UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

CALIFORNIA COASTAL COMMUNITIES, INC.

(Exact name of registrant as specified in its charter)

(949) 250-7700

(Registrant’s telephone number, including area code)

Not applicable

(Former name, former address and former fiscal year, if changed from last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x  NO o

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):

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

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

As of October 29, 2007, 10,855,963 shares of Common Stock par value $.05 per share were outstanding.

CALIFORNIA COASTAL COMMUNITIES, INC.

FORM 10-Q

FOR THE QUARTER ENDED SEPTEMBER 30, 2007

I N D E X

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CAUTIONARY STATEMENT ABOUT FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Exchange Act of 1933 and Section 21E of the Securities Exchange Act of 1934 that relate to future events or our future financial performance. In addition, other statements we may make from time to time, such as press releases, oral statements made by our officials and other reports that we file with the Securities and Exchange Commission may also contain such forward-looking statements. Undue reliance should not be placed on these statements which involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “continue,” or the negative of such terms or other comparable terminology.

These forward-looking statements include, but are not limited to:

•                  statements about our strategies, plans, objectives, goals, expectations and intentions, including our platform for continued growth;

•                  information relating to anticipated operating results, financial resources, changes in revenues, changes in profitability, interest expense, growth and expansion, anticipated income to be realized from our investments in unconsolidated entities;

•                  the impact of demographic trends and supply constraints on the demand for and supply of housing;

•                  housing market conditions in the geographic markets in which we operate, including the relative impact of interest rates, jobs, land constraints, demographic trends, and the availability of mortgage financing;

•                  the number and types of homes and number of acres of land that we may develop and sell;

•                  the ability to deliver homes from backlog;

•                  our strategic focus on growing in existing markets and our focus on generating strong financial returns and conservatively managing our balance sheet;

•                  the timing and outcomes of regulatory approval processes or administrative proceedings, which may result in delays in the land entitlement, development, construction, or the opening of new communities (including, but not limited to ongoing administrative proceedings related to our joint venture near Oxnard, California);

•                  the ability to secure materials and subcontractors;

•                  the ability to produce the liquidity and capital necessary to expand and take advantage of opportunities in the future;

•                  our expected homebuilding gross margin percentage, anticipated buyer demand, and expected joint venture income and deliveries;

•                  our ability to realize the value of our net operating loss carry forwards;

•                  our ability to continue relationships with current or future partners;

•                  the effectiveness and adequacy of our disclosure and internal controls;

•                  the impact of recent accounting pronouncements; and

•                  stock market valuations.

Any or all of the forward-looking statements included in this report and in any other reports or public statements made by us may turn out to be inaccurate. This can occur as a result of incorrect assumptions or as a consequence of known or unknown risks and uncertainties. These risks and uncertainties include the competitive environment in which we operate; local, regional and national economic conditions, including consumer confidence, employment rates, interest rates, the cost and availability of mortgage financing, and stock market, home and land valuations; the demand for homes; fluctuations in interest rates and the availability of mortgage financing; changes in home prices; the availability and cost of land for future growth; the availability of capital; the cost and availability of construction financing; uncertainties and fluctuations in capital and securities markets; the cyclical and competitive nature of our business; changes in tax laws and their interpretation; legal proceedings; the ability of customers to finance the purchase of homes or sell existing homes; cancellations of purchase contracts by homebuyers; the availability and cost of labor and materials; delays in the land entitlement process, development, construction, or the opening of new home communities; the significant amount of our debt and the impact of restrictive covenants in our loan agreements; adverse weather conditions; natural disasters such as earthquakes, wildfires and floods; domestic and international political events; the impact on economic conditions of terrorist attacks or the outbreak or escalation of armed conflict involving the United States; litigation and warranty claims; the effects of governmental regulation, including regulations concerning development of land, the home building industry, sales and customer financing processes, and the environment; future business decisions and our ability to successfully implement our operational, growth and other strategies; and other risks discussed in our filings with the Securities and Exchange Commission.  Many factors

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mentioned in this report or in other reports or public statements made by us, such as government regulation and the competitive environment, will be important in determining our future performance. Consequently, actual results may differ materially from those that might be anticipated from our forward-looking statements. You should not place undue reliance on any of these forward-looking statements because they are based on current expectations or beliefs regarding future events or circumstances, which involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from any future results, performances or achievements expressed or implied by these forward-looking statements.

Although we believe that our strategies, plans, objectives, goals, expectations and intentions reflected in, or suggested by these forward-looking statements are reasonable given current information available to us, we can give no assurance that any of them will be achieved. Forward-looking statements speak only as of the date they are made. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise. However, any further disclosures made on related subjects in our subsequent reports on Forms 10-K, 10-Q and 8-K should be consulted.

These forward-looking statements should be considered in light of the information included in this report and our other filings with the Securities and Exchange Commission, including, without limitation, the “Risk Factors” set forth below, as well as the description of trends and other factors in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” set forth in our Form 10-K for the year ended December 31, 2006. You should also read the following “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in conjunction with the unaudited consolidated financial statements and the related notes that appear elsewhere in this report.

We assume no, and hereby disclaim any, obligation to update any of the foregoing or any other forward-looking statements. We nonetheless reserve the right to make such updates from time to time by press release, periodic report or other method of public disclosure without the need for specific reference to this Form 10-Q or any other report filed by us. No such update shall be deemed to indicate that other statements not addressed by such update remain correct or create an obligation to provide any other updates.

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PART I. FINANCIAL INFORMATION

ITEM 1 – FINANCIAL STATEMENTS

CALIFORNIA COASTAL COMMUNITIES, INC.

CONSOLIDATED BALANCE SHEETS

(unaudited)

(in millions)

See the accompanying notes to consolidated financial statements.

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CALIFORNIA COASTAL COMMUNITIES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in millions, except per share amounts)

(unaudited)

See the accompanying notes to consolidated financial statements.

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CALIFORNIA COASTAL COMMUNITIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in millions)

(unaudited)

See the accompanying notes to consolidated financial statements.

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CALIFORNIA COASTAL COMMUNITIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Note 1 - Basis of Presentation

The accompanying financial statements have been prepared by California Coastal Communities, Inc. and its consolidated subsidiaries (the “Company”), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The Company believes that these unaudited consolidated financial statements reflect all material adjustments (consisting only of normal recurring adjustments) and disclosures necessary for the fair presentation of the results of operations and statements of financial position when read in conjunction with the Consolidated Financial Statements and Notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006 and the current year’s previously issued Quarterly Reports on Form 10-Q. Intercompany accounts and transactions have been eliminated.

The results for interim periods are not necessarily indicative of the results to be expected for the full year. This report contains forward-looking statements. Readers are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties that actual events or results may differ materially from those described herein as a result of various factors, including without limitation, the factors discussed generally in this report.

