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 Financial Highlights and the Consolidated Financial Statements and Notes thereto appearing elsewhere in this Annual Report.

General Overview. On November 5, 1999, The Presley Companies ("Presley"), which subsequently changed its name to William Lyon Homes on December 31, 1999 (the "Company") as described below, acquired substantially all of the assets and assumed substantially all of the related liabilities of William Lyon Homes, Inc. ("Old William Lyon Homes"), in accordance with a Purchase Agreement executed as of October 7, 1999 with Old William Lyon Homes, William Lyon and William H. Lyon. William Lyon is Chairman of the Board of Old William Lyon Homes and also Chairman of the Board and Chief Executive Officer of the Company. William H. Lyon is the son of William Lyon and a director and an employee of the Company.

The total purchase price consisted of approximately $42,598,000 in cash and the assumption of approximately $101,058,000 of liabilities of Old William Lyon Homes. The acquisition has been accounted for as a purchase and, accordingly, the purchase price has been allocated based on the fair value of the assets and liabilities acquired. The excess of the purchase price over the net assets acquired amounting to approximately $8,689,000 has been reflected as goodwill and is being amortized on a straight-line basis over an estimated useful life of seven years.

After the acquisition described above and prior to the effectiveness of the merger as described below, William Lyon and a trust of which William H. Lyon is the beneficiary acquired (1) 5,741,454 shares of the Company's Series A Common Stock for $0.655 per share in a tender offer for the purchase of up to 10,678,792 shares of the Company's Series A Common Stock which closed on November 5, 1999 and (2) 14,372,150 shares of the Company's Series B Common Stock for $0.655 per share under agreements with certain holders of the Company's Series B Common Stock which closed on November 8, 1999. On November 5, 1999 William Lyon and the Company cancelled all of William Lyon's outstanding options to purchase 750,000 shares of the Company's Series A Common Stock. The completion of these transactions, together with the previous disposition on August 12, 1999 of 3,000,000 shares by William Lyon and a trust of which William H. Lyon is the beneficiary, resulted in William Lyon and a trust of which William H. Lyon is a beneficiary owning approximately 49.9% of the Company's outstanding Common Stock. The foregoing number of shares does not reflect the subsequent merger and the conversion of each share of Series A and Series B Common Stock into 0.2 share of common stock as described in Note 2 of "Notes to Consolidated Financial Statements."

In accordance with the bond indenture agreement governing the Company's Senior Notes which are due on July 1, 2001, if the Company's Consolidated Tangible Net Worth is less than $60 million for two consecutive fiscal quarters, the Company is required to offer to purchase $20 million in principal amount of the Senior Notes. Because the Company's Consolidated Tangible Net Worth had been less than $60 million beginning with the quarter ended June 30, 1997 and continuing through the quarter ended March 31, 2000, the Company would, effective on December 4, 1997, June 4, 1998, December 4, 1998, June 4, 1999, December 4, 1999 and June 4, 2000, have been required to make offers to purchase $20 million of the Senior Notes at par plus accrued interest, less the face amount of Senior Notes acquired by the Company after September 30, 1997, March 31, 1998, September 30, 1998, March 31, 1999, September 30, 1999, and March 31, 2000, respectively. The Company acquired Senior Notes with a face amount equal to or greater than $20 million after September 30, 1997 and prior to December 4, 1997, again after March 31, 1998 and prior to June 4, 1998, and again after September 30, 1998 and prior to December 4, 1998, again after March 31, 1999 and prior to June 4, 1999, again after September 30, 1999 and prior to December 4, 1999 and again after March 31, 2000 and prior to June 4, 2000 and therefore was not required to make offers to purchase Senior Notes. As a result of these transactions, the Company recognized as an extraordinary item net gains from retirement of debt totaling $0.5 million, $4.2 million and $2.7 million during the years ended December 31, 2000, 1999 and 1998, respectively, after giving effect to income taxes and amortization of related loan costs.

At December 31, 2000, the Company's Consolidated Tangible Net Worth was $94.6 million. As long as the Company's Consolidated Tangible Net Worth is not less than $60.0 million on the last day of each of any two consecutive fiscal quarters, the Company will not be required to make similar offers to purchase $20.0 million in principal amount of the Senior Notes.

