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, 2008

OR

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

    SECURITIES EXCHANGE ACT OF 1934

Commission file number 001-31625

WILLIAM LYON HOMES

(Exact name of registrant as specified in its charter)

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

(949) 833-3600

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year,

if changed since last report)

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

YES  ¨                    NO  x

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

Large accelerated filer  ¨                    Accelerated filer  ¨

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

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

YES  ¨                    NO  x

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

Class of Common Stock	Outstanding at August 1, 2008
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, 2008 (unaudited) and December 31, 2007	4
Consolidated Statements of Operations — Three and Six Months Ended June 30, 2008  and 2007 (unaudited)	5
Consolidated Statement of Stockholders’ Equity — Six Months Ended June 30, 2008 (unaudited)	6
Consolidated Statements of Cash Flows — Six Months Ended June 30, 2008 and 2007 (unaudited)	7
Notes to Consolidated Financial Statements	8
Item 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations	38
Item 3.    Quantitative and Qualitative Disclosures About Market Risk	59
Item 4.    Controls and Procedures	59
Item 4T. Not Applicable	59
PART II.    OTHER INFORMATION	60
Item 1.    Legal Proceedings	60
Item 1A. Risk Factors	61
Item 2.    Not Applicable	61
Item 3.    Not Applicable	61
Item 4.    Not Applicable	61
Item 5.    Not Applicable	61
Item 6.    Exhibits	61
SIGNATURES	62
EXHIBIT INDEX	63

2

NOTE ABOUT FORWARD-LOOKING STATEMENTS

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

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

3

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, 2008		December 31, 2007
	(unaudited)
Cash and cash equivalents	$	91,910	$	73,197
Receivables — Note 7		27,731		45,267
Real estate inventories — Notes 2 and 3
Owned		916,228		1,061,660
Not owned		124,744		144,265
Investments in and advances to unconsolidated joint ventures — Note 4		2,878		4,671
Property and equipment, less accumulated depreciation of $13,229 and $12,093 at June 30, 2008 and December 31, 2007, respectively		14,980		16,092
Deferred loan costs		8,219		9,645
Goodwill		5,896		5,896
Deferred taxes — Note 7		41,602		—
Other assets		10,614		14,635
	$	1,244,802	$	1,375,328
LIABILITIES AND STOCKHOLDERS’ EQUITY
Accounts payable	$	25,292	$	40,890
Accrued expenses		53,833		67,786
Liabilities from inventories not owned		93,874		113,395
Notes payable — Note 5		231,064		266,932
7 5/8% Senior Notes due December 15, 2012 — Note 5		150,000		150,000
10 3/4% Senior Notes due April 1, 2013 — Note 5		247,735		247,553
7 1/2% Senior Notes due February 15, 2014 — Note 5		150,000		150,000
		951,798		1,036,556
Minority interest in consolidated entities — Notes 2 and 4		49,977		56,009
Stockholders’ equity — Note 8
Common stock, par value $.01 per share; 3,000 shares authorized; 1,000 shares outstanding at June 30, 2008 and December 31, 2007, respectively		—		—
Additional paid-in capital		48,867		48,867
Retained earnings		194,160		233,896
		243,027		282,763
	$	1,244,802	$	1,375,328

See accompanying notes.

4

WILLIAM LYON HOMES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands)

(unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
	2008			2007			2008			2007
Operating revenue
Home sales	$	133,241		$	256,920		$	245,957		$	449,600
Lots, land and other sales		6,848			14,168			31,569			27,529
		140,089			271,088			277,526			477,129
Operating costs
Cost of sales — homes		(127,302	)		(219,869	)		(235,086	)		(377,877	)
Cost of sales — lots, land and other		(7,391	)		(12,974	)		(32,276	)		(24,767	)
Impairment loss on real estate assets —  Note 3		(20,918	)		(84,111	)		(46,118	)		(87,665	)
Sales and marketing		(10,999	)		(17,232	)		(22,103	)		(30,705	)
General and administrative		(6,515	)		(9,182	)		(13,499	)		(20,696	)
Other		(332	)		—			(1,774	)		(111	)
		(173,457	)		(343,368	)		(350,856	)		(541,821	)
Equity in (loss) income of unconsolidated joint ventures — Note 4		(714	)		28			(805	)		(614	)
Minority equity in loss (income) of consolidated entities — Note 2		790			(6,935	)		1,715			(9,218	)
Operating loss		(33,292	)		(79,187	)		(72,420	)		(74,524	)
Interest expense, net of amounts capitalized		(6,088	)		—			(9,254	)		—
Other income, net		450			1,401			346			2,542
Loss before benefit (provision) for income taxes		(38,930	)		(77,786	)		(81,328	)		(71,982	)
Benefit (provision) for income taxes — Note 7
Provision for income taxes		—			914			(10	)		413
Reduction of deferred tax assets as a result of election to be taxed as an “S” corporation for income tax purposes effective on January 1, 2007		—			—			—			(31,887	)
Recordation of deferred tax assets as a result of revocation of election to be taxed as an “S” corporation for income tax purposes effective January 1, 2008		—			—			41,602			—
		—			914			41,592			(31,474	)
Net loss	$	(38,930	)	$	(76,872	)	$	(39,736	)	$	(103,456	)

See accompanying notes.

5

WILLIAM LYON HOMES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

Six Months Ended June 30, 2008

(in thousands)

(unaudited)

	Common Stock			Additional Paid-In Capital		Retained Earnings			Total
	Shares	Amount
Balance — December 31, 2007	1	$	—	$	48,867	$	233,896		$	282,763
Net loss	—		—		—		(39,736	)		(39,736	)
Balance — June 30, 2008	1	$	—	$	48,867	$	194,160		$	243,027

See accompanying notes.

6

WILLIAM LYON HOMES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Six Months Ended June 30,
	2008			2007
Operating activities
Net loss	$	(39,736	)	$	(103,456	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization		1,136			1,236
Impairment loss on real estate assets		46,118			87,665
Equity in loss of unconsolidated joint ventures		805			614
Distribution of income from unconsolidated joint ventures		816			—
Minority equity in (loss) income of consolidated entities		(1,715	)		9,218
(Benefit) provision for income taxes		(41,592	)		31,474
Net changes in operating assets and liabilities:
Receivables		17,536			80,591
Real estate inventories — owned		99,496			(80,381	)
Deferred loan costs		1,426			907
Other assets		4,021			(6,865	)
Accounts payable		(15,598	)		2,571
Accrued expenses		(13,963	)		(51,523	)
Net cash provided by (used in) operating activities		58,750			(27,949	)
Investing activities
Investments in and advances to unconsolidated joint ventures		(40	)		(4,636	)
Distributions of capital from unconsolidated joint ventures		212			—
Purchases of property and equipment		(24	)		(615	)
Net cash provided by (used in) investing activities		148			(5,251	)
Financing activities
Proceeds from borrowing on notes payable		325,787			888,899
Principal payments on notes payable		(361,655	)		(855,949	)
Minority interest distributions, net		(4,317	)		(22,573	)
Net cash (used in) provided by financing activities		(40,185	)		10,377
Net increase (decrease) in cash and cash equivalents		18,713			(22,823	)
Cash and cash equivalents — beginning of period		73,197			38,732
Cash and cash equivalents — end of period	$	91,910		$	15,909
Supplemental disclosures of cash flow information
Income tax benefit credited to additional paid-in capital and retained earnings	$	—		$	6,776
Net changes in real estate inventories — not owned and liabilities from inventories not owned	$	19,521		$	29,411
Net changes in real estate inventories —  not owned and minority interests	$	—		$	19,937

See accompanying notes.

7

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, 2007.

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, 2008 are not necessarily indicative of the results that may be expected for the year ending December 31, 2008.

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, 2008 and December 31, 2007 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 period 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) income 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, 2007.

8

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,
	2008			2007
Warranty liability, beginning of period	$	30,048		$	23,364
Warranty provision during period		2,337			4,533
Warranty payments during period		(4,795	)		(6,543	)
Warranty charges related to pre-existing warranties during period		317			1,163
Warranty liability, end of period	$	27,907		$	22,517

In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, Fair Value Measurements, (“FAS 157”). FAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. FAS 157 applies under other accounting pronouncements that require or permit fair value measurement and requires prospective application for fiscal years beginning after November 15, 2007. In February 2008, the FASB issued FASB Staff Position No. FAS 157-2, “Effective Date of FASB Statement No. 157” (the “FSP”). The FSP amends FAS 157 to delay the effective date of FAS 157 for non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis. For items within its scope, the FSP defers the effective date of FAS 157 to fiscal years beginning after November 15, 2008. The adoption of FAS 157 by the Company effective as of January 1, 2008 did not have a material impact on the Company’s consolidated financial position or results of operations.

In February 2007, the FASB issued SFAS NO. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“FAS 159”). FAS 159 permits all entities to choose to measure eligible items at fair value at specified election dates. FAS 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. On January 1, 2008, the Company did not elect to apply the fair value option to any specific financial assets or liabilities.

In December 2007, the FASB issued SFAS No. 141 (Revised), Business Combinations (“FAS 141R”). FAS 141R establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed (including intangibles), and any non-controlling interest in the acquired entity. FAS 141R also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. FAS 141R is effective for fiscal years beginning after December 15, 2008. The adoption of FAS No. 141R on January 1, 2009 will require the Company to expense all transaction costs for future business combinations, which may be significant to the Company. The Company is currently evaluating the effect FAS 141R will have on its consolidated financial statements.

In December 2007, the FASB issued SFAS No. 160, Non-controlling Interests in Consolidated Financial Statements-an amendment of ARB No. 51 (“FAS 160”). FAS 160 establishes accounting and reporting standards

9

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

for a parent company’s non-controlling interest in a subsidiary and for the de-consolidation of a subsidiary. FAS 160 is effective for fiscal years beginning after December 15, 2008. The adoption of FAS No. 160 on January 1, 2009 shall be applied prospectively, except for the presentation and disclosure requirements, which shall be applied retrospectively for all periods presented, including the non-controlling interest shall be reclassified to equity. The adoption of FAS No. 160 will require the Company to record gains or losses upon changes in control which could have a significant impact on the consolidated financial statements.

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment of SFAS No. 133, (“FAS 161”). FAS 161 applies to all derivative instruments and related hedged items accounted for under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (“FAS 133”). FAS 161 requires entities to provide greater transparency about (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedged items are accounted for under FAS 133 and its related interpretations and (iii) how derivative instruments and related hedged items affect an entity’s financial position, results of operations, and cash flows. FAS 161 is effective for financial statements issued for fiscal years beginning after November 15, 2008. The Company does not anticipate the adoption of FAS 161 to have a material impact on its financial position, results of operations or cash flows.

Note 2 — Consolidation of Variable Interest Entities

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

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

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

Supplemental consolidating financial information of the Company, specifically including information for the joint ventures and land banking arrangements consolidated under Interpretation No. 46, is presented below to allow investors to determine the nature of assets held and the operations of the consolidated entities. Investments in consolidated entities in the financial statements of wholly-owned entities presented below use the equity

10

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

method of accounting. Consolidated real estate inventories-owned include land deposits under option agreements or land banking arrangements of $57,372,000 and $57,321,000 at June 30, 2008 and December 31, 2007, 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.

Summary information with respect to the Company’s consolidated and unconsolidated land banking arrangements is as follows as of June 30, 2008 (dollars in thousands):

Total number of land banking projects		4
Total number of lots		1,054
Total purchase price	$	243,310
Balance of lots still under option and not purchased:
Number of lots		626
Purchase price	$	124,744
Forfeited deposits (cash and letters of credit) if lots are not purchased	$	42,003

11

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONDENSED CONSOLIDATING BALANCE SHEET BY FORM OF OWNERSHIP

(in thousands)

	June 30, 2008
	Wholly- Owned		Variable Interest Entities Under Interpretation No. 46		Eliminating Entries			Consolidated Total
ASSETS
Cash and cash equivalents	$	85,665	$	6,245	$	—		$	91,910
Receivables		27,731		—		—			27,731
Real estate inventories
Owned		751,486		164,742		—			916,228
Not owned		93,874		30,870		—			124,744
Investments in and advances to unconsolidated joint ventures		2,878		—		—			2,878
Investments in consolidated entities		64,704		—		(64,704	)		—
Other assets		81,311		—		—			81,311
Intercompany receivables		—		2,475		(2,475	)		—
	$	1,107,649	$	204,332	$	(67,179	)	$	1,244,802
LIABILITIES AND STOCKHOLDERS’ EQUITY
Accounts payable and accrued expenses	$	70,697	$	8,428	$	—		$	79,125
Liabilities from inventories not owned		93,874		—		—			93,874
Notes payable		150,172		80,892					231,064
7 5/8% Senior Notes due December 15, 2012		150,000		—		—			150,000
10 3/4% Senior Notes due April 1, 2013		247,735		—		—			247,735
7 1/2% Senior Notes due February 15, 2014		150,000		—		—			150,000
Intercompany payables		2,144		331		(2,475	)		—
Total liabilities		864,622		89,651		(2,475	)		951,798
Minority interest in consolidated entities		—		—		49,977			49,977
Owners’ capital
William Lyon Homes		—		64,704		(64,704	)		—
Others		—		49,977		(49,977	)		—
Stockholders’ equity		243,027		—		—			243,027
	$	1,107,649	$	204,332	$	(67,179	)	$	1,244,802

