| WILLIAM LYON HOMES Item 1A Risk Factors An investment in the Company entails the following risks and uncertainties |
| These risk factors should be carefully considered when evaluating any investment in the Company |
| Any of these risks and uncertainties could cause the actual results to differ materially from the results contemplated by the forward-looking statements set forth herein, and could otherwise have a significant adverse impact on the Company’s business, prospects, financial condition or results of operations or on the price of the Company’s common stock |
| Revenues may decrease and results of operations may be adversely affected as a result of declines in demand for housing and other changes in economic and business conditions |
| The residential homebuilding industry is cyclical and is highly sensitive to changes in general economic conditions such as levels of employment, consumer confidence and income, availability of financing for acquisitions, construction and permanent mortgages, interest rate levels, inflation, in-migration trends and demand for housing |
| For example, California, where many of the Company’s projects are located, underwent a significant recession in the early 1990s that affected demand for housing |
| Should current economic and business conditions decline, demand for housing could be further affected |
| An important segment of the Company’s customer base consists of move-up buyers, who often purchase homes subject to contingencies related to the sale of their existing homes |
| The difficulties facing these buyers in selling their homes during recessionary periods may adversely affect home sales |
| Moreover, during such periods, the Company may need to reduce sales prices and offer greater incentives to buyers to compete for sales that may result in reduced margins |
| Increases in the rate of inflation could adversely affect gross margins by increasing costs and expenses |
| In times of high inflation, demand for housing may decline and the Company may be unable to recover increased costs through higher sales |
| 13 ______________________________________________________________________ [41]Table of Contents Interest rates and the unavailability of mortgage financing can adversely affect demand for housing |
| In general, housing demand is negatively impacted by increases in interest rates and housing costs and the unavailability of mortgage financing |
| Most buyers finance their home purchases through third-party lenders providing mortgage financing |
| If mortgage interest rates increase and, consequently, the ability of prospective buyers to finance home purchases is reduced, home sales, gross margins and cash flow may also be adversely affected and the impact may be material |
| The Federal Reserve Board has recently announced several interest rate increases, which may result in increases in mortgage interest rates |
| The Company’s homebuilding activities also depend upon the availability and costs of mortgage financing for buyers of homes owned by potential customers, as those customers (move-up buyers) often need to sell their existing residences before they purchase the Company’s homes |
| Various proposals have been publicly discussed to limit mortgage interest deductions and to limit the exclusion of gain from the sale of a principal residence |
| Enactment of such proposals may have an adverse effect on the homebuilding industry in general |
| No meaningful prediction can be made as to whether any such proposals will be enacted and, if enacted, the particular form such laws would take |
| Financial condition and results of operations may be adversely affected by any decrease in the value of land inventory, as well as by the associated carrying costs |
| The Company continuously acquires land for replacement and expansion of land inventory within the markets in which it builds |
| The risks inherent in purchasing and developing land increase as consumer demand for housing decreases |
| Thus, the Company may have bought and developed land on which homes cannot be profitably built and sold |
| The market value of land, building lots and housing inventories can fluctuate significantly as a result of changing market conditions |
| The Company employs measures to manage inventory risks which may not be successful |
| In addition, inventory carrying costs can be significant and can result in losses in a poorly performing project or market |
| In the event of significant changes in economic or market conditions, the Company may have to sell homes at significantly lower margins or at a loss |
| Further, the Company may be required to write-down the book value of certain real estate assets in accordance with generally accepted accounting principles, and some of those write-downs could be material |
| Any material write-downs of assets could have a material adverse effect on the Company’s financial condition and earnings |
| Adverse weather and geological conditions may increase costs, cause project delays and reduce consumer demand for housing, all of which would adversely affect the Company’s results of operations and prospects |
| As a homebuilder, the Company is subject to numerous risks, many of which are beyond management’s control, including: adverse weather conditions such as droughts, floods, or wildfires, which could damage projects, cause delays in completion of projects, or reduce consumer demand for housing; shortages in labor or materials, which could delay project completion and cause increases in the prices for labor or materials, thereby affecting the Company’s sales and profitability; and landslides, soil subsidence, earthquakes and other geologic events, which could damage projects, cause delays in the completion of projects or reduce consumer demand for the Company’s projects |