On February 27, 2001, the Company announced its intention to solicit consents to extend for two years the maturity of its 12 1/2% Senior Notes due July 1, 2001, and to make certain amendments to the note covenants. The Company intends to offer a consent fee of 4% to the holders whose consents are accepted, subject to receipt of consents from holders of at least 25% of the principal amount of the Senior Notes outstanding as of February 15, 2001 and other conditions. There can be no assurance that the minimum number of consents will he received and accepted. The Company intends to accept consents from holders of up to 50% of the principal amount of the Senior Notes outstanding as of February 15, 2001. The Company commenced the consent solicitation on February 28, 2001 and intends to terminate the consent solicitation on March 21, 2001. Holders who do nor consent or whose consents are not accepted will receive repayment of their Senior Notes at scheduled maturity. The Company may waive any conditions or extend any deadlines in its discretion.

Management of the Company currently anticipates that the Company will retire at the maturity date of July 1, 2001 the outstanding Senior Notes which have not been extended by internally-generated cash flow, utilization of undrawn availability under revolving credit facilities and/or proceeds from unsecured financing. There can be no assurances, however, that the Company will be able to secure additional unsecured financing and the failure to do so could have an adverse effect on the Company.

Because of the Company's obligation to offer to purchase $20 million in principal amount of the Senior Notes every six months so long as the Company's Consolidated Tangible Net Worth was less than $60 million, the Company has been restricted in its ability to acquire, hold and develop real estate projects. The Company changed its operating strategy during 1997 to finance certain projects by forming joint ventures with venture partners that would provide a substantial portion of the capital necessary to develop these projects. The Company believes that the use of joint venture partnerships better enables it to reduce its capital investments and risks in the highly capital intensive California markets, as well as to repurchase the Company's Senior Notes as described above. The Company generally receives, after priority returns and capital distributions to its partners, approximately 50% of the profits and losses, and cash flows from joint ventures.

As of December 31, 2000, the Company and certain of its subsidiaries are general partners or members in twenty-eight joint ventures involved in the development and sale of residential projects. Such joint ventures are 50% or less owned and, accordingly, the financial statements of such joint ventures are not consolidated in the preparation of the Company's financial statements. The Company's investments in unconsolidated joint ventures are accounted for using the equity method. See Note 7 of "Notes to Consolidated Financial Statements" for condensed combined financial information for these joint ventures. Based upon current estimates, substantially all future development and construction costs will be funded by the Company's joint venture partners or from the proceeds of construction financing obtained by the joint ventures.

At December 31, 2000 the Company had net operating loss carryforwards for Federal tax purposes of approximately $56.0 million, of which $1.3 million expires in 2008, $10.5 million expires in 2009, $14.1 million expires in 2010, $13.7 million expires in 2011, $16.4 million expires in 2012 and $28,000 expires in 2018. In addition, unused recognized built-in losses in the amount of $23.9 million are available to offset future income and expire between 2009 and 2011. The Company's ability to utilize the foregoing tax benefits will depend upon the amount of its otherwise taxable income and may be limited in the event of an "ownership change" under federal tax laws and regulations. In addition, the Company's federal income tax returns for 1997, 1998 and 1999 are currently under examination by the Internal Revenue Service and there can be no assurance that the Service will not challenge the amount of tax benefits calculated by the Company.

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

Results of Operations

Homes sold, closed and in backlog as of and for the periods presented are as follows:

 
As of and for Years Ended December 31,
   
   
2000
 
1999
 
1998
Number of homes sold  
 
 
   Company  
1,697
 
1,689
 
1,937
   Unconsolidated joint ventures  
906
 
614
 
202
   
2,603
 
2,303
 
2,139
Number of homes closed  
 
 
   Company  
1,757
 
2,031
 
1,834
   Unconsolidated joint ventures  
909
 
587
 
91
   
2,666
 
2,618
 
1,925
Backlog of homes sold but not closed at end  
 
 
   of period  
 
 
   Company  
383
 
443
 
499
   Unconsolidated joint ventures  
184
 
187
 
118
   
567
 
630
 
617
Dollar amount of backlog of homes sold but not  
 
 
   closed at end of period (in millions)  
 
 
   Company
$
89.2
$
109.6
$
111.8
   Unconsolidated joint ventures
82.1
83.6
53.3
 
$
171.3
193.2
$
165.1

Homes in backlog are generally closed within three to six months. The dollar amount of backlog of homes sold but not closed as of December 31, 2000 was $171.3 million as compared to $193.2 million as of December 31, 1999. The cancellation rate of buyers who contracted to buy a home but did not close escrow at the Company's projects was approximately 20% during 2000.