12

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONDENSED CONSOLIDATING BALANCE SHEET BY FORM OF OWNERSHIP

(in thousands)

	December 31, 2007
	Wholly-Owned		Variable Interest Entities Under Interpretation No. 46		Eliminating Entries			Consolidated Total
ASSETS
Cash and cash equivalents	$	64,357	$	8,840	$	—		$	73,197
Receivables		45,262		5		—			45,267
Real estate inventories
Owned		906,254		155,406		—			1,061,660
Not owned		113,395		30,870		—			144,265
Investments in and advances to unconsolidated joint ventures		4,671		—		—			4,671
Investments in consolidated entities		52,211		—		(52,211	)		—
Other assets		46,268		—		—			46,268
Intercompany receivables		1,853		—		(1,853	)		—
	$	1,234,271	$	195,121	$	(54,064	)	$	1,375,328
LIABILITIES AND STOCKHOLDERS’ EQUITY
Accounts payable and accrued expenses	$	100,039	$	8,637	$	—		$	108,676
Liabilities from inventories not owned		113,395		—		—			113,395
Notes payable		190,521		76,411		—			266,932
7 5/8% Senior Notes due December 15, 2012		150,000		—		—			150,000
10 3/4% Senior Notes due April 1, 2013		247,553		—		—			247,553
7 1/2% Senior Notes due February 15, 2014		150,000		—		—			150,000
Intercompany payables		—		1,853		(1,853	)		—
Total liabilities		951,508		86,901		(1,853	)		1,036,556
Minority interest in consolidated entities		—		—		56,009			56,009
Owners’ capital
William Lyon Homes		—		52,211		(52,211	)		—
Others		—		56,009		(56,009	)		—
Stockholders’ equity		282,763		—		—			282,763
	$	1,234,271	$	195,121	$	(54,064	)	$	1,375,328

13

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS BY FORM OF OWNERSHIP

(in thousands)

	Three Months Ended June 30, 2008
	Wholly- Owned			Variable Interest Entities Under Interpretation No. 46			Elimination Entries			Consolidated Total
Operating revenue
Sales	$	135,819		$	4,270		$	—		$	140,089
Management fees		186			—			(186	)		—
		136,005			4,270			(186	)		140,089
Operating costs
Cost of sales		(130,240	)		(4,639	)		186			(134,693	)
Loss on impairment of real estate assets		(20,918	)		—			—			(20,918	)
Sales and marketing		(10,411	)		(588	)		—			(10,999	)
General and administrative		(6,513	)		(2	)		—			(6,515	)
Other		(332	)		—			—			(332	)
		(168,414	)		(5,229	)		186			(173,457	)
Equity in loss of unconsolidated joint ventures		(714	)		—			—			(714	)
Equity in loss of consolidated entities		(154	)		—			154			—
Minority equity in loss of consolidated entities		—			—			790			790
Operating loss		(33,277	)		(959	)		944			(33,292	)
Interest expense, net of amounts capitalized		(6,088	)		—			—			(6,088	)
Other income, net		435			15			—			450
Net loss	$	(38,930	)	$	(944	)	$	944		$	(38,930	)

14

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS BY FORM OF OWNERSHIP

(in thousands)

	Three Months Ended June 30, 2007
	Wholly-Owned			Variable Interest Entities Under Interpretation No. 46			Eliminating Entries			Consolidated Total
Operating revenue
Sales	$	226,062		$	62,368		$	(17,342	)	$	271,088
Management fees		1,128			—			(1,128	)		—
		227,190			62,368			(18,470	)		271,088
Operating costs
Cost of sales		(200,035	)		(51,278	)		18,470			(232,843	)
Impairment loss on real estate assets		(84,111	)		—			—			(84,111	)
Sales and marketing		(14,162	)		(3,070	)		—			(17,232	)
General and administrative		(9,176	)		(6	)		—			(9,182	)
		(307,484	)		(54,354	)		18,470			(343,368	)
Equity in income of unconsolidated joint ventures		28			—			—			28
Equity in income of consolidated entities		1,198			—			(1,198	)		—
Minority equity in income of consolidated entities		—			—			(6,935	)		(6,935	)
Operating (loss) income		(79,068	)		8,014			(8,133	)		(79,187	)
Other income, net		1,282			119			—			1,401
(Loss) income before benefit for income taxes		(77,786	)		8,133			(8,133	)		(77,786	)
Benefit for income taxes		914			—			—			914
Net (loss) income	$	(76,872	)	$	8,133		$	(8,133	)	$	(76,872	)

15

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS BY FORM OF OWNERSHIP

(in thousands)

	Six Months Ended June 30, 2008
	Wholly- Owned			Variable Interest Entities Under Interpretation No. 46			Elimination Entries			Consolidated Total
Operating revenue
Sales	$	268,022		$	9,504		$	—		$	277,526
Management fees		400			—			(400	)		—
		268,422			9,504			(400	)		277,526
Operating costs
Cost of sales		(257,171	)		(10,591	)		400			(267,362	)
Loss on impairment of real estate assets		(46,118	)		—			—			(46,118	)
Sales and marketing		(20,921	)		(1,182	)		—			(22,103	)
General and administrative		(13,451	)		(48	)		—			(13,499	)
Other		(1,774	)		—			—			(1,774	)
		(339,435	)		(11,821	)		400			(350,856	)
Equity in loss of unconsolidated joint ventures		(805	)		—			—			(805	)
Equity in loss of consolidated entities		(549	)		—			549			—
Minority equity in loss of consolidated entities		—			—			1,715			1,715
Operating loss		(72,367	)		(2,317	)		2,264			(72,420	)
Interest expense, net of amounts capitalized		(9,254	)		—			—			(9,254	)
Other income, net		293			53			—			346
Loss before benefit from income taxes		(81,328	)		(2,264	)		2,264			(81,328	)
Benefit from income taxes		41,592			—			—			41,592
Net loss	$	(39,736	)	$	(2,264	)	$	2,264		$	(39,736	)

16

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS BY FORM OF OWNERSHIP

(in thousands)

	Six Months Ended June 30, 2007
	Wholly- Owned			Variable Interest Entities Under Interpretation No. 46			Elimination Entries			Consolidated Total
Operating revenue
Sales	$	413,444		$	81,027		$	(17,342	)	$	477,129
Management fees		1,836			—			(1,836	)		—
		415,280			81,027			(19,178	)		477,129
Operating costs
Cost of sales		(356,973	)		(64,849	)		19,178			(402,644	)
Loss on impairment of real estate assets		(87,665	)		—			—			(87,665	)
Sales and marketing		(26,488	)		(4,217	)		—			(30,705	)
General and administrative		(20,683	)		(13	)		—			(20,696	)
Other		(111	)		—			—			(111	)
		(491,920	)		(69,079	)		19,178			(541,821	)
Equity in loss of unconsolidated joint ventures		(614	)		—			—			(614	)
Equity in income of consolidated entities		2,961			—			(2,961	)		—
Minority equity in income of consolidated entities		—			—			(9,218	)		(9,218	)
Operating (loss) income		(74,293	)		11,948			(12,179	)		(74,524	)
Other income, net		2,311			231			—			2,542
(Loss) income before provision for income taxes		(71,982	)		12,179			(12,179	)		(71,982	)
Provision for income taxes		(31,474	)		—			—			(31,474	)
Net (loss) income	$	(103,456	)	$	12,179		$	(12,179	)	$	(103,456	)

17

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

Note 3 — Real Estate Inventories

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

	June 30, 2008		December 31, 2007
Inventories owned: (1)
Land deposits	$	57,372	$	57,321
Land and land under development		579,140		609,023
Homes completed and under construction		171,552		258,161
Model homes		108,164		137,155
Total	$	916,228	$	1,061,660
Inventories not owned: (2)
Variable interest entities — land banking arrangement	$	30,870	$	30,870
Other land options contracts		93,874		113,395
Total inventories not owned	$	124,744	$	144,265

(1) In 2008, the Company has temporarily suspended all development, sales and marketing activities at thirteen of its projects which are in the early stages of development. Management of the Company has concluded that this strategy is necessary under the prevailing market conditions and would allow the Company to market the properties at some future time when market conditions may have improved. The Company has incurred costs related to the thirteen projects of $243,824,000 as of June 30, 2008, of which $131,258,000 is included in Land and land under development, $68,246,000 is included in Homes completed and under construction and $44,320,000 is included in Model homes.

(2) Includes the consolidation of certain lot option arrangements and land banking arrangements determined to be VIEs under Interpretation No. 46 in which the company is considered the primary beneficiary (See Note 2 above) and the consolidation of a certain land banking arrangement recorded as a product financing arrangement. Amounts are net of deposits.

The Company accounts for its real estate inventories under Financial Accounting Standards Board Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“Statement No. 144”). Statement No. 144 requires impairment losses to be recorded on real estate inventories when indicators of impairment are present and the undiscounted cash flows estimated to be generated by real estate inventories are less than the carrying amount of such assets. When an impairment loss is required for real estate inventories, the related assets are adjusted to their estimated fair value. Management determines the estimated fair value by present valuing the estimated future cash flows, including interest cost, at discount rates which are commensurate with the risk of the project under evaluation, generally ranging from 8% to 14%.

Fair value represents the amount at which an asset could be bought or sold in a current transaction between willing parties, that is, other than a forced or liquidation sale. The estimation process involved in determining if assets have been impaired and in the determination of fair value is inherently uncertain because it requires estimates of current market yields as well as future events and conditions. Such future events and conditions include economic and market conditions, as well as the availability of suitable financing to fund development and construction activities. The realization of the Company’s real estate projects is dependent upon future uncertain events and conditions and, accordingly, the actual timing and amounts realized by the Company may be materially different from those estimated.

18

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

The results of operations for the three and six months ended June 30, 2008, include non-cash charges of $20,918,000 and $46,118,000, respectively, to record impairment losses on real estate assets held by the Company at certain of its homebuilding projects. The impairments were primarily attributable to slower than anticipated home sales and lower than anticipated net revenue due to softening market conditions. As a result, the future undiscounted cash flows estimated to be generated were determined to be less than the carrying amount of the assets. Accordingly, the related real estate assets were written-down to their estimated fair value. The non-cash charges are reflected in impairment loss on real estate assets in the accompanying consolidated statements of operations.

Note 4 — 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, 2008 and December 31, 2007 is summarized as follows:

CONDENSED COMBINED BALANCE SHEETS

(in thousands)

	June 30, 2008		December 31, 2007
	(unaudited)
ASSETS
Cash and cash equivalents	$	1,646	$	1,912
Real estate inventories		12,412		9,910
Investment in unconsolidated joint venture		721		3,899
	$	14,779	$	15,721
LIABILITIES AND OWNERS’ CAPITAL
Accounts payable	$	485	$	294
Accrued expenses		28		—
Notes payable		7,389		4,991
		7,902		5,285
Owners’ capital
William Lyon Homes		2,878		4,671
Others		3,999		5,765
		6,877		10,436
	$	14,779	$	15,721

19

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONDENSED COMBINED STATEMENTS OF OPERATIONS

(in thousands)

	Three Months Ended June 30,						Six Months Ended June 30,
	2008			2007			2008			2007
Operating costs
General and administrative	$	(226	)	$	—		$	(420	)	$	—
Other		—			(325	)		—			(743	)
		(226	)		(325	)		(420	)		(743	)
Equity in income (loss) of unconsolidated joint ventures		(1,202	)		311			(1,190	)		(592	)
Operating loss		(1,428	)		(14	)		(1,610	)		(1,335	)
Other income, net		—			70			—			108
Net (loss) income	$	(1,428	)	$	56		$	(1,610	)	$	(1,227	)
Allocation to owners:
William Lyon Homes	$	(714	)	$	28		$	(805	)	$	(614	)
Others		(714	)		28			(805	)		(613	)
	$	(1,428	)	$	56		$	(1,610	)	$	(1,227	)

Income and loss allocations and cash distributions to the Company are made on a pro rata basis in accordance with the Company’s ownership interest in each respective joint venture. The Company’s ownership interest in these joint ventures is approximately 50%.

Note 5 — Senior Notes

As of June 30, 2008 and December 31, 2007, the Company had the following outstanding Senior Note obligations (collectively, the “Senior Notes”) (in thousands):

	June 30, 2008		December 31, 2007
	(unaudited)
7 5/8% Senior Notes due December 15, 2012	$	150,000	$	150,000
10 3/4% Senior Notes due April 1, 2013		247,735		247,553
7 1/2% Senior Notes due February 15, 2014		150,000		150,000
	$	547,735	$	547,553

20

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

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 California Lyon, in whole or in part, at a redemption price equal to 100% of the principal amount plus a premium declining ratably to par, plus accrued and unpaid interest, if any.

10 ³/4% Senior Notes

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 were not redeemable prior to April 1, 2008. Thereafter, the 10 ³/4% Senior Notes are redeemable at the option of California Lyon, in whole or in part, at a redemption price equal to 100% of the principal amount plus a premium declining ratably to par, plus accrued and unpaid interest, if any.

7 ¹/2% Senior Notes

On February 6, 2004, California Lyon 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

21

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

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. 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.

*    *    *    *    *

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.