| Many of the Company’s projects are located in California, which has experienced significant earthquake activity |
| In addition to directly damaging the Company’s projects, earthquakes or other geologic events could damage roads and highways providing access to those projects, thereby adversely affecting the Company’s ability to market homes in those areas and possibly increasing the costs of completion |
| For example, losses associated with landslides, earthquakes and other geologic events may not be insurable and other losses, such as those arising from terrorism, may not be economically insurable |
| A sizeable uninsured loss could adversely affect the Company’s business, results of operations and financial condition |
| The Company’s business is geographically concentrated, and sales, results of operations, financial condition and business would be negatively impacted by a decline in regional economies |
| The Company presently conducts all of its business in five geographical areas: Southern California, Northern California, San Diego, California, Arizona and Nevada |
| Because the Company’s operations are concentrated in these geographic areas, a prolonged economic downturn in these markets could cause housing prices and sales to decline, which could have a material adverse effect on the Company’s business, results of operations, and financial condition |
| The Company may not be able to compete effectively against competitors in the homebuilding industry |
| The homebuilding industry is highly competitive |
| Homebuilders compete for, among other things, desirable properties, financing, raw materials and skilled labor |
| The Company competes both with large homebuilding companies, some of which have greater financial, marketing and sales resources than the Company, and with smaller local builders |
| The consolidation of some homebuilding companies may create competitors that have greater financial, marketing and sales resources than the Company and thus are able to compete more effectively against the Company |
| In addition, there may be new entrants in the markets in which the Company currently conducts business |
| The Company also competes for sales with individual resales of existing homes and with available rental housing |
| The Company’s operating results are variable |
| The Company has historically experienced, and in the future expects to continue to experience, variability in operating results on a quarterly and an annual basis |
| Factors expected to contribute to this variability include, among other things: • the timing of land acquisitions and zoning and other regulatory approvals; • the timing of home closings, land sales and level of sales; • product mix; • the ability to continue to acquire additional land or options thereon at acceptable terms; • the condition of the real estate market and the general economy; • delays in construction due to acts of God, adverse weather, reduced subcontractor availability, and strikes; • changes in prevailing interests rates and the availability of mortgage financing; and • costs of material and labor |
| Many of the factors affecting the Company’s results are beyond the Company’s control and may be difficult to predict |
| Difficulty in obtaining sufficient capital could result in increased costs and delays in completion of projects |
| The homebuilding industry is capital intensive and requires significant up-front expenditures to acquire land and begin development |
| Land acquisition, development and construction activities may be adversely affected by any shortage or increased cost of financing or the unwillingness of third parties to engage in joint ventures |
| Any difficulty in obtaining sufficient capital for planned development expenditures could cause project delays and any such delay could result in cost increases and may adversely affect the Company’s sales and future results of operations and cash flows |
| 15 ______________________________________________________________________ [43]Table of Contents The Company’s success depends on key executive officers and personnel |
| The Company’s success is dependent upon the efforts and abilities of its executive officers and other key employees, many of whom have significant experience in the homebuilding industry and in the Company’s regional markets |
| In particular, the Company is dependent upon the services of General William Lyon and Wade H Cable, the Chairman of the Board and Chief Executive Officer and President and Chief Operating Officer, respectively, as well as the services of the division presidents |
| The loss of the services of any of these executives or key personnel, for any reason, could have a material adverse effect upon the Company’s business, operating results and financial condition |
| Construction defect, soil subsidence and other building-related claims may be asserted against the Company, and the Company may be subject to liability for such claims |
| California law provides that consumers can seek redress for patent (ie, observable) defects in new homes within three or four years (depending on the type of claim asserted) from when the defect is discovered or should have been discovered |
| If the defect is latent (ie, non-observable), consumers must still seek redress within three or four years from the date when the defect is discovered or should have been discovered, but in no event later than ten years after the date of substantial completion of the work on the construction |