The number of homes closed in 2000 increased 1.8 percent to 2,666 from 2,618 in 1999. Net new home orders for the year ended December 31, 2000 increased 13.0 percent to 2,603 units from 2,303 for the year ended December 31, 1999. The backlog of homes sold as of December 31, 2000 was 567, down 10.0% from 630 units as of December 31, 1999. The Company's inventory of completed and unsold homes as of December 31, 2000 decreased to 52 units from 71 units as of December 31, 1999.

The improvement in net new home orders and closings for 2000 as compared with 1999 is primarily the result of improved market conditions in substantially all of the Company's markets. At December 31, 2000, the Company had 42 sales locations as compared to 50 sales locations at December 31, 1999.

Financial Accounting Standards Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," ("Statement No. 121") requires impairment losses to be recorded on assets to be held and used by the Company when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets (excluding interest) are less than the carrying amount of the assets. Under the new pronouncement, when an impairment loss is required for assets to be held and used by the Company, the related assets are adjusted to their estimated fair value.

The net loss for the year ended December 31, 1997 included a non-cash charge of $74,000,000 during the second quarter of 1997 to record impairment losses on certain real estate assets held and used by the Company. The impairment losses related to three of the Company's master-planned communities. The impairment losses related to two communities, which are located in the Inland Empire area of Southern California, arose primarily from declines in home sales prices due to continued weak economic conditions and competitive pressures in that area of Southern California. The impairment loss relating to the other community, which is located in Contra Costa County in the East San Francisco Bay area of Northern California, was primarily attributable to lower than expected cash flow relating to one of the high end residential products in this community and to a deterioration in the value of the non-residential portion of the project. The significant deteriorations in the market conditions associated with these communities resulted in the undiscounted cash flows (excluding interest) estimated to be generated by these communities being less than their historical book values. Accordingly, the master-planned communities were written-down to their estimated fair value.

The following represents the home sales and excess of revenue from sales over related cost of sales (i.e., gross profit) of the three master-planned communities since the recordation of impairment losses on June 30, 1997:

 
For the
Year Ended
December 31,
2000
For the
Year Ended
December 31,
1999
For the
Year Ended
December 31,
1998
For the Six
Months Ended
December 31,
1997
Sales
$ 51,917,000
$ 79,584,000
$ 54,828,000
$ 17,662,000
Gross profit
$ 13,884,000
$ 13,012,000
$   5,850,000
$   1,202,000
Gross profit %
26.7%
16.4%
10.7%
6.8%

The gross profits recognized on the three master-planned communities subsequent to the recordation of the impairment losses has increased due to better than projected sales price increases beginning in 1998.

The Company periodically evaluates its real estate assets to determine whether such assets have been impaired and therefore would be required to be adjusted to fair value. 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 in 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 since 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 their estimated fair values.

Interest incurred during the period in which real estate projects are not under development or during the period subsequent to the completion of product available for sale is expensed in the period incurred. Economic conditions in the real estate industry can cause a delay in the development of certain real estate projects and, as a result, can lengthen the periods when such projects are not under development and, accordingly, have a significant impact on profitability as a result of expensed interest. Interest expense during 2000, 1999, and 1998 was approximately $5.6 million, $6.2 million and $9.2 million, respectively.

In general, housing demand is adversely affected by increases in interest rates and housing prices. Interest rates, the length of time that assets remain in inventory, and the proportion of inventory that is financed affect the Company's interest cost. If the Company is unable to raise sales prices sufficiently to compensate for higher costs or if mortgage interest rates increase significantly, affecting prospective buyers' ability to adequately finance home purchases, the Company's sales, gross margins and net results may be adversely impacted. To a limited extent, the Company hedges against increases in interest costs by acquiring interest rate protection that locks in or caps interest rates for limited periods of time for mortgage financing for prospective homebuyers.