Note 2 - Significant Accounting Policies

Basis of Consolidation

Certain of the Company’s wholly-owned subsidiaries are members in joint ventures involved in the development and sale of residential projects and residential loan production. The Company’s consolidated financial statements include the Company’s accounts and all of its majority-owned and controlled subsidiaries and joint ventures. The financial statements of joint ventures in which the Company has a controlling or majority economic interest (and thus are controlled by the Company) are consolidated with the Company’s financial statements. Minority interest represents the equity interest of the Company’s joint venture partner for one consolidated venture and is further described in Note 10 to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006. The Company’s investments in unconsolidated joint ventures are accounted for using the equity method when the Company does not have voting or economic control of the venture operations, as further discussed in Note 4 to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

Real Estate

Real estate inventories primarily consist of homes under construction and lots under development and are carried at the lower of cost or fair value less costs to sell. The estimation process involved in the determination of fair value is inherently uncertain since it requires estimates as to future events and market conditions. Such estimation process assumes the Company’s ability to complete development and dispose of its real estate properties in the ordinary course of business based on management’s present plans and intentions. Economic, market, and environmental conditions may affect management’s development and marketing plans. In addition, the implementation of such development and marketing plans could be affected by the availability of future financing for development and construction activities. Accordingly, the ultimate values of the Company’s real estate properties depend upon future economic and market conditions, and the availability of financing.

The cost of sales of multi-unit projects is generally computed using the relative sales value method. Interest and other carrying costs are capitalized to real estate projects during their development and construction period.

Impairment of Long-Lived Assets

The Company assesses the impairment of real estate inventories and other long-lived assets in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, (“SFAS 144”) which requires that long-lived assets be reviewed for impairment whenever events or changes in

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circumstances indicate that the carrying amount of an asset may not be recoverable. As provided by SFAS 144, impairment is evaluated by comparing an asset’s carrying value to the undiscounted estimated cash flows expected from the asset’s operations and eventual disposition. If the sum of the undiscounted estimated future cash flows is less than the carrying value of the asset, an impairment loss is recognized based on the fair value of the asset. If impairment occurs, the fair value of an asset for purposes of SFAS 144 is deemed to be the amount a willing buyer would pay a willing seller for such asset in a current transaction. Additionally, as appropriate, the Company identifies alternative courses of action to recover the carrying value of its long-lived assets and evaluates all likely alternatives under a probability-weighted approach as described in SFAS 144.

In accordance with SFAS 144, in developing estimated future cash flows for impairment testing for its real estate inventories, the Company has incorporated its own market assumptions including those regarding home prices, sales pace, sales and marketing costs, infrastructure and home-building costs and financing costs regarding real estate inventories. The Company’s assumptions are based, in part, on general economic conditions, the current state of the homebuilding industry, expectations about the short- and long-term outlook for the housing market, and competition from other homebuilders in the areas in which the Company builds and sells homes. These assumptions can significantly affect the Company’s estimates of future cash flows. For those communities deemed to be impaired, the Company determined fair value based on discounted estimated future cash flows using estimated absorption rates for each community.

The impairment charges recorded during the three and nine months ended September 30, 2007 are as follows (in millions):

The Company recorded additional impairment charges of $28.0 million during the third quarter of 2007 as a result of the continuing slowdown in the housing market and the Company’s current expectations about the pace of sales and sales prices. To date, the Company has recorded impairment charges for five of its active projects. As required by SFAS 144, should market conditions further deteriorate in the future or other events occur that indicate the carrying amount of the Company’s real estate inventories may not be recoverable, the Company will reevaluate the expected cash flows from each project to determine whether any additional impairment exists at any point in time.

Earnings Per Common Share

Earnings per common share is accounted for in accordance with SFAS No. 128, “Earnings Per Share”. Basic earnings per common share is computed using the weighted-average number of common shares outstanding for the period. Diluted earnings per common share is computed using the weighted-average number of common shares outstanding and the dilutive effect of potential common shares outstanding. For the three and nine months ended September 30, 2006, the average market price of the Company’s common stock exceeded the exercise price of outstanding stock options. Therefore, diluted earnings per share includes the dilutive effect of the weighted average number of common shares from the exercise of 12,500 options during the second quarter of 2006, an additional 679,996 options which were exercised during the third quarter of 2006 and the potential exercise of an additional 15,000 options which remained outstanding at September 30, 2006.

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The table below sets forth the reconciliation of the denominator of the earnings per share calculation (in millions):

Recent Accounting Pronouncements

In July 2006, the FASB issued FASB Interpretation No. 48,  “Accounting for Uncertainty in Income Taxes”, (“FIN 48”), which prescribes a recognition threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return. Additionally, FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure requirements for uncertain tax positions. The accounting provisions of FIN 48 are effective for reporting periods beginning after December 15, 2006.  The Company adopted FIN 48 during the first quarter of 2007 and recorded a net reduction to deferred tax assets of $3.3 million. This reduction was recorded as a $3.1 million decrease in additional paid-in capital and a $200,000 decrease in retained earnings as of January 1, 2007 as a cumulative effect of a change in accounting principle.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal periods beginning after November 15, 2007 (the Company’s fiscal year beginning January 1, 2008), and interim periods within those fiscal years. The Company is currently evaluating the impact of adopting SFAS 157 on the consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”), which expands the standards under SFAS 157 and provides entities a one-time election to measure financial instruments and certain other items at fair value. SFAS 159 is effective for financial statements issued for fiscal periods beginning after November 15, 2007 (the Company’s fiscal year beginning January 1, 2008). The Company is currently evaluating the impact of adopting SFAS 159 on its consolidated financial statements.

Note 3 – Real Estate Inventories

Real estate inventories primarily consist of homes under construction and lots under development at Brightwater and seven additional communities in four Southern California counties. At September 30, 2007, real estate inventories aggregated 761 lots and homes, including 21 homes completed and unsold, and 18 homes completed and in escrow. For the three and nine months ended September 30, 2007, real estate inventories reflects asset impairment charges of $28.0 million and $32.0 million, respectively. See additional discussion in Note 2. Real estate inventories at September 30, 2007 included $208.9 million recorded for the Brightwater community which is located on a 105-acre parcel on a mesa north of the Bolsa Chica wetlands (“Upper Mesa”). Brightwater is under development for 356 homes as discussed below. In addition, real estate inventories include approximately 51 acres nearby which have been offered for dedication to the County of Orange for inclusion in the Harriet M. Weider Linear Park in conjunction with the development of Brightwater, and 51 additional acres which are subject to a conservation easement. The carrying value of these two properties is zero. The Company capitalizes carrying costs including interest and property taxes, as well as direct construction costs, to real estate inventories during the development and construction period.

The Brightwater planned community offers a broad mix of home choices, averaging 2,850 square feet and ranging in size from 1,710 square feet to 4,090 square feet. The community also has 37 acres of open space and conservation area. With 349 homes permitted on 68 acres of the Upper Mesa, the resulting low-density plan equates to approximately five homes per acre, consistent and compatible with the neighboring Huntington Beach communities. In addition, the Company owns land adjacent to the Brightwater development, on which it intends to process permits to build seven additional homes which will be included in the Brightwater community.

Model home construction for The Trails and The Sands products was completed in July 2007. The Company began selling homes at The Trails and The Sands in August 2007 and expects to begin delivering homes for these products during the fourth quarter of 2007. As of September 30, 2007, there were 10 Brightwater homes in escrow at an average price of $1.2 million for homes averaging 1,949 square feet. Construction of models for the remaining two products, The Cliffs and The Breakers, began during the first quarter of 2007 and is expected to be completed in January 2008. The Company expects to

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begin offering homes for sale at The Cliffs and The Breakers in February 2008. However, there can be no assurance in that regard, or as to the absence of further development or construction delay.