| Consumers purchasing homes in Arizona and Nevada may also be able to obtain redress under state laws for either patent or latent defects in their new homes |
| Although the Company has obtained insurance for construction defect and subsidence claims, the Company may still be liable for damages, the cost of repairs, and/or the expense of litigation surrounding possible claims, including claims that arise out of uninsurable events, such as landslides or earthquakes, or other circumstances not covered by insurance and not subject to effective indemnification agreements with subcontractors |
| Governmental laws and regulations may increase the Company’s expenses, limit the number of homes that the Company can build or delay completion of projects |
| The Company is subject to numerous local, state, federal and other statutes, ordinances, rules and regulations concerning zoning, development, building design, construction and similar matters which impose restrictive zoning and density requirements in order to limit the number of homes that can eventually be built within the boundaries of a particular area |
| Projects that are not entitled may be subjected to periodic delays, changes in use, less intensive development or elimination of development in certain specific areas due to government regulations |
| The Company may also be subject to periodic delays or may be precluded entirely from developing in certain communities due to building moratoriums or “slow-growth” or “no-growth” initiatives that could be implemented in the future in the states in which the Company operates |
| Local and state governments also have broad discretion regarding the imposition of development fees for projects in their jurisdiction |
| Projects for which the Company has received land use and development entitlements or approvals may still require a variety of other governmental approvals and permits during the development process and can also be impacted adversely by unforeseen health, safety, and welfare issues, which can further delay these projects or prevent their development |
| As a result, home sales could decline and costs increase, which could negatively affect the Company’s results of operations |
| The Company is subject to environmental laws and regulations, which may increase costs, limit the areas in which the Company can build homes and delay completion of projects |
| The Company is also subject to a variety of local, state, federal and other statutes, ordinances, rules and regulations concerning the environment |
| The particular environmental laws which apply to any given homebuilding site vary according to the site’s location, its environmental conditions and the present and former uses of the site, as well as adjoining properties |
| Environmental laws and conditions may result in delays, may cause the Company to incur substantial compliance and other costs, and can prohibit or severely restrict homebuilding activity in environmentally sensitive regions or areas, which could negatively affect the 16 ______________________________________________________________________ [44]Table of Contents Company’s results of operations |
| Under various environmental laws, current or former owners of real estate, as well as certain other categories of parties, may be required to investigate and clean up hazardous or toxic substances or petroleum product releases, and may be held liable to a governmental entity or to third parties for property damage and for investigation and clean up costs incurred by such parties in connection with the contamination |
| In addition, in those cases where an endangered species is involved, environmental rules and regulations can result in the elimination of development in identified environmentally sensitive areas |
| The Company’s results of operations and prospects may be adversely affected if it is not able to acquire desirable lots for residential buildout |
| The Company’s future growth depends upon the Company’s ability to acquire attractive properties for development |
| There is increasing competition for desirable lots in all of the Company’s markets, particularly in California, as the number of properties available for residential development decreases |
| Shortages in available properties could cause the Company to incur additional costs to acquire such properties or could limit the number of future projects and the Company’s growth |
| The Company’s financial position, future results and prospects may be adversely affected if properties at desirable prices and locations are not continually available |
| Utility shortages or price increases could have an adverse impact on operations |
| In prior years, certain areas in northern and southern California have experienced power shortages, including mandatory periods without electrical power, as well as significant increases in utility costs |
| The Company may incur additional costs and may not be able to complete construction on a timely basis if such power shortages and utility rate increases continue |
| Furthermore, power shortages and rate increases may adversely affect the regional economies in which the Company operates, which may reduce demand for housing |
| The Company’s operations may be adversely impacted if further rate increases and/or power shortages occur |
| The Company’s business and results of operations are dependent on the availability and skill of subcontractors |
| Substantially all construction work is done by subcontractors with the Company acting as the general contractor |
| Accordingly, the timing and quality of construction depends on the availability and skill of the Company’s subcontractors |
