DESCRIPTION OF BUSINESS AND NATURE OF OPERATIONS:

As used in this report, unless the context otherwise requires or indicates, references to “the Company,” and “UCP” refer (1) prior to the July 23, 2013 completion of the initial public offering of Class A common stock, par value $0.01 per share ( “Class A common stock”) of UCP, Inc. (the “IPO”) and related transactions, to UCP, LLC and its consolidated subsidiaries and (2) after the IPO and related transactions, to UCP, Inc. and its consolidated subsidiaries including UCP, LLC. UCP, Inc. had nominal assets and no liabilities, and conducted no operations prior to the completion of the Company’s IPO. Presentation of the historical results of UCP, Inc. would not be meaningful and accordingly the historical financial information prior to the IPO represents those of UCP, LLC.

Business Description and Organizational Structure of the Company:

Company’s Business

The Company is a homebuilder and land developer with land acquisition and entitlement expertise in California and Washington State.

Company’s History

The Company’s operations began in 2004, and principally focused on acquiring land, entitling and developing it for residential construction, and selling residential lots to third-party homebuilders. In January 2008, the Company’s business was acquired by PICO Holdings, Inc. (“PICO”), a NASDAQ -listed, diversified holding company, which allowed the Company to accelerate the development of its business and gain access to a capital partner capable of funding its growth. In 2010, the Company formed Benchmark Communities, LLC, its wholly owned homebuilding subsidiary, to design, construct and sell high quality single-family homes.

Company’s Reorganization and the IPO

UCP, Inc. was incorporated in the State of Delaware on May 7, 2013 as a wholly-owned subsidiary of PICO for the purpose of facilitating the IPO and to become a holding company owning, as its principal asset, membership interests in UCP, LLC. UCP, LLC is a holding company for the entities that directly or indirectly own and operate the Company’s business. The net proceeds of $105.5 million from the IPO, were used by UCP, Inc. for acquiring the 42.3% ownership in UCP, LLC.

As of December 31, 2012 and 2011, the Company's capital structure was comprised solely of PICO's membership interests and the Company did not have any outstanding shares. During the years ended December 31, 2013 (prior to the completion of the IPO), 2012 and 2011, the Company received $37.5 million, $41.0 million and $30.5 million, respectively in contributions from PICO. As the Company generated excess cash, primarily from the sale of real estate inventories, it repaid $25.4 million, $34.7 million and $18.3 million of the contributions to PICO during the years ended December 31, 2013 (prior to the completion of the IPO), 2012 and 2011, respectively. Subsequent to the IPO, the Company has not received additional contributions from PICO or repaid any additional contributions to PICO, and does not anticipate receiving additional contributions from PICO or repaying any remaining contributions to PICO.

Prior to the completion of the IPO, PICO allocated expenses to the Company for certain corporate services and other expenses. The material expenses allocated were payroll and benefits, which were allocated based on estimated time for the services provided. The service costs allocated included executive management, information technology, legal, finance and accounting, human resources, risk management, tax and treasury. The total amounts of the expense allocations from PICO to the Company for the years ended December 31, 2013, 2012, and 2011 were $0.6 million, $1.2 million and $0.9 million, respectively. Of these expenses, $0.6 million, $0 and $0 were payable as of December 31, 2013, 2012 and 2011, respectively. These expense allocations are primarily reflected within general and administrative expenses in the Company's consolidated statements of operations and comprehensive income or loss. The Company's management believes the basis on which the expenses have been allocated is a reasonable reflection of the services and other benefits received by the Company during the periods presented, and that the financial statements reflect all of the costs of doing business related to the Company's operations, including expenses incurred by PICO on the Company's behalf.

Upon completion of the IPO, UCP, Inc. issued 7,750,000 shares of Class A common stock (par value $0.01 per share) at a public offering price of $15.00 per share and received net proceeds of $105.5 million after deducting the underwriting discount, and other offering costs. UCP, Inc. invested these net proceeds into UCP, LLC and acquired UCP, LLC’s newly-issued Series B Units (as defined below), which represents a 42.3% economic interest in UCP, LLC; PICO, through its ownership of UCP, LLC Series A Units (as defined below), holds the remaining 57.7% economic interest in UCP, LLC.