22

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

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, 2008, the Company had approximately $150,172,000 of secured indebtedness (excluding approximately $80,892,000 of secured indebtedness of consolidated entities — see Note 2) and approximately $57,531,000 of additional secured indebtedness available to be borrowed under the Company’s credit facilities, as limited by the Company’s borrowing base formulas.

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

23

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONSOLIDATING BALANCE SHEET

June 30, 2008

(in thousands)

	Unconsolidated
	Delaware Lyon		California Lyon		Guarantor Subsidiaries		Non-Guarantor Subsidiaries		Eliminating Entries			Consolidated Company
ASSETS
Cash and cash equivalents	$	—	$	81,275	$	3,774	$	6,861	$	—		$	91,910
Receivables		—		12,980		14,751		—		—			27,731
Real estate inventories
Owned		—		751,486		—		164,742		—			916,228
Not Owned		—		124,744		—		—		—			124,744
Investments in and advances to unconsolidated joint ventures		—		2,878		—		—		—			2,878
Property and equipment, net		—		2,177		12,803		—		—			14,980
Deferred loan costs		—		8,219		—		—		—			8,219
Goodwill		—		5,896		—		—		—			5,896
Deferred taxes		—		41,602		—		—		—			41,602
Other assets		—		7,833		2,781		—		—			10,614
Investments in subsidiaries		243,027		65,170		8,697		—		(316,894	)		—
Intercompany receivables		—		—		195,451		2,475		(197,926	)		—
	$	243,027	$	1,104,260	$	238,257	$	174,078	$	(514,820	)	$	1,244,802
LIABILITIES AND STOCKHOLDERS’ EQUITY
Accounts payable	$	—	$	16,507	$	357	$	8,428	$	—		$	25,292
Accrued expenses		—		50,337		3,360		136		—			53,833
Liabilities from inventories not owned		—		93,874		—		—		—			93,874
Notes payable		—		137,137		13,035		80,892		—			231,064
7 5/8% Senior Notes		—		150,000		—		—		—			150,000
10 3/4% Senior Notes		—		247,735		—		—		—			247,735
7 1/2% Senior Notes		—		150,000		—		—		—			150,000
Intercompany payables		—		197,581		—		345		(197,926	)		—
Total liabilities		—		1,043,171		16,752		89,801		(197,926	)		951,798
Minority interest in consolidated entities		—		—		—		—		49,977			49,977
Stockholders’ equity		243,027		61,089		221,505		84,277		(366,871	)		243,027
	$	243,027	$	1,104,260	$	238,257	$	174,078	$	(514,820	)	$	1,244,802

24

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONSOLIDATING BALANCE SHEET

December 31, 2007

(in thousands)

	Unconsolidated
	Delaware Lyon		California Lyon		Guarantor Subsidiaries		Non-Guarantor Subsidiaries		Eliminating Entries			Consolidated Company
ASSETS
Cash and cash equivalents	$	—	$	55,412	$	6,931	$	10,854	$	—		$	73,197
Receivables		—		32,345		12,901		21		—			45,267
Real estate inventories
Owned		—		897,880		—		163,780		—			1,061,660
Not owned		—		144,265		—		—		—			144,265
Investments in and advances to unconsolidated joint ventures		—		4,671		—		—		—			4,671
Property and equipment, net		—		2,592		13,500		—		—			16,092
Deferred loan costs		—		9,645		—		—		—			9,645
Goodwill		—		5,896		—		—		—			5,896
Other assets		—		12,243		2,392		—		—			14,635
Investments in subsidiaries		282,763		67,430		8,693		—		(358,886	)		—
Intercompany receivables		—		—		192,714		4,075		(196,789	)		—
	$	282,763	$	1,232,379	$	237,131	$	178,730	$	(555,675	)	$	1,375,328
LIABILITIES AND STOCKHOLDERS’ EQUITY
Accounts payable	$	—	$	33,028	$	391	$	7,471	$	—		$	40,890
Accrued expenses		—		62,125		3,493		2,168		—			67,786
Liabilities from inventories not owned		—		113,395		—		—		—			113,395
Notes payable		—		179,067		11,454		76,411		—			266,932
7 5/8% Senior Notes		—		150,000		—		—		—			150,000
10 3/4% Senior Notes		—		247,553		—		—		—			247,553
7 1/2% Senior Notes		—		150,000		—		—		—			150,000
Intercompany payables		—		196,678		—		111		(196,789	)		—
Total liabilities		—		1,131,846		15,338		86,161		(196,789	)		1,036,556
Minority interest in consolidated entities		—		—		—		—		56,009			56,009
Stockholders’ equity		282,763		100,533		221,793		92,569		(414,895	)		282,763
	$	282,763	$	1,232,379	$	237,131	$	178,730	$	(555,675	)	$	1,375,328

25

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONSOLIDATING STATEMENT OF OPERATIONS

Three Months Ended June 30, 2008

(in thousands)

	Unconsolidated
	Delaware Lyon			California Lyon			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminating Entries			Consolidated Company
Operating revenue
Sales	$	—		$	118,987		$	16,832		$	4,270		$	—		$	140,089
Management fees		—			(186	)		—			—			186			—
		—			118,801			16,832			4,270			186			140,089
Operating costs
Cost of sales		—			(114,663	)		(15,205	)		(4,639	)		(186	)		(134,693	)
Loss on impairment of real estate assets		—			(20,918	)		—			—			—			(20,918	)
Sales and marketing		—			(9,258	)		(1,153	)		(588	)		—			(10,999	)
General and administrative		—			(6,408	)		(105	)		(2	)		—			(6,515	)
Other		—			(332	)		—			—			—			(332	)
		—			(151,579	)		(16,463	)		(5,229	)		(186	)		(173,457	)
Equity in loss of unconsolidated joint ventures		—			(714	)		—			—			—			(714	)
(Loss) income from subsidiaries		(38,930	)		(212	)		3			—			39,139			—
Minority equity in loss of consolidated entities		—			—			—			—			790			790
Operating (loss) income		(38,930	)		(33,704	)		372			(959	)		39,929			(33,292	)
Interest expense, net of amounts capitalized		—			(6,088	)		—			—			—			(6,088	)
Other income (loss), net		—			513			(76	)		13			—			450
Loss before benefit for income taxes		(38,930	)		(39,279	)		296			(946	)		39,929			(38,930	)
Benefit from income taxes		—			—			—			—			—			—
Net loss	$	(38,930	)	$	(39,279	)	$	296		$	(946	)	$	39,929		$	(38,930	)

26

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONSOLIDATING STATEMENT OF OPERATIONS

Three Months Ended June 30, 2007

(in thousands)

	Unconsolidated
	Delaware Lyon			California Lyon			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminating Entries			Consolidated Company
Operating revenue
Sales	$	—		$	199,472		$	26,590		$	62,368		$	(17,342	)	$	271,088
Management fees		—			1,128			—			—			(1,128	)		—
		—			200,600			26,590			62,368			(18,470	)		271,088
Operating costs
Cost of sales		—			(178,734	)		(21,301	)		(51,278	)		18,470			(232,843	)
Impairment loss on real estate assets		—			(84,111	)		—			—			—			(84,111	)
Sales and marketing		—			(12,593	)		(1,569	)		(3,070	)		—			(17,232	)
General and administrative		—			(9,057	)		(119	)		(6	)		—			(9,182	)
		—			(284,495	)		(22,989	)		(54,354	)		18,470			(343,368	)
Equity in income (loss) of unconsolidated joint ventures		—			190			(162	)		—			—			28
(Loss) income from subsidiaries		(76,872	)		4,626			—			—			72,246			—
Minority equity in income of consolidated entities		—			—			—			—			(6,935	)		(6,935	)
Operating (loss) income		(76,872	)		(79,079	)		3,439			8,014			65,311			(79,187	)
Other income, net		—			264			1,015			122			—			1,401
(Loss) income before provision for income taxes		(76,872	)		(78,815	)		4,454			8,136			65,311			(77,786	)
Provision for income taxes		—			914			—			—			—			914
Net (loss) income	$	(76,872	)	$	(77,901	)	$	4,454		$	8,136		$	65,311		$	(76,872	)

27

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONSOLIDATING STATEMENT OF OPERATIONS

Six Months Ended June 30, 2008

(in thousands)

	Unconsolidated
	Delaware Lyon			California Lyon			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminating Entries			Consolidated Company
Operating revenue
Sales	$	—		$	240,463		$	27,559		$	9,504		$			$	277,526
Management fees		—			400			—			—			(400	)		—
		—			240,863			27,559			9,504			(400	)		277,526
Operating costs
Cost of sales		—			(232,166	)		(25,005	)		(10,591	)		400			(267,362	)
Impairment loss on real estate assets		—			(46,118	)		—			—			—			(46,118	)
Sales and marketing		—			(19,014	)		(1,907	)		(1,182	)		—			(22,103	)
General and administrative		—			(13,234	)		(217	)		(48	)		—			(13,499	)
Other		—			(1,773	)		(1	)		—			—			(1,774	)
		—			(312,305	)		(27,130	)		(11,821	)		400			(350,856	)
Equity in loss of unconsolidated joint ventures		—			(805	)		—			—			—			(805	)
(Loss) income from subsidiaries		(39,736	)		(823	)		4			—			40,555			—
Minority equity in income of consolidated entities		—			—			—			—			1,715			1,715
Operating (loss) income		(39,736	)		(73,070	)		433			(2,317	)		42,270			(72,420	)
Interest expense, net of amounts capitalized		—			(9,254	)		—			—			—			(9,254	)
Other income, net		—			928			(632	)		50			—			346
(Loss) income before provision for income taxes		(39,736	)		(81,396	)		(199	)		(2,267	)		42,270			(81,328	)
Provision for income taxes		—			41,592			—			—			—			41,592
Net (loss) income	$	(39,736	)	$	(39,804	)	$	(199	)	$	(2,267	)	$	42,270		$	(39,736	)

28

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONSOLIDATING STATEMENT OF OPERATIONS

Six Months Ended June 30, 2007

(in thousands)

	Unconsolidated
	Delaware Lyon			California Lyon			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminating Entries			Consolidated Company
Operating revenue
Sales	$	—		$	346,306		$	67,138		$	81,027		$	(17,342	)	$	477,129
Management fees		—			1,836			—			—			(1,836	)
		—			348,142			67,138			81,027			(19,178	)		477,129
Operating costs
Cost of sales		—			(304,037	)		(52,936	)		(64,849	)		19,178			(402,644	)
Impairment loss on real estate assets		—			(87,665	)		—			—			—			(87,665	)
Sales and marketing		—			(22,806	)		(3,682	)		(4,217	)		—			(30,705	)
General and administrative		—			(20,478	)		(205	)		(13	)		—			(20,696	)
Other		—			—			(111	)		—			—			(111	)
		—			(434,986	)		(56,934	)		(69,079	)		19,178			(541,821	)
Equity in (loss) income of unconsolidated joint ventures		—			(242	)		(372	)		—			—			(614	)
(Loss) income from subsidiaries		(103,456	)		12,481			13			—			90,962			—
Minority equity in income of consolidated entities		—			—			—			—			(9,218	)		(9,218	)
Operating (loss) income		(103,456	)		(74,605	)		9,845			11,948			81,744			(74,524	)
Other income, net		—			663			1,638			241			—			2,542
Income (loss) before provision for income taxes		(103,456	)		(73,942	)		11,483			12,189			81,744			(71,982	)
Provision for income taxes		—			(31,474	)		—			—			—			(31,474	)
Net (loss) income	$	(103,456	)	$	(105,416	)	$	11,483		$	12,189		$	81,744		$	(103,456	)

29

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONSOLIDATING STATEMENT OF CASH FLOWS

Six Months Ended June 30, 2008

(in thousands)

	Unconsolidated
	Delaware Lyon			California Lyon			Guarantor Subsidiaries			Non-Guarantor     Subsidiaries			Eliminating Entries			Consolidated Company
Operating activities
Net loss	$	(39,736	)	$	(39,804	)	$	(199	)	$	(2,267	)	$	42,270		$	(39,736	)
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization		—			432			704			—			—			1,136
Impairment loss on real estate assets		—			46,118			—			—			—			46,118
Equity in loss of unconsolidated joint ventures		—			805			—			—			—			805
Distribution of income from unconsolidated joint ventures		—			816			—			—			—			816
Minority equity in loss of consolidated entities		—			—			—			—			(1,715	)		(1,715	)
Equity in earnings (loss) of subsidiaries		39,736			823			(4	)		—			(40,555	)		—
Benefit from income taxes		—			(41,592	)		—			—			—			(41,592	)
Net changes in operating assets and liabilities:
Receivables		—			19,365			(1,850	)		21			—			17,536
Intercompany receivables/payables		—			—			(2,737	)		1,834			903			—
Real estate inventories—owned		—			100,458			—			(962	)		—			99,496
Deferred loan costs		—			1,426			—			—			—			1,426
Other assets		—			4,410			(389	)		—			—			4,021
Accounts payable		—			(16,521	)		(34	)		957			—			(15,598	)
Accrued expenses		—			(11,798	)		(133	)		(2,032	)		—			(13,963	)
Net cash provided by (used in) operating activities		—			64,938			(4,642	)		(2,449	)		903			58,750
Investing activities
Net change in investment in and advances to unconsolidated joint ventures		—			(40	)		—			—			—			(40	)
Distributions of capital from unconsolidated joint ventures		—			212			—			—			—			212
Purchases of property and equipment		—			(17	)		(7	)		—			—			(24	)
Investments in subsidiaries		—			1,437			—			—			(1,437	)		—
Advances to affiliates		—			1,263			—			—			(1,263	)		—
Net cash provided by (used in) investing activities		—			2,855			(7	)		—			(2,700	)		148
Financing activities
Proceeds from borrowings on notes payable		—			171,501			149,805			4,481			—			325,787
Principal payments on notes payable		—			(213,431	)		(148,224	)		—			—			(361,655	)
Minority interest contributions, net		—			—			—			—			(4,317	)		(4,317	)
Advances to affiliates		—			—			(89	)		(6,025	)		6,114			—
Net cash provided by (used in) financing activities		—			(41,930	)		1,492			(1,544	)		1,797			(40,185	)
Net (decrease) increase in cash and cash equivalents		—			25,863			(3,157	)		(3,993	)		—			18,713
Cash and cash equivalents at beginning of period		—			55,412			6,931			10,854			—			73,197
Cash and cash equivalents at end of period	$	—		$	81,275		$	3,774		$	6,861		$	—		$	91,910