| While the Company has been able to obtain sufficient materials and subcontractors during times of material shortages and believes that its relationships with suppliers and subcontractors are good, the Company does not have long-term contractual commitments with any subcontractors or suppliers |
| The inability to contract with skilled subcontractors at reasonable costs on a timely basis could have a material adverse effect on the Company’s business and results of operations |
| An ownership change may have occurred with the result that the Company’s ability to use tax net operating loss carryforwards may have been severely limited and thus the Company may have liability for additional taxes |
| On November 11, 1999, the Company implemented transfer restrictions with respect to shares of stock |
| In general, these transfer restrictions prohibited, without the prior approval of the Company’s board of directors, the direct or indirect sale, transfer, disposition, purchase or acquisition of any of the Company’s stock by or to any holder who beneficially owned directly or through attribution 5prca or more of the Company’s stock; or who, upon the direct or indirect sale, transfer, disposition, purchase or acquisition of any of the Company’s stock, would beneficially own directly or through attribution 5prca or more of the Company’s stock |
| These transfer restrictions were intended to help reduce, but not eliminate, the risk of unfavorable ownership changes which could have severely limited the Company’s use of tax benefits from tax net operating loss carryforwards for use in offsetting taxable income |
| (See Note 8 of “Notes to Consolidated Financial Statements” for more information on the Company’s income taxes) |
| It is possible that the tax authorities could take the position that the transfer restrictions did not provide the intended effect or adequate remedies for tax purposes |
| Thus, transactions could 17 ______________________________________________________________________ [45]Table of Contents have occurred that would severely limit the Company’s ability to have used the tax benefits associated with the net operating loss carryforwards |
| In that case, the Internal Revenue Service or state taxing authorities may seek payment from the Company of taxes that would otherwise have been payable by the Company, as well as penalties and interest |
| If the Company was required to make such payments, the Company’s results of operations could be adversely affected |
| Pursuant to the Company’s certificate of incorporation, the transfer restrictions terminated on November 11, 2002 |
| Neither the amount of the net operating loss carryforwards nor the amount of limitation on such carryforwards claimed by the Company have been audited or otherwise validated by the Internal Revenue Service, and it could challenge either amount that the Company has calculated |
| It is possible that legislation or regulations will be adopted that would limit the ability to use the tax benefits associated with the Company’s current tax net operating loss carryforwards |
| The Company’s principal stockholders are General William Lyon and two trusts, of which William H Lyon is the sole beneficiary |
| General William Lyon and two trusts, of which William H Lyon, General William Lyon’s son, is the sole beneficiary, beneficially own over 74prca of the outstanding shares of the Company’s common stock |
| As a result of their stock ownership, General William Lyon and the trusts control the Company and have the power to elect all of the Company’s directors and approve or reject any action requiring the majority approval of the holders of the Company stock, including any merger transactions or any sale of all or substantially all of the Company’s assets |
| General William Lyon and the trusts may vote in their capacity as stockholders to approve strategic transactions which may pose significant risks, such as an acquisition that significantly increases the Company’s indebtedness |
| Increased insurance costs and reduced insurance coverages may affect the Company’s results of operations and increase the potential exposure to liability |
| Recently, lawsuits have been filed against builders asserting claims of personal injury and property damage caused by the presence of mold in residential dwellings |
| Some of these lawsuits have resulted in substantial monetary judgments or settlements against these builders |
| The Company’s insurance may not cover all of the claims, including personal injury claims, arising from the presence of mold or such coverage may become prohibitively expensive |
| If the Company is unable to obtain adequate insurance coverage, a material adverse effect on business, financial condition and results of operations could result if the Company is exposed to claims arising from the presence of mold |
| The cost of insurance has risen, deductibles and retentions have increased and the availability of insurance has diminished |
| Significant increases in the cost of insurance coverage or significant limitations on coverage could have a material adverse effect on business, financial condition and results of operations from such increased costs or from liability for significant uninsurable or underinsured claims |
| The Company’s substantial level of indebtedness could adversely affect its financial condition and prevent it from fulfilling its obligations |
| Subject to restrictions, the Company may incur substantial additional indebtedness |