The estimation process involved in the determination of value is inherently uncertain since it requires estimates as to future events and market conditions. Such estimation process assumes the Company’s ability to complete development and disposition of its real estate properties in the ordinary course of business based on management’s present plans and intentions. Economic and market conditions may affect management’s development and marketing plans. In addition, the implementation of such development and marketing plans could be affected by the availability of future financing for development and construction activities. Accordingly, the amount ultimately realized from such project may differ materially from current estimates and the project’s carrying value.

Capitalized interest is allocated to real estate inventories when incurred and charged to cost of sales when the related property is delivered. Changes in capitalized interest follow (in millions):

Note 4 – Senior Secured Project Revolver

On September 15, 2006, the Company entered into a three-year, $100 Million Senior Secured Revolving Credit Agreement with KeyBank National Association, as a lender and agent for several other lenders (the “Revolving Loan”). The Revolving Loan is secured by a first trust deed on the Brightwater project, and stock pledges of the Company’s material subsidiaries. The Revolving Loan will fund the first $100 million of development and construction costs for the project.

Beginning December 31, 2008 and at the end of each subsequent quarter, the commitment amount will decrease by $25 million until the commitment under the Revolving Loan is reduced to zero by the final maturity date on September 15, 2009. The Revolving Loan is also subject to mandatory repayments based on 40% of the $600,000 release price on the first 50 units closed at the Brightwater project, and 40% of the $1 million release price per unit thereafter. These mandatory repayments are applicable to the commitment reductions set forth above.

Under the Revolving Loan, the Company is required to comply with a number of covenants, including a leverage covenant and a minimum consolidated tangible net worth covenant of $100 million. As a result of the sustained downturn in the homebuilding industry, the tangible net worth covenant was reduced to $80 million, effective as of September 30, 2007, for a fee of $142,500, with no change to the Company’s borrowing rate. As of September 30, 2007, the Company was in compliance with its covenants. As of September 30, 2007, the Company has taken impairment charges totaling $32.0 million which have negatively affected the Company’s earnings and net worth.

Availability under the $100 million Revolving Loan is subject to the applicable borrowing base limitations. The borrowing base limits lender advances to 50% of asset value. The borrowing base value is the appraised value of the Brightwater project, increased for costs incurred subsequent to the most recent lender appraisal and reduced by 72% of the sales value of homes delivered. The initial borrowing base value of the Brightwater project was determined by an independent third-party appraisal of the project on an “as-is” basis as of July 6, 2006. Certain subsidiaries of the Company provided full unconditional guarantees. The Revolving Loan includes financial covenants which may limit the amount that may be borrowed. Outstanding advances bear interest at the Company’s option at either (i) the Alternate Base rate (“Prime”) minus 25 basis points or (ii) LIBOR plus 200 basis points.

As of September 30, 2007 and December 31, 2006, $61.7 million and $18.3 million, respectively, was outstanding under the Revolving Loan. As of September 30, 2007, the undrawn availability was $38.3 million, as limited by the borrowing base formulas. Interest on the facility is calculated on the average, outstanding daily balance and is paid monthly. Interest incurred on the Revolving Loan for the three and nine months ended September 30, 2007 was $900,000 and $2.1 million, respectively, at a weighted-average interest rate of 7.31% and 7.32%, respectively, which reflects the Company’s elected rate of LIBOR plus 2%.

Initial loan fees and closing costs of approximately $800,000 incurred for the Revolving Loan on September 15, 2006 are deferred and included in other assets and amortized over the life of the loan. Amortization of these costs is included

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in the capitalization of interest allocated to real estate inventories when incurred, and charged to cost of sales when the related homes are delivered. As of September 30, 2007 and December 31, 2006, approximately $531,000 and $734,000, respectively, of deferred loan fees and closing costs related to the Revolving Loan are included in other assets.

Note 5 – Senior Secured Term Loan

On September 15, 2006, the Company entered into a five-year, $125 Million Senior Secured Term Loan Agreement with KeyBank National Association, as a lender and agent for several other lenders (the “Term Loan”), and on September 15, 2006, the Company borrowed the maximum loan amount of $125 million. The proceeds were used to fund a “special dividend” of $12.50 per share, totaling $135.7 million, to common stockholders paid on September 28, 2006.

On December 31, 2008, September 30, 2009 and September 30, 2010, the commitment amount will decrease by $15 million, $25 million, and $35 million, respectively. Thereafter, at the end of each subsequent quarter, the Term Loan commitment amount will decrease in four equal installments of $12.5 million, until the commitment under the agreement is reduced to zero by the final maturity date on September 15, 2011. The Term Loan is also subject to mandatory repayments based on 60% of the $600,000 release price on the first 50 units closed at the Brightwater project, and 60% of the $1 million release price per unit thereafter. These mandatory repayments are applicable to the commitment reductions set forth above.

Under the Term Loan, the Company is required to comply with a number of covenants, including covenants related to leverage, a minimum ratio of EBITDA to interest, and a minimum consolidated tangible net worth of $100 million. As a result of the sustained downturn in the homebuilding industry, the Term Loan was amended, effective as of September 30, 2007, for a fee of $187,500, with no change to the Company’s borrowing rate. The amendment reduced the minimum ratio of EBITDA to interest covenant from a range of 1.0 to 2.5, phased in beginning in the first quarter of 2008 through the fourth quarter of 2009, to a range of 1.00 to 2.5, phased in beginning in the third quarter of 2008 through the fourth quarter of 2009 to provide greater operating flexibility and accommodate the Company’s currently anticipated operating results for 2008. The Term Loan was also amended to reduce the tangible net worth covenant from $100 million to $80 million, effective as of September 30, 2007. As of September 30, 2007, the Company is in compliance with these covenants. As of September 30, 2007, the Company has taken impairment charges totaling $32.0 million which have negatively affected the Company’s earnings and net worth.

Availability under the Term Loan is subject to the applicable borrowing base loan to value limitations. The loan to value limits total lender advances under the Term Loan and the Revolving Loan to 65% of asset value. This is based upon the appraised value of the Brightwater project, increased for costs incurred subsequent to the most recent lender appraisal and reduced by 72% of the sales value of homes delivered. The Term Loan is secured by a second trust deed on the Brightwater project, and a general pledge and assignment of the Company’s ownership interests in all material subsidiaries. All existing material subsidiaries of the Company have provided full unconditional guarantees. The Term Loan includes financial covenants which may limit the amount that may be outstanding. The outstanding balance bears interest at the Company’s option at either (i) the prime interest rate plus 25 basis points, or (ii) LIBOR plus 275 basis points.

As of September 30, 2007 and December 31, 2006, $125 million was outstanding under the Term Loan. Interest on the Term Loan is calculated on the average, outstanding daily balance and is paid monthly. Interest incurred on the Term Loan for the three and nine months ended September 30, 2007 was $2.7 million and $7.9 million, respectively, at a weighted-average interest rate of 8.10% and 8.08%, respectively, which reflects the Company’s elected rate of LIBOR plus 2.75%.

Initial loan fees and closing costs of $2.3 million incurred for the Term Loan on September 15, 2006 are deferred and included in other assets and amortized over the life of the loan. Amortization of these costs is included in the capitalization of interest allocated to real estate inventories when incurred, and charged to cost of sales when the related homes are delivered. As of September 30, 2007 and December 31, 2006, approximately $1.8 million and $2.2 million, respectively, of deferred loan fees and closing costs related to the Term Loan are included in other assets.