Comparison of Years Ended December 31, 2000 and 1999. Operating revenue for the year ended December 31, 2000 was $417.3 million, a decrease of $27.5 million (6.2%), from operating revenue of $444.8 million for the year ended December 31,1999. Revenue from sales of homes decreased $22.9 million (5.4%) to $403.9 million in 2000 from $426.8 million in 1999. This decrease was due primarily to a decrease in the number of wholly-owned homes closed to 1,757 in 2000 from 2,031 in 1999, offset by an increase in the average sales prices of wholly-owned homes to $229,900 in 2000 from $210,200 in 1999. Management fee income increased by $5.7 million to $10.5 million in 2000 from $4.8 million in 1999 as a direct result of the Company's strategy of financing an increased number of projects through unconsolidated joint ventures. Equity in income of unconsolidated joint ventures amounting to $24.4 million was recognized in 2000, compared to $17.9 million in 1999 also as a direct result of the Company's strategy of financing an increased number of projects through unconsolidated joint ventures. The number of homes closed in unconsolidated joint ventures increased to 909 in 2000 from 587 in 1999. The average sales price of homes sold by joint ventures has been higher than the average sales price of wholly-owned units. The Company generally receives, after priority returns and a return of capital, approximately 50% of the profits and losses and cash flows from joint ventures.

Total operating income increased from $48.4 million in 1999 to $49.4 million in 2000. The excess of revenue from sales of homes over the related cost of sales decreased by $1.7 million, to $68.0 million in 2000 from $69.7 million in 1999. This decrease was primarily due to a decrease of 13.5% in the number of wholly-owned units closed to 1,757 units in 2000 from 2,031 units in 1999, offset by an increase in the average sales prices to $229,900 in 2000 from $210,200 in 1999 (a 9.4% increase). Gross margins increased by 0.5% to 16.8% in 2000 from 16.3% in 1999. Sales and marketing expenses decreased by $2.9 million (14.9%) to $16.5 million in 2000 from $19.4 million in 1999 primarily due to a decrease in the number of wholly-owned homes closed to 1,757 in 2000 from 2,031 in 1999. General and administrative expenses increased by $11.1 million to $35.3 million in 2000 from $24.2 million in 1999, primarily as a result of higher employment levels to support the increased level of operations and additional employee bonuses based upon improved operating results of the Company, partially offset by reimbursement of overhead expenses from joint ventures.

Total interest incurred during 2000 increased $1.5 million to $26.0 million from $24.5 million in 1999 as a result of an increase in the average amount of outstanding debt and increases in interest rates. Net interest expense decreased to $5.6 million in 2000 from $6.2 million for 1999 as a result of an increase in the amount of real estate inventories available for capitalization of interest.

As a result of the transactions as described previously in "General Overview", the Company incurred financial advisory expenses of approximately $2.2 million for the year ended December 31, 1999, with no corresponding amounts for the year ended December 31, 2000.

Other income (expense), net increased to $7.3 million in 2000 from $3.4 million in 1999 primarily as a result of the gain of $1.7 million on the sale of an office building in 2000, increased income from the Company's mortgage company operations and increased income from the Company's design center operations.

As a result of the retirement of certain debt as described previously in "General Overview", the Company has recognized net gains of $0.5 million and $4.2 million during the years ended December 31, 2000 and 1999, respectively, after giving effect to income taxes and amortization of related loan costs.

For the year ended December 31, 2000, income tax benefits of $9.3 million related to temporary differences resulting from the quasi-reorganization were excluded from the results of operations and not reflected as a reduction to the Company's provision for income taxes but credited directly to additional paid-in capital. For the years ended December 31, 2000 and 1999, post quasi-reorganization temporary differences, partially offset by temporary differences that existed prior to the quasi-reorganization, along with pre quasi-reorganization net operating loss carryforwards resulted in income tax expense, at Alternative Minimum Tax rates, of $3.1 million and $245,000, respectively.

The $9.3 million included in the Company's provision for income taxes for the year ended December 31, 2000 represents income taxes which the Company will not be required to pay. As described in Note 4 of Notes to Consolidated Financial Statements, the pre-quasi-reorganization income tax benefits which would otherwise reduce the provision for income taxes are credited directly to paid-in capital.

Stockholders' equity per common share increased by $4.62 during the year ended December 31, 2000 as a result of the net income for the period and the income tax benefits credited directly to paid-in capital for the period, compared with an increase of $4.55 for the comparable period a year ago.