| The Company’s high level of indebtedness could have important consequences, including the following: • the ability to obtain additional financing for working capital, land acquisition costs, building costs, other capital expenditures, or general corporate purposes, may be impaired; 18 ______________________________________________________________________ [46]Table of Contents • the Company will need to use a substantial portion of cash flow from operations to pay interest and principal on its senior notes and other indebtedness, which will reduce the funds available for other purposes; • the Company will have a higher level of indebtedness than competitors, which may put the Company at a competitive disadvantage and reduce the Company’s flexibility in planning for, or responding to, changing conditions in the industry, including increased competition; • substantially all of the Company’s assets are pledged as security for the Company’s credit agreements and a default on the secured debt could result in foreclosure on the Company’s assets which could, under certain circumstances, limit or prohibit the ability to operate as a going concern; and • the Company will be more vulnerable to economic downturns and adverse developments in the business |
| The Company expects to obtain the money to pay expenses and to pay the principal and interest on the Company’s senior notes, and other obligations from cash flow from operations |
| The Company’s ability to meet expenses depends on future performance, which will be affected by financial, business, economic and other factors |
| The Company will not be able to control many of these factors, such as economic conditions in the markets where the Company operates and pressure from competitors |
| The Company cannot be certain that the cash flow will be sufficient to allow it to pay principal and interest on debt, including the senior notes, support operations, and meet other obligations |
| If the Company does not have the resources, the Company may be required to refinance all or part of the existing debt, including the senior notes, sell assets or borrow more money |
| The Company may not be able to do so on acceptable terms, if at all |
| In addition, the terms of existing or future debt agreements, including the credit facilities and the senior note indentures, may restrict the Company from pursuing any of these alternatives |
| The Company is the general partner in partnership joint ventures and may be liable for joint venture obligations |
| Certain of the Company’s active joint ventures are organized as limited partnerships |
| The Company is the general partner in each of these and may serve as the general partner in future joint ventures |
| As a general partner, the Company may be liable for a joint venture’s liabilities and obligations should the joint venture fail or be unable to pay these liabilities or obligations |
| In addition, the Company has provided unsecured environmental indemnities to some of the lenders who provide loans to the partnerships |
| The Company has also provided a completion guarantee for a limited partnership under its credit facility |
| If the Company were required to satisfy such liabilities, obligations or completion guarantee, the results of operations could be adversely affected |
| The Company’s senior notes are unsecured, and effectively subordinated to other secured indebtedness |
| The Company’s credit facilities and construction loans are secured by liens on the real estate under development that is financed by those facilities or loans |
| If the Company becomes insolvent or is liquidated, or if payment under any secured indebtedness was accelerated, the holders of the Company’s secured indebtedness would be entitled to repayment from their collateral before those assets could be used to satisfy any unsecured claims, including claims under the Company’s senior notes or any guarantees of these notes |
| As a result, the senior notes will be effectively subordinated to the secured indebtedness to the extent of the value of the assets securing that indebtedness, and the holders of the notes will likely recover ratably less than the secured creditors |
| The guarantees of the Company’s senior notes by the Company’s subsidiaries may be avoidable as fraudulent transfers and any new guarantees may be avoidable as preferences |
| The guarantees of the Company’s senior notes by the Company’s subsidiaries may be subject to review under US bankruptcy law and comparable provisions of state fraudulent conveyance laws |
| Under these laws, if a court were to find that, at the time any subsidiary guarantor issued a guarantee of the notes: 19 ______________________________________________________________________ [47]Table of Contents • it issued the guarantee to delay, hinder or defraud present or future creditors; or • it received less than reasonably equivalent value or fair consideration for issuing the guarantee at the time it issued the guarantee and: • it was insolvent or rendered insolvent by reason of issuing the guarantee; or • it was engaged, or about to engage, in a business or transaction for which its assets constituted unreasonably small capital to carry on its business; or • it intended to incur, or believed that it would incur, debts beyond its ability to pay as they mature; then the court could avoid the obligations under the guarantee, subordinate the guarantee of the senior notes to that of the guarantor’s other debt, require holders of the senior notes to return amounts already paid under that guarantee, or take other action detrimental to holders of the senior notes and the guarantees of the senior notes |
| The measures of insolvency for purposes of fraudulent transfer laws vary depending upon the law of the jurisdiction that is being applied in any proceeding to determine whether a fraudulent transfer had occurred |