Under the Term Loan agreement, the Company was required to enter into a swap agreement to hedge against risks associated with fluctuating interests rates related to $62.5 million of floating rate debt. On September 15, 2006 the Company entered into an interest rate swap transaction to effectively fix the interest rate on $62.5 million in floating rate debt at 8.015% per annum. The swap transaction terminates in September 2008. Since the Company does not use derivative financial instruments for trading purposes, the swap did not qualify for hedge accounting under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”. The fair value of the interest rate swap agreement represents the spread between the interest rate the Company paid and the interest rate the Company would receive over the remaining life of the agreement, however, this was insignificant at September 30, 2007. The change in fair value of the interest rate swap

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agreement during the three and nine months ended September 30, 2007 was not material. The counterparties to the interest rate swap agreement are financial institutions.

Note 6 – Other Project Debt

In conjunction with the acquisition of single-family residential lots, the Company’s homebuilding subsidiary, Hearthside Homes, Inc. and its subsidiaries, enter into construction loan agreements with commercial banks. These loan facilities finance a portion of the land acquisition and the majority of the construction of infrastructure and homes. Each loan facility requires a guaranty of project completion and an environmental indemnity. The loans are secured by first trust deeds and bear an interest rate of prime plus one-half or prime plus three-fourths percent (8.25% to 8.5% at September 30, 2007). Some of these loan facilities have a minimum interest rate ranging from 5.75% to 7.5%. During the three and nine months ended September 30, 2007, Hearthside Homes, Inc. did not enter into any new loan facilities.

During the third quarter of 2007, the Company extended the Beaumont loan for three months to December 17, 2007, with the option to exercise three additional three-month extensions subject to achieving minimum sales of four homes for each of the three-month periods beginning September 17, 2007, December 18, 2007 and March 18, 2008. In addition, during October 2007, the Company extended the Ontario and Lancaster loans to December 1, 2007 and September 30, 2008, respectively. The Company has two additional three-month extensions available for the Ontario loan, subject to achieving minimum sales of two homes for each of the three-month periods beginning October 19, 2007 and January 18, 2008, or the equivalent repayment minimums. The Lancaster loan extension requires minimum repayments of $1 million per quarter by January 1, 2008, April 1, 2008 and July 1, 2008. The following amounts were available and outstanding under these loan facilities as of September 30, 2007 and December 31, 2006 ($ in millions):

Note 7 - Other Liabilities

Other liabilities were comprised of the following (in millions):

Contingent indemnity and environmental obligations partially reflect reserves before related discount (recorded pursuant to Fresh-Start Reporting) for contingent indemnity obligations for businesses disposed of by former affiliates and unrelated to the Company’s current operations.

Home Warranty Reserve

The Company provides a home warranty reserve to reflect its contingent obligation for product liability. The Company generally records a provision as homes are delivered, based upon historical and industry experience, for the items listed in the homeowner warranty manual, which does not include items that are covered by manufacturers’ warranties or

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items that are not installed by the Company’s employees or contractors. The home warranty reserve activity is presented below (in millions):

Note 8 - Income Taxes

The following is a summary of the tax provision (benefit):

The net deferred tax balance at September 30, 2007 and December 31, 2006 is primarily composed of federal net operating losses (“NOLs”). The Company has concluded that it is “more likely than not” that the Company will be able to generate sufficient taxable income to realize such assets. Therefore, the Company has no valuation allowance related to the potential utilization of its deferred tax assets due to uncertainties. Such uncertainties include the availability of real estate for development at economically viable prices, government approvals, results of litigation and economic factors affecting the Company’s operations. The Company monitors these, as well as other positive and negative factors that may arise in the future, as it assesses the need for a valuation allowance against its deferred tax assets.

The federal NOLs available as of September 30, 2007 were approximately $137 million. The amount of federal NOLs which expire if not utilized is zero for 2007 and $3 million, $11 million, $49 million, $42 million, and $32 million for 2008, 2009, 2010, 2011 and thereafter, respectively.

The Internal Revenue Code (the “Code”) generally limits the availability of NOLs if an ownership change occurs within any three-year period under Section 382. If the Company were to experience an ownership change of more than 50%, the use of all remaining NOLs would generally be subject to an annual limitation equal to the value of the Company’s equity before the ownership change, multiplied by the long-term tax-exempt rate (4.5% as of October 2007) plus (ii) recognized built-in-gains, defined as those gains recognized within five years of the ownership change subject to an overall limitation of the net unrealized built-in gains existing as of the ownership change date. The Company believes it has net unrealized built-in gains sufficient to allow utilization of the entire net operating loss, assuming that the Company is able to recognize these gains within the five-year time limitation. The Company estimates that after giving effect to various transactions by stockholders who hold a 5% or greater interest in the Company, it has experienced a three-year cumulative ownership shift of approximately 37% as of October 29, 2007, as computed in accordance with Section 382.

On September 18, 2006, the Company’s Board of Directors suspended enforcement of the Company’s charter documents that restrict stockholders from acquiring more than 5% of the outstanding shares of Common Stock. The Board determined that such restrictions were not currently required to preserve the tax benefits of the Company’s $137 million of NOLs. While the Company remains subject to Code section 382, which limits the availability of NOLs in the event of an ownership change, the Company would have five years from the date of any such ownership change to recognize its built in gains and utilize its NOLs. With the commencement of construction at Brightwater in 2006, and the related built-in-gain of the project, the Company believes it will fully utilize its NOLs within the next five years if an ownership change does occur; however, the Board may reinstitute the 5% ownership limitation if required by currently unanticipated events.

Pursuant to SFAS 123(R), the Company has elected to recognize stock option deductions on the tax law ordering method, which maximizes the realization of the stock option deductions in the current year. While the Company realized the majority of its 2006 stock option deductions, approximately $400,000 of unrealized tax benefits related to stock option deductions are not reflected in the consolidated financial statements. Upon realization of the tax benefits, the Company will increase its additional paid-in capital.

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Uncertain Tax Positions

The Company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), on January 1, 2007. As a result of the implementation of FIN 48, during the first quarter of 2007, the Company recorded a $5.1 million decrease in deferred tax assets for unrecognized tax benefits, which was offset by an increase in deferred tax assets of $1.8 million for assets re-evaluated as recognizable. The net change in deferred tax assets of $3.3 million resulted in a decrease to the January 1, 2007 retained earnings balance of $200,000 and a decrease to the additional paid in capital balance of $3.1 million related to fresh-start accounting pursuant to a 1997 pre-packaged bankruptcy. There have been no changes to this amount during the three and nine month periods ended September 30, 2007. Of the Company’s unrecognized tax benefits of $5.1 million at September 30, 2007, $200,000 would decrease the Company’s effective tax rate if recognized. The Company does not believe that its unrecognized tax benefits will significantly fluctuate or change within twelve months of the reporting date.

The Company recognizes interest expense and penalties related to uncertain tax positions as interest or other expense. As of September 30, 2007, the Company has not recorded any interest or penalties related to unrecognized tax benefits.

The tax years 2003-2006 remain open to Federal and California examination, which are the Company’s primary tax jurisdictions. The Company has utilized NOLs generated between 1990 and 1994 to offset taxable income in those years and expects to utilize NOLs generated between 1994 and 1997 and in 1999, 2006 and 2007 in future years.