In connection with the IPO, UCP, LLC's Amended and Restated Limited Liability Company Operating Agreement was amended and restated to, among other things, designate UCP, Inc. as the sole managing member of UCP, LLC and establish a new series of units (“UCP, LLC Series B Units”), are held solely by UCP, Inc., and reclassify PICO's units into 10,593,000 UCP, LLC Series A Units (the “UCP, LLC Series A Units”), which are held solely by PICO (and its permitted transferees). UCP, Inc. purchased 7,750,000 UCP, LLC Series B Units through its investment in UCP, LLC with the net proceeds from the IPO. The UCP, LLC Series B Units rank on a parity with the UCP, LLC Series A Units as to distribution rights and rights upon liquidation, winding up or dissolution. Subsequent to the IPO and related transactions, as the sole managing member of UCP, LLC, UCP, Inc. operates and controls all of the business and affairs and consolidates the financial results of UCP, LLC and its subsidiaries.

The amended and restated certificate of incorporation of UCP, Inc. authorizes two classes of common stock: Class A common stock, and Class B common stock, par value $0.01 per share (“Class B common stock”). Shares of Class A common stock represent 100% of the economic rights of the holders of all classes of UCP, Inc.'s common stock. Shares of Class B common stock, which are held exclusively by PICO, are not entitled to any dividends paid by, or rights upon liquidation of, UCP, Inc. PICO holds 100 shares of Class B common stock of UCP, Inc., providing PICO with no economic rights but entitling PICO, without regard to the number of shares of Class B common stock held by PICO, to one vote on matters presented to stockholders of UCP, Inc. for each UCP, LLC Series A Unit held by PICO. Holders of the Company’s Class A common stock and Class B common stock will vote together as a single class on all matters presented to the Company’s stockholders for their vote or approval, except as otherwise required by applicable law. As of July 23, 2013, PICO held 10,593,000 UCP, LLC Series A Units and 100 shares of Class B common stock, which provide PICO with 57.7% of the aggregate voting power of UCP, Inc.'s outstanding Class A common stock and Class B common stock, effectively providing PICO with control over the outcome of votes on all matters requiring approval by the Company’s stockholders.

The Company's charter provides that its board of directors has the authority, without action by the stockholders, to designate and issue up to 50,000,000 shares of preferred stock in one or more classes or series and to fix for each class or series the powers, rights, preferences and privileges of each series of preferred stock, including dividend rights, conversion rights, voting rights, terms of redemption, liquidation preferences and the number of shares constituting any class or series, which may be greater than the rights of the holders of the Class A common stock or Class B common stock. The Company has no present plans to issue any shares of preferred stock.

Exchange Agreement

In connection with the IPO, UCP, Inc. entered into an Exchange Agreement, pursuant to which PICO (and its permitted transferees) have the right to cause UCP, Inc. to exchange PICO's UCP, LLC Series A Units for shares of UCP, Inc. Class A common stock on a one-for-one basis, subject to equitable adjustments for stock splits, stock dividends and reclassifications. As of December 31, 2013, giving effect to the Class A common stock that the Company would issue if PICO were to elect to exchange all of its UCP, LLC Series A Units for shares of Class A common stock, the Company would have 18,343,000 shares of Class A common stock outstanding. In addition, in connection with the IPO, the Company issued an aggregate of 430,333 Class A restricted stock units to the members of its management team, other officers and employees and directors. These Class A restricted stock units vest at various points in time beginning December 31, 2013 through 2015, and the Company will issue Class A common stock on a one-for-one basis in connection with the vesting of each Class A restricted stock unit. Any UCP, LLC Series A Units being exchanged will be reclassified as UCP, LLC Series B Units in connection with such exchange. Exchanges by PICO of its UCP, LLC Series A Units for shares of UCP, Inc. Class A common stock are expected to result, with respect to UCP, Inc., in increases in the tax basis of the assets of UCP, LLC that otherwise would not have been available. These increases in tax basis may reduce the amount of tax that UCP, Inc. would otherwise be required to pay in the future. These increases in tax basis may also decrease gains (or increase losses) on future dispositions of certain assets to the extent tax basis is allocated to those assets.

Tax Receivable Agreement

In connection with the IPO, the Company entered into a tax receivable agreement (“TRA”) with PICO. When PICO sells or exchanges its UCP, LLC Series A Units for shares of the Company’s Class A common stock, such a sale or exchange by PICO would result in an adjustment to the tax basis of the assets owned by UCP, LLC at the time of an exchange. An increase in tax basis is expected to increase the depreciation and amortization income tax deductions and create other tax benefits and therefore may reduce the amount of income tax that the Company would otherwise be required to pay in the future. Under the TRA, the Company generally is required to pay to PICO 85% of the applicable cash savings in U.S. federal and state income tax that the Company actually realizes (or is deemed to realize in certain circumstances) as a result of sales or exchanges of the Series A units held by PICO for shares of Class A common stock, leaving the Company with 15% of the benefits of the tax savings. Cash savings in income tax will be computed by comparing the Company’s actual income tax liability to the amount of income taxes that the Company would have been required to pay had there been no increase in the tax basis of the tangible and intangible assets of UCP, LLC as a result of the exchanges. If the Company does not have taxable income in a given taxable year, no payment under the TRA for that taxable year is required because no tax savings will have been realized.