| Generally, however, a person would be considered insolvent if, at the time it incurred the debt: • the present fair saleable value of its assets was less than the amount that would be required to pay its probable liability on its existing debts, including contingent liabilities, as they become absolute and mature; or • it could not pay its debts as they become due |
| The Company cannot be sure what standard a court would use to determine whether or not a guarantor was solvent at the relevant time, or, regardless of the standard that the court uses, that the issuance of the guarantee would not be avoided or the guarantee would not be subordinated to the guarantors’ other debt |
| If such a case were to occur, the guarantee could also be subject to the claim that, since the guarantee was incurred for the benefit of the issuer of the senior notes, and only indirectly for the benefit of the guarantor, the obligations of the applicable guarantor were incurred for less than fair consideration |
| In addition, if the Company is required to grant an additional subsidiary guarantee for the notes at a time in the future when the guarantor was insolvent, its guarantee may also be avoidable as a preference under US bankruptcy law or comparable provisions of state law |
| The indentures for the senior notes impose significant operating and financial restrictions, which may prevent us from capitalizing on business opportunities and taking some corporate actions |
| The indentures for the senior notes impose significant operating and financial restrictions |
| These restrictions limit the ability of the Company and its subsidiaries, among other things, to: • incur additional indebtedness; • pay dividends or make other distributions or repurchase or redeem the Company’s stock; • make investments; • sell assets; • incur liens; • enter into agreements restricting the Company’s subsidiaries’ ability to pay dividends; • enter into transactions with affiliates; and • consolidate, merge or sell all or substantially all of the Company’s assets |
| 20 ______________________________________________________________________ [48]Table of Contents The Company’s other debt agreements contain additional restrictions |
| In addition, the Company may in the future enter into other agreements governing indebtedness which impose yet additional restrictions |
| These restrictions may adversely affect the Company’s ability to finance future operations or capital needs or to pursue available business opportunities |
| A breach of any of these covenants could result in a default in respect of the related indebtedness |
| If a default occurs, the relevant lenders could elect to declare the indebtedness, together with accrued interest and other fees, to be immediately due and payable and proceed against any collateral securing that indebtedness |
| The Company may not be able to satisfy its obligations upon a change of control |
| Upon the occurrence of a “change of control,” as defined in the senior notes indentures, each holder of the senior notes will have the right to require the Company to purchase the senior notes at a price equal to 101prca of the principal amount, together with any accrued and unpaid interest, to the date of purchase |
| The Company’s failure to purchase, or give notice of purchase of, the senior notes would be a default under the indenture, which could in turn be a default under the Company’s other indebtedness |
| In addition, a change of control may constitute an event of default under the Company’s credit facilities |
| A default under the Company’s credit facilities could result in an event of default under the indentures if the lenders accelerate the debt under the credit facilities |
| If this event occurs, the Company may not have enough assets to satisfy all obligations under the indentures and any other indebtedness |
| In order to satisfy the obligations, the Company could seek to refinance the indebtedness under the senior notes and any other indebtedness or obtain a waiver from the holders of the indebtedness |
| The Company may not be able to obtain a waiver or refinance the indebtedness on acceptable terms |
| In addition, the definition of change of control in the indentures governing the senior notes includes a phrase relating to the sale, lease, transfer, conveyance or other disposition of “all or substantially all” of the assets of the Company and the restricted subsidiaries |
| Although there is a developing body of case law interpreting the phrase “substantially all,” there is no precise established definition of the phrase under applicable law |
| Accordingly, the ability of a holder of senior notes to require the Company to repurchase such notes as a result of a sale, lease, transfer, conveyance or other disposition of less than all of the assets of the Company and the restricted subsidiaries may be uncertain |
| Moreover, under the indentures governing the senior notes, the Company could engage in certain important corporate events, including acquisitions, refinancings or other recapitalizations or highly leveraged transactions, that would not constitute a change of control under the indentures and thus would not give rise to any repurchase rights, but which could increase the amount of indebtedness outstanding at such time or otherwise affect the Company’s capital structure or credit ratings or otherwise adversely affect holders of the senior notes |
| Any such transaction, however, would have to comply with the operating and financial restrictions contained in the indentures governing the senior notes |