Note 9 - Commitments and Contingencies

Real Estate Matters

The Company is subject to the usual obligations associated with entering into contracts for the purchase of land and improved home sites. The purchase of properties under these contracts is generally contingent upon satisfaction of certain requirements by the sellers, including obtaining applicable property entitlements. The Company also utilizes option contracts with third-party land sellers and financial entities as a method of acquiring land in staged takedowns and minimizing the use of funds from other corporate financing sources. These option contracts also help to manage the financial and market risk associated with land holdings. Option contracts generally require the payment of a non-refundable cash deposit of 5% to 15% of the purchase price for the right to acquire lots over a specified period of time (usually one to two years) at predetermined prices. The Company has the right at its discretion to terminate its obligations under these land purchase and option agreements by forfeiting the cash deposit with no further financial responsibility. As of December 31, 2006, the Company had one consolidated $25,000 land option deposit which was refunded in September 2007.

The Company has outstanding performance and surety bonds, for the benefit of city and county jurisdictions, related principally to its obligations for site improvements at various projects at September 30, 2007. 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.

Oxnard Land Development Joint Venture

In February 2003, the Company entered into two option contracts to acquire land adjacent to the City of Oxnard in Ventura County, California aggregating approximately 168 acres. The Company is developing a land plan for the area, which also includes an additional 149 acres owned by other landowners, with the intention of entitling the property for residential development and annexing it into Oxnard. During October 2003, the Company entered into a limited liability company joint venture agreement with a major financial partner to pursue the Oxnard development opportunity. The Company assigned the land purchase option contracts to the Oxnard limited liability company (“Oxnard LLC”). Hearthside Homes, Inc., the Company’s homebuilding subsidiary, is the managing member of the Oxnard LLC.

The Oxnard LLC is funded by both of its members. Hearthside Homes, Inc. made an initial contribution of $500,000. The non-managing member also made an initial contribution of $500,000 to the joint venture and, as of December 31, 2005, had made an aggregate of $4 million of first tier additional contributions. In June 2007, the members agreed to provide up to an additional $5.7 million, to be contributed equally by the members, to complete the business plan. As of September 30, 2007, the members have contributed an aggregate of $3.1 million of additional capital. During the three and nine months ended September 30, 2007, the members each contributed approximately $224,000 and $347,000, respectively, to the Oxnard LLC.

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The Company’s total investment in the Oxnard LLC as of September 30, 2007 is $2.4 million. The Company expects to make additional aggregate capital contributions of approximately $140,000 to the Oxnard LLC during the remaining three months of 2007, bringing the Company’s total expected investment to $2.6 million. During the first nine months of 2008, the Company expects to make additional aggregate capital contributions of up to approximately $1.2 million.

In addition to the land purchase options for the project property, the Oxnard LLC held a land purchase option which controlled property which was expected to provide fill dirt for the project property. On April 16, 2007, the Oxnard LLC sold the non-project land purchase option for $1.8 million since the venture has contracted for an alternate source for the fill dirt. The Oxnard LLC received net proceeds of approximately $1.6 million and is utilizing the proceeds to fund ongoing entitlement and development costs.

While the Company exerts a large degree of influence over the venture, the Company’s partner does have various substantive participating rights such as approval rights with regard to the majority of business decisions, including approval of project budgets.

Legal Proceedings

There are various lawsuits and claims pending against the Company and certain subsidiaries. In the opinion of the Company’s management, ultimate liability, if any, will not have a material adverse effect on the Company’s financial condition or results of operations.

California Department of Toxic Substances Control

On October 13, 2006, the California Department of Toxic Substances Control (“DTSC”) filed a civil complaint against the Company’s Hearthside Residential Corp. subsidiary (“HRC”) in the Federal District Court for the Southern Division of the Central District of California. The DTSC’s complaint requests that HRC pay for approximately $1.0 million of costs incurred by the DTSC, together with interest on that amount, primarily in connection with the oversight and remediation of PCB contamination found on residential properties adjacent to a 43-acre site where HRC completed the removal of PCB contaminated soil during September 2005. HRC’s remediation process was approved by the DTSC in December 2005 when it issued a final acceptance of the remediation work. The complaint also seeks an order for HRC to pay any future costs which may be incurred in connection with further remediation, together with court costs and attorney’s fees.

Since May 2004, HRC has received invoices from DTSC seeking reimbursement for these costs; however, HRC contends, based upon advice of counsel, that it is not responsible for such costs because neither HRC nor any affiliate ever developed or built the neighboring residential properties, neither HRC nor any affiliate generated the contamination, and the contamination did not emanate from the 43-acre site that HRC remediated. Furthermore, HRC has also disputed such charges due to the fact that DTSC improperly submitted its bill. This litigation is currently scheduled for a trial date in the fourth quarter of 2008. The Company’s subsidiary intends to vigorously defend itself in this matter. Therefore, the Company has not accrued for any of DTSC’s approximately $1.0 million of claims related to these residential properties.

See Note 7 for a discussion of other contingencies.

Corporate Indemnification Matters

The Company and its former affiliates have, through a variety of transactions effected since 1986, disposed of several assets and businesses, many of which are unrelated to the Company’s current operations. By operation of law or contractual indemnity provisions, the Company may have retained liabilities relating to certain of these assets and businesses. There is generally no maximum obligation or amount of indemnity provided for such liabilities. A portion of such liabilities is supported by insurance or by indemnities from certain of the Company’s previously affiliated companies. The Company believes its consolidated balance sheet reflects adequate reserves for these matters.

Note 10 – Stock Plan

1993 Stock Option/Stock Issuance Plan

The 1993 Stock Option/Stock Issuance Plan (“1993 Plan”) was approved at the 1994 Annual Meeting of Stockholders, reserving 7.5 million shares each of Series A Preferred Stock and Class A Common Stock for issuance to

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officers, key employees and consultants of the Company and its subsidiaries and the non-employee members of the Board of Directors (the “Board”). On April 28, 1997, in connection with the Recapitalization, a new class of Common Stock replaced the Series A Preferred Stock and Class A Common Stock, and the Compensation Committee of the Board authorized the grant of stock options for 759,984 shares, equivalent at that time to 6% of the Company’s fully diluted equity, for certain directors and officers. At the May 2004 and June 2006 stockholder meetings, the stockholders of the Company authorized an additional 150,000 and 250,000 stock options, respectively, for the 1993 Plan, resulting in total authorized grants of 1,159,984.

In January 2007, the Company issued a total of 3,255 shares of its common stock to three independent directors under the Director Fee Program, which is a component of the 1993 Plan. These shares vest at the rate of 25% per quarter during 2007. The Company did not grant any options during the three and nine months ended September 30, 2007. During the comparable periods of 2006, the Company granted 2,500 and 7,500 options, respectively, with a fair value of $24,000 and $71,000, respectively. The grants vest 50% after one year and 100% after two years, and the options have a term of 10 years. Pursuant to SFAS 123 and SFAS 123(R), the Company recorded $28,000 and $98,000 of compensation expense during the three and nine months ended September 30, 2007, respectively, which is reflected in additional paid-in capital. During the comparable periods of 2006, the Company recorded $20,000 and $54,000 of compensation expense. A summary of the status of the Company’s 1993 Plan for the nine months ended September 30, 2007 follows:

As of September 30, 2007, there were 17,500 options outstanding with a weighted-average exercise price of $21.58 (ranging from $13.35 to $25.99) and a weighted-average remaining life of 8.35 years. All outstanding unvested stock options are expected to vest. The aggregate intrinsic value of all outstanding, fully-vested and exercisable stock options at September 30, 2007 was insignificant.