30

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

CONSOLIDATING STATEMENT OF CASH FLOWS

Six Months Ended June 30, 2007

(in thousands)

	Unconsolidated
	Delaware Lyon			California Lyon			Guarantor Subsidiaries			Non-Guarantor     Subsidiaries			Eliminating Entries			Consolidated Company
Operating activities:
Net (loss) income	$	(103,456	)	$	(105,416	)	$	11,483		$	12,189		$	81,744		$	(103,456	)
Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:
Depreciation and amortization		—			496			740			—			—			1,236
Equity in loss of unconsolidated joint ventures		—			242			372			—			—			614
Minority equity in income of consolidated entities		—			—			—			—			9,218			9,218
Equity in loss (earnings) of subsidiaries		103,456			(12,481	)		(13	)		—			(90,962	)		—
Impairment loss on real estate asset		—			87,665			—			—			—			87,665
Provision for income taxes		—			31,474			—			—			—			31,474
Net changes in operating assets and liabilities:
Receivables		—			44,431			35,641			519			—			80,591
Intercompany receivables/payables		—			—			(16,669	)		(2,151	)		18,820			—
Real estate inventories owned		—			(103,647	)		1,788			21,478			—			(80,381	)
Real estate inventories not owned		—			19,937			—			—			—			19,937
Deferred loan costs		—			907			—			—			—			907
Other assets		—			(6,822	)		(43	)		—			—			(6,865	)
Accounts payable		—			3,567			(359	)		(637	)		—			2,571
Accrued expenses		—			(47,565	)		(3,950	)		(8	)		—			(51,523	)
Net cash (used in) provided by operating activities		—			(87,212	)		28,990			31,390			18,820			(8,012	)
Investing activities:
Net change in investment in unconsolidated joint ventures		—			(4,264	)		(372	)		—			—			(4,636	)
Purchases of property and equipment		—			(113	)		(502	)		—			—			(615	)
Investments in subsidiaries		—			20,438			(1	)		—			(20,437	)		—
Advances (to) from affiliates		—			(10,075	)		—			—			10,075			—
Net cash provided by (used in) investing activities		—			5,986			(875	)		—			(10,362	)		(5,251	)
Financing activities:
Proceeds from borrowings on notes payable		—			489,186			405,320			(5,607	)		—			888,899
Principal payments on notes payable		—			(416,263	)		(439,686	)		—			—			(855,949	)
Minority interest distributions, net		—			—			—			(42,510	)		—			(42,510	)
Advances (to) from affiliates		—			—			(551	)		9,009			(8,458	)		—
Net cash provided by (used in) financing activities		—			72,923			(34,917	)		(39,108	)		(8,458	)		(9,560	)
Net decrease in cash and cash equivalents		—			(8,303	)		(6,802	)		(7,718	)		—			(22,823	)
Cash and cash equivalents at beginning of period		—			12,253			11,222			15,257			—			38,732
Cash and cash equivalents at end of period	$	—		$	3,950		$	4,420		$	7,539		$	—		$	15,909

31

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

Note 6 — 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 occurred 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. During the three months ended March 31, 2007, $8,305,000 was paid to the seller, and a total amount has been paid of $14,015,000 as of March 31, 2007. 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, 2008 and 2007, the Company incurred reimbursable on-site labor costs of $40,000 and $29,000, respectively, for providing customer service to real estate projects developed by entities controlled by William Lyon and William H. Lyon, of which $25,000 and $89,000 was due to the Company at June 30, 2008 and December 31, 2007, respectively. For the six months ended June 30, 2008 and 2007, the Company incurred reimbursable on-site labor costs of $95,000 and $79,000, respectively, for providing customer service to real estate projects developed by entities controlled by William Lyon and William H. Lyon.

For the three months ended June 30, 2008 and 2007, the Company incurred charges of $197,000 and $189,000, respectively related to rent on its corporate office, from a trust of which William H. Lyon is the sole beneficiary. For the six months ended June 30, 2008 and 2007, the Company incurred charges of $385,000 and $378,000, respectively, 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. The terms of the agreement provide that the Affiliate shall consult and render its advice and management services to the Company with respect to all functions necessary to the operation, maintenance and administration of the aircraft. The Company’s business plan for the aircraft includes (i) use by Company executives for traveling on Company business to the Company’s divisional offices and other destinations, (ii) charter service to outside third parties and (iii) charter service to William Lyon personally. Charter services for outside third parties 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

32

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

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 $422,000 and $259,000 for the three months ended June 30, 2008 and 2007, respectively, and $647,000 and $616,000, for the six months ended June 30, 2008 and 2007, respectively.

General William Lyon entered into a time sharing agreement (“the Agreement”) with the Company pertaining to his personal use of the aircraft. The agreement calls for General Lyon to reimburse the company for all costs incurred by the Company during his personal flights plus a surcharge on fuel consumption of two times the cost. Pursuant to the agreement, the Company had earned revenue of $117,000 and $139,000 for charter services provided to William Lyon personally, during the three months ended June 30, 2008 and 2007, respectively, and $561,000 and $337,000 was due to the Company at June 30, 2008 and December 31, 2007, respectively. For the six months ended June 30, 2008 and 2007, the Company had earned revenue of $223,000 and $198,000, 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 7 — Income Taxes

Effective January 1, 2007, the Company made an election in accordance with federal and state regulations to be taxed as an “S” corporation rather than a “C” corporation. Under this election, the Company’s taxable income flows through to and is reported on the personal tax returns of its shareholders. The shareholders are responsible for paying the appropriate taxes based on this election. The Company does not pay any federal taxes under this election and is only required to pay certain state taxes based on a rate of approximately 1.5% of taxable income. As a result of this election, the Company’s provision for income taxes for the six months ended June 30, 2007 included a reduction of deferred tax assets of $31,887,000 due to the elimination of any future tax benefit by the Company from such assets. In addition, unused recognized built in losses in the amount of $19,414,000 were no longer available to the Company.

Effective January 1, 2008, the Company and its shareholders made a revocation of the “S” corporation election. As a result of this revocation, the Company will be taxed as a “C” corporation. The shareholders will

33

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

not be able to elect “S” corporation status for at least five years. The revocation of the “S” corporation election will allow taxable losses generated in 2008 to be carried back to the 2006 “C” corporation year. As a result of the change in tax status, the Company recorded a deferred tax asset and related income tax benefit of $41,602,000 as of January 1, 2008. The recorded deferred tax asset reflects the anticipated tax refund for the carry back of the estimated 2008 tax loss to 2006 as a result of the reversal of temporary differences in 2008. The Company expects to receive the tax refund in early 2009. In addition, as of January 1, 2008, the Company has unused built-in losses of $19,414,000 which are available to offset future income and expire between 2010 and 2011. The utilization of these losses is limited to $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 2010 and 2011. The maximum cumulative unused built-in loss that may be carried forward through 2010 and 2011 is $11,526,000 and $7,888,000, respectively. The Company’s ability to utilize the foregoing tax benefits will depend upon the amount of its future taxable income and may be limited under certain circumstances.

Effective January 1, 2007, the company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be considered “more-likely-than-not” to be sustained upon examination by taxing authorities. The Company has taken positions in certain taxing jurisdictions for which it is more likely than not that previously unrecognized tax benefits will be recognized. In addition, the Company has elected to recognize interest and penalties related to uncertain tax positions in the income tax provision. In accordance with the provisions of FIN 48, effective January 1, 2007, the Company recorded an income tax refund receivable of $5,654,000 and recognized the associated tax benefit as an increase in additional paid-in capital. In connection therewith, the Company recorded interest receivable of $1,122,000 and recognized the associated tax benefit as an increase in retained earnings. At December 31, 2007 and June 30, 2008, the Company has no unrecognized tax benefits.

The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various state jurisdictions. The Company is subject to U.S. federal income tax examination for calendar tax years ending 2002 through 2007. The Company is subject to various state income tax examinations for calendar tax years ending 2004 through 2007.

The Company is currently under income tax examination by the Internal Revenue Service for the years ended December 31, 2002, 2003 and 2004. During 2007, the Company completed state income tax examinations in the states of California and Arizona for the years ended December 31, 2002 and 2003 with no significant adjustments.

Note 8 — Tender Offer and Merger

On May 18, 2006, General William Lyon announced the completion of a 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. 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.

After receiving deliveries of a sufficient number of tendered shares to reach the 90% threshold, General Lyon and the two trusts contributed all the shares of the Company owned by them to WLH Acquisition Corp., a corporation owned by General Lyon and the two trusts. On July 25, 2006, WLH Acquisition Corp. was then

34

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

merged with and into the Company under the “short-form” merger provisions of Delaware law, 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.

As a consequence of the merger, the Company’s equity now consists solely of 1,000 shares of common stock outstanding held by General Lyon and the two trusts.

See Note 9 for information on certain lawsuits which have been filed relating to General Lyon’s proposal.

Note 9 — Commitments and Contingencies

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

Litigation Arising from General Lyon’s Tender Offer

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

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

On March 23, 2006, the Company announced that its Board had appointed a special committee of independent directors who were 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 were 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”).

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.

35

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

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 on August 9, 2006, the Delaware Chancery Court certified a class in the Consolidated Delaware Action, approved the settlement, and dismissed the Consolidated Delaware Action with prejudice as to all defendants and the class. On February 16, 2007, the fee award to Plaintiffs’ counsel was appealed to the Supreme Court of the State of Delaware. On July 18, 2007, a three-judge panel of the Delaware Supreme Court remanded the matter to the Chancery Court for further proceedings regarding the fee award to Plaintiff’s counsel. Under the appealed award, the Company has no expected liability for Plaintiffs’ counsel fees, which are expected to be paid by General Lyon.

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.

36

WILLIAM LYON HOMES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(unaudited)

As of June 30, 2008, the Company had $18,674,000 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 12 months and have varying maturities through 2009, 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 $219,116,000 at June 30, 2008 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 4 and 5 for additional information relating to the Company’s guarantee arrangements.

37

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, 2007.

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,
	2008									2007
	Wholly-Owned			Joint Ventures			Consolidated Total			Wholly-Owned			Joint Ventures			Consolidated Total
Selected Financial Information (dollars in thousands)
Homes closed		308			11			319			471			77			548
Home sales revenue	$	128,971		$	4,270		$	133,241		$	224,432		$	32,488		$	256,920
Cost of sales		(122,849	)		(4,453	)		(127,302	)		(195,020	)		(24,849	)		(219,869	)
Gross margin	$	6,122		$	(183	)	$	5,939		$	29,412		$	7,639		$	37,051
Gross margin percentage		4.7	%		(4.3	)%		4.5	%		13.1	%		23.5	%		14.4	%
Number of homes closed
California		200			11			211			302			77			379
Arizona		73			—			73			86			—			86
Nevada		35			—			35			83			—			83
Total		308			11			319			471			77			548
Average sales price
California	$	510,000		$	388,200		$	503,600		$	561,300		$	421,900		$	533,000
Arizona		233,300			—			233,300			294,100			—			294,100
Nevada		284,300			—			284,300			356,800			—			356,800
Total	$	418,700		$	388,200		$	417,700		$	476,500		$	421,900		$	468,800
Number of net new home orders
California		255			22			277			302			47			349
Arizona		78			—			78			87			—			87
Nevada		63			—			63			54			—			54
Total		396			22			418			443			47			490
Average number of sales locations during period
California		25			3			28			30			6			36
Arizona		4			—			4			5			—			5
Nevada		11			—			11			10			—			10
Total		40			3			43			45			6			51

38

	As of June 30,
	2008						2007
	Wholly-Owned		Joint Ventures		Consolidated Total		Wholly-Owned		Joint Ventures		Consolidated Total
Backlog of homes sold but not closed at end of period
California		278		26		304		482		74		556
Arizona		77		—		77		166		—		166
Nevada		65		—		65		74		—		74
Total		420		26		446		722		74		796
Dollar amount of homes sold but not closed at end of period (dollars in thousands)
California	$	117,935	$	8,524	$	126,459	$	299,542	$	32,487	$	332,029
Arizona		15,579		—		15,579		39,311		—		39,311
Nevada		18,326		—		18,326		25,327		—		25,327
Total	$	151,840	$	8,524	$	160,364	$	364,180	$	32,487	$	396,667
Lots controlled at end of period
Owned lots
California		2,745		795		3,540		4,467		1,019		5,486
Arizona		4,362		1,745		6,107		4,716		1,745		6,461
Nevada		2,960		—		2,960		1,173		—		1,173
Total		10,067		2,540		12,607		10,356		2,764		13,120
Optioned lots(1)
California						534						1,163
Arizona						328						2,703
Nevada						—						1,013
Total						862						4,879
Total lots controlled
California						4,074						6,649
Arizona						6,435						9,164
Nevada						2,960						2,186
Total						13,469						17,999

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

39

	Six Months Ended June 30,
	2008									2007
	Wholly-owned			Joint Ventures			Combined Total			Wholly-owned			Joint Ventures			Combined Total
Selected Financial Information (dollars in thousands)
Homes closed		597			25			622			854			115			969
Home sales revenue	$	236,454		$	9,503		$	245,957		$	398,453		$	51,147		$	449,600
Cost of sales		(224,895	)		(10,191	)		(235,086	)		(339,911	)		(37,966	)		(377,877	)
Gross margin	$	11,559		$	(688	)	$	10,871		$	58,542		$	13,181		$	71,723
Gross margin percentage		4.9	%		(7.2	)%		4.4	%		14.7	%		25.8	%		16.0	%
Number of homes closed
California		382			25			407			504			115			619
Arizona		119			—			119			224			—			224
Nevada		96			—			96			126			—			126
Total		597			25			622			854			115			969
Average sales price
California	$	477,400		$	380,100		$	471,500		$	571,900		$	444,800		$	548,300
Arizona		236,600			—			236,600			293,900			—			293,900
Nevada		270,000			—			270,000			352,200			—			352,200
Total	$	396,100		$	380,100		$	395,400		$	466,600		$	444,800		$	464,000
Number of net new home orders
California		485			41			526			683			137			820
Arizona		129			—			129			199			—			199
Nevada		134			—			134			140			—			140
Total		748			41			789			1,022			137			1,159
Average number of sales locations during period
California		31			3			34			31			6			37
Arizona		4			—			4			5			—			5
Nevada		11			—			11			10			—			10
Total		46			3			49			46			6			52

On a consolidated basis, the number of net new home orders for the three months ended June 30, 2008 decreased 14.7% to 418 homes from 490 homes for the three months ended June 30, 2007. The number of homes closed on a consolidated basis for the three months ended June 30, 2008, decreased 41.8% to 319 homes from 548 homes for the three months ended June 30, 2007. On a consolidated basis, the backlog of homes sold but not closed as of June 30, 2008 was 446, down 44.0% from 796 homes a year earlier, and up 28.5% from 347 homes at March 31, 2008.

Homes in backlog are generally closed within three to six months. The dollar amount of backlog of homes sold but not closed on a consolidated basis as of June 30, 2008 was $160.4 million, down 59.6% from $396.7 million as of June 30, 2007 and up 13.0% from $141.9 million as of March 31, 2008. The cancellation rate of buyers who contracted to buy a home but did not close escrow at the Company’s projects was approximately 21% during the three months ended June 30, 2008 compared to 32% during the three months ended June 30, 2007. The inventory of completed and unsold homes was 32 homes as of June 30, 2008, down from 99 homes at March 31, 2008.

The average number of sales locations during the quarter ended June 30, 2008 was 43, down 15.7% from 51 in the comparable period a year ago. The Company’s number of new home orders per average sales location increased slightly to 9.7 for the quarter ended June 30, 2008 as compared to 9.6 for the quarter ended June 30, 2007.

40

Comparison of Three Months Ended June 30, 2008 to June 30, 2007

Consolidated operating revenue for the three months ended June 30, 2008 was $140.1 million, a decrease of $131.0 million, or 48.3%, from consolidated operating revenue of $271.1 million for the three months ended June 30, 2007. Revenue from sales of wholly-owned homes decreased $95.4 million, or 42.5%, to $129.0 million in the 2008 period from $224.4 million in the 2007 period. This decrease was comprised of (i) a decrease of $77.6 million due to a decrease in the number of wholly-owned homes closed to 308 in 2008 from 471 in 2007 and (ii) a decrease of $17.8 million due to a decrease in the average sales price of wholly-owned homes closed to $418,700 in the 2008 period from $476,500 in the 2007 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 $28.2 million, or 86.8%, to $4.3 million in the 2008 period from $32.5 million in the 2007 period. This decrease was comprised of (i) a decrease of $0.4 million due to a decrease in the average sales price of joint venture homes closed to $388,200 in the 2008 period from $421,900 in the 2007 period and (ii) a decrease of $27.8 million due to a decrease in the number of joint venture homes closed to 11 in 2008 from 77 in 2007. Revenue from sales of lots, land and other decreased to $6.8 million in the 2008 period from $14.2 million in the 2007 period due to the bulk sales of land in California in 2008, compared to the sale of a golf course in one of the Company’s markets and other bulk sales of land in Arizona in 2007.

Operating loss decreased to $33.3 million in the 2008 period from $79.2 million in the 2007 period. The excess of revenue from sales of homes over the related costs of sales (gross margin) decreased by $31.2 million to $5.9 million in the 2008 period from $37.1 million in the 2007 period primarily due to (i) a decrease in the number of homes closed to 319 in the 2008 period from 548 in the 2007 period, (ii) a decrease in the average sales price of homes closed to $417,700 in the 2008 period from $468,800 in the 2007 period and (iii) a decrease in the gross margin percentage to 4.5% in the 2008 period from 14.4% in the 2007 period. The excess of revenue from sales of lots, land and other over the related cost of sales (gross margin) decreased to a loss of $(0.6) million in the 2008 period from a profit of $1.2 million in the 2007 period primarily due to the bulk sales of land in California in the 2008 period and the sale of a golf course in one of the Company’s markets and other bulk sales of land in Arizona in the 2007 period.

Operating costs for the three months ended June 30, 2008 include a non-cash charge of $20.9 million to record impairment loss on real estate assets held by the Company at certain of its homebuilding projects compared to $84.1 million for the three months ended June 30, 2007. The impairment was primarily attributable to slower than anticipated home sales and lower than anticipated net revenue due to continued depressed market conditions in the housing industry. As a result, the future undiscounted cash flows estimated to be generated were determined to be less than the carrying amount of the assets. Accordingly, the related real estate assets were written-down to their estimated fair value. Management determines the estimated fair value by present valuing the estimated future cash flows, including interest cost, at discount rates which are commensurate with the risk of the project under evaluation, generally ranging from 8% to 14%. The non-cash charge is reflected in impairment loss on real estate assets in the consolidated statements of operations.

Sales and marketing expense decreased $6.2 million to $11.0 million in the 2008 period from $17.2 million in the 2007 period primarily due to (i) a decrease of $0.5 million in sales commissions due to the reduction in units closed and revenue from home sales in 2008 as compared to 2007, (ii) a decrease of $2.2 million in commissions paid to outside brokers in 2008 as compared to 2007, (iii) a decrease of $1.4 million in seller closing costs in 2008 as compared to 2007 and (iv) a decrease of $1.8 million in advertising expenses in 2008 compared to 2007. General and administrative expenses decreased $2.7 million to $6.5 million in the 2008 period from $9.2 million in the 2007 period primarily as a result of (i) a decrease in salaries and benefits of $2.2 million to $4.2 million in the 2008 period from $6.6 million in the 2007 period due to a reduction in the Company’s number of employees and (ii) other cost reduction measures implemented by management due to the soft housing market. Other operating costs consist of (i) operating losses realized by golf course operations in certain of the Company’s divisions which increased to $0.3 million in the 2008 period with no comparable amount in the 2007 period. Equity in (loss) income of unconsolidated joint ventures decreased to $(0.7) million in the 2008 period from $0.02 million in the 2007 period. Minority equity in loss (income) of consolidated entities increased to

41

income of $0.8 million in the 2008 period from a loss of $(6.9) million in the 2007 period, primarily due to net losses recorded at certain joint venture projects in the 2008 period compared to net income recorded at certain joint venture projects in the 2007 period.

Interest incurred decreased to $17.0 million in the 2008 period from $18.7 million in the 2007 period primarily due to a decrease in average debt balances and a decrease in interest rates. Interest expense, net of amounts capitalized was $6.1 million in the 2008 period, with no comparable amount in the 2007 period due to a decrease in real estate assets which qualify for interest capitalization in the 2008 period.

The benefit (provision) for income taxes was a benefit of $0.9 million in the 2007 period with no comparable amount in the 2008 period.

As a result of the foregoing factors, net loss decreased to $38.9 million in the 2008 period from a net loss of $76.9 million in the 2007 period.

Comparison of Six Months Ended June 30, 2008 to June 30, 2007

Consolidated operating revenue for the six months ended June 30, 2008 was $277.5 million, a decrease of $199.6 million, or 41.8%, from consolidated operating revenue of $477.1 million for the six months ended June 30, 2007. Revenue from sales of wholly-owned homes decreased $162.0 million, or 40.6%, to $236.5 million in the 2008 period from $398.5 million in the 2007 period. This decrease was comprised of (i) a decrease of $119.9 million due to a decrease in the number of wholly-owned homes closed to 597 in 2008 from 854 in 2007 and (ii) a decrease of $42.1 million due to a decrease in the average sales price of wholly-owned homes closed to $396,100 in the 2008 period from $466,600 in the 2007 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 $41.6 million, or 81.4%, to $9.5 million in the 2008 period from $51.1 million in the 2007 period. This decrease was comprised of (i) a decrease of $1.6 million due to a decrease in the average sales price of joint venture homes closed to $380,100 in the 2008 period from $444,800 in the 2007 period and (ii) a decrease of $40.0 million due to a decrease in the number of joint venture homes closed to 25 in 2008 from 115 in 2007. Revenue from sales of lots, land and other increased to $31.6 million in the 2008 period from $27.5 million in the 2007 period due to the bulk sales of land in California in 2008, compared to the sale of a golf course in one of the Company’s markets and other bulk sales of land in Arizona in 2007.

Operating loss decreased to $72.4 million in the 2008 period from $74.5 million in the 2007 period. The excess of revenue from sales of homes over the related costs of sales (gross margin) decreased by $60.8 million to $10.9 million in the 2008 period from $71.7 million in the 2007 period primarily due to (i) a decrease in the number of homes closed to 622 in the 2008 period from 969 in the 2007 period, (ii) a decrease in the average sales price of homes closed to $395,400 in the 2008 period from $464,000 in the 2007 period and (iii) a decrease in the gross margin percentage to 4.4% in the 2008 period from 16.0% in the 2007 period. The excess of revenue from sales of lots, land and other over the related cost of sales (gross margin) decreased to a loss of $(0.7) million in the 2008 period from a profit of $2.7 million in the 2007 period primarily due to the bulk sales of land in California in the 2008 period and the sale of a golf course in one of the Company’s markets and other bulk sales of land in Arizona in the 2007 period.

Operating costs for the six months ended June 30, 2008 include a non-cash charge of $46.1 million to record impairment loss on real estate assets held by the Company at certain of its homebuilding projects compared to $87.7 million for the six months ended June 30, 2007. The impairment was primarily attributable to slower than anticipated home sales and lower than anticipated net revenue due to continued depressed market conditions in the housing industry. As a result, the future undiscounted cash flows estimated to be generated were determined to be less than the carrying amount of the assets. Accordingly, the related real estate assets were written-down to their estimated fair value. Management determines the estimated fair value by present valuing the estimated future cash flows, including interest cost, at discount rates which are commensurate with the risk of the project

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under evaluation, generally ranging from 8% to 14%. The non-cash charge is reflected in impairment loss on real estate assets in the consolidated statements of operations.

Sales and marketing expense decreased $8.6 million to $22.1 million in the 2008 period from $30.7 million in the 2007 period primarily due to (i) a decrease of $0.8 million in sales commissions due to the reduction in units closed and revenue from home sales in 2008 as compared to 2007, (ii) a decrease of $3.9 million in commissions paid to outside brokers in 2008 as compared to 2007, (iii) a decrease of $1.5 million in seller paid closing costs and (iv) a decrease of $2.7 million in advertising expenses in 2008 compared to 2007. General and administrative expenses decreased $7.2 million to $13.5 million in the 2008 period from $20.7 million in the 2007 period primarily as a result of (i) a decrease in salaries and benefits of $6.1 million to $8.8 million in the 2008 period from $14.9 in the 2007 period due to a reduction in the Company’s number of employees, (ii) a decrease in bonus expense of $0.7 million to $1.6 million in the 2008 period from $2.3 million in the 2007 period and (iii) other cost reduction measures implemented by management due to the soft housing market. Other operating costs consist of (i) operating losses realized by golf course operations in certain of the Company’s divisions which increased to $0.7 million in the 2008 period from $0.1 million in the 2007 period and (ii) non-recurring items of approximately $1.1 million incurred by the Company during the 2008 period. Equity in (loss) income of unconsolidated joint ventures decreased to a loss of $(0.8) million in the 2008 period from a loss of $(0.6) million in the 2007 period. Minority equity in loss (income) of consolidated entities increased to income of $1.7 million in the 2008 period from a loss of $9.2 million in the 2007 period, primarily due to net losses recorded at certain joint venture projects in the 2008 period compared to net income recorded at certain joint venture projects in the 2007 period.

Interest incurred decreased to $35.1 million in the 2008 period from $36.2 million in the 2007 period primarily due to a slight decrease in average debt balances and a decrease in interest rates. Interest expense, net of amounts capitalized was $9.3 million in the 2008 period, with no comparable amount in the 2007 period due to a decrease in real estate assets which qualify for interest capitalization in the 2008 period.

The benefit (provision) for income taxes was a benefit of $41.6 million in the 2008 period compared to a provision of $31.5 million in the 2007 period. Effective January 1, 2008, the Company revoked the “S” corporation election and changed its tax status to a “C” corporation. As a result, the Company recorded a deferred tax asset and related tax benefit of $41.6 million in the 2008 period. Effective January 1, 2007 the Company elected to change its tax status to an “S” Corporation from a “C” Corporation, which required the Company to reduce deferred tax assets and incur an income tax provision of $31.9 million in the 2007 period. See Note 7 of “Notes to Consolidated Financial Statements” for further discussion.

As a result of the foregoing factors, net loss decreased to $39.7 million in the 2008 period from $103.5 million in the 2007 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

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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.

In 2008, the homebuilding industry has experienced continued decreased demand for housing, which has resulted in a decrease in new home orders, home closings, average sales prices and gross margins for the Company compared to the 2007 period. During the three and six months ended June 30, 2008, the Company incurred impairment losses on real estate assets in the amount of $20.9 million and $46.1 million, respectively. The impairments were primarily attributable to slower than anticipated homes sales and lower than anticipated net revenue due to the continued decline in market conditions in the homebuilding industry. The Company was required to write-down the book value of certain real estate assets in accordance with Statement No. 144, as defined in Note 1 of “Notes to Consolidated Financial Statements”.

During 2007 and 2008, in response to the slow-down in the homebuilding industry, the Company entered into certain land sales transactions to improve its liquidity and to reduce its overall debt. On December 26, 2007 and January 7, 2008, the Company entered into ten separate agreements with various affiliates of one of its equity partners (the “Equity Partner Agreements”). Pursuant to the Equity Partner Agreements, the Company agreed to sell to the equity partner affiliates 604 residential lots and 5 model homes in 10 communities in Orange County, San Diego County and Ventura County, California for an aggregate purchase price of $90.6 million in cash. The purchase and sale of 404 of the residential lots and the 5 model homes closed on December 27, 2007 (for an aggregate consideration of approximately $65.9 million) and the remainder of the residential lots closed on January 9, 2008. Prior to the sale, the collective net book value of these lots (as reflected on the Company’s financial statements) was approximately $210.7 million, resulting in a total loss on the sales transactions of $120.1 million. The loss of $40.3 million related to the portion of the land sales which closed in January 2008 was reflected in the Consolidated Statement of Operations as Impairment Losses on Real Estate Assets for the year ended December 31, 2007. The Company has entered into agreements with the various affiliates of the equity partner to build and market homes in 5 of the 10 communities on behalf of the affiliates. For such services, the Company receives fees (generally five percent of the sale price as defined) and may, under certain circumstances, receive additional compensation if certain financial thresholds are achieved. On April 4, 2008, certain of the equity partner affiliates acquired an additional 9 model homes in 2 of the 10 communities for an aggregate purchase price of $7.1 million.

On December 27, 2007, the Company sold certain land in San Diego County, California for $12.0 million in cash to a limited liability corporation owned indirectly by Frank T. Suryan, Jr. as Trustee of the Suryan Family Trust. Mr. Suryan is Chairman and Chief Executive Officer of Lyon Capital Ventures, a company wholly owned by Frank T. Suryan, Jr., General William Lyon, Chairman and Chief Executive Officer of the Company, and a trust whose sole beneficiary is William H. Lyon, Executive Vice President and Chief Administrative Officer of the Company. The Company has received a report from a third-party valuation and financial advisory services firm as to the reasonableness of the sales price in the transaction. Further, the transaction was unanimously approved by all independent members of the Board of Directors. Prior to the sale, the net book value of this land (as reflected on the Company’s financial statements) was approximately $18.7 million, resulting in a loss on the transaction of $6.7 million, which was reflected in the Consolidated Statement of Operations for the year ended December 31, 2007.

In 2008, the Company has temporarily suspended all development, sales and marketing activities at thirteen of its projects which are in the early stages of development. Management of the Company has concluded that this strategy is necessary under the prevailing market conditions and would allow the Company to market the properties at some future time when market conditions may have improved.

Upon consummation of the land sales transactions described above, the Company would not have been in compliance with the tangible net worth covenants in certain of the Revolving Credit Facilities. The Company has reached agreement with each of the lenders to modify the terms of the respective Revolving Credit Facilities so that upon consummation of the land sales transactions described above, the Company would be in compliance with the modified terms.

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Under the modified Revolving Credit Facilities, the aggregate loan commitment is $305 million at June 30, 2008 (including one facility of $60.0 million, three of $50.0 million each, two of $35.0 million each and one of $25.0 million), with maturities at various dates as follows:

Loan Commitment Amount (in millions)		Balance Outstanding at June 30, 2008 (in millions)		Initial Maturity Date(1)
$	35.0	$	14.6	September 2008
	60.0		12.5	September 2008
	50.0		21.6	December 2008
	35.0		7.3	April 2009
	25.0		3.3	May 2009
	50.0		28.1	June 2009
	50.0		8.4	July 2009
$	305.0	$	95.8

(1) After the initial maturity date, additional advances may be obtained to complete previously approved projects subject to all other requirements for advances under the borrowing base. Repayments of borrowed amounts are required at the time a sold house closes escrow or at the time a house must be removed from the borrowing base. The final maturity date would generally be twelve to twenty-four months after the initial maturity date.

The Company is required to comply with a number of covenants, the most restrictive of which require the Company to maintain:

• A tangible net worth, as defined, of $175.0 million;

• A ratio of total liabilities to tangible net worth, each as defined, of less than 5.00 to 1; and

• Minimum liquidity, as defined, of at least $20.0 million.

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

Effective January 1, 2007, the Company made an election in accordance with federal and state regulations to be taxed as an “S” corporation rather than a “C” corporation. Under this election, the Company’s taxable income flows through to and is reported on the personal tax returns of its shareholders. The shareholders are responsible for paying the appropriate taxes based on this election. The Company does not pay any federal taxes under this election and is only required to pay certain state taxes based on a rate of approximately 1.5% of taxable income. As a result of this election, the Company’s provision for income taxes for the six months ended June 30, 2007 included a reduction of deferred tax assets of $31.9 million due to the elimination of any future tax benefit by the

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Company from such assets. In addition, unused recognized built in losses in the amount of $19.4 million were no longer available to the Company.

Effective January 1, 2008, the Company and its shareholders made a revocation of the “S” corporation election. As a result of this revocation, the Company will be taxed as a “C” corporation. The shareholders will not be able to elect “S” corporation status for at least five years. The revocation of the “S” corporation election will allow taxable losses generated in 2008 to be carried back to the 2006 “C” corporation year. As a result of the change in tax status, the Company recorded a deferred tax asset and related income tax benefit of $41.6 million as of January 1, 2008. The recorded deferred tax asset reflects the anticipated tax refund for the carry back of the estimated 2008 tax loss to 2006 as a result of the reversal of temporary differences in 2008. The Company expects to receive the refund in early 2009. In addition, as of January 1, 2008, the Company has unused built-in losses of $19.4 million which are available to offset future income and expire between 2010 and 2011. The utilization of these losses is limited to $3.9 million of taxable income per year; however, any unused losses in any year may be carried forward for utilization in future years through 2010 and 2011. The maximum cumulative unused built-in loss that may be carried forward through 2010 and 2011 is $11.5 million and $7.9 million, respectively. The Company’s ability to utilize the foregoing tax benefits will depend upon the amount of its future taxable income and may be limited under certain circumstances.

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.

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.

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Except as set forth in the Indenture governing the 10 ³/4% Senior Notes, the 10 ³/4% Senior Notes were not redeemable prior to April 1, 2008. Thereafter, the 10 ³/4% Senior Notes are redeemable at the option of California Lyon, in whole or in part, at a redemption price equal to 100% of the principal amount plus a premium declining ratably to par, plus accrued and unpaid interest, if any.

7 ¹/2% Senior Notes

On February 6, 2004, California Lyon 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. 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.

*  *  *  *  *

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.

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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, 2008, the Company had approximately $150.2 million of secured indebtedness, (excluding approximately $80.9 million of secured indebtedness of consolidated entities) and approximately $57.5 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, 2008, the Company has seven revolving credit facilities which have an aggregate maximum loan commitment of $305.0 million, (including one facility of $60.0 million, three of $50.0 million each, two of $35.0 million each and one of $25.0 million), with maturities at various dates as follows:

Loan Commitment Amount (in millions)		Balance Outstanding at June 30, 2008 (in millions)		Initial Maturity Date(1)
$	35.0	$	14.6	September 2008
	60.0		12.5	September 2008
	50.0		21.6	December 2008
	35.0		7.3	April 2009
	25.0		3.3	May 2009
	50.0		28.1	June 2009
	50.0		8.4	July 2009
$	305.0	$	95.8

(1) After the initial maturity date, additional advances may be obtained to complete previously approved projects subject to all other requirements for advances under the borrowing base. Repayments of borrowed amounts are required at the time a sold house closes escrow or at the time a house must be removed from the borrowing base. The final maturity date would generally be twelve to twenty-four months after the initial maturity date.

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

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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, 2008, $95.8 million was outstanding under these credit facilities, with a weighted-average interest rate of 4.875%, and the undrawn availability was $57.5 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, 2008, the Company borrowed $47.4 million and $159.6 million, respectively, and repaid $103.3 million and $203.5 million, respectively, under these facilities. The maximum amount outstanding was $144.4 million and the weighted average borrowings were $123.8 million during the three months ended June 30, 2008. Interest incurred on the revolving credit facilities for the three and six months ended June 30, 2008 was $1.7 million and $4.2 million, respectively. The Company routinely makes borrowings under its revolving credit facilities in the ordinary course of business within the maximum aggregate loan commitment amounts to fund its operations, including its land acquisition and home building activities, and repays such borrowings, as required by the credit facilities, with the net sales proceeds of sales of the real property, including homes, which secure the applicable credit facility.

Under the modified revolving credit facilities as described above, 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 $175.0 million;

• A ratio of total liabilities to tangible net worth, each as defined, of less than 5.00 to 1; and

• Minimum liquidity, as defined, of at least $20.0 million.

As of and for the period ending June 30, 2008, the Company is in compliance with these covenants.

Construction Notes Payable

At June 30, 2008, the Company had construction notes payable on certain consolidated entities amounting to $122.2 million. The construction notes have various maturity dates through 2017 and bear interest at rates ranging from prime plus 0.25% to prime plus 1.50% at June 30, 2008. Interest is calculated on the average daily balance and is paid following the end of each month.

Seller Financing

At June 30, 2008, the Company had no notes payable outstanding related to land acquisitions for which seller financing was provided.

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 September 2008, provides for revolving loans of up to $22.5 million outstanding, $15.0 million of which is committed (lender obligated to lend if stated conditions are satisfied) and $7.5 million is not committed (lender advances are optional even if stated conditions are otherwise satisfied). The

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Company’s mortgage subsidiary and one of its unconsolidated joint ventures entered into an additional $20.0 million credit facility which matures in May 2009. The Company expects the maturities to be extended by the lender at each maturity date. 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, 2008 the outstanding balance under these facilities was $13.0 million.

Land Banking Arrangements

The Company enters into purchase agreements with various land sellers. In some instances, and as a method of acquiring land in staged takedowns, thereby minimizing the use of funds from the Company’s revolving credit facilities and other corporate financing sources and limiting the Company’s risk, the Company transfers its right in such purchase agreements to entities owned by third parties (land banking arrangements). These entities use equity contributions and/or incur debt to finance the acquisition and development of the lots. The entities grant the Company an option to acquire lots in staged takedowns. In consideration for this option, the Company makes a non-refundable deposit of 15% to 25% 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 two of the Company’s land banking arrangements including, as of June 30, 2008, real estate inventories of $30.9 million, which are included in real estate inventories not owned in the Company’s consolidated balance sheet.

In addition, the Company participates in two land banking arrangements, which are not a VIE in accordance with Interpretation No. 46, but are consolidated in accordance with SFAS No. 49, Accounting for Product Financing Arrangements, (“FAS 49”). Under the provisions of FAS 49, the Company has determined it is economically compelled, based on certain factors, to purchase the land in the land banking arrangements, and therefore, must record the remaining purchase price of the land of $93.8 million, which is included in real estate inventories not owned and liabilities from inventories not owned in the accompanying balance sheet.

Summary information with respect to the Company’s consolidated and unconsolidated land banking arrangements is as follows as of June 30, 2008 (dollars in thousands):

Total number of land banking projects		4
Total number of lots		1,054
Total purchase price	$	243,310
Balance of lots still under option and not purchased:
Number of lots		626
Purchase price	$	124,744
Forfeited deposits (cash and letters of credit) if lots were not purchased	$	42,003

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Joint Venture Financing

The Company and certain of its subsidiaries are general partners or members in joint ventures involved in the development and sale of residential projects. As described more fully in Note 2 of “Notes to Consolidated Financial Statements”, in accordance with 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 4 of “Notes to Consolidated Financial Statements” for condensed combined financial information for the unconsolidated joint ventures. Based upon current estimates, substantially all future development and construction costs incurred by the joint ventures will be funded by the venture partners or from the proceeds of construction financing obtained by the joint ventures.

As of June 30, 2008, the Company’s investment in and advances to unconsolidated joint ventures was $2.9 million and the venture partners’ investment in such joint ventures was $4.0 million. As of June 30, 2008, these joint ventures had obtained financing from construction lenders which amounted to $7.4 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, 2008 to Six Months Ended June 30, 2007

Net cash provided by (used in) operating activities increased to a source of $58.8 million in the 2008 period from a use of $27.9 million in the 2007 period. The change was primarily as a result of (i) a decrease in real estate inventories-owned of $99.5 million in the 2008 period from an increase of $80.4 million in the 2007 period, (ii) a decrease in accrued expenses of $14.0 million in the 2008 period compared to a decrease of $51.5 million in the 2007 period, (iii) a decrease in receivables of $17.5 million in the 2008 period compared to a decrease of $80.6 million in the 2007 period, (iv) a benefit for income taxes of $41.6 million in the 2008 period compared to a provision for income taxes of $31.5 million in the 2007 period, (v) impairment loss on real estate assets of $46.1 million in the 2008 period compared to $87.7 million in the 2007 period and (vi) net loss of $39.7 million in the 2008 period compared to net loss of $103.5 million in the 2007 period.

The decrease in real estate inventories-owned is primarily attributable to a decrease in land acquisitions and construction expenditures during the 2008 period compared to the 2007 period due to decreased demand for housing.

51

The decrease in accrued expenses is partially attributable to the decrease in accrued deferred compensation of $6.7 million in the 2008 period due to the termination of the Company’s Executive Deferred Compensation Plan (previously disclosed in the Company’s Annual Report on Form 10-K for the year ending December 31, 2007). As of December 31, 2007, the deferred compensation liability balance was $6.7 million. In addition, a net decrease in accrued bonus expense of $5.3 million during the 2008 period from a balance of $7.1 million as of December 31, 2007 compared to $1.8 million as of June 30, 2008 compared to a net decrease in accrued bonus expense of $29.8 million during the 2007 period from a balance of $39.4 million as of December 31, 2006 compared to $9.6 million as of June 30, 2007. The changes identified above during the first three months of the periods ending March 31, 2008 and 2007 are recurring in nature and are attributable to the timing of bonus payments made each year, offset by normal accruals for the period.

The decrease in receivables is attributable to a decrease in escrow proceeds receivable of $16.9 million during the 2008 period from a balance of $19.2 million as of December 31, 2007 to a balance of $2.3 million as of June 30, 2008, compared to a decrease of $43.2 million during the 2007 period, from a balance of $47.3 million as of December 31, 2006 to a balance of $4.1 million as of June 30, 2007. The large balance as of December 31, 2007 and 2006 was temporary in nature and primarily due to a significant number of homes closed in the last five days of the year of 122 in 2007 and 192 in 2006 where the homes had closed escrow but the Company had not yet received the funds from the escrow and title companies. The entire balance of escrow proceeds receivable at December 31, 2007 and 2006 was collected within the first few days of the following period.

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 provided by (used in) investing activities increased to source of $0.1 million in the 2008 period from a use of $5.3 million in the 2007 period. The change was primarily as a result of a decrease in investments in and advances to unconsolidated joint ventures to $0.04 million in the 2008 period from $4.6 million in the 2007 period.

Net cash (used in) provided by financing activities decreased to a use of $40.2 million in the 2008 period from a source of $10.4 million in the 2007 period, primarily as a result of minority interest distributions of $4.3 million in the 2008 period compared to $22.6 million in the 2007 period and net principal payments on notes payable of $35.9 million in the 2008 period compared to net borrowings on notes payable of $33.0 in the 2007 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, 4 and 9 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, 2007.

52

Description of Projects

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

Project (County) Product	Year of First Delivery	Estimated Number of Homes at Completion(1)	Cumulative Units Closed as of June 30, 2008	Backlog at June 30, 2008(2)(3)	Lots Owned as of June 30, 2008(4)	Homes Closed for the Year Ended June 30,  2008	Sales Price Range(5)
	SOUTHERN CALIFORNIA REGION
SAN DIEGO/INLAND EMPIRE DIVISION
Wholly-Owned:
San Diego:
Promenade	2006	168	79	1	89	13	$370,000—480,000
Alcala Del Sur	2005	83	83	0	0	2	$660,000—710,000
Pasado Del Sur	2009	89	0	0	25	0	$535,000—575,000
Maybeck	2006	51	51	0	0	13	$620,000—710,000
Sunset Cove	2007	35	35	0	0	6	$420,000—460,000
Santee:
Altair	2008	85	17	14	68	17	$330,000—355,000
Riverside County:
Parkside, Corona	2007	122	81	27	41	12	$436,000—529,000
Serafina, North Corona	2007	314	210	22	104	20	$265,000—349,000
Bridle Creek, Corona	2003	274	240	10	34	5	$436,000—560,000
Savannah at Harveston Ranch, Temecula	2005	162	136	21	26	3	$240,000—306,000
San Bernardino County:
Adelina, Fontana	2008	109	17	7	92	17	$265,000—295,000
Rosabella, Fontana	2008	114	24	4	90	20	$288,000—310,000
Amador, Rancho Cucamonga	2007	69	27	2	42	10	$278,000—335,000
Vintner’s Grove, Rancho Cucamongo
Sollara SFD	2007	45	11	8	34	2	$390,000—455,000
Canela Triplex	2007	63	15	8	48	2	$278,000—335,000
Chapman Heights, Yucaipa
Braeburn	2005	113	104	9	9	12	$434,000—609,000
Crofton	2005	140	140	0	0	4	$403,000—433,000
Vista Bella	2012	108	0	0	108	0	$264,000—295,000
Redcort	2012	90	0	0	90	0	$298,000—323,000
Total Wholly-Owned:		2,234	1,270	133	900	158
Joint Ventures:
San Diego:
Ravenna	2005	199	199	0	0	1	$453,000—513,000
Treviso	2005	186	158	19	28	4	$300,000—410,000
Total Joint Ventures:		385	357	19	28	5
TOTAL SAN DIEGO/INLAND EMPIRE DIVISION		2,619	1,627	152	928	163
ORANGE COUNTY/LOS ANGELES DIVISION
Wholly-Owned:
Irvine:
San Carlos	2007	152	33	2	7	13	$380,000—545,000
Ivy	2009	135	0	0	0	0	$430,000—520,000
Columbus Grove:
Lantana	2006	102	97	5	5	9	$765,000—840,000
Kensington	2006	63	62	1	1	10	$640,000—775,000
Tustin:
Columbus Grove/Columbus Square:
Clarendon	2007	102	102	0	0	2	$270,000—650,000
Astoria	2007	38	37	1	1	11	$725,000—850,000
Cambridge Lane	2007	156	94	30	62	3	$126,000—500,000
Ciara	2007	67	47	7	20	8	$1,000,000—1,265,000
Verandas	2007	44	44	0	0	18	$650,000—705,000

53

Project (County) Product	Year of First Delivery	Estimated Number of Homes at Completion(1)	Cumulative Units Closed as of June 30, 2008	Backlog at June 30, 2008(2)(3)	Lots Owned as of June 30, 2008(4)	Homes Closed for the Year Ended  June 30, 2008	Sales Price Range(5)
San Clemente:
Alora	2008	13	12	1	1	12	$950,000—1,050,000
San Juan Capistrano:
Floralisa	2005	80	80	0	0	6	$1,275,000—1,295,000
Estrella Rosa	2006	40	40	0	0	1	$1,675,000—1,725,000
Moorpark:
Meridian Hills:
Ashford	2006	31	31	0	0	3	$780,000—890,000
Marquis	2007	34	34	0	0	7	$830,000—975,000
Los Angeles:
Arboreta at Rainbird
Vintage	2008	87	0	21	87	0	$435,000—545,000
Tradition	2008	53	0	32	53	0	$600,000—689,000
Hawthorne:
360 South Bay(6):
The Flats	2010	188	0	0	188	0	$495,000—700,000
The Lofts	2010	123	0	0	123	0	$525,000—775,000
The Rows	2010	94	0	0	94	0	$700,000—810,000
The Courts	2010	118	0	0	118	0	$635,000—790,000
The Gardens	2010	102	0	0	102	0	$755,000—980,000
Azusa:
Rosedale(6)
Gardenia	2010	147	0	0	147	0	$455,000—550,000
Sage Court	2010	176	0	0	176	0	$420,000—515,000
TOTAL ORANGE COUNTY/LOS ANGELES DIVISION		2,145	713	100	1,185	103
SOUTHERN CALIFORNIA REGION COMBINED TOTAL
Wholly-Owned		4,379	1,983	233	2,085	261
Joint Ventures		385	357	19	28	5
		4,764	2,340	252	2,113	266
	NORTHERN CALIFORNIA REGION
Wholly-Owned:
Contra Costa County:
Seagate at Bayside, Hercules	2005	96	96	0	0	1	$615,000—727,000
Rivergate I & II, Antioch	2006	167	126	13	41	9	$350,000—430,000
Vista Del Mar, Pittsburgh
Vineyard(6)	2007	155	7	5	148	6	$650,000—710,000
Victory(6)	2008	129	7	2	122	7	$680,000—745,000
Stanislaus County:
Falling Leaf, Modesto
Trails	2006	43	43	0	0	15	$260,000—325,000
Groves	2006	43	43	0	0	9	$273,000—308,000
Meadows	2006	33	33	0	0	14	$359,000—400,000
Placer County:
Whitney Ranch, Rocklin
Shady Lane	2006	96	54	4	42	12	$365,000—391,000
Twin Oaks	2006	92	34	2	58	9	$430,000—558,000
Sacramento County:
Big Horn, Elk Grove
Plaza Walk	2005	106	79	6	27	13	$250,000—300,000
Gallery Walk	2005	149	104	8	45	9	$200,000—235,000
Verona at Anatolia, Rancho Cordova	2005	79	78	1	1	11	$400,000—425,000
Marquee at Fair Oaks	2007	190	14	4	176	6	$300,000—360,000
Total Wholly-Owned		1,378	718	45	660	121

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Project (County) Product	Year of First Delivery	Estimated Number of Homes at Completion(1)	Cumulative Units Closed as of June 30, 2008	Backlog at June 30, 2008(2)(3)	Lots Owned as of June 30, 2008(4)	Homes Closed for the Year Ended June 30, 2008	Sales Price Range(5)
Joint Ventures:
Contra Costa County:
Vista Del Mar, Pittsburgh
Villages	2007	102	35	4	67	11	$	303,000—361,000
Venue	2007	132	35	3	97	9	$	363,000—579,000
Monterey County:
East Garrison	2011	603	0	0	603	0	$	239,000—780,000
Total Joint Ventures:		837	70	7	767	20
NORTHERN CALIFORNIA REGION COMBINED TOTAL
Wholly-Owned		1,378	718	45	660	121
Joint Ventures		837	70	7	767	20
		2,215	788	52	1,427	141
	ARIZONA REGION
Wholly-Owned:
Maricopa County     Copper Canyon Ranch, Surprise Sunset Point	2004	282	282	0	0	1	$	287,000—383,000
Talavera, Phoenix	2006	134	134	0	0	9	$	256,000—330,000
Coldwater Ranch, Maricopa County	2009	368	0	0	368	0	$	149,000—190,000
Lehi Crossing, Mesa	2013	880	0	0	552	0	$	209,000—288,000
Rancho Mercado, Phoenix	2012	1,850	0	0	1,850	0	$	194,000—282,000
Hastings Property, Queen Creek	2011	631	0	0	631	0	$	158,000—435,000
Lyon’s Gate, Gilbert:
Pride	2006	650	300	35	350	35	$	173,000—188,000
Savanna	2006	174	132	15	42	20	$	200,000—244,000
Sahara	2006	169	126	12	43	24	$	234,000—300,000
Acacia	2007	365	52	15	313	30	$	190,000—252,000
Future Products	2009	213	0	0	213	0
Total Wholly-Owned:		5,716	1,026	77	4,362	119
Joint Ventures:
Maricopa County     Circle G at the Church Farm North	2012	1,745	0	0	1,745	0	$	154,000—435,000
Total Joint Ventures:		1,745	0	0	1,745	0
ARIZONA REGION TOTAL		7,461	1,026	77	6,107	119
	NEVADA REGION
Wholly-Owned:
Clark County
Summerlin, Las Vegas
Kingwood Crossing	2006	100	68	15	32	8	$	385,000—471,000
North Las Vegas
The Cottages	2004	360	301	1	59	4	$	172,000—199,000
La Tierra	2006	67	59	1	8	6	$	315,000—345,000
Tierra Este	2008	126	5	1	121	5	$	275,000—305,000
Carson Ranch, Las Vegas
West Series I	2005	71	67	0	4	0	$	395,000—430,000
West Series II	2005	59	53	0	6	2	$	406,000—503,000
East Series I	2006	103	58	4	45	8	$	355,000—390,000
East Series II	2007	58	12	2	46	5	$	406,000—461,000
West Park, Las Vegas
Villas	2006	191	61	10	130	17	$	283,000—325,000
Courtyards	2006	113	51	11	62	14	$	330,000—380,000
Mesa Canyon, Las Vegas	2011	49	0	0	49	0	$	410,000—446,000
The Lyon Estates, Las Vegas	2012	129	0	0	129	0	$	635,000—700,000

55

Project (County) Product	Year of First Delivery	Estimated Number of Homes at Completion(1)	Cumulative Units Closed as of June 30, 2008	Backlog at June 30, 2008(2)(3)	Lots Owned as of June 30, 2008(4)	Homes Closed for the Year Ended June 30, 2008	Sales Price Range(5)
Nye County
Mountain Falls, Pahrump:
Cascata	2005	147	137	0	10	0	$	216,000—238,000
Tramonto	2005	212	161	3	51	8	$	256,000—291,000
Move up product	2011	91	0	0	91	0
Bella Sera	2005	129	100	5	29	8	$	312,000—352,000
Cascata Ancora	2007	118	44	7	74	7	$	196,000—218,000
Entrata	2007	99	10	5	89	4	$	177,000—199,000
Future Projects	2010	1,925	0	0	1,925	0
NEVADA REGION TOTAL		4,147	1,187	65	2,960	96
GRAND TOTALS:
Wholly-Owned		15,620	4,914	420	10,067	597
Joint Ventures		2,967	427	26	2,540	25
		18,587	5,341	446	12,607	622

(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, 2008, 416 represent homes completed or under construction and 30 represent homes not yet under construction.

(4) Lots owned as of June 30, 2008 include lots in backlog at June 30, 2008.

(5) Sales price range reflects base price only and excluded 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, 2008. The Company consolidated the purchase price of the lots in accordance with Interpretation No. 46, and considers the lots owned at June 30, 2008.

(7) During the three months ended June 30, 2008, 195 homesites were sold from this project in a bulk land sale transaction.

56

Income Taxes

Effective January 1, 2007, the Company made an election in accordance with federal and state regulations to be taxed as an “S” corporation rather than a “C” corporation. Under this election, the Company’s taxable income flows through to and is reported on the personal tax returns of its shareholders. The shareholders are responsible for paying the appropriate taxes based on this election. The Company does not pay any federal taxes under this election and is only required to pay certain state taxes based on a rate of approximately 1.5% of taxable income. As a result of this election, the Company’s provision for income taxes for the six months ended June 30, 2007 included a reduction of deferred tax assets of $31.9 million due to the elimination of any future tax benefit by the Company from such assets. In addition, unused recognized built in losses in the amount of $19.4 million are no longer available to the Company.

Effective January 1, 2008, the Company and its shareholders made a revocation of the “S” corporation election. As a result of this revocation, the Company will be taxed as a “C” corporation. The shareholders will not be able to elect “S” corporation status for at least five years. The revocation of the “S” corporation election will allow taxable losses generated in 2008 to be carried back to the 2006 “C” corporation year. As a result of the change in tax status, the Company recorded a deferred tax asset of $41.6 million as of January 1, 2008. The recorded deferred tax asset reflects the anticipated tax refund for the carry back of the estimated 2008 tax loss to 2006 as a result of the reversal of temporary differences in 2008. The Company expects to receive the refund in early 2009. In addition, as of January 1, 2008, the Company has unused built-in losses of $19.4 million which are available to offset future income and expire between 2010 and 2011. The utilization of these losses is limited to $3.9 million of taxable income per year; however, any unused losses in any year may be carried forward for utilization in future years through 2010 and 2011. The maximum cumulative unused built-in loss that may be carried forward through 2010 and 2011 is $11.5 million and $7.9 million, respectively. The Company’s ability to utilize the foregoing tax benefits will depend upon the amount of its future taxable income and may be limited under certain circumstances.

Effective January 1, 2007, the company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be considered “more-likely-than-not” to be sustained upon examination by taxing authorities. The Company has taken positions in certain taxing jurisdictions for which it is more likely than not that previously unrecognized tax benefits will be recognized. In addition, the Company has elected to recognize interest and penalties related to uncertain tax positions in the income tax provision. In accordance with the provisions of FIN 48, effective January 1, 2007, the Company recorded an income tax refund receivable of $5.7 million and recognized the associated tax benefit as an increase in additional paid-in capital. In connection therewith, the Company recorded interest receivable of $1.1 million and recognized the associated tax benefit as an increase in retained earnings. At December 31, 2007 and June 30, 2008, the Company has no unrecognized tax benefits.

The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various state jurisdictions. The Company is subject to U.S. federal income tax examination for calendar tax years ending 2002 through 2007. The Company is subject to various state income tax examinations for calendar tax years ending 2004 through 2007.

The Company is currently under income tax examination by the Internal Revenue Service for the years ended December 31, 2002, 2003 and 2004. During 2007, the Company completed state income tax examinations in the states of California and Arizona for the years ended December 31, 2002 and 2003 with no significant adjustments.

Related Party Transactions

See Note 6 of the Notes to Consolidated Financial Statements for a description of the Company’s transactions with related parties.

57

Critical Accounting Polices

The Company’s financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and costs and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments, including those which impact its most critical accounting policies. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. As disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007, 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, 2007, 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

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, (“FAS 157”). FAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. FAS 157 applies under other accounting pronouncements that require or permit fair value measurement and requires prospective application for fiscal years beginning after November 15, 2007. In February 2008, the FASB issued FASB Staff Position No. FAS 157-2, “Effective Date of FASB Statement No. 157” (the “FSP”). The FSP amends FAS 157 to delay the effective date of FAS 157 for non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis. For items within its scope, the FSP defers the effective date of FAS 157 to fiscal years beginning after November 15, 2008. The adoption of FAS 157 by the Company effective as of January 1, 2008 does not have a material impact on the Company’s consolidated financial position or results of operations.

In February 2007, the FASB issued SFAS NO. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“FAS 159”). FAS 159 permits all entities to choose to measure eligible items at fair value at specified election dates. FAS 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. On January 1, 2008, the Company did not elect to apply the fair value option to any specific financial assets or liabilities.

In December 2007, the FASB issued SFAS No. 141 (Revised), Business Combinations (“FAS 141R”). FAS 141R establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed (including intangibles), and any non-controlling interest in the acquired entity. FAS 141R also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. FAS 141R is effective for fiscal years beginning after December 15, 2008. The adoption of FAS No. 141R on January 1, 2009 will require the Company to expense all transaction costs for future business combinations which may be significant to the Company based on historical acquisition activity.

In December 2007, the FASB issued SFAS No. 160, Non-controlling Interests in Consolidated Financial Statements-an amendment of ARB No. 51 (“FAS 160”). FAS 160 establishes accounting and reporting standards for a parent company’s non-controlling interest in a subsidiary and for the de-consolidation of a subsidiary. FAS 160 is effective for fiscal years beginning after December 15, 2008. The adoption of FAS No. 160 on January 1, 2009 shall be applied prospectively, except for the presentation and disclosure requirements, which shall be applied retrospectively for all periods presented, including the non-controlling interest shall be reclassified to equity. The adoption of FAS No. 160 will require the Company to record gains or losses upon changes in control which could have a significant impact on the consolidated financial statements.

58

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment of SFAS No. 133, (“FAS 161”). FAS 161 applies to all derivative instruments and related hedged items accounted for under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (“FAS 133”). FAS 161 requires entities to provide greater transparency about (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedged items are accounted for under FAS 133 and its related interpretations and (iii) how derivative instruments and related hedged items affect an entity’s financial position, results of operations, and cash flows. FAS 161 is effective for financial statements issued for fiscal years beginning after November 15, 2008. The Company does not anticipate the adoption of FAS 161 to have a material impact on its financial position, results of operations or cash flows.

Item 3.    Quantitative and Qualitative Disclosures About Market Risk

The Company’s Annual Report on Form 10-K for the year ended December 31, 2007, 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, 2007.

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.

Item 4T.

Not Applicable

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WILLIAM LYON HOMES

PART II.     OTHER INFORMATION

Item 1.    Legal Proceedings

Litigation Arising from General Lyon’s Tender Offer

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

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

On March 23, 2006, the Company announced that its Board had appointed a special committee of independent directors who were 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 were 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”).

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 on August 9, 2006, the Delaware Chancery Court certified a class in the Consolidated Delaware Action, approved the settlement, and dismissed the Consolidated Delaware Action with prejudice as to all defendants and the class. On February 16, 2007, the fee award to Plaintiffs’ counsel was appealed to the Supreme Court of the State of Delaware. On July 18, 2007, a three-judge panel of the Delaware Supreme Court remanded the matter to the Chancery Court for further proceedings regarding the fee award to Plaintiff’s counsel. Under the appealed award, the Company has no expected liability for Plaintiffs’ counsel fees, which are expected to be paid by General Lyon.

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

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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 named the Company and the directors of the Company as defendants and alleged, among other things, that the defendants had 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, 2007, includes detailed disclosure about risk factors which should be carefully considered when evaluating any investment in the Company. Risk factors have not materially changed since the filing of the Annual Report on Form 10-K for the year ended December 31, 2007.

Items 2, 3, 4 and 5.

Not applicable.

Item 6.    Exhibits

Exhibit No.	Description
10.1	Amended and Restated Master Loan Agreement dated as of January 28, 2008 by and between William Lyon Homes, Inc., a California corporation (“Borrower”) and Guaranty Bank, a federal savings bank organized and existing under the laws of the United States (“Lender”).
10.2	Seventh Modification Agreement to Borrowing Base Revolving Line of Credit Agreement dated as of March 12, 2008 by and between William Lyon Homes, Inc., a California corporation (“Borrower”) and JPMorgan Chase Bank, N.A., a national banking association (“Bank”).
10.3	Fourth Amendment to Borrowing Base Revolving Line of Credit Agreement entered into as of May 14, 2008 between William Lyon Homes, Inc., a California corporation (“Borrower”) and Wachovia Bank, National Association, a national banking association (“Lender”), formerly referenced as Agent for Wachovia Financial Services, Inc., a North Carolina corporation (incorporated herein by reference to Exhibit 10.1 filed with the registrant’s Current Report on Form 8-K filed on July 10, 2008).
10.4	Fifth Amendment to Amended and Restated Revolving Line of Credit Loan Agreement dated as of May 20, 2008 by and between William Lyon Homes, Inc., a California corporation (“Borrower”), and California Bank & Trust, a California banking corporation (“Lender”).
10.5	Second Extension and Modification Agreement dated May 21, 2008 by and between William Lyon Homes, Inc., a California corporation (“Owner”), and California National Bank, a national banking association (“Lender”) (incorporated herein by reference to Exhibit 10.1 filed with the registrant’s Current Report on Form 8-K filed on May 28, 2008).
10.6	Eighth Modification Agreement to Borrowing Base Revolving Line of Credit Agreement dated as of June 5, 2008 by and between William Lyon Homes, Inc., a California corporation (“Borrower”) and JPMorgan Chase Bank, N.A., a national banking association (“Bank”).
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 5, 2008	By:	/s/    MICHAEL D. GRUBBS
		MICHAEL D. GRUBBS Senior Vice President, Chief Financial Officer and Treasurer (Principal Financial Officer)
Date:  August 5, 2008	By:	/s/    W. DOUGLASS HARRIS
		W. DOUGLASS HARRIS Senior Vice President, Corporate Controller and Corporate Secretary (Principal Accounting Officer)

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EXHIBIT INDEX

Exhibit No.	Description
10.1	Amended and Restated Master Loan Agreement dated as of January 28, 2008 by and between William Lyon Homes, Inc., a California corporation (“Borrower”) and Guaranty Bank, a federal savings bank organized and existing under the laws of the United States (“Lender”).
10.2	Seventh Modification Agreement to Borrowing Base Revolving Line of Credit Agreement dated as of March 12, 2008 by and between William Lyon Homes, Inc., a California corporation (“Borrower”) and JPMorgan Chase Bank, N.A., a national banking association (“Bank”).
10.3	Fourth Amendment to Borrowing Base Revolving Line of Credit Agreement entered into as of May 14, 2008 between William Lyon Homes, Inc., a California corporation (“Borrower”) and Wachovia Bank, National Association, a national banking association (“Lender”), formerly referenced as Agent for Wachovia Financial Services, Inc., a North Carolina corporation (incorporated herein by reference to Exhibit 10.1 filed with the registrant’s Current Report on Form 8-K filed on July 10, 2008).
10.4	Fifth Amendment to Amended and Restated Revolving Line of Credit Loan Agreement dated as of May 20, 2008 by and between William Lyon Homes, Inc., a California corporation (“Borrower”), and California Bank & Trust, a California banking corporation (“Lender”).
10.5	Second Extension and Modification Agreement dated May 21, 2008 by and between William Lyon Homes, Inc., a California corporation (“Owner”), and California National Bank, a national banking association (“Lender”) (incorporated herein by reference to Exhibit 10.1 filed with the registrant’s Current Report on Form 8-K filed on May 28, 2008).
10.6	Eighth Modification Agreement to Borrowing Base Revolving Line of Credit Agreement dated as of June 5, 2008 by and between William Lyon Homes, Inc., a California corporation (“Borrower”) and JPMorgan Chase Bank, N.A., a national banking association (“Bank”).
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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