Comparison of Years Ended December 31, 1999 and 1998. Operating revenue for the year ended December 31, 1999 was $444.8 million, an increase of $74.3 million (20.1%), from operating revenue of $370.5 million for the year ended December 31, 1998. Revenue from sales of homes increased $78.4 million to $426.8 million in 1999 from $348.4 million in 1998. This increase was due primarily to an increase in the number of homes closed to 2,031 in 1999 from 1,834 in 1998, and an increase in the average sales prices of homes to $210,200 in 1999 from $189,900 in 1998. Management fee income increased by $2.6 million to $4.8 million in 1999 from $2.2 million in 1998 as a direct result of the Company's strategy of financing an increased number of projects through unconsolidated joint ventures. Equity in income of unconsolidated joint ventures amounting to $17.9 million was recognized in 1999, compared to $3.5 million in 1998 also as a direct result of the Company's strategy of financing an increased number of projects through unconsolidated joint ventures. The Company did not begin investing in unconsolidated joint ventures until the fourth quarter of 1997 and limited operating results were realized in the first nine months of 1998.

Total operating income increased from $15.6 million in 1998 to $48.4 million in 1999. The excess of revenue from sales of homes over the related cost of sales increased by $19.1 million, to $69.7 million in 1999 from $50.6 million in 1998. This increase was primarily due to (1) an increase of 10.7% in the number of units closed to 2,031 units in 1999 from 1,834 units in 1998, and (2) an increase in the average sales prices to $210,200 from $189,900 (a 10.7% increase). Sales and marketing expenses decreased by $2.1 million (9.8%) to $19.4 million in 1999 from $21.5 million in 1998 primarily as a result of reductions in advertising and sales office/model operation expenses, offset by increased direct sales expenses related to the increased sales volume. General and administrative expenses increased by $6.0 million to $24.2 million in 1999 from $18.2 million in 1998, primarily as a result of higher employment levels to support the increased level of operations and additional accruals for increased employee bonuses based upon improved operating results of the Company, partially offset by reimbursement of overhead expenses from joint ventures.

Total interest incurred during 1999 decreased $7.0 million to $24.5 million from $31.5 million in 1998 as a result of a decrease in the average amount of outstanding debt. Net interest expense decreased to $6.2 million in 1999 from $9.2 million for 1998 as a result of the decrease in the average amount of outstanding debt.

As a result of the transactions as described previously in "General Overview", the Company incurred financial advisory expense of approximately $2.2 million for the year ended December 31, 1999.

As a result of the retirement of certain debt as described previously in "General Overview", the Company recognized a net gain of $4.2 million during the year ended December 31, 1999, after giving effect to income taxes and amortization of related loan costs.

For the year ended December 31, 1999, post quasi-reorganization temporary differences, partially offset by temporary differences that existed prior to the quasi-reorganization, along with pre quasi-reorganization net operating loss carryforwards resulted in income tax expense, at Alternative Minimum Tax rates, of $245,000. For the year ended December 31, 1998, income tax benefits of $1,650,000 related to temporary differences resulting from the quasi-reorganization were excluded from the results of operations and not reflected as a reduction to the Company's provision for income taxes but credited to additional paid-in capital.

Financial Condition and Liquidity

The Company provides for its ongoing cash requirements principally from internally generated funds from the sales of real estate and from outside borrowings and, beginning in the fourth quarter of 1997, by joint venture financing from newly formed joint ventures with venture partners that provide a substantial portion of the capital required for certain projects. The Company currently maintains the following major credit facilities: 12 1/2% Senior Notes (the "Senior Notes") and secured revolving lending facilities ("Revolving Credit Facilities"). The Company also finances certain projects with construction loans secured by real estate inventories and finances certain land acquisitions with seller-provided financing.

The ability of the Company to meet its obligations on the Senior Notes and its other 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. The Company's degree of leverage may limit its ability to meet its obligations, withstand adverse business conditions and capitalize on business opportunities.

The Company will in all likelihood be required to refinance the Senior Notes and the Revolving Credit Facilities when they mature, and no assurances can be given that the Company will be successful in that regard.

Quasi-Reorganization

In 1994, the Company's Board of Directors approved a Plan for Quasi-Reorganization retroactive to January 1, 1994. The Company implemented a quasi-reorganization at that time because it was implementing a substantial change in its capital structure in accordance with a plan for capital restructuring. A quasi-reorganization allows certain companies which are undergoing a substantial change in capital structure to utilize "fresh start accounting."

Under the Plan for Quasi-Reorganization, the Company implemented an overall accounting readjustment effective January 1, 1994, which resulted in the adjustment of assets and liabilities to estimated fair values, and the elimination of the accumulated deficit. The net amount of such revaluation adjustments and costs related to the capital restructuring, together with the accumulated deficit as of the date thereof, was transferred to paid-in capital in accordance with the accounting principles applicable to quasi-reorganizations.

As a result of the quasi-reorganization, any income tax benefits resulting from the utilization of net operating losses and other carryforwards existing at January 1, 1994 and temporary differences resulting from the quasi-reorganization, are excluded from the Company's results of operations and credited to paid-in capital.

Senior Notes

The 12 1/2% Senior Notes due July 1, 2001 are obligations of William Lyon Homes (formerly The Presley Companies), a Delaware corporation ("Delaware Lyon"), and are unconditionally guaranteed on a senior basis by William Lyon Homes, Inc. (formerly Presley Homes), a California corporation and a wholly owned subsidiary of Delaware Lyon. However, William Lyon Homes, Inc. has granted liens on substantially all of its assets as security for its obligations under the Revolving Credit Facilities and other loans. Because the William Lyon Homes, Inc. guarantee is not secured, holders of the Senior Notes are effectively junior to borrowings under the Revolving Credit Facilities with respect to such assets. Delaware Lyon and its consolidated subsidiaries are referred to collectively herein as the "Company." Interest on the Senior Notes is payable on January 1 and July 1 of each year.

Except as set forth in the Indenture Agreement (the "Indenture"), the Senior Notes are redeemable at the option of Delaware Lyon, in whole or in part, at the redemption prices set forth in the Indenture.

The Senior Notes are senior obligations of Delaware Lyon and rank pari passu in right of payment to all existing and future unsecured indebtedness of Delaware Lyon, and senior in right of payment to all future indebtedness of the Company which by its terms is subordinated to the Senior Notes.

As described above in "General Overview", Delaware Lyon is required to offer to repurchase certain Senior Notes at a price equal to 100% of the principal amount plus any accrued and unpaid interest to the date of repurchase if Delaware Lyon's Consolidated Tangible Net Worth is less than $60 million for any two consecutive fiscal quarters, as well as from the proceeds of certain asset sales.

Upon certain changes of control as described in the Indenture, Delaware Lyon must offer to repurchase Senior Notes at a price equal to 101% of the principal amount plus accrued and unpaid interest, if any, to the date of repurchase.

The Indenture governing the Senior Notes restricts Delaware Lyon and certain of its subsidiaries with respect to, among other things: (i) the payment of dividends on and redemptions of capital stock, (ii) the incurrence of indebtedness or the issuance of preferred stock, (iii) the creation of certain liens, (iv) consolidations or mergers with or transfers of all or substantially all of its assets and (v) transactions with affiliates. These restrictions are subject to a number of important qualifications and exceptions.

As of December 31, 2000, the outstanding 12 1/2% Senior Notes with a face value of $77.2 million were valued at a range from $75.3 million to $77.2 million, based on quotes from industry sources.

Management of the Company currently anticipates that the Company will retire at the maturity date of July 1, 2001 the outstanding Senior Notes which have not been extended by internally-generated cash flow, utilization of undrawn availability under revolving credit facilities and/or proceeds from unsecured financing. There can be no assurances, however, that the Company will be able to secure additional unsecured financing and the failure to do so could have an adverse effect on the liquidity of the Company.

Revolving Credit Facilities

On September 27, 2000 the Company completed agreements with various lenders to provide financing to replace the Company's prior $100.0 million Working Capital Facility which was scheduled to mature on May 20, 2001. Under these agreements, project level financing was obtained in facilities provided by these lenders which, collectively, provided for the repayment on September 27, 2000 of all amounts then outstanding under the Company's prior Working Capital Facility.

Three of the facilities described in the preceding paragraph are Revolving Credit Facilities with an aggregate maximum loan commitment of $170.0 million, with various maturities beginning in 2002 through September 2004. The collateral for the loans provided by the Revolving Credit Facilities includes substantially all real estate of the Company (excluding assets which are pledged as collateral for construction notes payable described below and excluding assets of partnerships and limited liability companies). Although the aggregate maximum loan commitment for these loans is $170.0 million, the credit facilities have limitations on the amounts which can be borrowed at any time based on assets which are included in the credit facilities and the specified borrowings permitted under borrowing base calculations. The undrawn availability at December 31, 2000 was $29.2 million and the principal outstanding under the Revolving Credit Facilities at December 31, 2000 was $66.3 million.

Pursuant to the terms of the Revolving Credit Facilities, outstanding advances bear interest at various rates which approximate the prime rate.

The Revolving Credit Facilities include financial covenants which may limit the amount which may he borrowed thereunder.

Construction Notes Payable

At December 31, 2000, the Company had construction notes payable amounting to $9.6 million related to various real estate projects. The notes are due as units close or at various dates on or before December 31, 2002 and bear interest at rates of prime plus 0.25% to prime plus 0.50%.

Seller Financing

Another source of financing available to the Company is seller-provided financing for land acquired by the Company. At December 31, 2000, the Company had various notes payable outstanding related to land acquisitions for which seller financing was provided in the amount of $6.6 million.

Revolving Mortgage Warehouse Credit Facility

The Company has a $15.0 million revolving mortgage warehouse credit facility with a bank to fund its mortgage origination operations. Mortgage loans are generally held for a short period of time and are typically sold to investors within 7 to 15 days following funding. Borrowings are secured by the related mortgage loans held for sale. At December 31, 2000 the outstanding balance was $7.2 million. The facility, which has a current maturity date of May 31, 2001, also contains a financial covenant requiring that the Company maintains cash and/or marketable securities on the books of account of its subsidiary, Duxford Financial, Inc., a California corporation ("Duxford") in an amount equal to no less than $1.0 million and a financial covenant requiring the Company to maintain total assets net of total liabilities and net of amounts receivable from the Company and/or affiliates on the books of account of Duxford in an amount equal to no less than $1.0 million.

Joint Venture Financing

As of December 31, 2000, the Company and certain of its subsidiaries are general partners or members in twenty-eight joint ventures involved in the development and sale of residential projects. Such joint ventures are 50% or less owned and, accordingly, the financial statements of such joint ventures are not consolidated with the Company's financial statements. The Company's investments in unconsolidated joint ventures are accounted for using the equity method. See Note 7 of "Notes to Consolidated Financial Statements" for condensed combined financial information for these joint ventures. Based upon current estimates, substantially all future development and construction costs will be funded by the Company's venture partners or from the proceeds of construction financing obtained by the joint ventures.

As of December 31, 2000, the Company's investment in and advances to such joint ventures was approximately $50.0 million and the Company's venture partners' investment in such joint ventures was approximately $137.4 million. In addition, certain joint ventures have obtained financing from land sellers or construction lenders which amounted to approximately $45.2 million at December 31, 2000.

Assessment District Bonds and Seller Financing

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 Years Ended December 31, 2000 and 1999

Net cash provided by operating activities decreased from $65.9 million in 1999 to $9.3 million in 2000 primarily as a result of decreased income and increases in real estate inventories.

Net cash provided by investing activities increased from $13.8 million in 1999 to $19.2 million in 2000 primarily as a result of increased amounts received from investments in and advances to unconsolidated joint ventures.

Net cash used in financing activities decreased from $101.5 million in 1999 to $16.0 million in 2000. The change was primarily due to borrowings on notes payable.

Cash Flows - Comparison of Years Ended December 31, 1999 and 1998

Net cash provided by operating activities increased from $55.1 million in 1998 to $65.9 million in 1999 primarily as a result of increased income and reductions in real estate inventories.

Net cash provided by investing activities decreased from $5.8 million in 1998 to $13.8 million in 1999 primarily as a result of decreased amounts received from investments in and advances to unconsolidated joint ventures offset by net increases in investments in notes receivable.

Net cash used in financing activities increased from $41.5 million in 1998 to $101.5 million in 1999. The change was primarily due to repayment of debt, offset by borrowings on notes payable.

Quantitative and Qualitative Disclosures About Market Risk

The Company's exposure to market risk for changes in interest rates relates primarily to the Company's revolving lines of credit with a total outstanding balance at December 31, 2000 of $66.3 million where the interest rate is variable based upon certain bank reference or prime rates. If interest rates were to increase by 10%, the estimated impact on the Company's consolidated financial statements would be to reduce income before raxes by approximately $235,000 based on amounts outstanding and rates in effect at December 31, 2000, as well as to increase capitalized interest by approximately $864,000 which would be amortized to cost of sales as unit closings occur.