The Company adopted SFAS 123(R) in the first quarter of 2006 using the modified prospective method. Similar to SFAS 123, which the Company adopted in 2003, SFAS 123(R) requires the cost of all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values measured at the grant date, or the date of later modification, over the requisite service period. For tax purposes, the Company expects to be entitled to a tax deduction, subject to certain limitations, based on the fair value of certain equity awards when stock options are exercised. SFAS 123(R) requires that compensation cost be recognized in the financial statements based on the fair value measured at the grant date, or the date of later modification, over the requisite service period. The cumulative compensation cost recognized for equity awards pursuant to SFAS 123(R) and amounts that ultimately will be deductible for tax purposes are temporary differences as prescribed by SFAS 109, “Accounting for Income Taxes”. The tax effect of compensation deductions for tax purposes in excess of compensation cost recognized in the financial statements, if any, will be recorded as an increase to additional paid-in capital when realized. A deferred tax asset recorded for compensation cost recognized in the financial statements that exceeds the amount that is ultimately realized on the tax return, if any, will be charged to income tax expense when the restrictions lapse or stock options are exercised or expire unless the Company has an available additional paid-in capital pool (“APIC Pool”), as defined pursuant to SFAS 123(R). The Company is required to assess whether there is an available APIC Pool when the stock options are exercised or expire.

SFAS 123(R) also amends SFAS 95, “Statement of Cash Flows”, to require companies to change the classification in the statement of cash flows of any tax benefits realized upon the exercise of stock options or issuance of nonvested share unit awards in excess of that which is associated with the expense recognized for financial reporting purposes. These amounts are required to be reported as a financing cash inflow rather than as a reduction of income taxes paid in operating cash flows.

In addition, SFAS 123(R) requires a calculation to establish the beginning pool of excess tax benefits, or the additional paid-in capital pool (“APIC pool”), available to absorb any tax deficiencies recognized after the adoption of SFAS 123(R). The Company has elected the alternative transition method, which includes a simplified calculation method, set forth in FASB Staff Position No. FAS 123(R)-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards” to calculate its beginning APIC pool.

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The Company estimates the fair value of its stock options using the Black-Scholes option pricing model (the “Option Model”).  The Option Model requires the use of subjective and complex assumptions, including the option’s expected term and the estimated future price volatility of the underlying stock, which determine the fair value of the share-based awards.  The Company’s estimate of expected term in 2006 was determined based on the weighted-average period of time that options granted are expected to be outstanding considering current vesting schedules and the historical exercise patterns of the existing option plan.  The expected volatility assumption used in the Option Model is based on historical volatility of the Company’s stock in accordance with guidance provided in SFAS 123(R) and SAB 107.  The risk-free interest rate used in the Option Model is based on the yield of U.S. Treasuries with a maturity closest to the expected term of the Company’s stock options.

The weighted-average assumptions used for stock option grants during the nine months ended September 30 follows:

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ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview of California Coastal Communities, Inc.

We are a residential land development and homebuilding company with properties owned or controlled in five Southern California counties (Los Angeles, Orange, Riverside, San Bernardino and Ventura). Our principal activities include:

•                  obtaining zoning and other entitlements for land we own or control through purchase options or joint ventures;

•                  improving the land for residential development; and

•                  designing, constructing and selling single-family homes in Southern California.

Once our residential land is entitled, we may build homes, sell unimproved land to other developers or homebuilders, sell improved land to homebuilders, or participate in joint ventures with other developers, investors or homebuilders to finance and construct infrastructure and homes. The majority of our homes are designed to appeal to move-up homebuyers and are generally offered for sale in advance of their construction. During the next 12 months, we will focus our primary efforts to:

•                  begin delivering homes for The Trails and The Sands neighborhoods at our 356-home Brightwater project located on the Bolsa Chica mesa in Huntington Beach, California in December 2007;

•                  complete model home construction for The Cliffs and The Breakers neighborhoods at our 356-home Brightwater project and begin offering homes for sale in February 2008;

•                  complete the entitlement process for a 168-acre joint venture project near Oxnard, California currently being planned for 554 single-family detached homes and 347 attached homes (townhomes, condominiums and apartments) during 2008; and

•                  maximize deliveries and revenues of our other homebuilding projects throughout Southern California.

However, we may also consider other strategic opportunities; and there can be no assurance that we will accomplish, in whole or in part, all or any of these strategic goals.

Our total revenues for the three months ended September 30, 2007 and 2006 were $5.2 million and $24.8 million, respectively, and $21.6 million and $71.5 million for the nine months ended September 30, 2007 and 2006, respectively. For the three months ended September 30, 2007 and 2006, we delivered 12 and 36 homes, respectively, and for the nine months ended September 30, 2007 and 2006, we delivered 36 and 113 homes, respectively. Our total assets as of September 30, 2007 and December 31, 2006 were $355.5 million and $332.3 million, respectively. Our homebuilding subsidiary, Hearthside Homes, Inc., has delivered over 2,000 homes to families throughout Southern California since its formation in 1994.

Prior to obtaining the Coastal Development Permit for our Brightwater project in December 2005, we historically maintained a minimal amount of leverage. In September 2006, we obtained $225 million of debt financing as described in Notes 4 and 5 to the consolidated financial statements in this Form 10-Q, which provided $125 million to fund the $12.50 special dividend to our stockholders on September 28, 2006 that is described in Note 13 to the consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2006. As of September 30, 2007, we had $236.8 million of debt against $99.4 million of book equity and a $133.3 million equity market capitalization.

We were formed in 1988 and our executive offices are located at 6 Executive Circle, Suite 250, Irvine, California 92614. Our website address is http://www.californiacoastalcommunities.com and our telephone number is (949) 250-7700. Through our website we make available our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to these reports filed or furnished pursuant to Section 13(d) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after they are filed with, or furnished to, the Securities and Exchange Commission. Copies of our Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to these reports are available free of charge upon request. In addition, at our website we post current versions of our code of ethics, audit committee charter and nominating committee charter.

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Outlook

Our homebuilding outlook varies significantly between the high-end coastal location of our Brightwater project in Huntington Beach and our inland projects. Conditions in the Inland Empire and Lancaster markets continue to be very challenging and we expect these conditions to continue through 2008 or 2009.

While our Brightwater community is exposed to current uncertainties in the housing market which have affected consumer behavior, we remain optimistic about sales at Brightwater due to the limited supply of new home communities on the coast and the absence of competition from other homebuilders in the Huntington Beach market. Given today’s challenging market conditions, we are pleased to have 10 sales orders for The Trails and The Sands neighborhoods as of September 30, 2007 (discussed below under “Our Current and Future Homesites—Brightwater at Bolsa Chica”). We expect the sales pace to increase at Brightwater after we open the larger model homes for The Cliffs and The Breakers in February 2008. While price competition is essential for us to sell homes in our inland markets, we do not plan to offer discounts at Brightwater, which represents one of the last opportunities to purchase a new home in a master-planned community on the Southern California coast.

