outstanding shares of the Company, which would be sufficient to enable General Lyon to effect a short-form merger with the Company under Delaware law.

On July 26, 2006, General Lyon announced that on July 25, 2006, WLH Acquisition Corp., a corporate owned by General Lyon, The William Harwell Lyon 1987 Trust and The William Harwell Lyon Separate Property Trust, was merged with and into the Company, with the Company continuing as the surviving corporation of the merger. At the effective time of the merger, each outstanding share of the Company’s common stock (except for shares owned by WLH Acquisition Corp. and by stockholders who properly exercise their appraisal rights in accordance with Delaware law) was cancelled and converted into the right to receive $109.00 per share in cash, without interest, which is the same consideration that was paid for shares of the Company in the tender offer by General Lyon. Shareholders of the Company as of the effective time of the merger were sent additional information by mail on the process for receiving the merger consideration or exercising their appraisal rights.

Prior to the completion of the merger, General Lyon and the two trusts contributed all the shares of the Company owned by them, which constituted more than 90% of the outstanding shares, to WLH Acquisition Corp. WLH Acquisition Corp. was then merged with and into the Company pursuant to the short-form merger provisions of Delaware law. Prior to the merger, the Company had cancelled and retired 1,275,000 shares of its common stock which had been repurchased and were being held in the treasury. After the merger, the Company’s capital structure consists of common stock, par value $.01 per share, 3,000 shares authorized, and 1,000 shares outstanding. The Company will continue as a privately held company, wholly owned by General Lyon and the two trusts.

The Company has incurred approximately $3.1 million in financial advisory expenses related to the tender offer, of which $1,500,000 was incurred during the three months ended March 31, 2006, and is reflected as financial advisory expenses in the accompanying consolidated statement of income.

Board of Directors

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

Critical Accounting Polices

The Company’s financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and costs and expenses during the reporting period. On an

54

on-going basis, management evaluates its estimates and judgments, including those which impact its most critical accounting policies. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. As disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, the Company’s most critical accounting policies are real estate inventories and cost of sales; impairment of real estate inventories; sales and profit recognition; and variable interest entities. Since December 31, 2005, there have been no changes in the Company’s most critical accounting policies and no material changes in the assumptions and estimates used by management.

Recently Issued Accounting Standards

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

Effective January 1, 2006, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”) using the modified prospective transition method. In accordance with the modified prospective transition method, results for prior periods have not been restated. Prior to January 1, 2006, the Company accounted for all stock-based awards granted, modified or settled under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and related Interpretations.

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

In July 2006, the Financial Accounting Standards Board (the “FASB”) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). This interpretation, among other things, creates a two step approach for evaluating uncertain tax positions. Recognition (step one) occurs when an enterprise concludes that a tax position, based solely on its technical merits, is more-likely-than-not to be sustained upon examination. Measurement (step two) determines the amount of benefit that more-likely-than-not will be realized upon settlement. Derecognition of a tax position that was previously recognized would occur when a company subsequently determines that a tax position no longer meets the more-likely-than-not threshold of being sustained. FIN 48 specifically prohibits the use of a valuation allowance as a substitute for derecognition of tax positions, and it has expanded disclosure requirements. FIN 48 is effective for fiscal years beginning after December 15, 2006, in which the impact of adoption should be accounted for as a cumulative-effect adjustment to the beginning balance of retained earnings. The Company is evaluating FIN 48 and has not yet determined the impact the adoption will have on the consolidated financial statements.

Forward-Looking Statements

Investors are cautioned that certain statements contained in this Quarterly Report on Form 10-Q, as well as some statements by the Company in periodic press releases and some oral statements by Company officials to securities analysts and stockholders during presentations about the Company are “forward-looking statements”

55

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

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

Item 3.    Quantitative and Qualitative Disclosures About Market Risk

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

Item 4.    Controls and Procedures

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

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

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WILLIAM LYON HOMES

PART II.    OTHER INFORMATION

Item 1.    Legal Proceedings

Captive Title Reinsurance Investigation

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

Litigation Arising from General Lyon’s Tender Offer

As described above in Part I, Item 2 under the caption “Tender Offer and Merger”, on March 17, 2006, the Company’s principal stockholder commenced a tender offer (the “Tender Offer”) to purchase all outstanding shares of the Company’s common stock not already owned by him. Initially, the price offered in the Tender was $93 per share, but it has since been increased to $109 per share.

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

On March 23, 2006, the Company announced that its Board had appointed a special committee of independent directors who are not members of the Company’s management or employed by the Company (the “Special Committee”) to consider the Tender Offer. The members of the Special Committee are Harold H. Greene, Lawrence M. Higby, and Dr. Arthur Laffer. The Company also announced that the Special Committee had retained Morgan Stanley & Co. as its financial advisor and Gibson, Dunn & Crutcher LLP as its legal counsel.

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

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

On April 23, 2006, Delaware Chancery Court conditionally certified a class in the Consolidated Delaware Action. The parties to the Consolidated Delaware Action agreed to a Stipulation of Settlement, and the Delaware Chancery Court approved the settlement on August 9, 2006 to evaluate the settlement.

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

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

Item 1A.    Risk Factors

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

Items 2, 3, 4 and 5.

Not applicable.

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Item 6.    Exhibits

Exhibit No.	Description
10.1	Mortgage Warehouse Loan and Security Agreement dated June 29, 2006 by and between Duxford Financial, Inc. dba William Lyon Financial Services and/or Bayport Mortgage, L.P. and/or California Pacific Mortgage, L.P., and First Tennessee Bank (Incorporated herein by reference to Exhibit 10.1 filed with the registrant’s Current Report on Form 8-K on July 6, 2006).
31.1	Certification of Chief Executive Officer Pursuant to Section 302 of The Sarbanes-Oxley Act of 2002
31.2	Certification of Chief Financial Officer Pursuant to Section 302 of The Sarbanes-Oxley Act of 2002
32.1	Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002
32.2	Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002

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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:  August 9, 2006	By:	/s/    MICHAEL D. GRUBBS
		MICHAEL D. GRUBBS Senior Vice President, Chief Financial Officer and Treasurer (Principal Financial Officer)
Date:  August 9, 2006	By:	/s/    W. DOUGLASS HARRIS
		W. DOUGLASS HARRIS Vice President, Corporate Controller (Principal Accounting Officer)

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EXHIBIT INDEX

Exhibit No.	Description
10.1	Mortgage Warehouse Loan and Security Agreement dated June 29, 2006 by and between Duxford Financial, Inc. dba William Lyon Financial Services and/or Bayport Mortgage, L.P. and/or California Pacific Mortgage, L.P., and First Tennessee Bank (Incorporated herein by reference to Exhibit 10.1 filed with the registrant’s Current Report on Form 8-K on July 6, 2006).
31.1	Certification of Chief Executive Officer Pursuant to Section 302 of The Sarbanes-Oxley Act of 2002
31.2	Certification of Chief Financial Officer Pursuant to Section 302 of The Sarbanes-Oxley Act of 2002
32.1	Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002
32.2	Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002

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