As of December 31, 2013, PICO has not exchanged any of its UCP, LLC Series A Units. Estimating the amount of future payments to be made under the TRA cannot be done reliably at this time because any increase in tax basis, as well as the amount and timing of any payments will vary depending on a number of factors, including:


•	the timing of any exchanges of UCP, LLC Series A Units for shares of the Company’s Class A common stock by PICO, as the increase in any tax deductions will vary depending on the allocation of fair market value to the assets of UCP, LLC at the time of any such exchanges, and this value allocation may fluctuate over time;

•

the price of the Company’s Class A common stock at the time of any exchanges of UCP, LLC Series A Units for shares of the Company’s Class A common stock (since the increase in the Company’s share of the basis in the assets of UCP, LLC, as well as the corresponding increase in any tax deductions, will be related to the price of the Company’s Class A common stock at the time of any such exchanges);


•	the tax rates in effect at the time the Company uses the increased amortization and depreciation deductions or realize other tax benefits; and


•	the amount, character and timing of the Company’s taxable income.

The effects of the TRA on the Company’s consolidated balance sheet if PICO elects to exchange all or a portion of its UCP, LLC Series A Units for the Company’s Class A common stock will be as follows:

•

an increase in deferred tax assets for the estimated income tax effects of the increase in the tax basis of the assets owned by UCP, LLC based on enacted federal, state and local income tax rates at the date of the relevant transaction. To the extent the Company believes that it is more likely than not that the Company will not realize the full tax benefit represented by the deferred tax asset, the Company will reduce the deferred tax asset with a valuation allowance;


•	the Company may record 85% of the applicable cash tax savings in U.S. federal and state income taxes resulting from the increase in the tax basis of the UCP, LLC Series A Units and certain other tax benefits related to entering into the TRA, including tax benefits attributable to payments under the TRA as an increase in a payable due to PICO; and


•	an increase to additional paid-in capital equal to the difference between the increase in deferred tax assets and the increase in the liability due to PICO.

The Company has the right to terminate the TRA at any time. In addition, the TRA will terminate early if the Company breaches obligations under the TRA or upon certain mergers, asset sales, other forms of business combinations or other changes of control. In either case, the Company’s payment obligations under the TRA would be accelerated and would become due and payable based on certain assumptions, including that (a) all the UCP, LLC Series A Units are deemed exchanged for their fair value, (b) the Company would have sufficient taxable income to fully utilize the deductions arising from the increased tax deductions and tax basis and (c) the subsidiaries of UCP, LLC will sell certain nonamortizable assets (and realize certain related tax benefits) no later than a specified date. In each of these instances, the Company would be required to make an immediate payment to PICO equal to the present value of the anticipated future tax benefits (discounted over the applicable amortization and depreciation periods for the assets the tax bases of which are stepped up (which could be as long as fifteen years in respect of intangibles and goodwill) at a discount rate equal to LIBOR plus 100 basis points). The benefits would be payable even though, in certain circumstances, no UCP, LLC Series A Units are actually exchanged at the time of the accelerated payment under the TRA, thereby resulting in no corresponding tax basis step up at the time of such accelerated payment under the TRA.

Transition Services Agreement and Investor Rights Agreement

UCP, Inc. also entered into a Transition Services Agreement (“TSA”) with PICO, pursuant to which PICO provides certain services to UCP, Inc., including, among other things, accounting, human resources and information technology services.

Additionally, pursuant to an Investor Rights Agreement that UCP, Inc. entered into with PICO in connection with the IPO, PICO has the right to nominate two individuals for election to UCP, Inc.'s board of directors for as long as PICO owns 25% or more of the combined voting power of UCP, Inc.'s outstanding Class A and Class B common stock and one individual for as long as it owns at least 10% (in each case, excluding shares of any of UCP, Inc.'s common stock that are subject to issuance upon the exercise or exchange of rights of conversion or any options, warrants or other rights to acquire shares). However, the Investor Rights Agreement does not entitle PICO to nominate individuals for election to UCP, Inc.'s board of directors if their election would result in PICO nominees comprising more than two of UCP, Inc.'s directors (for as long as PICO owns 25% or more of the combined voting power of UCP, Inc.'s outstanding Class A and Class B common stock) or one of UCP, Inc.'s directors (for as long as PICO owns at least 10% of the combined voting power of UCP, Inc.'s outstanding Class A and Class B common stock).