The housing market downturn that began in 2006 continued into the first nine months of 2007 and is expected to continue through 2008 or 2009. The sustained softness in the housing market is compounded by ongoing difficulties in the mortgage lending industry and the continued tightening of credit available to some homebuyers. During the third quarter of 2007, net new orders increased to 23 homes compared with 17 homes during the comparable period of 2006, primarily due to the grand opening of The Trails and The Sands at Brightwater in August 2007 which yielded 10 sales orders. Cancellations as a percentage of new orders were 28% during the third quarter of 2007, compared with approximately 31% during the first half of 2007, 41% for the fourth quarter of 2006, and 37% for the third quarter of 2006. There were no cancellations at Brightwater during the third quarter of 2007. Backlog as of September 30, 2007 decreased to 28 homes compared with 31 homes as of September 30, 2006 due to fewer homes in backlog at June 30, 2007 and reduced sales activity in our Inland Empire and Lancaster markets during the first nine months of 2007.

This sales slowdown reflects an overall softening of demand for new homes, as well as an oversupply of homes available for sale. We attribute the reduction in demand to reduced affordability of new homes due to rapid price increases between 2002 and 2005 and declines in consumer confidence related to concerns on the part of prospective home buyers about the future direction of home prices, and their ability to obtain financing and sell existing homes. In addition, speculators and investors are no longer helping to fuel demand. We try to avoid selling homes to speculators and start few homes without having a signed agreement of sale. As of September 30, 2007 we had standing inventory of 21 homes compared with 46 homes as of December 31, 2006 and 33 homes as of June 30, 2007.

We have also been impacted by an overall increase in the supply of homes available for sale in our markets as certain large homebuilders continue to build product in excess of current demand and as speculators attempt to sell the homes they previously purchased. At the same time, many of the large national homebuilders operating in our markets are aggressively attempting to reduce their inventories by offering significant incentives and/or lowering prices, leading to lower gross margins on home sales.

As the housing market downturn continues to unfold, we continue to adjust and reevaluate our operating strategy to improve our margins and liquidity. Our operating strategy includes:

•      continuing to assess our owned land position to identify those assets that should be sold or repositioned;

•                  adjusting our cost structure to today’s market conditions by rebidding subcontracts and materials in line with reduced demand;

•                  offering more incentives and price reductions at our inland projects to reduce standing inventories and achieve acceptable levels of sales volume and cash flow; and

•      limiting construction starts to better align with sales activity.

Despite the housing market slowdown, we continue to remain cautiously optimistic about the future growth of our business given the potential of our Brightwater project. The long-term outlook for homebuilding in Southern California remains strong due to the continuing regulation-induced constraints on lot supplies. We have traditionally employed a conservative approach to managing our real estate inventories and believe we are well-positioned, with Brightwater representing 74% of our real estate inventories, to withstand the effects of the continuing market downturn. While the

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current weaknesses in the homebuilding market has impacted our Brightwater project, that impact appears less severe than the weakness in our inland markets. We believe that the reduced impact is a result of Brightwater’s superior coastal location, the extremely limited supply of new homes on the coast of Southern California and the absence of significant competition from other homebuilders in the Huntington Beach market. However, there can be no assurance that further negative impacts will not occur, and there is substantial uncertainty regarding the depth and duration of the current downturn in the Southern California residential real estate market.

In particular, the following events may exert recessionary pressures on the Southern California economy and may have further negative impacts on the Southern California housing market: (i) the ongoing difficulties in the mortgage lending industry and more stringent lending standards which have negatively impacted the ability of certain homebuyers to obtain financing, (ii) increases in foreclosures due to interest rate adjustments on variable rate or “teaser” rate mortgages and other factors, (iii) the significant increases in home prices between 2002 and 2005 and the related decline in the affordability of new homes in Southern California, (iv) the decline in consumer confidence with respect to the housing market, (v) the state of the national economy and the possibility of a recession in the future, and (vi) uncertainties with respect to inflation and the direction of future interest rate changes.

Our Current and Future Homesites

We currently have on-going Southern California homebuilding projects in:

•                  Orange County in the Huntington Beach area;

•                  Riverside County near the cities of Corona and North Corona, and in the City of Beaumont;

•                  San Bernardino County in the City of Ontario; and

•                  Northern Los Angeles County in the City of Lancaster.

We started selling homes at our Brightwater community in Orange County during August 2007 and plan to process permits for seven homes on adjacent parcels in the City of Huntington Beach, which would bring the total unit count up to 356. The following chart describes our current projects, their location and our lot inventories as of September 30, 2007:

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These homebuilding projects are currently expected to generate cash flows and gross operating margins through mid-2011. Up to approximately 554 additional single-family lots could be available for homebuilding operations if we obtain entitlements for our Oxnard project; however, the exact number of homes will depend on the final outcome of the entitlement process.

Brightwater at Bolsa Chica

The 110-acre Bolsa Chica upper mesa is the largest property in our portfolio, representing approximately 74% of our real estate inventories as of September 30, 2007. The Bolsa Chica upper mesa is one of the last large undeveloped coastal properties in Southern California, and is located in Orange County, approximately 35 miles south of downtown Los Angeles. Bolsa Chica is bordered on the north and east by residential development in the City of Huntington Beach and Huntington Harbor, to the south by open space and the 1,200-acre Bolsa Chica wetlands, and to the west by 120 acres of publicly-owned conservation land and open space on the lower bench of the Bolsa Chica mesa, Pacific Coast Highway, Bolsa Chica State Beach, and the Pacific Ocean. Our holdings on the Bolsa Chica mesa include 68 acres of developable land on the upper mesa currently under development for a residential community known as Brightwater, 37 acres of open space and conservation area in the planned community, and five acres in the City of Huntington Beach which are currently zoned agricultural. We are analyzing development alternatives for this 5-acre parcel and expect to submit a proposed site plan to the City of Huntington Beach during 2008.

We also own approximately 104 non-developable acres on, or adjacent to, the Huntington Mesa. Approximately 51 acres of land on the Huntington Mesa have been offered for dedication to the County of Orange for inclusion in the Harriet M. Weider Linear Park in conjunction with the development of Brightwater and an additional 51 acres are subject to a conservation easement.

The Brightwater residential community offers a broad mix of home choices averaging 2,850 square feet and ranging in size from 1,710 square feet to 4,090 square feet. We completed construction of eight model homes for The Trails and The Sands products, which range from 1,710 to 2,160 square feet, in July 2007 and held a grand opening on August 11, 2007. Homes at The Trails and The Sands are currently offered at prices ranging from $1.0 to $1.3 million and the larger homes at The Cliffs (2,724 to 3,477 square feet) and The Breakers (3,174 to 4,090 square feet) are currently expected to be offered for sale beginning in February 2008 at prices starting at approximately $1.7 million and in excess of $2 million, respectively. To date, over 3,000 people have registered on our website requesting information about purchasing a home at Brightwater.

During the third quarter of 2007, we had sales orders for 10 homes at The Trails and The Sands at sales prices ranging from $1.1 to $1.3 million, for homes ranging from 1,710 to 2,160 square feet. For sales orders generated during the third quarter of 2007, the average home size was 1,949 square feet and the average sales price was $1,188,000 or $610 per square foot. We anticipate first deliveries at The Trails and The Sands during the fourth quarter of 2007 which should generate significant gross operating profits. We also currently expect to:

•                  complete construction of nine additional model homes for The Cliffs and The Breakers during January 2008, and

•                  start selling production homes for The Cliffs and The Breakers products during February 2008.

However, there can be no assurance that these targeted dates will be realized, or that further delays will not be encountered.

We used the following facts and assumptions in estimating the value that we expect to receive from the Brightwater development project:

•                  The Brightwater coastal development permit provides for 349 homes aggregating approximately 995,000 square feet.

•                  We own land adjacent to Brightwater in the City of Huntington Beach, for which we intend to process permits to build seven additional homes which would be included in the Brightwater community.

•                  There are 62 homes at Brightwater which will have unobstructed views of the Pacific Ocean and/or the Bolsa Chica wetlands, including 35 homes at The Breakers, 25 homes at The Cliffs and two homes at The Sands.

•                  Build-out of production homes, which is subject to market conditions, is currently expected to take approximately four years and be completed by the end of 2011.

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•                  We completed construction of model homes for The Trails and The Sands products at Brightwater during July 2007. As of September 30, 2007 we have sales orders for 10 homes at The Trails and The Sands ranging from 1,710 to 2,160 square feet. For sales orders generated during the third quarter of 2007, the average home size was 1,949 square feet and the average sales price was $1,188,000 or $610 per square foot.

•                  The finished lot component of home prices ranges from 60% to 65%.

•                  Costs to improve the lots from their raw condition to finished lots, including County permits, City annexation fees and school fees, approximate $199,000 per lot.

•                  The direct costs (excluding indirect costs such as supervision, overhead, sales and marketing, warranty, insurance, etc.) of building homes at Brightwater are currently expected to range from approximately $130 to $150 per square foot.

•                  Indirect costs are expected to approximate 6% of sales revenues.

•                  Brightwater is currently expected to generate gross margins of approximately 30-40% due to our low carrying value in Brightwater.

The estimation process involved in the determination of value is inherently uncertain because it requires estimates as to future events and market conditions. This estimation process assumes our ability to complete development and disposition of our real estate inventories in the ordinary course of business based on management’s present plans and intentions. Economic, market, and environmental conditions may affect our development and marketing plans. The development of Brightwater depends upon various factors. Accordingly, the amount ultimately realized from the Brightwater project may differ materially from our current estimates and the project’s carrying value.

Oxnard Land Development - Unconsolidated Joint Venture

In February 2003, we entered into two option contracts to acquire approximately 168 acres of land adjacent to the City of Oxnard in Ventura County, California. We are developing a land plan for the area, which also includes an additional 149 acres owned by other landowners, with the intention of entitling the property for residential development and annexing it into Oxnard. During October 2003, we entered into a joint venture agreement with a major financial partner to pursue the Oxnard development opportunity. We assigned the land purchase option contracts to the Oxnard joint venture. Hearthside Homes, Inc., our homebuilding subsidiary, is the manager of the Oxnard joint venture.

We currently expect the residential development plan to include approximately 760 single-family detached lots and approximately 630 attached residential units (townhomes, condominiums and apartments); however, these numbers are subject to change during the course of the entitlement process. Approximately 554 of the single-family lots and approximately 347 of the attached units would be developed on the 168 acres of optioned land that we currently expect the Oxnard joint venture to purchase. The single-family detached product is currently expected to range from approximately 1,700 square feet to 3,000 square feet and the attached units are currently expected to range from approximately 1,450 square feet to 1,575 square feet.

The option contracts give the Oxnard joint venture two years, plus up to three and one half additional years through the exercise of extensions, to complete entitlement activities before purchasing the land. The Oxnard joint venture has the right to terminate these option agreements by forfeiting the cash deposits. The Oxnard joint venture is attempting to obtain approval of its plan from the Oxnard City Council in the first half of 2008 and approval of annexation into the City of Oxnard from the Local Agency Formation Commission in the second half of 2008; however, delays could be encountered. If the Oxnard joint venture completes the entitlement process in the time frame set forth above, and decides to build homes (rather than sell lots), most of the homes would be delivered between 2011 and 2015, based on current expectations and assumptions. The Oxnard joint venture has exercised six six-month extensions, extending the current closing date for the option contracts to February 2008, and there is one remaining six-month extension through August 2008.

The Oxnard joint venture is funded by both of its members. Hearthside Homes, Inc. made an initial contribution of $500,000. The non-managing member also made an initial contribution of $500,000 to the joint venture and, as of December 31, 2005, had made an aggregate of $4 million of first tier additional contributions. In June 2007, the members agreed to provide up to an additional $5.7 million, to be contributed equally by the members, to complete the business plan. As of September 30, 2007, the members have contributed an aggregate of $3.1 million of additional capital. During the three and

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nine months ended September 30, 2007, the members each contributed approximately $224,000 and $347,000, respectively, to the joint venture.

Our total investment in the venture as of September 30, 2007 is $2.4 million. We expect to make additional aggregate capital contributions of approximately $140,000 to the joint venture during the remaining three months of 2007, bringing our total expected investment in the venture to $2.6 million. During the first nine months of 2008, we expect to make additional aggregate capital contributions of up to approximately $1.2 million.

In addition to the land purchase options for the project property, the Oxnard joint venture held a land purchase option which controlled property which was expected to provide fill dirt for the project property. On April 16, 2007, the Oxnard joint venture sold the non-project land purchase option for $1.8 million since the venture has contracted for an alternate source for the fill dirt. The Oxnard joint venture received net proceeds of approximately $1.6 million for the land and is utilizing the proceeds to fund ongoing entitlement and development costs.

After payment of a 10% preferred return on invested capital to us and our partner, the first $8 million of profits are allocated 75% to our partner and 25% to us, and profits over $8 million and losses over $5 million are generally allocated on a 50/50 basis in accordance with the operating agreement. The first $5 million of losses are generally allocated 80% to our partner and 20% to us.

While we exert a large degree of influence over the joint venture, our partner does have various substantive participating rights such as approval rights with regard to the majority of business decisions, including approval of project budgets.

Homebuilding

We delivered 12 homes during the third quarter of 2007, compared with 36 deliveries during the comparable period of 2006. We acquired no single-family residential lots during 2006 or the first nine months of 2007. After several years of dramatic home price appreciation in Southern California, we have seen price depreciation during 2006 and 2007 in the Inland Empire (Corona, Ontario and Beaumont) and Lancaster markets. Therefore, we have further reduced sales prices and offered incentives for a number of our homes which are not yet in escrow in response to our competition and to reflect current market pricing. The price reductions and additional incentives are expected to result in significantly reduced gross profits for the Inland Empire and Lancaster markets. As a result, we recorded asset impairment charges of $28.0 million and $32.0 million, respectively, during the three and nine months ended September 30, 2007. These charges relate to our real estate inventories for the remaining homes at our Chandler Ranch, Alisal at Ontario, Woodhaven, Hearthside Lane and Quartz Hill projects. The impairment charges reflect our expectations about home prices, sales pace, sales and marketing costs, infrastructure and homebuilding costs and financing costs for these projects. As required by SFAS 144, should market conditions further deteriorate, we will reevaluate the expected cash flows from our homebuilding projects to determine whether any additional impairment exists.

Deliveries of homes at our Brightwater project in coastal Huntington Beach are expected to commence during the fourth quarter of 2007. We expect to begin offering homes for sale at The Breakers and The Cliffs in February 2008.

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Our homebuilding projects are described below: