Form 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM 10-Q

(Mark One)

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2007

OR

 

¨

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File No. 1-8951

M.D.C. HOLDINGS, INC.

(Exact name of Registrant as specified in its charter)

 

Delaware   84-0622967

(State or other jurisdiction

of incorporation or organization)

 

(I.R.S. employer

identification no.)

4350 South Monaco Street, Suite 500 Denver, Colorado  

80237

(Zip code)

(Address of principal executive offices)  

(303) 773-1100

(Registrant’s telephone number, including area code)

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  ¨

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

Large Accelerated Filer  x    Accelerated Filer  ¨    Non-Accelerated Filer  ¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  ¨  No  x

As of September 30, 2007, 45,838,000 shares of M.D.C. Holdings, Inc. common stock were outstanding.

 



Table of Contents

M.D.C. HOLDINGS, INC. AND SUBSIDIARIES

FORM 10-Q

FOR THE QUARTER ENDED SEPTEMBER 30, 2007

INDEX

 

            

Page

No.

Part I.   Financial Information:   
  Item 1.  

Unaudited Consolidated Financial Statements:

   1
   

Consolidated Balance Sheets at September 30, 2007 and December 31, 2006

   1
   

Consolidated Statements of Operations for the three and nine months ended September 30, 2007 and 2006

   2
   

Consolidated Statements of Cash Flows for the nine months ended September 30, 2007 and 2006

   3
   

Notes to Unaudited Consolidated Financial Statements

   4
  Item 2.  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   25
  Item 3.  

Quantitative and Qualitative Disclosures About Market Risk

   48
  Item 4.  

Controls and Procedures

   48
Part II.   Other Information:   
  Item 1.  

Legal Proceedings

   49
  Item 1A.  

Risk Factors

   50
  Item 2.  

Unregistered Sales of Equity Securities and Use of Proceeds

   53
  Item 3.  

Defaults Upon Senior Securities

   53
  Item 4.  

Submission of Matters to a Vote of Security Holders

   53
  Item 5.  

Other Information

   54
  Item 6.  

Exhibits

   54
  Signature    55

 

(i)


Table of Contents
ITEM 1. Unaudited Consolidated Financial Statements

M.D.C. HOLDINGS, INC.

Consolidated Balance Sheets

(In thousands, except share and per share amounts)

(Unaudited)

 

     September 30,
2007
    December 31,
2006
 

ASSETS

    

Cash and cash equivalents

   $ 729,479     $ 507,947  

Restricted cash

     1,633       2,641  

Home sales and other receivables

     66,891       143,936  

Mortgage loans held in inventory, net

     72,863       212,903  

Income taxes receivable, net

     22,748       -  

Inventories

    

Housing completed or under construction

     1,267,478       1,178,671  

Land and land under development

     754,728       1,575,158  

Property and equipment, net

     47,020       44,606  

Deferred income taxes

     306,942       124,880  

Prepaid expenses and other assets, net

     91,471       119,133  
                

Total Assets

   $ 3,361,253     $ 3,909,875  
                

LIABILITIES

    

Accounts payable

   $ 150,037     $ 171,005  

Accrued liabilities

     369,168       418,953  

Income taxes payable

     -       28,485  

Related party liabilities

     701       2,401  

Homebuilding line of credit

     -       -  

Mortgage line of credit

     41,957       130,467  

Senior notes, net

     996,986       996,682  
                

Total Liabilities

     1,558,849       1,747,993  
                

COMMITMENTS AND CONTINGENCIES

     -       -  
                

STOCKHOLDERS’ EQUITY

    

Preferred stock, $0.01 par value; 25,000,000 shares authorized; none issued or outstanding

     -       -  

Common stock, $0.01 par value; 250,000,000 shares authorized; 45,869,000 and 45,838,000 issued and outstanding, respectively, at September 30, 2007 and 45,179,000 and 45,165,000 issued and outstanding, respectively, at December 31, 2006

     459       452  

Additional paid-in-capital

     791,212       760,831  

Retained earnings

     1,012,395       1,402,261  

Accumulated other comprehensive loss

     (1,003 )     (1,003 )

Treasury stock, at cost; 31,000 and 14,000 shares at September 30, 2007 and December 31, 2006, respectively

     (659 )     (659 )
                

Total Stockholders’ Equity

     1,802,404       2,161,882  
                

Total Liabilities and Stockholders’ Equity

   $   3,361,253     $   3,909,875  
                

The accompanying Notes are an integral part of the Unaudited Consolidated Financial Statements.

 

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Table of Contents

M.D.C. HOLDINGS, INC.

Consolidated Statements of Operations

(In thousands, except per share amounts)

(Unaudited)

 

    

Three Months

Ended September 30,

   

Nine Months

Ended September 30,

 
     2007     2006     2007     2006  

REVENUE

        

Home sales revenue

   $ 651,124     $ 1,050,700     $ 2,050,737     $ 3,356,416  

Land sales revenue

     2,700       3,336       12,151       18,812  

Other revenue

     32,837       26,887       85,605       83,101  
                                

Total Revenue

     686,661       1,080,923       2,148,493       3,458,329  
                                

COSTS AND EXPENSES

        

Home cost of sales

     559,402       813,824       1,749,165       2,540,381  

Land cost of sales

     452       3,210       7,740       18,124  

Asset impairments

     248,950       19,915       551,422       20,775  

Marketing expenses

     28,694       31,296       87,144       91,899  

Commission expenses

     23,900       36,390       71,530       106,627  

General and administrative expenses

     76,482       99,779       247,229       326,595  

Related party expenses

     95       88       286       2,792  
                                

Total Costs and Expenses

     937,975       1,004,502       2,714,516       3,107,193  
                                

(Loss) income before income taxes

     (251,314 )     76,421       (566,023 )     351,136  

Benefit from (provision for) income taxes

     95,936       (27,715 )     210,175       (130,518 )
                                

NET (LOSS) INCOME

   $ (155,378 )   $ 48,706     $ (355,848 )   $ 220,618  
                                

(LOSS) EARNINGS PER SHARE

        

Basic

   $ (3.40 )   $ 1.08     $ (7.79 )   $ 4.91  
                                

Diluted

   $ (3.40 )   $ 1.06     $ (7.79 )   $ 4.80  
                                

WEIGHTED-AVERAGE SHARES

        

Basic

     45,751       44,972       45,659       44,911  
                                

Diluted

     45,751       45,868       45,659       45,932  
                                

DIVIDENDS DECLARED PER SHARE

   $            0.25     $            0.25     $            0.75     $            0.75  
                                

The accompanying Notes are an integral part of the Unaudited Consolidated Financial Statements.

 

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M.D.C. HOLDINGS, INC.

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

     Nine Months Ended September 30,  
     2007     2006  

OPERATING ACTIVITIES

    

Net (loss) income

   $ (355,848 )   $ 220,618  

Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities

    

Asset impairments

     551,422       20,775  

Deferred income taxes

     (182,062 )     (22,940 )

Amortization of deferred marketing costs

     23,091       27,367  

Non-cash land option deposit and pre-acquisition write-off costs

     15,419       23,022  

Depreciation and amortization of long-lived assets

     10,903       14,170  

Stock-based compensation expense

     8,227       10,169  

Gain on sale of property and equipment

     (7,955 )     -  

Non-cash related party expenses

     -       2,301  

Excess tax benefits from stock-based compensation

     (6,349 )     (1,569 )

Other non-cash expenses

     1,769       286  

Net change in assets and liabilities

    

Restricted cash

     1,008       1,660  

Home sales and other receivables

     77,045       41,460  

Mortgage loans held in inventory, net

     140,040       34,001  

Housing completed or under construction

     (209,897 )     (264,840 )

Land and land under development

     390,098       1,389  

Prepaid expenses and other assets, net

     (9,313 )     (46,720 )

Accounts payable

     (20,968 )     (1,044 )

Accrued liabilities

     (46,373 )     (15,810 )

Income taxes receivable/payable

     (44,689 )     (85,638 )
                

Net cash provided by (used in) operating activities

     335,568       (41,343 )
                

INVESTING ACTIVITIES

    

Sale of property and equipment

     22,000       -  

Purchase of property and equipment

     (30,362 )     (7,224 )
                

Net cash used in investing activities

     (8,362 )     (7,224 )
                

FINANCING ACTIVITIES

    

Lines of credit

    

Advances

     568,987       450,900  

Principal payments

     (657,497 )     (455,063 )

Excess tax benefits from stock-based compensation

     6,349       1,569  

Dividend payments

     (34,311 )     (33,703 )

Proceeds from exercise of stock options

     10,798       3,177  
                

Net cash used in financing activities

     (105,674 )     (33,120 )
                

Net increase (decrease) in cash and cash equivalents

     221,532       (81,687 )

Cash and cash equivalents

    

Beginning of period

     507,947       214,531  
                

End of period

   $      729,479     $      132,844  
                

The accompanying Notes are an integral part of the Unaudited Consolidated Financial Statements.

 

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

 

1.

Basis of Presentation

The Unaudited Consolidated Financial Statements of M.D.C. Holdings, Inc. (“MDC” or the “Company,” which refers to M.D.C. Holdings, Inc. and its subsidiaries) have been prepared, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Accordingly, they do not include all information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. These statements reflect all normal and recurring adjustments which, in the opinion of management, are necessary to present fairly the financial position, results of operations and cash flows of MDC at September 30, 2007 and for all periods presented. These statements should be read in conjunction with MDC’s Consolidated Financial Statements and Notes thereto included in MDC’s Annual Report on Form 10-K for the year ended December 31, 2006, filed with the SEC on February 28, 2007. Certain prior period balances have been reclassified to conform to the current year’s presentation.

Prior to 2006, the Company experienced seasonality and quarter-to-quarter variability in homebuilding activity levels. In general, the number of homes closed and associated home sales revenue increased during the third and fourth quarters, compared with the first and second quarters. The Company believes that this seasonality reflected the historical tendency of homebuyers to purchase new homes in the spring with closings scheduled in the fall or winter, as well as the scheduling of construction to accommodate seasonal weather conditions in certain geographical areas (or markets). The same seasonality was experienced in the financial services operation because our mortgage loan originations are directly attributed to the closing of homes from our homebuilding operations. Due to reduced home closing levels during 2006 and continuing in 2007, this seasonality pattern in the homebuilding and financial services operations did not continue for the third and fourth quarters of 2006 and for the first three quarters of 2007, and there can be no assurance that it will be present in the future. The Unaudited Consolidated Statements of Operations for the three and nine months ended September 30, 2007 and the Unaudited Consolidated Statement of Cash Flows for the nine months ended September 30, 2007 are not necessarily indicative of the results to be expected for the full year. Refer to the economic conditions described under the caption “Risk Factors” in Part II, Item 1A of this Quarterly Report on Form 10-Q and “Risk Factors Relating to our Business” in Item 1A of the Company’s December 31, 2006 Annual Report on Form 10-K.

The following table summarizes, by quarter, home sales revenue during 2007, 2006 and 2005 (in thousands).

 

     Three Months Ended
     March 31,    June 30,    September 30,    December 31,

2007

   $      711,800    $      687,813    $      651,124      N/A

2006

     1,117,155      1,188,561      1,050,700    $   1,294,140

2005

     914,751      1,026,943      1,145,481      1,705,525

 

2.

Asset Impairment

On a quarterly basis, the Company evaluates its inventory for impairment in accordance with Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”).

 

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (Continued)

 

As a result of its evaluation, the Company recorded impairments of its housing completed or under construction inventories of $56.6 million and $121.1 million during the three and nine months ended September 30, 2007, respectively, and impairments of its land and land under development inventories of $192.4 million and $430.3 million during the three and nine months ended September 30, 2007, respectively. These impairments, which primarily relate to assets contracted for in 2004 and 2005, were due to decreases in home sales prices and/or increases in incentives offered in an effort to: (1) remain competitive with home sales prices offered by the Company’s competitors; (2) stimulate new home orders; and (3) maintain homes in Backlog (defined as homes under contract but not yet delivered) until they close. In accordance with SFAS 144, the Company generally determined the fair value of each impaired asset based upon the present value of the estimated future cash flows on a subdivision-by-subdivision basis at a discount rate commensurate with the risk of the subdivision under evaluation, generally ranging from 10% to 18%.

The impairments recorded during the three and nine months ended September 30, 2007 and 2006, by reportable segment (as defined in Note 9), are as follows (in thousands):

 

    

Three Months

Ended September 30,

  

Nine Months

Ended September 30,

     2007    2006    2007    2006

Housing Completed or Under Construction

           

West

   $ 40,973    $ 5,424    $ 97,319    $ 5,424

Mountain

     1,875      405      3,797      405

East

     5,579      151      7,575      151

Other Homebuilding

     8,162      271      12,400      271
                           

Total asset impairments

   $        56,589    $          6,251    $      121,091    $          6,251
                           

 

    

Three Months

Ended September 30,

  

Nine Months

Ended September 30,

     2007    2006    2007    2006

Land and Land Under Development

           

West

   $ 149,517    $ 9,819    $ 347,803    $ 9,819

Mountain

     5,055      222      12,912      222

East

     10,658      1,206      17,094      1,206

Other Homebuilding

     27,131      2,417      52,522      3,277
                           

Total asset impairments

   $      192,361    $        13,664    $      430,331    $        14,524
                           

 

3.

Recent Accounting Pronouncements

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, Including an amendment of FASB Statement No. 115” (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS 159 is effective for financial

 

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (Continued)

 

statements issued for fiscal years beginning after November 15, 2007. The Company does not expect SFAS 159 to have a material impact on its financial position, results of operations or cash flows upon adoption.

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 years beginning after November 15, 2007 and interim periods within those fiscal years. The Company currently is evaluating the impact, if any, that SFAS 157 may have on its financial position, results of operations or cash flows.

In July 2006, the FASB issued FASB Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). FIN 48 is an interpretation of SFAS No. 109, “Accounting for Income Taxes” (“SFAS 109”). FIN 48 provides interpretive guidance for the financial statement recognition and measurement of a tax position taken, or expected to be taken, in a tax return. FIN 48 requires the affirmative evaluation that it is more-likely-than-not, based on the technical merits of a tax position, that an enterprise is entitled to economic benefits resulting from positions taken in income tax returns. If a tax position does not meet the “more-likely-than-not” recognition threshold, the benefit of that position is not recognized in the financial statements. FIN 48 also requires companies to disclose additional quantitative and qualitative information in their financial statements about uncertain tax positions. FIN 48 was effective for fiscal year beginning January 1, 2007, and the $0.3 million cumulative effect of applying FIN 48 was reported as an adjustment to the opening balance of retained earnings for this fiscal year.

 

4.

Balance Sheet Components

The following table sets forth information relating to accrued liabilities (in thousands).

 

     September 30,
2007
   December 31,
2006

Accrued liabilities

     

Warranty reserves

   $ 106,019    $ 102,033

Insurance reserves

     54,379      50,854

Land development and home construction accruals

     37,984      64,224

Accrued compensation and related expenses

     53,746      74,751

Customer and escrow deposits

     27,844      28,705

Accrued interest payable

     20,337      13,321

Accrued pension liability

     14,083      13,183

Deferred revenue

     705      23,089

Other accrued liabilities

     54,071      48,793
             

Total accrued liabilities

   $      369,168    $      418,953
             

 

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (Continued)

 

5.

(Loss) Earnings Per Share

The Company calculates (loss) earnings per share (“EPS”) in accordance with SFAS No. 128, “Earnings per Share” (“SFAS 128”). Pursuant to SFAS 128, basic EPS excludes the dilutive effect of common stock equivalents and is computed by dividing net income or loss by the weighted-average number of common shares outstanding during the period. Diluted EPS includes the dilutive effect of common stock equivalents and is computed using the weighted-average number of common stock and common stock equivalents outstanding during the period. Common stock equivalents include stock options and unvested restricted stock awards. Diluted EPS for the three and nine months ended September 30, 2007 excluded common stock equivalents because the effect of their inclusion would be anti-dilutive, or would decrease the reported loss per share. Using the treasury stock method pursuant to SFAS 128, the weighted-average common stock equivalents excluded from diluted EPS were 1.5 million shares during the three and nine months ended September 30, 2007.

The basic and diluted EPS calculations are shown below (in thousands, except per share amounts).

 

    

Three Months

Ended September 30,

  

Nine Months

Ended September 30,

     2007     2006    2007     2006

Basic (Loss) Earnings Per Share

         

Net (loss) income

   $     (155,378 )   $ 48,706    $     (355,848 )   $ 220,618
                             

Basic weighted-average shares outstanding

     45,751       44,972      45,659       44,911
                             

Per share amounts

   $ (3.40 )   $ 1.08    $ (7.79 )   $ 4.91
                             

Diluted (Loss) Earnings Per Share

         

Net (loss) income

   $ (155,378 )   $ 48,706    $ (355,848 )   $ 220,618
                             

Basic weighted-average shares outstanding

     45,751       44,972      45,659       44,911

Stock options, net

     -       896      -       1,021
                             

Diluted weighted-average shares outstanding

     45,751       45,868      45,659       45,932
                             

Per share amounts

   $ (3.40 )   $            1.06    $ (7.79 )   $            4.80
                             

 

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (Continued)

 

6.

Interest Activity

The Company capitalizes interest incurred on its senior notes and Homebuilding Line (as defined below) during the period of active development and through the completion of construction of its homebuilding inventories. Interest incurred on the senior notes or Homebuilding Line that is not capitalized, if any, and interest expense on the Mortgage Line (as defined below) is included in interest income, net, which is a component of other revenue in the Unaudited Consolidated Statements of Operations. Interest activity is shown below (in thousands).

 

    

Three Months

Ended September 30,

   

Nine Months

Ended September 30,

 
     2007     2006     2007     2006  

Total Interest Incurred

        

Corporate and Homebuilding

   $ 14,444     $ 14,150     $ 43,320     $ 43,993  

Financial Services and Other

     343       2,291       1,353       6,572  
                                

Total interest incurred

   $ 14,787     $ 16,441     $ 44,673     $ 50,565  
                                

Total Interest Capitalized

        

Interest capitalized in homebuilding inventory, beginning of period

   $ 53,988     $ 48,569     $ 50,655     $ 41,999  

Interest capitalized during the period

     14,444       14,150       43,320       43,993  

Previously capitalized interest included in home cost of sales during the period

     (14,428 )     (12,574 )     (39,971 )     (35,847 )
                                

Interest capitalized in homebuilding inventory, end of period

   $        54,004     $        50,145     $        54,004     $        50,145  
                                

Interest income and interest expense are shown below (in thousands).

 

    

Three Months

Ended September 30,

  

Nine Months

Ended September 30,

     2007    2006    2007    2006

Interest income

   $ 9,776    $ 4,663    $ 28,291    $ 11,797

Interest expense, net of interest capitalized

     343      2,291      1,353      6,572
                           

Total interest income, net

   $          9,433    $          2,372    $        26,938    $          5,225
                           

 

7.

Warranty Reserves

Warranty reserves presented in the table below relate to general and structural reserves, as well as reserves for known, unusual warranty-related expenditures not covered by the Company’s general and structural warranty reserve. Generally, warranty reserves are reviewed monthly, using historical data and other relevant information, to determine the reasonableness and adequacy of both the reserve and the per-unit reserve amount originally included in home cost of sales, as well as the timing of the reversal of any excess reserve. Warranty payments for an individual house may exceed the related reserve. Payments in excess of the reserve are evaluated in the aggregate to determine if an adjustment

 

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (Continued)

 

to the warranty reserve should be recorded, which could result in a corresponding adjustment to home cost of sales. Warranty reserve activity for the three and nine months ended September 30, 2007 and 2006 is shown below (in thousands).

 

    

Three Months

Ended September 30,

   

Nine Months

Ended September 30,

 
     2007     2006     2007     2006  

Warranty reserve balance at beginning of period

   $ 104,089     $ 92,010     $ 102,033     $ 82,238  

Warranty expense provision

     6,252       11,041       18,843       34,334  

Warranty cash payments

     (6,138 )     (8,309 )     (19,991 )     (24,220 )

Warranty reserve adjustments

     1,816       451       5,134       2,841  
                                

Warranty reserve balance at end of period

   $      106,019     $        95,193     $      106,019     $        95,193  
                                

 

8.

Insurance Reserves

The Company records expenses and liabilities for losses and loss adjustment expenses for claims associated with: (1) insurance policies and re-insurance agreements issued by StarAmerican Insurance Ltd. (“StarAmerican”) and Allegiant Insurance Company, Inc., A Risk Retention Group (“Allegiant”); (2) self-insurance, including workers compensation; and (3) deductible amounts under the Company’s insurance policies. The establishment of the provisions for outstanding losses and loss adjustment expenses is based on actuarial studies that include known facts and interpretation of circumstances, including the Company’s experience with similar cases and historical trends involving claim payment patterns, pending levels of unpaid claims, product mix or concentration, claim severity, frequency patterns such as those caused by natural disasters, fires, or accidents, depending on the business conducted, and changing regulatory and legal environments.

The following table summarizes the insurance reserve activity for the three and nine months ended September 30, 2007 and 2006 (in thousands).

 

    

Three Months

Ended September 30,

   

Nine Months

Ended September 30,

 
     2007     2006     2007     2006  

Insurance reserve balances at beginning of period

   $        53,952     $        43,540     $        50,854     $        35,570  

Insurance expense provisions

     2,376       4,113       8,086       11,858  

Insurance cash payments

     (1,216 )     (1,143 )     (3,538 )     (2,806 )

Insurance reserve adjustments

     (733 )     (1,978 )     (1,023 )     (90 )
                                

Insurance reserve balances at end of period

   $ 54,379     $ 44,532     $ 54,379     $ 44,532  
                                

 

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Table of Contents

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (Continued)

 

9.

Information on Business Segments

SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information” (“SFAS 131”), defines operating segments as a component of an enterprise for which discrete financial information is available and is reviewed regularly by the chief operating decision-maker, or decision-making group, to evaluate performance and make operating decisions. The Company has identified its chief operating decision-makers (“CODMs”) as three key executives—the Chief Executive Officer, Chief Operating Officer and Chief Financial Officer.

The Company has identified each homebuilding subdivision as an operating segment in accordance with SFAS 131. Each homebuilding subdivision engages in business activities from which it earns revenue primarily from the sale of single-family detached homes, generally to first-time and first-time move-up homebuyers. Subdivisions in the reportable segments noted below have been aggregated because they are similar in the following regards: (1) economic characteristics; (2) housing products; (3) class of homebuyer; (4) regulatory environments; and (5) methods used to construct and sell homes. The Company’s homebuilding reportable segments are as follows:

 

  (1)

West (Arizona, California and Nevada markets)

 

  (2)

Mountain (Colorado and Utah markets)

 

  (3)

East (Virginia and Maryland markets)

 

  (4)

Other Homebuilding (Delaware Valley, Florida, Illinois and Texas markets)

The Company’s Financial Services and Other reportable segment consists of the operations of the following operating segments: (1) HomeAmerican Mortgage Corporation (“HomeAmerican”); (2) American Home Insurance Agency, Inc. (“American Home Insurance”); (3) American Home Title and Escrow Company (“American Home Title”); (4) Allegiant; and (5) StarAmerican. These operating segments have been aggregated into one reportable segment because they do not individually exceed 10 percent of: (1) consolidated revenue; (2) the greater of (A) the combined reported profit of all operating segments that did not report a loss or (B) the positive value of the combined reported loss of all operating segments that reported losses; or (3) consolidated assets. The Company’s Corporate reportable segment incurs general and administrative expenses that are not identifiable specifically to another operating segment.

Inter-company supervisory fees (“Supervisory Fees”), which are included in (loss) income before income taxes, are charged by the Company’s Corporate segment to the homebuilding segments and the Financial Services and Other segment. Supervisory Fees represent costs incurred by the Company’s Corporate segment associated with certain resources that support the Company’s other reportable segments. Transfers, if any, between operating segments are recorded at cost. Inter-company adjustments noted in the revenue table below relate to mortgage loan origination fees paid by the Company’s homebuilding subsidiaries to HomeAmerican on behalf of homebuyers.

 

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Table of Contents

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (Continued)

 

The following table summarizes revenue and (loss) income before income taxes for each of the Company’s six reportable segments (in thousands).

 

    

Three Months

Ended September 30,

   

Nine Months

Ended September 30,

 
     2007     2006     2007     2006  

Revenue

        

Homebuilding

        

West

   $ 389,309     $ 653,932     $   1,277,012     $   2,061,708  

Mountain

     138,439       168,193       418,300       519,107  

East

     72,368       137,050       205,523       444,765  

Other Homebuilding

     60,364       105,553       184,195       374,299  
                                

Total Homebuilding

     660,480       1,064,728       2,085,030       3,399,879  

Financial Services and Other

     14,652       23,843       47,836       74,158  

Corporate

     16,048       60       30,510       675  

Inter-company adjustments

     (4,519 )     (7,708 )     (14,883 )     (16,383 )
                                

Consolidated

   $ 686,661     $   1,080,923     $ 2,148,493     $ 3,458,329  
                                

(Loss) Income Before Income Taxes

        

Homebuilding

        

West

   $ (197,917 )   $ 53,762     $ (462,547 )   $ 274,642  

Mountain

     (925 )     9,320       3,218       25,183  

East

     (15,998 )     23,911       (27,168 )     85,691  

Other Homebuilding

     (43,158 )     (4,660 )     (81,776 )     237  
                                

Total Homebuilding

     (257,998 )     82,333       (568,273 )     385,753  

Financial Services and Other

     5,018       12,989       16,776       35,161  

Corporate

     1,666       (18,901 )     (14,526 )     (69,778 )
                                

Consolidated

   $     (251,314 )   $ 76,421     $ (566,023 )   $ 351,136  
                                

The following table summarizes total assets for each of the Company’s six reportable segments (in thousands). Inter-company adjustments noted in the table below relate to loans from the Company’s Financial Services and Other segment to its Corporate segment.

 

     September 30,
2007
    December 31,
2006
 

Homebuilding

    

West

   $   1,157,760     $   1,869,442  

Mountain

     535,568       535,554  

East

     308,070       333,902  

Other Homebuilding

     168,990       266,326  
                

Total Homebuilding

     2,170,388       3,005,224  

Financial Services and Other

     142,456       284,791  

Corporate

     1,091,566       657,917  

Inter-company adjustments

     (43,157 )     (38,057 )
                

Consolidated

   $ 3,361,253     $ 3,909,875  
                

 

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Table of Contents

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (Continued)

 

The following table summarizes depreciation and amortization of long-lived assets and amortization of deferred marketing costs for each of the Company’s six reportable segments (in thousands).

 

    

Three Months

Ended September 30,

  

Nine Months

Ended September 30,

     2007    2006    2007    2006

Homebuilding

           

West

   $ 6,968    $ 7,128    $ 20,459    $ 22,888

Mountain

     1,242      1,236      3,317      3,963

East

     656      644      1,835      2,362

Other Homebuilding

     1,742      2,532      4,044      7,773
                           

Total Homebuilding

     10,608      11,540      29,655      36,986

Financial Services and Other

     160      79      280      254

Corporate

     1,009      1,409      4,059      4,297
                           

Consolidated

   $        11,777    $        13,028    $        33,994    $        41,537
                           

 

10.

Other Comprehensive (Loss) Income

Total other comprehensive (loss) income primarily includes net (loss) income plus minimum pension liability adjustments, which has been reflected as a component of stockholders’ equity and has not affected consolidated net (loss) income. The Company’s other comprehensive loss was $155.4 million and $355.8 million for the three and nine months ended September 30, 2007, respectively, and other comprehensive income was $48.7 million and $220.6 million for the three and nine months ended September 30, 2006, respectively.

 

11.

Commitments and Contingencies

The Company often is required to obtain performance bonds and letters of credit in support of its obligations primarily with respect to subdivision improvement, homeowner association dues and start-up expenses, warranty work, contractor license fees and earnest money deposits. At September 30, 2007, the Company had issued and outstanding performance bonds and letters of credit totaling $316.0 million and $55.3 million, respectively, including $18.2 million in letters of credit issued by HomeAmerican, a wholly owned subsidiary of MDC. In the event any such performance bonds or letters of credit issued by third parties are called, MDC’s indemnity obligations could require it to reimburse the issuer of the performance bond or letter of credit.

 

12.

Lines of Credit and Total Debt Obligations

Homebuilding.  The Company’s homebuilding line of credit (“Homebuilding Line”) is an unsecured revolving line of credit with a group of lenders for support of its homebuilding segments. The Company’s Homebuilding Line has an aggregate commitment amount of $1.25 billion and a maturity date of March 21, 2011. The facility’s provision for letters of credit is available in the aggregate amount of $500 million. The facility permits an increase in the maximum commitment amount to $1.75 billion upon the Company’s request, subject to receipt of additional commitments

 

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Table of Contents

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (Continued)

 

from existing or additional participant lenders. Interest rates on outstanding borrowings are determined by reference to a chosen London Interbank Offered Rate (“LIBOR”), with a spread from LIBOR, which is determined based on changes in the Company’s credit ratings and leverage ratio, or to an alternate base rate. At September 30, 2007, the Company did not have any borrowings under the Homebuilding Line and had $34.0 million in letters of credit issued as of such date, which reduced the amount available to be borrowed under the Homebuilding Line.

Mortgage Lending.  The Company’s mortgage line of credit (“Mortgage Line”) has a borrowing limit of $225 million with terms that allow for increases of up to $175 million in the borrowing limit to a maximum of $400 million, subject to concurrence by the participating banks. Available borrowings under the Mortgage Line are collateralized by mortgage loans and mortgage-backed securities and are limited to the value of eligible collateral, as defined. At September 30, 2007, $42.0 million was borrowed and an additional $14.8 million was collateralized and available to be borrowed. The Mortgage Line is cancelable upon 120 days notice.

General.  The agreements for the Company’s bank lines of credit and the indentures for the Company’s senior notes require compliance with certain representations, warranties and covenants. The Company believes that it is in compliance with these bank line and indenture covenant requirements, and the Company is not aware of any covenant violations. The agreements containing these representations, warranties and covenants for the bank lines of credit and the indentures for the Company’s senior notes are on file with the SEC and are listed in the Exhibit Table in Part IV of the Company’s Annual Report on Form 10-K for the year ended December 31, 2006 and in Part II of this Quarterly Report on Form 10-Q.

The Company’s debt obligations at September 30, 2007 and December 31, 2006 are as follows (in thousands):

 

     September 30,
2007
   December 31,
2006

7% Senior Notes due 2012

   $ 149,077    $ 148,963

5 1/2% Senior Notes due 2013

     349,426      349,361

5 3/8% Medium Term Senior Notes due 2014

     248,766      248,663

5 3/8% Medium Term Senior Notes due 2015

     249,717      249,695
             

Total Senior Notes

     996,986      996,682

Homebuilding Line

     -      -
             

Total Corporate and Homebuilding Debt

     996,986      996,682

Mortgage Line

     41,957      130,467
             

Total Debt

   $   1,038,943    $   1,127,149
             

 

13.

Related Party Liabilities

Effective March 1, 2006, the Company entered into a consulting agreement (the “Agreement”) with a firm owned by Mr. Gilbert Goldstein (a member of the Company’s Board of Directors). Pursuant to the terms of the Agreement, the Company has agreed that, among other things, in the event that Mr. Goldstein retires from the practice of law, becomes disabled, dies or the Agreement with the

 

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Table of Contents

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (Continued)

 

Company is not renewed or extended during the term of the Agreement, the Company will pay Mr. Goldstein’s firm or his estate, in lieu of any other payments, other benefits or services to be provided by the Company, $15,000 per month for five years or the duration of Mr. Goldstein’s life, whichever is longer. At September 30, 2007, the Company had a related party liability of $0.7 million associated with the foregoing obligation.

In December 2006, the Company committed to contributing $1.7 million to the MDC/Richmond American Homes Foundation, a Delaware non-profit corporation that was incorporated on September 30, 1999 (the “Foundation”). In January 2007, the Company contributed to the Foundation 29,798 shares of MDC common stock in fulfillment of its December 2006 commitment.

 

14.

Income Taxes

The Company’s overall effective income tax rates were 38.2% and 37.1% for the three and nine months ended September 30, 2007, respectively, and were 36.3% and 37.2% for the three and nine months ended September 30, 2006, respectively. These changes in the effective tax rates during the 2007 periods, compared with the same periods during 2006, resulted from the impact of reductions in the benefits from I.R.C. Sec. 199, “Income Attributable to Domestic Production Activities,” and increases in estimated permanent differences primarily related to accruals for non-deductible excess compensation under I.R.C. Sec. 162(m), “Certain Excessive Employee Remuneration.”

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of the assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The tax effects of significant temporary differences that give rise to the net deferred tax asset are as follows (in thousands).

 

     September 30,
2007
   December 31,
2006

Deferred tax assets

     

Warranty, litigation and other reserves

   $ 57,438    $ 52,752

Asset impairment

     227,137      41,876

Accrued liabilities

     9,021      8,298

Deferred revenue

     359      8,797

Inventory, additional costs capitalized for tax purposes

     10,596      12,356

Stock-based compensation expense

     8,382      5,620

Property, equipment and other assets, net

     284      730
             

Total gross deferred tax assets

     313,217      130,429
             

Deferred tax liabilities

     

Deferred revenue

     3,551      1,532

Inventory, additional costs capitalized for financial statement purposes

     585      596

Other, net

     2,139      3,421
             

Total gross deferred tax liabilities

     6,275      5,549
             

Net deferred tax asset

   $      306,942    $      124,880
             

 

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Table of Contents

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (Continued)

 

On January 1, 2007, the Company adopted the provisions of FIN 48. As a result of the implementation of FIN 48, the Company decreased its liability for unrecognized tax benefits by approximately $0.3 million, which was accounted for as an increase to the January 1, 2007 retained earnings balance. A reconciliation of the beginning and ending balance for liabilities associated with unrecognized tax benefits is as follows (in thousands):

 

Balances at January 1, 2007

   $ 18,739  

Tax positions related to the current year

     717  

Lapse of applicable statute of limitations

     (147 )
        

Balances at September 30, 2007

   $        19,309  
        

The total liabilities associated with unrecognized tax benefits that, if recognized, would impact the effective tax rates were $12.9 million and $13.2 million at January 1, 2007 and September 30, 2007, respectively.

The Company recognizes interest and penalties associated with unrecognized tax benefits in income tax expense in the Unaudited Consolidated Statements of Operations, and the corresponding liability in income taxes payable or income taxes receivable, net on the Unaudited Consolidated Balance Sheets. The expense for interest and penalties reflected in the Unaudited Consolidated Statements of Operations for the three and nine months ended September 30, 2007 was approximately $0.6 million and $1.7 million, respectively (interest net of related tax benefits). The corresponding liabilities on the Unaudited Consolidated Balance Sheets were $2.6 million and $4.3 million at January 1, 2007 and September 30, 2007, respectively.

The Company has taken positions in certain taxing jurisdictions for which it is reasonably possible that the total amounts of unrecognized tax benefits may significantly decrease within the next twelve months. The possible decrease could result from the finalization of certain state income tax audits. An estimate of the range of the reasonably possible change cannot be made.

The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various state jurisdictions. The Company is subject to U.S. federal income tax examination for calendar tax years ending 2004 through 2006. The Company recently received notification from the Internal Revenue Service of its intent to audit the Company for the 2004 and 2005 tax years. Additionally, the Company is subject to various state income tax examinations for the 1996 through 2006 calendar tax years. The Company currently is under state income tax examination in the states of California, Virginia and Arizona.

 

15.

Subsequent Event

On October 24, 2007, the Company entered into an amendment (the “Amendment”) to its Homebuilding Line, effectively resetting the consolidated tangible net worth (as defined) base amount of the consolidated tangible net worth test, as defined. Pursuant to the Amendment, the Company’s “consolidated tangible net worth” under the Homebuilding Line “consolidated tangible net worth test” must not be less than (1) $1.405 billion; plus (2) 50% of consolidated net income, as defined, of the Company and the guarantor subsidiaries earned after September 30, 2007; plus (3) 50% of the net

 

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Table of Contents

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (Continued)

 

proceeds or other consideration received by the Company for the issuance of capital stock after September 30, 2007; minus (4) the lesser of (A) the aggregate amount paid by the Company after September 30, 2007 to repurchase its common stock and (B) $300 million.

 

16.

Supplemental Guarantor Information

The Company’s senior notes and Homebuilding Line are fully and unconditionally guaranteed on an unsecured basis, jointly and severally, by the following subsidiaries (collectively, the “Guarantor Subsidiaries”), which are 100%-owned subsidiaries of the Company.

 

   

M.D.C. Land Corporation

   

RAH of Florida, Inc.

   

Richmond American Construction, Inc.

   

Richmond American Homes of Arizona, Inc.

   

Richmond American Homes of California, Inc.

   

Richmond American Homes of Colorado, Inc.

   

Richmond American Homes of Delaware, Inc.

   

Richmond American Homes of Florida, LP

   

Richmond American Homes of Illinois, Inc.

   

Richmond American Homes of Maryland, Inc.

   

Richmond American Homes of Nevada, Inc.

   

Richmond American Homes of New Jersey, Inc.

   

Richmond American Homes of Pennsylvania, Inc.

   

Richmond American Homes of Utah, Inc.

   

Richmond American Homes of Virginia, Inc.

   

Richmond American Homes of West Virginia, Inc.

Subsidiaries that do not guarantee the Company’s senior notes and Homebuilding Line (collectively, the “Non-Guarantor Subsidiaries”) include:

 

   

American Home Insurance

   

American Home Title

   

HomeAmerican

   

StarAmerican

   

Allegiant

   

RAH of Texas, LP (as of January 2007)

   

RAH Texas Holdings, LLC (as of January 2007)

   

Richmond American Homes of Texas, Inc. (as of January 2007)

The Supplemental Condensed Combining Statement of Operations for the three and nine months ended September 30, 2006 previously disclosed inter-company cost of capital charges by the Company’s Corporate segment to its homebuilding segments. The Supplemental Condensed Combining Statement of Operations for the three and nine months ended September 30, 2006 have been adjusted to eliminate this inter-company cost of capital charge in order to conform the presentation to the Company’s segment reporting included in Note 9 of the Unaudited Consolidated Financial Statements.

 

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Table of Contents

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (Continued)

 

Supplemental Condensed Combining Balance Sheet

September 30, 2007

(In thousands)

 

     MDC     Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
    Eliminating
Entries
    Consolidated
MDC

ASSETS

          

Cash and cash equivalents

   $ 707,618     $ 4,185     $ 17,676     $ -     $ 729,479

Restricted cash

     -       1,633       -       -       1,633

Home sales and other receivables

     3,169       58,518       48,361       (43,157 )     66,891

Mortgage loans held in inventory, net

     -       -       72,863       -       72,863

Income taxes receivable, net

     22,748       -       -       -       22,748

Inventories

          

Housing completed or under construction

     -       1,267,476       2       -       1,267,478

Land and land under development

     -       754,728       -       -       754,728

Investment in and advances to parent and subsidiaries

     189,782       112,198       393       (302,373 )     -

Other assets, net

     357,742       84,138       3,553       -       445,433
                                      

Total Assets

   $ 1,281,059     $ 2,282,876     $ 142,848     $ (345,530 )   $ 3,361,253
                                      

LIABILITIES

          

Accounts payable and related party liabilities

   $ 45,234     $ 147,896     $ 765     $ (43,157 )   $ 150,738

Accrued liabilities

     91,744       222,667       54,757       -       369,168

Advances and notes payable to parent and subsidiaries

     (1,921,005 )     1,924,182       (3,177 )     -       -

Income taxes payable

     265,696       (268,210 )     2,514       -       -

Homebuilding Line

     -       -       -       -       -

Mortgage Line

     -       -       41,957       -       41,957

Senior notes, net

     996,986       -       -       -       996,986
                                      

Total Liabilities

     (521,345 )     2,026,535       96,816       (43,157 )     1,558,849
                                      

STOCKHOLDERS’ EQUITY

     1,802,404       256,341       46,032       (302,373 )     1,802,404
                                      

Total Liabilities and Stockholders’ Equity

   $   1,281,059     $   2,282,876     $      142,848     $     (345,530 )   $   3,361,253
                                      

 

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Table of Contents

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (Continued)

 

Supplemental Condensed Combining Balance Sheet

December 31, 2006

(In thousands)

 

     MDC     Guarantor
Subsidiaries
   Non-Guarantor
Subsidiaries
    Eliminating
Entries
    Consolidated
MDC

ASSETS

           

Cash and cash equivalents

   $ 484,682     $ 6,400    $ 16,865     $ -     $ 507,947

Restricted cash

     -       2,641      -       -       2,641

Home sales and other receivables

     -       129,559      53,379       (39,002 )     143,936

Mortgage loans held in inventory, net

     -       -      212,903       -       212,903

Inventories

           

Housing completed or under construction

     -       1,178,671      -       -       1,178,671

Land and land under development

     -       1,575,158      -       -       1,575,158

Investment in and advances to parent and subsidiaries

     480,650       1,068      (37,782 )     (443,936 )     -

Other assets, net

     169,961       113,383      5,275       -       288,619
                                     

Total Assets

   $ 1,135,293     $ 3,006,880    $ 250,640     $ (482,938 )   $ 3,909,875
                                     

LIABILITIES

           

Accounts payable and related party liabilities

   $ 41,458     $ 168,401    $ 1,604     $ (38,057 )   $ 173,406

Accrued liabilities

     93,755       271,482      54,661       (945 )     418,953

Advances and notes payable to parent and subsidiaries

     (2,114,146 )     2,103,373      10,773       -       -

Income taxes payable

     (44,338 )     66,668      6,155       -       28,485

Homebuilding Line

       -      -       -       -

Mortgage Line

     -       -      130,467       -       130,467

Senior notes, net

     996,682       -      -       -       996,682
                                     

Total Liabilities

     (1,026,589 )     2,609,924      203,660       (39,002 )     1,747,993
                                     

STOCKHOLDERS’ EQUITY

     2,161,882       396,956      46,980       (443,936 )     2,161,882
                                     

Total Liabilities and Stockholders’ Equity

   $   1,135,293     $   3,006,880    $      250,640     $     (482,938 )   $   3,909,875
                                     

 

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (Continued)

 

Supplemental Condensed Combining Statements of Operations

Three Months Ended September 30, 2007

(In thousands)

 

     MDC     Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
    Eliminating
Entries
    Consolidated
MDC
 

REVENUE

          

Home sales revenue

   $ -     $ 655,531     $ 112     $ (4,519 )   $ 651,124  

Land sales and other revenue

     16,049       4,837       14,651       -       35,537  

Equity in earnings of subsidiaries

     (142,124 )     -       -       142,124       -  
                                        

Total Revenue

     (126,075 )     660,368       14,763       137,605       686,661  
                                        

COSTS AND EXPENSES

          

Home cost of sales

     -       563,857       64       (4,519 )     559,402  

Asset impairments

     -       248,950       -       -       248,950  

Marketing and commission expenses

     -       52,589       5       -       52,594  

General and administrative expenses

     14,285       52,431       9,766       -       76,482  

Other expenses

     95       452       -       -       547  
                                        

Total Costs and Expenses

     14,380       918,279       9,835       (4,519 )     937,975  
                                        

(Loss) income before income taxes

     (140,455 )     (257,911 )     4,928       142,124       (251,314 )

(Provision for) benefit from income taxes

     (14,923 )     112,627       (1,768 )     -       95,936  
                                        

NET (LOSS) INCOME

   $     (155,378 )   $     (145,284 )   $          3,160     $      142,124     $     (155,378 )
                                        

 

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (Continued)

 

Supplemental Condensed Combining Statements of Operations

Three Months Ended September 30, 2006

(In thousands)

 

     MDC     Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
    Eliminating
Entries
    Consolidated
MDC
 

REVENUE

          

Home sales revenue

   $ -     $   1,058,408     $ -     $ (7,708 )   $   1,050,700  

Land sales and other revenue

     49       6,102       24,072       -       30,223  

Equity in earnings of subsidiaries

     78,938       -       -       (78,938 )     -  
                                        

Total Revenue

     78,987       1,064,510       24,072       (86,646 )     1,080,923  
                                        

COSTS AND EXPENSES

          

Home cost of sales

     -       821,513       19       (7,708 )     813,824  

Asset impairments

     -       19,915       -       -       19,915  

Marketing and commission expenses

     373       67,313       -       -       67,686  

General and administrative expenses

     18,945       69,316       11,518       -       99,779  

Other expenses

     88       3,210       -       -       3,298  
                                        

Total Costs and Expenses

     19,406       981,267       11,537       (7,708 )     1,004,502  
                                        

Income before income taxes

     59,581       83,243       12,535       (78,938 )     76,421  

Provision for income taxes

           (10,875 )     (12,180 )             (4,660 )     -       (27,715 )
                                        

NET INCOME

   $ 48,706     $ 71,063     $ 7,875     $       (78,938 )   $ 48,706  
                                        

 

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (Continued)

 

Supplemental Condensed Combining Statements of Operations

Nine Months Ended September 30, 2007

(In thousands)

 

     MDC     Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminating
Entries
    Consolidated
MDC
 

REVENUE

          

Home sales revenue

   $ -     $   2,062,250     $ 3,370     $ (14,883 )   $   2,050,737  

Land sales and other revenue

     30,510       19,126       48,120       -       97,756  

Equity in earnings of subsidiaries

     (288,991 )     -       -       288,991       -  
                                        

Total Revenue

     (258,481 )     2,081,376       51,490       274,108       2,148,493  
                                        

COSTS AND EXPENSES

          

Home cost of sales

     -       1,760,740       3,308       (14,883 )     1,749,165  

Asset impairments

     -       551,422       -       -       551,422  

Marketing and commission expenses

     -       158,316       358       -       158,674  

General and administrative expenses

     44,749       170,782       31,698       -       247,229  

Other expenses

     286       7,515       225       -       8,026  
                                        

Total Costs and Expenses

     45,035       2,648,775       35,589       (14,883 )     2,714,516  
                                        

(Loss) income before income taxes

     (303,516 )     (567,399 )     15,901       288,991       (566,023 )

(Provision for) benefit from income taxes

     (52,332 )     268,210       (5,703 )     -       210,175  
                                        

NET (LOSS) INCOME

   $     (355,848 )   $ (299,189 )   $        10,198     $      288,991     $ (355,848 )
                                        

 

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (Continued)

 

Supplemental Condensed Combining Statements of Operations

Nine Months Ended September 30, 2006

(In thousands)

 

     MDC     Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
    Eliminating
Entries
    Consolidated
MDC
 

REVENUE

          

Home sales revenue

   $ -     $   3,372,799     $ -     $ (16,383 )   $   3,356,416  

Land sales and other revenue

     642       26,590       74,681       -       101,913  

Equity in earnings of subsidiaries

     309,319       -       -       (309,319 )     -  
                                        

Total Revenue

     309,961       3,399,389       74,681       (325,702 )     3,458,329  
                                        

COSTS AND EXPENSES

          

Home cost of sales

     -       2,556,701       63       (16,383 )     2,540,381  

Asset impairments

     -       20,775       -       -       20,775  

Marketing and commission expenses

     480       198,046       -       -       198,526  

General and administrative expenses

     67,733       219,821       39,041       -       326,595  

Other expenses

     2,792       18,124       -       -       20,916  
                                        

Total Costs and Expenses

     71,005       3,013,467       39,104       (16,383 )     3,107,193  
                                        

Income before income taxes

     238,956       385,922       35,577       (309,319 )     351,136  

Provision for income taxes

     (18,338 )     (98,827 )     (13,353 )     -       (130,518 )
                                        

NET INCOME

   $      220,618     $ 287,095     $        22,224     $     (309,319 )   $ 220,618  
                                        

 

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (Continued)

 

Supplemental Condensed Combining Statements of Cash Flows

Nine Months Ended September 30, 2007

(In thousands)

 

     MDC     Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
    Eliminating
Entries
   Consolidated
MDC
 

Net cash provided by (used in) operating activities

   $ 244,999     $ (1,011 )   $ 91,580     $                 -    $ 335,568  
                                       

Net cash used in investing activities

     (4,899 )     (1,204 )     (2,259 )     -      (8,362 )
                                       

Financing activities

           

Lines of credits

           

Advances

     160,448       -       408,539       -      568,987  

Principal payments

     (160,448 )     -       (497,049 )     -      (657,497 )

Excess tax benefit from stock- based compensation

     6,349       -       -       -      6,349  

Dividend payments

     (34,311 )     -       -       -      (34,311 )

Proceeds from exercise of stock options

     10,798       -       -       -      10,798  
                                       

Net cash used in financing activities

     (17,164 )     -       (88,510 )     -      (105,674 )
                                       

Net increase (decrease) in cash and cash equivalents

     222,936       (2,215 )     811       -      221,532  

Cash and cash equivalents

           

Beginning of period

     484,682       6,400       16,865       -      507,947  
                                       

End of period

   $      707,618     $          4,185     $        17,676     $ -    $      729,479  
                                       

 

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (Continued)

 

Supplemental Condensed Combining Statements of Cash Flows

Nine Months Ended September 30, 2006

(In thousands)

 

     MDC     Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
    Eliminating
Entries
    Consolidated
MDC
 

Net cash provided by (used in) operating activities

   $ 83,595     $ (129,829 )   $ 6,011     $         (1,120 )   $ (41,343 )
                                        

Net cash used in investing activities

     (1,949 )     (5,249 )     (26 )     -       (7,224 )
                                        

Financing activities

          

Net (decrease) increase in borrowings from parent and subsidiaries

     (136,299 )     136,501       (202 )     -       -  

Lines of credits

          

Advances

     450,900       -       -       -       450,900  

Principal payments

     (450,900 )     -       (4,163 )     -       (455,063 )

Excess tax benefit from stock- based compensation

     1,569       -       -       -       1,569  

Dividend payments

     (34,823 )     -       -       1,120       (33,703 )

Proceeds from exercise of stock options

     3,177       -       -       -       3,177  
                                        

Net cash (used in) provided by financing activities

     (166,376 )     136,501       (4,365 )     1,120       (33,120 )
                                        

Net (decrease) increase in cash and cash equivalents

     (84,730 )     1,423       1,620       -       (81,687 )

Cash and cash equivalents

          

Beginning of period

     196,032       5,527       12,972       -       214,531  
                                        

End of period

   $      111,302     $          6,950     $        14,592     $ -     $      132,844  
                                        

 

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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with, and is qualified in its entirety by, the Unaudited Consolidated Financial Statements and Notes thereto included elsewhere in this Quarterly Report on Form 10-Q. This item contains forward-looking statements that involve risks and uncertainties. Actual results may differ materially from those indicated in such forward-looking statements. Factors that may cause such a difference include, but are not limited to, those discussed in “Item 1A: Risk Factors Relating to our Business” of our Annual Report on Form 10-K for the year ended December 31, 2006 and this Quarterly Report on Form 10-Q.

INTRODUCTION

M.D.C. Holdings, Inc. is a Delaware corporation. We refer to M.D.C. Holdings, Inc. as the “Company,” “MDC,” “we” or “our” in this Quarterly Report on Form 10-Q, and these designations include our subsidiaries unless we state otherwise. Our homebuilding segments consist of subsidiary companies that build and sell homes under the name “Richmond American Homes.” The Company’s homebuilding reportable segments are as follows: (1) West (Arizona, California and Nevada); (2) Mountain (Colorado and Utah); (3) East (Maryland and Virginia, which includes Virginia and West Virginia); and (4) Other Homebuilding (Florida, Illinois, Delaware Valley, which includes Pennsylvania, Delaware and New Jersey, and Texas, although we recently completed our exit of the Texas market).

Our Financial Services and Other segment consists of HomeAmerican Mortgage Corporation (“HomeAmerican”), which originates mortgage loans primarily for our homebuyers, American Home Insurance Agency, Inc. (“American Home Insurance”), which offers third-party insurance products to our homebuyers, and American Home Title and Escrow Company (“American Home Title”), which provides title agency services to our homebuyers in Colorado, Delaware, Florida, Illinois, Nevada, Maryland, Virginia and West Virginia. This segment also includes Allegiant Insurance Company, Inc., A Risk Retention Group (“Allegiant”), which provides general liability coverage for products and completed operations to the Company and, in most of the Company’s markets, to subcontractors of MDC’s homebuilding subsidiaries, and StarAmerican Insurance Ltd. (“StarAmerican”), a Hawaii corporation. StarAmerican, a wholly owned subsidiary of MDC formed in 2003, has agreed to re-insure all claims pursuant to two policies issued to the Company by a third party. Pursuant to agreements beginning in June 2004, StarAmerican has agreed to re-insure all Allegiant claims in excess of $50,000 per occurrence, up to $3.0 million per occurrence, subject to various aggregate limits, not to exceed $18.0 million per year.

EXECUTIVE SUMMARY

During the 2007 third quarter, the homebuilding business experienced a dramatic decline in consumer demand for new homes. We have responded to these market conditions in a number of ways, as further discussed below. However, we are not immune from the uncertainties in the wider credit and capital markets, which we believe will play a major role in the timing, strength and sustainability of any housing correction. Additionally, while certain governmental organizations and other mortgage industry participants have taken steps recently to ease the downturn in the credit and capital markets, we cannot provide any assurance as to the impact their efforts will have on our Company or the homebuilding industry as a whole. See “Forward-Looking Statements” below.

Each of our homebuilding segments and our Financial Services and Other segment continued to be impacted by the downturn in the homebuilding and mortgage lending industries, which included,

 

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among other things, on-going homebuyer concerns about declines in the market value of homes, lower availability of credit for homebuyers resulting from tightened mortgage loan underwriting criteria, and an overall reduction in liquidity in the mortgage industry. We believe these and other factors contributed to, among other things: (1) significant increases in competition for new home orders driven by builders significantly reducing pricing in an attempt to reduce their inventory levels; (2) continued high levels of incentives and, in many cases, increased incentives required to stimulate new home orders and maintain previous home orders in Backlog (as defined below) until they close; (3) high levels of foreclosures, which contributed to the excess supply of homes available to be purchased; (4) prospective homebuyers having a more difficult time selling their existing homes in this increasingly competitive environment; and (5) reduced affordability of homes, partially due to increased difficulty of homebuyers to qualify for mortgage loans.

For MDC, these conditions resulted in fewer closed homes, decreased new home orders, reduced year-over-year Backlog and lower Home Gross Margins (as defined below) in 2007, as well as asset impairments of $249.0 million and $551.4 million for the third quarter and first nine months of 2007, respectively. As a consequence, we recognized net losses of $155.4 million and $355.8 million during the three and nine months ended September 30, 2007, respectively, compared with net income of $48.7 million and $220.6 million for the same periods in 2006. Due to homebuyer uncertainty with respect to the volatility in the homebuilding and mortgage lending industries, we cannot determine the potential for net losses in future reporting periods. See “Forward-Looking Statements” below.

Recognizing the challenges presented by the current homebuilding and mortgage lending environments, our management continued to focus on: (1) consolidating divisions in an attempt to reduce our general and administrative expenses, primarily through personnel reductions; (2) reducing our portfolio of lots controlled to accommodate the current pace of new home orders in our markets; (3) limiting cash outflows, including tighter controls over land development and home construction costs, speculative inventory levels and new home starts; (4) lowering risks associated with the origination and subsequent sales of mortgage loan products; (5) implementing initiatives to generate traffic, new home orders and maintain home orders in Backlog until they close, including focused sales and marketing programs and increased home sales incentives; (6) providing flexibility to new and existing homebuyers by offering mortgage loan products for which they are able to qualify, such as government loans, that continue to conform to HomeAmerican’s tightened mortgage underwriting criteria; and (7) expanding the scope of our national customer experience initiative, which is intended to improve the home buying and home ownership experience.

CRITICAL ACCOUNTING ESTIMATES AND POLICIES

The preparation of financial statements in conformity with accounting policies generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting periods. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Management evaluates such estimates and judgments on an on-going basis and makes adjustments as deemed necessary. Actual results could differ from these estimates using different estimates and assumptions, or if conditions are significantly different in the future. See “Forward-Looking Statements” below.

 

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The accounting policies and estimates, which we believe are critical and require the use of complex judgment in their application, are those related to (1) homebuilding inventory valuation; (2) revenue recognition; (3) segment reporting; (4) stock-based compensation; (5) home cost of sales; (6) warranty reserves; (7) land option contracts; and (8) insurance reserves. Our critical accounting estimates and policies have not changed from those reported in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2006.

RESULTS OF OPERATIONS

The following discussion compares results for the three and nine months ended September 30, 2007 with the three and nine months ended September 30, 2006.

(Loss) Income Before Income Taxes.  The table below summarizes our (loss) income before income taxes by segment (dollars in thousands).

 

    

Three Months

Ended September 30,

    Change
     2007     2006     Amount     %

Homebuilding

        

West

   $ (197,917 )   $ 53,762     $ (251,679 )   -468%

Mountain

     (925 )     9,320       (10,245 )   -110%

East

     (15,998 )     23,911       (39,909 )   -167%

Other Homebuilding

     (43,158 )     (4,660 )     (38,498 )   N/A
                          

Total Homebuilding

     (257,998 )     82,333       (340,331 )   -413%

Financial Services and Other

     5,018       12,989       (7,971 )   -61%

Corporate

     1,666       (18,901 )     20,567     -109%
                          

Consolidated

   $ (251,314 )   $ 76,421     $ (327,735 )   -429%
                          
    

Nine Months

Ended September 30,

    Change
     2007     2006     Amount     %

Homebuilding

        

West

   $ (462,547 )   $ 274,642     $ (737,189 )   -268%

Mountain

     3,218       25,183       (21,965 )   -87%

East

     (27,168 )     85,691       (112,859 )   -132%

Other Homebuilding

     (81,776 )     237       (82,013 )   N/A
                          

Total Homebuilding

     (568,273 )     385,753       (954,026 )   -247%

Financial Services and Other

     16,776       35,161       (18,385 )   -52%

Corporate

     (14,526 )     (69,778 )     55,252     -79%
                          

Consolidated

   $     (566,023 )   $      351,136     $     (917,159 )   -261%
                          

We recognized a loss before income taxes in our homebuilding segments during the three and nine months ended September 30, 2007, primarily resulting from: (1) asset impairments of $249.0 million and $551.4 million, respectively; (2) significant decreases in Home Gross Margins in most of our homebuilding segments; and (3) closing fewer homes in each of our homebuilding

 

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segments during the 2007 third quarter and first nine months. Partially offsetting these items were decreases in general and administrative, commission and marketing expenses of $16.8 million, $12.5 million and $2.6 million, respectively, during the 2007 third quarter and $48.4 million, $35.1 million and $4.8 million, respectively, during the nine months ended September 30, 2007.

In our West segment, the loss before income taxes during the three and nine months ended September 30, 2007 primarily was due to: (1) asset impairments of $190.5 million and $445.1 million, respectively; (2) significant decreases in Home Gross Margins; and (3) closing 548 and 1,842 fewer homes, respectively. These items partially were offset by a combined decrease in general and administrative, marketing and commission expenses of $22.5 million and $42.9 million during the three and nine months ended September 30, 2007, respectively.

In our Mountain segment, the loss before income taxes during the 2007 third quarter primarily resulted from asset impairments of $6.9 million and closing 159 fewer homes. Mountain segment income before income taxes for the nine months ended September 30, 2007 decreased primarily due to asset impairments of $16.7 million and closing 583 fewer homes, partially offset by a $2.5 million decrease in commission expense.

In our East segment, we recognized losses before income taxes during the 2007 third quarter and first nine months, primarily due to: (1) asset impairments of $16.2 million and $24.7 million, respectively; (2) significant decreases in Home Gross Margins; and (3) closing 111 and 391 fewer homes, respectively. These items partially were offset by a combined decrease in general and administrative, marketing and commission expenses of $5.7 million and $23.2 million for the three and nine months ended September 30, 2007, respectively.

We recognized losses before income taxes during the 2007 third quarter and first nine months in our Other Homebuilding segment, primarily resulting from: (1) asset impairments of $35.3 million and $64.9 million, respectively; (2) closing 174 and 718 fewer homes, respectively; and (3) significant decreases in Home Gross Margins. These items partially were offset by a combined decrease in general and administrative, marketing and commission expenses of $3.0 million and $19.9 million for the three and nine months ended September 30, 2007, respectively.

Income before income taxes in our Financial Services and Other segment decreased during the 2007 third quarter and first nine months due to lower gains on sales of mortgage loans. These declines partially were offset by decreases of $1.9 million and $8.0 million in general and administrative expenses during the three and nine months ended September 30, 2007, respectively. Our Corporate segment generated income before income taxes during the 2007 third quarter, and decreased the loss before income taxes during the nine months ended September 30, 2007, primarily as a result of: (1) increases in interest income, net; (2) an $8.0 million gain recognized on the sale of an aircraft; and (3) decreases of $4.7 million and $23.0 million in general and administrative expense, respectively.

 

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Total Revenue.  The table below summarizes total revenue by segment (dollars in thousands).

 

    

Three Months

Ended September 30,

    Change
     2007     2006     Amount     %

Homebuilding

        

West

   $ 389,309     $ 653,932     $ (264,623 )   -40%

Mountain

     138,439       168,193       (29,754 )   -18%

East

     72,368       137,050       (64,682 )   -47%

Other Homebuilding

     60,364       105,553       (45,189 )   -43%
                          

Total Homebuilding

     660,480       1,064,728       (404,248 )   -38%

Financial Services and Other

     14,652       23,843       (9,191 )   -39%

Corporate

     16,048       60       15,988     N/A

Inter-company adjustments

     (4,519 )     (7,708 )     3,189     -41%
                          

Consolidated

   $      686,661     $   1,080,923     $     (394,262 )   -36%
                          
    

Nine Months

Ended September 30,

    Change
     2007     2006     Amount     %

Homebuilding

        

West

   $ 1,277,012     $ 2,061,708     $ (784,696 )   -38%

Mountain

     418,300       519,107       (100,807 )   -19%

East

     205,523       444,765       (239,242 )   -54%

Other Homebuilding

     184,195       374,299       (190,104 )   -51%
                          

Total Homebuilding

     2,085,030       3,399,879       (1,314,849 )   -39%

Financial Services and Other

     47,836       74,158       (26,322 )   -35%

Corporate

     30,510       675       29,835     N/A

Inter-company adjustments

     (14,883 )     (16,383 )     1,500     -9%
                          

Consolidated

   $   2,148,493     $   3,458,329     $  (1,309,836 )   -38%
                          

The decreases in total revenue for our homebuilding segments during the three and nine months ended September 30, 2007 resulted from significant declines in home sales revenue primarily due to: (1) closing fewer homes in each of our homebuilding segments, most notably in our West segment; and (2) decreases in the average selling prices of homes closed in most of our markets. Total revenue for our Financial Services and Other segment decreased due to lower gains on sales of mortgage loans, which were driven by: (1) originating significantly fewer mortgage loans resulting from the declines in our home closing levels; (2) lower Capture Rates (as defined below) during the 2007 periods; and (3) a shift to a less profitable, but risk-mitigating, strategy of selling a majority of mortgage loan products faster after origination. Total revenue in our Corporate segment improved during the 2007 third quarter and first nine months due to an increase in interest income generated from significantly higher cash balances throughout the first three quarters of 2007, as well as the recognized gain on sale of an aircraft.

Inter-company adjustments relate to mortgage loan origination fees paid at the time of a home closing by our homebuilding subsidiaries to HomeAmerican on behalf of our homebuyers.

 

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Home Sales Revenue.  The table below summarizes home sales revenue by segment (dollars in thousands).

 

    

Three Months

Ended September 30,

    Change
     2007     2006     Amount     %

West

   $ 385,139     $ 652,043     $ (266,904 )   -41%

Mountain

     138,051       167,422       (29,371 )   -18%

East

     72,209       135,629       (63,420 )   -47%

Other Homebuilding

     60,244       103,314       (43,070 )   -42%
                          

Total Homebuilding

     655,643       1,058,408       (402,765 )   -38%

Inter-company adjustments

     (4,519 )     (7,708 )     3,189     -41%
                          

Consolidated

   $      651,124     $   1,050,700     $   (399,576 )   -38%
                          

 

    

Nine Months

Ended September 30,

    Change
     2007     2006     Amount     %

West

   $ 1,269,329     $ 2,057,359     $ (788,030 )   -38%

Mountain

     408,943       517,301       (108,358 )   -21%

East

     204,117       441,480       (237,363 )   -54%

Other Homebuilding

     183,231       356,659       (173,428 )   -49%
                          

Total Homebuilding

     2,065,620       3,372,799       (1,307,179 )   -39%

Inter-company adjustments

     (14,883 )     (16,383 )     1,500     -9%
                          

Consolidated

   $   2,050,737     $   3,356,416     $   (1,305,679 )   -39%
                          

In our West segment, decreases in home sales revenue for the three and nine months ended September 30, 2007 primarily resulted from closing 548 and 1,842 fewer homes, respectively, as well as decreases in the average selling prices for homes closed in each market within this segment for both 2007 periods. Home sales revenue in our Mountain segment decreased during the 2007 third quarter and first nine months due to closing 159 and 583 fewer homes, respectively. These items partially were offset by increases in the average selling prices for homes closed in this segment during the 2007 third quarter and first nine months.

The decline in home sales revenue for the three months ended September 30, 2007 in our East segment primarily was due to decreases in the average selling prices of closed homes in Maryland and the impact of closing 111 fewer homes. Home sales revenue for the first nine months of 2007 decreased due to closing 391 fewer homes and a decrease in the average selling prices of homes closed in each market within this segment. Home sales revenue in our Other Homebuilding segment decreased in the third quarter of 2007 and first nine months primarily due to closing 174 and 718 fewer homes, respectively, and decreases in the average selling prices for homes closed in our Florida market. These items partially were offset by increases in the average selling prices of homes closed in our Delaware Valley and Illinois markets.

Land Sales.  Land sales revenue was $2.7 million and $12.2 million during the three and nine months ended September 30, 2007, respectively, and primarily related to the sale of land in Utah, California and Arizona that no longer met our strategic objectives in those markets. Land sales revenue

 

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was $3.3 million and $18.8 million during the three and nine months ended September 30, 2006, respectively, and primarily related to the sale of land in Texas in connection with our exit of that market.

Other Revenue.  The table below sets forth the components of other revenue (dollars in thousands).

 

    

Three Months

Ended September 30,

   Change
     2007    2006    Amount     %

Gains on sales of mortgage loans, net

   $ 6,855    $ 12,950    $ (6,095 )   -47%

Broker origination fees

     1,561      2,255      (694 )   -31%

Insurance revenue

     4,153      6,534      (2,381 )   -36%

Interest income, net

     9,433      2,372      7,061     298%

Title and other revenue

     10,835      2,776      8,059     290%
                        

Total other revenue

   $        32,837    $        26,887    $          5,950     22%
                        

 

    

Nine Months

Ended September 30,

   Change
     2007    2006    Amount     %

Gains on sales of mortgage loans, net

   $ 22,536    $ 41,416    $ (18,880 )   -46%

Broker origination fees

     4,996      6,678      (1,682 )   -25%

Insurance revenue

     13,839      17,613      (3,774 )   -21%

Interest income, net

     26,938      5,225      21,713     416%

Title and other revenue

     17,296      12,169      5,127     42%
                        

Total other revenue

   $        85,605    $        83,101    $          2,504     3%
                        

Other revenue improved for the three and nine months ended September 30, 2007 primarily as a result of increases in interest income, net and title and other revenue. Interest income, net increased due to our cash balances being significantly higher during the 2007 periods, resulting from our on-going efforts to limit our inventory acquisitions during the current homebuilding down cycle. Our cash and cash equivalents consisted of funds in highly liquid, cash equivalents with an original maturity of 90 days or less, primarily commercial paper, money market funds and time deposits. Title and other revenue increased during both 2007 periods primarily due to the sale of an aircraft, which resulted in an $8.0 million gain. These increases to other revenue partially were offset by lower gains on sales of mortgage loans, due in part to originating fewer mortgage loans, declines in our 2007 Capture Rates and a shift to a less profitable, but risk-mitigating, strategy of selling mortgage loan products faster after origination.

Home Cost of Sales.  Home cost of sales (which primarily includes land and construction costs, capitalized interest, closing costs, and reserves for warranty and excludes commissions, amortization of deferred marketing costs and asset impairments) was $559.4 million and $1.7 billion for the three and nine months ended September 30, 2007, respectively, compared with $813.8 million and $2.5 billion during the same periods in 2006, respectively. The decrease during the 2007 third quarter primarily resulted from closing 992 fewer homes. The decrease during the nine months ended September 30, 2007 primarily resulted from closing 3,534 fewer homes, partially offset by the impact of closing more homes with higher land costs per closed home (more of the lots on which we closed homes during the first nine months of 2007 were purchased in the higher-priced 2005 and 2006 periods), and closing larger homes that included more options and upgrades as incentives for our homebuyers.

 

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Asset Impairments.  The following table sets forth by homebuilding segment the 2007 third quarter asset impairment, September 30, 2007 carrying values of impaired assets, and number of impaired lots and subdivisions (dollars in thousands).

 

    Three Months Ended September 30, 2007
    Land and
Land Under
Development
Impairments
  Housing
Completed
or Under
Construction
Impairments
  Total Asset
Impairments
  Post-
Impairment
Balances of
Impaired Assets
 

Number of

Lots

  Number of
Subdivisions

West

  $ 149,517   $ 40,973   $ 190,490   $ 623,129   5,285   80

Mountain

    5,055     1,875     6,930     38,677   345   12

East

    10,658     5,579     16,237     75,162   278   15

Other

  Homebuilding

    27,131     8,162     35,293     136,070   1,166   25
                               

Total

  $    192,361   $      56,589   $    248,950   $         873,038          7,074             132
                               

Consistent with our homebuilding inventory valuation policy, we evaluated facts and circumstances existing at quarter-end to determine whether the carrying values of our homebuilding inventories were recoverable on a subdivision-by-subdivision basis. Based upon the evaluation performed, we determined that the carrying values of certain inventory assets at September 30, 2007 in each of our homebuilding segments, particularly in our California, Nevada and Arizona markets, were not recoverable. Accordingly, during the three and nine months ended September 30, 2007, we recorded impairments of our housing completed or under construction in the amounts of $56.6 million and $121.1 million, respectively, and impairments of our land and land under development in the amounts of $192.4 million and $430.3 million, respectively. These impairments, which primarily relate to assets contracted for in 2004 and 2005, were due to decreases in home sales prices and/or increases in incentives offered in an effort to: (1) remain competitive with home sales prices offered by our competitors; (2) stimulate new home orders; and (3) maintain homes in Backlog until they close. As market conditions for the homebuilding industry can fluctuate significantly period-to-period and are impacted by uncertainty in the mortgage lending industry, we will continue to assess facts and circumstances existing at future period-ends to determine whether the carrying values of our homebuilding inventories are recoverable. We cannot provide any assurance as to the potential for future asset impairments. See “Forward-Looking Statements” below.

Marketing Expenses.  Marketing expenses (which include advertising, amortization of deferred marketing costs, model home expenses and other selling costs) were $28.7 million and $31.3 million for the three months ended September 30, 2007 and 2006, respectively, and $87.1 million and $91.9 million for nine months ended September 30, 2007 and 2006, respectively. The decline during the 2007 third quarter primarily resulted from lower advertising costs as we modified our marketing approach by shifting to lower cost advertising methods. The decrease during the first nine months of 2007 primarily related to lower amortization of deferred marketing costs resulting from closing fewer homes, and reduced salaries from a reduction in headcount.

Commission Expenses.  Commission expenses (which include direct incremental commissions paid for homes closed) were $23.9 million and $36.4 million for the three months ended September 30, 2007 and 2006, respectively, and $71.5 million and $106.6 million for the nine months ended September 30, 2007 and 2006, respectively. The decreases during the three and nine months ended September 30, 2007 primarily were attributable to closing 992 and 3,534 fewer homes, respectively.

 

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General and Administrative Expenses.  The following table summarizes our general and administrative expenses (dollars in thousands).

 

    

Three Months

Ended September 30,

   Change
     2007    2006    Amount     %

Homebuilding

   $ 52,561    $ 69,317    $ (16,756 )   -24%

Financial Services and Other

     9,635      11,516      (1,881 )   -16%

Corporate

     14,286      18,946      (4,660 )   -25%
                        

Total general and administrative expenses

   $        76,482    $        99,779    $       (23,297 )   -23%
                        

 

    

Nine Months

Ended September 30,

   Change
     2007    2006    Amount     %

Homebuilding

   $ 171,419    $ 219,820    $ (48,401 )   -22%

Financial Services and Other

     31,060      39,041      (7,981 )   -20%

Corporate

     44,750      67,734      (22,984 )   -34%
                        

Total general and administrative expenses

   $      247,229    $      326,595    $       (79,366 )   -24%
                        

General and administrative expenses for each of our homebuilding segments decreased during the three and nine months ended September 30, 2007, primarily due to lower compensation and other employee benefit-related costs. These reduced expenses resulted from various initiatives associated with right-sizing our operations in response to the reduced levels of homebuilding activity in each of our markets, including consolidating a number of our homebuilding divisions and reducing employee headcount. Through these efforts, we have reduced our homebuilding divisions to 17 as of September 30, 2007 from 27 and 23 at December 31, 2005 and 2006, respectively, allowing us to consolidate office space in many of our markets. Additionally, our employee headcount has decreased to approximately 2,500 at September 30, 2007, from a peak of approximately 4,200 at December 31, 2005 and approximately 3,200 at December 31, 2006. Lower general and administrative expenses in our homebuilding segments in the 2007 periods also reflect declines in write-offs of pre-acquisition costs and deposits on lot option contracts that we elected not to exercise.

In our Financial Services and Other segment, general and administrative expenses declined during the three and nine months ended September 30, 2007, primarily due to lower compensation-related costs. The decrease during the first nine months of 2007 partially was offset by increased costs associated with mortgage loans that were repurchased or subject to repurchase during 2007. In our Corporate segment, general and administrative expenses decreased during the three and nine months ended September 30, 2007, primarily resulting from lower compensation and other employee benefit-related costs.

Income Taxes.  Our overall effective income tax rates were 38.2% and 37.1% for the three and nine months ended September 30, 2007, respectively, and 36.3% and 37.2% for the three and nine months ended September 30, 2006. The changes in the effective tax rates during the 2007 periods, compared with the same periods during 2006, resulted from the impact of reductions in the benefits from I.R.C. Sec. 199, “Income Attributable to Domestic Production Activities,” and increases in estimated permanent differences primarily related to accruals for non-deductible excess compensation under I.R.C. Sec. 162(m), “Certain Excessive Employee Remuneration.”

 

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Homebuilding Operating Activities

The table below sets forth information relating to Home Gross Margins and orders for homes.

 

   

Three Months

Ended September 30,

  Change  

Nine Months

Ended September 30,

  Change
    2007   2006   Amount     %   2007   2006   Amount     %

Home Gross Margins

    14.1%     22.5%     -8.4%         14.7%     24.3%     -9.6%    

Orders For Homes, net (units)

               

Arizona

    385     680     (295 )   -43%     1,750     2,278     (528 )   -23%

California

    152     273     (121 )   -44%     849     1,209     (360 )   -30%

Nevada

    239     436     (197 )   -45%     984     1,734     (750 )   -43%
                                           

West

    776     1,389     (613 )   -44%     3,583     5,221     (1,638 )   -31%
                                           

Colorado

    153     196     (43 )   -22%     677     938     (261 )   -28%

Utah

    41     251     (210 )   -84%     390     916     (526 )   -57%
                                           

Mountain

    194     447     (253 )   -57%     1,067     1,854     (787 )   -42%
                                           

Maryland

    36     70     (34 )   -49%     227     320     (93 )   -29%

Virginia

    81     76     5     7%     275     383     (108 )   -28%
                                           

East

    117     146     (29 )   -20%     502     703     (201 )   -29%
                                           

Delaware Valley

    23     36     (13 )   -36%     104     110     (6 )   -5%

Florida

    81     81     -     0%     377     530     (153 )   -29%

Illinois

    37     20     17     85%     109     82     27     33%

Texas

    -     1     (1 )   -100%     14     158     (144 )   -91%
                                           

Other Homebuilding

    141     138     3     2%     604     880     (276 )   -31%
                                           

Total

    1,228     2,120     (892 )   -42%     5,756     8,658     (2,902 )   -34%
                                           

Approximate Cancellation Rates

    57%     49%     8%         44%     40%     4%    

Estimated Value of Orders for Homes, net

  $ 365,000   $ 678,000   $ (313,000 )   -46%   $ 1,920,000   $ 2,952,000   $ (1,032,000 )   -35%

Estimated Average Selling Price of Orders for Homes, net

  $ 297.2   $ 319.8   $ (22.6 )   -7%   $ 333.6   $ 341.0   $ (7.4 )   -2%

 

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Orders for Homes.  Most of our homebuilding segments experienced declines in net home orders during the 2007 third quarter and first nine months. This is consistent with the significant deterioration in demand for new homes reported for the markets in which we operate. Additionally, the continued high levels of competition during the three and nine months ended September 30, 2007 had a significant negative impact on our net home orders during such periods.

Home Gross Margins.  We define “Home Gross Margins” to mean home sales revenue less home cost of sales as a percent of home sales revenue. Home Gross Margins during the three and nine months ended September 30, 2007 decreased significantly in each of our West, East and Other Homebuilding segments due to offering lower selling prices and/or higher sales incentives to generate new home orders and subsequent home closings, increases in speculative homes that were sold and closed and higher land and home construction costs incurred to build larger homes that we were unable to fully offset through increases in the average selling prices of those homes. The decreases in Home Gross Margins for these three segments partially were offset by slight increases in Home Gross Margins in our Mountain segment. These increases resulted from closing homes in select subdivisions in our Colorado market with higher Home Gross Margins due, in part, to strong demand for our homes in those locations, partially offset by a decrease in Home Gross Margins in Utah.

Home Gross Margins for the three months ended September 30, 2007 were impacted positively by recognizing $5.6 million in “Operating Profits” (home sales revenue less home cost of sales and all direct incremental costs associated with the home closing) that had been deferred under Statement of Financial Accounting Standards (“SFAS”) No. 66, “Accounting for Sales of Real Estate” (“SFAS 66”), as of June 30, 2007, partially offset by a current deferral of $0.7 million in Operating Profits at September 30, 2007. Home Gross Margins for the first nine months of 2007 were impacted positively by recognizing $23.1 million in Operating Profits that had been deferred under SFAS 66 as of December 31, 2006, partially offset by our September 30, 2007 deferral. Home Gross Margins for the three months ended September 30, 2006 were impacted positively by recognizing $30.7 million in Operating Profits that had been deferred under SFAS 66 as of June 30, 2006, partially offset by a deferral of $18.5 million in Operating Profits as of September 30, 2006. Additionally, during the three and nine months ended September 30, 2007, we closed homes on lots for which we previously had recorded $28.6 million and $56.6 million, respectively, of asset impairments.

Future Home Gross Margins may be impacted negatively by, among other things: (1) increased competition and continued high levels of cancellations, which would affect our ability to maintain home prices and lower levels of incentives; (2) continued decline in demand for new homes in our markets; (3) increases in the costs of subcontracted labor, finished lots, building materials, and other resources, to the extent that market conditions prevent the recovery of increased costs through higher selling prices; (4) adverse weather; (5) shortages of subcontractor labor, finished lots and other resources, which can result in delays in the delivery of homes under construction and increases in related home cost of sales; (6) the impact of being unable to sell high loan-to-value mortgage loans on a timely basis, as this may affect the timing of recognizing the Operating Profit on closed homes pursuant to SFAS 66; and (7) other general risk factors. See “Forward-Looking Statements” below.

Approximate Cancellation Rate.  We define our home order “Approximate Cancellation Rate” as the approximate number of total cancelled home order contracts during a specified period of time as a percent of total home orders received during such time period. Our Approximate Cancellation Rate increased during both the three and nine months ended September 30, 2007. These increases primarily resulted from: (1) certain mortgage loan products no longer being available; (2) homebuyers having

 

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difficulty in qualifying for available mortgage loan products; (3) home orders that were contingent on our homebuyers being able to sell their existing homes; and (4) a decline in homebuyer confidence in the market value of homes and the lack of stabilization in home sales prices.

Homes Closed.  The following table sets forth homes closed for each market within our homebuilding segments (in units).

 

    

Three Months

Ended September 30,

   Change   

Nine Months

Ended September 30,

   Change
     2007    2006    Amount     %    2007    2006    Amount     %

Arizona

   700    716    (16 )   -2%    1,997    2,337    (340 )   -15%

California

   237    383    (146 )   -38%    831    1,252    (421 )   -34%

Nevada

   310    696    (386 )   -55%    1,028    2,109    (1,081 )   -51%
                                     

West

   1,247    1,795    (548 )   -31%    3,856    5,698    (1,842 )   -32%
                                     

Colorado

   219    334    (115 )   -34%    583    1,154    (571 )   -49%

Utah

   162    206    (44 )   -21%    568    580    (12 )   -2%
                                     

Mountain

   381    540    (159 )   -29%    1,151    1,734    (583 )   -34%
                                     

Maryland

   71    104    (33 )   -32%    181    290    (109 )   -38%

Virginia

   72    150    (78 )   -52%    216    498    (282 )   -57%
                                     

East

   143    254    (111 )   -44%    397    788    (391 )   -50%
                                     

Delaware Valley

   35    50    (15 )   -30%    116    122    (6 )   -5%

Florida

   115    195    (80 )   -41%    381    702    (321 )   -46%

Illinois

   41    46    (5 )   -11%    68    119    (51 )   -43%

Texas

   1    75    (74 )   -99%    26    366    (340 )   -93%
                                     

Other Homebuilding

   192    366    (174 )   -48%    591    1,309    (718 )   -55%
                                     

Total

       1,963        2,955        (992 )   -34%        5,995        9,529        (3,534 )   -37%
                                     

Our home closings were down during the three and nine months ended September 30, 2007 in each market of our homebuilding segments, primarily due to significantly lower Backlogs at the beginning of both 2007 periods, compared with the beginning of the corresponding 2006 periods. These declines in Backlog primarily resulted from decreases in new home orders during the second half of 2006 and first half of 2007, compared with the second half of 2005 and first half of 2006, partially as a result of homebuyer concerns about declines in the market value of homes and the lack of stabilization in home sales prices, and increases in our Approximate Cancellation Rates.

 

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Backlog.  The following table below sets forth information relating to Backlog for each market within our homebuilding segments (dollars in thousands).

 

      September 30,
2007
   December 31,
2006
   September 30,
2006
   December 31,
2005

Backlog (units)

           

Arizona

     1,257      1,504      2,040      2,099

California

     445      427      722      765

Nevada

     271      315      648      1,023
                           

West

     1,973      2,246      3,410      3,887
                           

Colorado

     347      253      361      577

Utah

     287      465      674      338
                           

Mountain

     634      718      1,035      915
                           

Maryland

     233      187      281      251

Virginia

     195      136      266      381
                           

East

     428      323      547      632
                           

Delaware Valley

     107      119      169      181

Florida

     193      197      427      599

Illinois

     64      23      43      80

Texas

     -      12      30      238
                           

Other Homebuilding

     364      351      669      1,098
                           

Total

     3,399      3,638      5,661      6,532
                           

Backlog Estimated Sales Value

   $   1,210,000    $   1,300,000    $   2,100,000    $   2,440,000
                           

Estimated Average Selling Price of Homes in Backlog

   $ 356.0    $ 357.3    $ 371.0    $ 373.5
                           

We define “Backlog” as homes under contract but not yet delivered. At September 30, 2007 and 2006, we had 3,399 and 5,661 homes in Backlog, respectively. Because our change in Backlog during the first nine months of 2007 is equal to the total net home orders received during the nine months ended September 30, 2007 less homes closed during the same period, refer to the previous discussion on “Homes Closed” and “Orders for Homes” for an explanation of the change in the number of homes in Backlog. The Backlog estimated sales value decreased from $2.1 billion at September 30, 2006 to $1.2 billion at September 30, 2007, primarily due to the 40% decrease in the number of homes in Backlog and a 4% decrease in the estimated average selling price of homes in Backlog.

 

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Active Subdivisions.  The following table displays the number of our active subdivisions for each market within our homebuilding segments.

 

     September 30,
2007
   December 31,
2006
   September 30,
2006

Arizona

   67    67    65

California

   41    45    46

Nevada

   41    41    37
              

West

   149    153    148
              

Colorado

   52    47    45

Utah

   25    22    21
              

Mountain

   77    69    66
              

Maryland

   16    19    17

Virginia

   21    19    19
              

East

   37    38    36
              

Delaware Valley

   4    8    7

Florida

   23    30    29

Illinois

   7    6    7

Texas

   -    2    2
              

Other Homebuilding

   34    46    45
              

Total

   297    306    295
              

Average for quarter ended

               303                299                296
              

Average Selling Prices Per Home Closed.  The following table displays our average selling prices per home closed, by market (dollars in thousands).

 

    

Three Months

Ended September 30,

   Change   

Nine Months

Ended September 30,

   Change
     2007    2006    Amount     %    2007    2006    Amount     %

Arizona

   $ 247.9    $ 311.8    $ (63.9 )   -20%    $ 254.4    $ 303.6    $ (49.2 )   -16%

California

     492.4      520.7      (28.3 )   -5%      524.7      542.8      (18.1 )   -3%

Colorado

     357.7      301.4      56.3     19%      345.5      302.2      43.3     14%

Delaware Valley

     417.2      394.3      22.9     6%      452.7      396.5      56.2     14%

Florida

     253.8      275.6      (21.8 )   -8%      265.2      290.1      (24.9 )   -9%

Illinois

     396.1      365.6      30.5     8%      381.7      367.7      14.0     4%

Maryland

     521.4      576.1      (54.7 )   -9%      521.3      573.8      (52.5 )   -9%

Nevada

     294.2      317.8      (23.6 )   -7%      301.5      320.6      (19.1 )   -6%

Texas

     110.0      164.0      (54.0 )   -33%      129.6      167.1      (37.5 )   -22%

Utah

     363.3      321.5      41.8     13%      359.8      293.0      66.8     23%

Virginia

     484.1      486.2      (2.1 )   0%      491.4      555.2      (63.8 )   -11%

Company average

   $   331.7    $   355.6    $     (23.9 )   -7%    $   342.1    $   352.2    $   (10.1 )   -3%

The average selling prices of homes closed for the Company decreased during the three and nine months ended September 30, 2007. Declines were most notable in Arizona, Maryland, California, Nevada, Florida and, for the nine-month period, Virginia. These decreases resulted in part from

 

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increased levels of incentives and reductions in sales prices required to close homes in response to lower demand for new homes in these markets. Additionally, during the three and nine months ended September 30, 2007, we experienced increases in the number of home order cancellations, which resulted in these homes being resold and closed as speculative homes, generally with lower prices or higher incentives. We experienced increases in average selling prices in our Delaware Valley, Colorado, Illinois and Utah markets during the third quarter and first nine months of 2007, primarily related to changes in the style and size of our single-family detached homes that were closed during these periods. Also contributing to the higher average selling prices of homes closed in Utah was our ability to raise home sales prices due to the higher demand for new homes in the second half of 2006, compared with the same period during 2005.

Land Inventory.  The table below shows the carrying value of land and land under development, for each market within our homebuilding segments (in thousands).

 

     September 30,
2007
   December 31,
2006
   September 30,
2006

Arizona

   $ 141,745    $ 284,407    $ 303,493

California

     89,092      391,170      438,128

Nevada

     136,343      305,089      331,828
                    

West

     367,180      980,666      1,073,449
                    

Colorado

     165,144      191,456      176,618

Utah

     77,850      90,607      89,703
                    

Mountain

     242,994      282,063      266,321
                    

Maryland

     36,780      76,981      69,529

Virginia

     67,520      108,646      115,601
                    

East

     104,300      185,627      185,130
                    

Delaware Valley

     9,516      29,345      30,882

Florida

     21,400      74,149      81,150

Illinois

     9,338      23,105      23,883

Texas

     -      203      1,219
                    

Other Homebuilding

     40,254      126,802      137,134
                    

Total

   $      754,728    $   1,575,158    $   1,662,034
                    

 

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The tables below show the total number of lots owned (excluding homes completed or under construction) and lots controlled under option agreements for each market within our homebuilding segments (in units).

 

      September 30,
2007
   December 31,
2006
   September 30,
2006

Lots Owned

        

Arizona

             3,962    6,368    6,958

California

            1,867    2,802    3,051

Nevada

            1,879    2,747    3,096
              

West

            7,708            11,917            13,105
              

Colorado

            2,904    3,479    3,325

Utah

   900    1,185    1,132
              

Mountain

   3,804    4,664    4,457
              

Maryland

   307    528    505

Virginia

   417    643    674
              

East

   724    1,171    1,179
              

Delaware Valley

   141    265    283

Florida

   849    1,093    1,220

Illinois

   201    287    300

Texas

   -    13    69
              

Other Homebuilding

   1,191    1,658    1,872
              

Total

   13,427    19,410    20,613
              

Lots Controlled Under Option

        

Arizona

   388    744    1,283

California

   157    387    1,053

Nevada

   4    250    627
              

West

   549    1,381    2,963
              

Colorado

   258    801    1,304

Utah

   -    91    272
              

Mountain

   258    892    1,576
              

Maryland

   605    960    1,034

Virginia

   1,769    2,381    2,459
              

East

   2,374    3,341    3,493
              

Delaware Valley

   315    683    874

Florida

   497    1,800    1,999

Illinois

   -    -    47

Texas

   -    -    -
              

Other Homebuilding

   812    2,483    2,920
              

Total

   3,993    8,097    10,952
              

Total Lots Owned and Controlled (excluding homes completed or under construction)

   17,420    27,507    31,565
              

 

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During the 2007 third quarter and first nine months, in view of the current pace of new home orders in our markets, we remained focused on managing the total number of lots owned and controlled under option. Accordingly, the total number of lots owned (excluding homes completed or under construction) at September 30, 2007 declined 35% and 31% from September 30, 2006 and December 31, 2006, respectively, including decreases in each of our homebuilding segments. In addition, partly as a result of our efforts to control land acquisitions through modifications to lot takedown prices and extensions of time for specified lot takedowns, we have reduced our land and land under development by $820.4 million since December 31, 2006, which includes the impact of $430.3 million of impairments recognized during the first nine months of 2007. Also during the 2007 third quarter, we implemented additional operating procedures intended to more closely control cash outflows associated with land development and home construction costs. Finally, in an effort to mitigate our exposure to increases in speculative home levels generated through home order cancellations, we tightened significantly our process for approving all new home starts.

Our total lots controlled under option at September 30, 2007 decreased by 64% and 51% from September 30, 2006 and December 31, 2006, respectively. These decreases include declines within each of our homebuilding segments and primarily related to the termination of lot option contracts with terms that no longer met our underwriting criteria and limiting the purchase of lots under option. As a result, we incurred approximately $5.1 million and $15.6 million in write-offs of lot option deposits and pre-acquisition costs during the three and nine months ended September 30, 2007, respectively, compared with $7.3 million and $23.0 million during the same periods in 2006.

In addition to the non-refundable option deposits noted in the table below (in thousands), we had $4.0 million and $5.6 million in capitalized pre-acquisition costs at September 30, 2007 and December 31, 2006, respectively.

 

     September 30,
2007
   December 31,
2006
   September 30,
2006

Non-refundable Option Deposits

        

Cash

   $ 8,093    $ 20,228    $ 34,034

Letters of Credit

     8,287      14,224      16,069
                    

Total Non-refundable Option Deposits

   $        16,380    $        34,452    $        50,103
                    

The table below shows the number of homes completed or under construction (in units).

 

     September 30,
2007
   December 31,
2006
   September 30,
2006

Unsold Homes Under Construction - Final

   493    476    468

Unsold Homes Under Construction - Frame

   862    573    780

Unsold Homes Under Construction - Foundation

   196    400    244
              

Total Unsold Homes Under Construction

   1,551    1,449    1,492

Sold Homes Under Construction

   2,791    2,430    4,340

Model Homes

   758    757    762
              

Homes Completed or Under Construction

              5,100               4,636               6,594
              

 

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Other Operating Results

HomeAmerican Operating Activities.  The following table sets forth information relating to mortgage loans originated by our HomeAmerican operations, mortgage loans brokered and our Capture Rates (dollars in thousands).

 

    

Three Months

Ended September 30,

   Change
     2007    2006    Amount     %

Principal amount of mortgage loans originated

   $      286,192    $ 541,446    $     (255,254 )   -47%

Principal amount of mortgage loans brokered

   $ 118,580    $ 162,783    $ (44,203 )   -27%

Capture Rate

     54%      60%      -6%    

Including brokered loans

     73%      78%      -5%    

Mortgage products (% of loans originated by HomeAmerican)

Fixed rate

     86%      53%      33%    

Adjustable rate - interest only

     11%      39%      -28%    

Adjustable rate - other

     3%      8%      -5%    

Prime loans (1)

     86%      54%      32%    

Alt-A loans (2)

     0%      41%      -41%    

Government loans (4)

     14%      4%      10%    

Sub-prime loans (3)

     0%      1%      -1%    
    

Nine Months

Ended September 30,

   Change
     2007    2006    Amount     %

Principal amount of mortgage loans originated

   $ 930,769    $   1,672,096    $ (741,327 )   -44%

Principal amount of mortgage loans brokered

   $ 364,813    $ 492,464    $ (127,651 )   -26%

Capture Rate

     55%      58%      -3%    

Including brokered loans

     74%      75%      -1%    

Mortgage products (% of loans originated by HomeAmerican)

          

Fixed rate

     78%      50%      28%    

Adjustable rate - interest only

     20%      42%      -22%    

Adjustable rate - other

     2%      8%      -6%    

Prime loans

     77%      61%      16%    

Alt-A loans

     14%      33%      -19%    

Government loans

     9%      4%      5%    

Sub-prime loans

     0%      2%      -2%    

 

(1)

Prime loans are defined as loans with Fair, Isaac & Company (“FICO”) scores greater than 620 and which comply with the documentation standards of the government sponsored enterprise guidelines.

(2)

Alt-A loans are defined as loans that would otherwise qualify as prime loans except that they do not comply with the documentation standards of the government sponsored enterprise guidelines.

 

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(3)

Government loans are loans either insured by the Federal Housing Administration or guaranteed by the Department of Veteran Affairs.

(4)

Sub-prime loans are loans that have FICO scores of less than or equal to 620.

The principal amount of mortgage loans originated and brokered decreased in the third quarter and first nine months of 2007, primarily due to closing 34% and 37% fewer homes, respectively, and declines in the Capture Rates for the respective 2007 periods. The “Capture Rate” is defined as the number of mortgage loans originated by HomeAmerican for our homebuyers as a percent of total MDC home closings.

Fixed rate mortgage loans as a percentage of the total mortgage loans HomeAmerican originated during the 2007 third quarter and first nine months increased significantly, due in part to a decrease in the difference in interest rates for adjustable rate mortgage loans and fixed rate mortgage loans, making fixed rate loans more attractive for our homebuyers. Also contributing to this increase was a reduced demand by third-party purchasers for non-conforming mortgage loans. Additionally, in response to the reduced liquidity in the mortgage lending industry, we tightened our mortgage loan underwriting criteria during 2007 by: (1) discontinuing Alt-A second mortgage loans and Non-Agency (defined as not being FNMA and FHLMC eligible) mortgage loans with combined-loan-to-values in excess of 95%; and (2) requiring larger down payments from homebuyers in communities where the market value of homes have been declining. As a result, during the 2007 periods, HomeAmerican originated fewer: (1) high loan-to-value mortgage loans; (2) sub-prime and Alt-A mortgage loan products; and (3) loans with related second mortgages.

During 2007, we started selling more of our originated mortgage loans on a flow basis rather than a bulk basis and, beginning in the 2007 third quarter, selling substantially all originated Non-Agency products faster after the closing of the home. While these strategies were undertaken to mitigate some of the risks associated with holding these mortgage loans, they also contributed to our lower gains on sales of mortgage loans.

Forward Sales Commitments.  HomeAmerican is exposed to market risks related to fluctuations in interest rates on its mortgage loan inventory. Derivative instruments utilized in the normal course of business by HomeAmerican include forward sales of mortgage-backed securities, commitments to sell whole mortgage loans and commitments to originate mortgage loans. HomeAmerican utilizes forward mortgage securities contracts to manage the price risk on fluctuations in interest rates on our mortgage loans owned and the interest rate lock commitments. Such contracts are the only significant financial derivative instruments utilized by us and are generally settled within 45 days of origination. Additionally, certain mortgage loans originated by HomeAmerican are sold pursuant to an early purchase program and generally are settled within five days of origination, which further mitigates some of the risks associated with holding mortgage loans. Due to this hedging philosophy, the market risk associated with HomeAmerican’s mortgages is limited. Reported gains on sales of mortgage loans may vary significantly from period to period depending on volatility in the interest rate market. See “Forward-Looking Statements” below.

Interest Activity.  We capitalize interest on our homebuilding inventories during the period of active development and through the completion of construction. All interest incurred by our Corporate and homebuilding segments during the three and nine months ended September 30, 2007 and 2006 was capitalized. Interest incurred by the Financial Services and Other segment is charged to interest expense, which is deducted from interest income. For a reconciliation of our interest incurred, capitalized and expensed, see Note 6 to our Unaudited Consolidated Financial Statements.

 

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LIQUIDITY AND CAPITAL RESOURCES

We use our liquidity and capital resources to (1) support our operations, including our homebuilding inventories; (2) provide working capital; and (3) provide mortgage loans for our homebuyers. Liquidity and capital resources are generated internally from operations and from external sources. Additionally, we have an effective shelf registration statement, which allows us to issue equity, debt or hybrid securities up to $1.0 billion, with $500 million earmarked for our medium-term senior notes program.

Capital Resources

Our capital structure is a combination of (1) permanent financing, represented by stockholders’ equity; (2) long-term financing, represented by our publicly traded 7% senior notes due 2012, 5 1/2% senior notes due 2013, 5 3/8% medium-term senior notes due 2014 and 2015 and our homebuilding line of credit (the “Homebuilding Line”); and (3) current financing, primarily our mortgage lending line of credit (the “Mortgage Line”). Based upon our current capital resources and additional capacity available under existing credit agreements, we believe that our current financial condition is both balanced to fit our current operating structure and adequate to satisfy our current and near-term capital requirements. We continue to monitor and evaluate the adequacy of our Homebuilding Line and Mortgage Line. However, we believe that we can meet our long-term capital needs (including meeting future debt payments and refinancing or paying off other long-term debt as it becomes due) from operations and external financing sources, assuming that no significant adverse changes in our business or capital and credit markets occur as a result of the various risk factors described in Item 1A “Risk Factors Relating to our Business,” which are included in our Annual Report on Form 10-K for the year ended December 31, 2006 and this Quarterly Report on Form 10-Q. See “Forward-Looking Statements” below.

Lines of Credit and Senior Notes

Homebuilding.  Our Homebuilding Line is an unsecured revolving line of credit with a group of lenders for support of our homebuilding segments. Our Homebuilding Line has an aggregate commitment amount of $1.25 billion (the “Commitment”) and a maturity date of March 21, 2011. The facility’s provision for letters of credit is available in the aggregate amount of $500 million. The facility permits an increase in the maximum commitment amount to $1.75 billion upon our request, subject to receipt of additional commitments from existing or additional participant lenders. Interest rates on outstanding borrowings are determined by reference to a chosen London Interbank Offered Rate (“LIBOR”), with a spread from LIBOR which is determined based on changes in our credit ratings and leverage ratio, or to an alternate base rate. At September 30, 2007, we did not have any borrowings on our Homebuilding Line and had $34.0 million in letters of credit issued, which reduced the amount available to be borrowed under the Homebuilding Line.

Mortgage Lending.  Our Mortgage Line has a borrowing limit of $225 million with terms that allow for increases of up to $175 million in the borrowing limit to a maximum of $400 million, subject to concurrence by the participating banks. Available borrowings under the Mortgage Line are collateralized by mortgage loans and mortgage-backed securities and are limited to the value of eligible collateral, as defined. At September 30, 2007, $42.0 million was borrowed and an additional $14.8 million was collateralized and available to be borrowed. The Mortgage Line is cancelable upon 120 days notice.

 

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General.  The agreements for our bank lines of credit and the indentures for our senior notes require compliance with certain representations, warranties and covenants. We believe that we are in compliance with these requirements, and we are not aware of any covenant violations. The agreements containing these representations, warranties and covenants for the bank lines of credit and the indentures for our senior notes are on file with the Securities and Exchange Commission and are listed in the Exhibit Table in Part IV of our Annual Report on Form 10-K for the year ended December 31, 2006 and in Part II of this Quarterly Report on Form 10-Q.

The financial covenants contained in the Homebuilding Line agreement include a leverage test and a consolidated tangible net worth test. Under the leverage test, generally, our consolidated indebtedness is not permitted to exceed 55% (subject to adjustment in certain circumstances) of the sum of consolidated indebtedness and our “adjusted consolidated tangible net worth,” as defined. Effective October 24, 2007, the Company’s “consolidated tangible net worth” (as defined) under the Homebuilding Line consolidated tangible net worth test must not be less than (1) $1.405 billion; plus (2) 50% of consolidated net income, as defined, earned by the Company and the guarantor subsidiaries after September 30, 2007; plus (3) 50% of the net proceeds or other consideration received by the Company for the issuance of capital stock after September 30, 2007; minus (4) the lesser of (A) the aggregate amount paid by the Company after September 30, 2007 to repurchase its common stock and (B) $300 million. Failure to satisfy the foregoing financial covenant tests would not result in a default, but would result in a scheduled reduction in the amount of the Commitment. In addition, “consolidated tangible net worth,” as defined, must not be less than the sum of (1) $850 million; (2) 50% of the “quarterly consolidated net income” of “borrower” and the “guarantors” earned after September 30, 2005; and (3) 50% of the net proceeds or other consideration received for the issuance of capital stock after September 30, 2005. Failure to satisfy this covenant could result in a termination of the facility. We believe that we are in full compliance with these covenants, and we are not aware of any covenant violations.

Our senior notes are not secured and, while the senior notes indentures contain some restrictions on secured debt and other transactions, they do not contain financial covenants. Our senior notes are fully and unconditionally guaranteed on an unsecured basis, jointly and severally, by most of our homebuilding segment subsidiaries.

MDC Common Stock Repurchase Program

At September 30, 2007, we were authorized to repurchase up to 4,000,000 shares of our common stock. We did not repurchase any shares of our common stock during the three months ended September 30, 2007 or 2006.

Consolidated Cash Flow

During the first nine months of 2007, we generated $335.6 million in cash from operating activities, primarily resulting from a reduction of $217.1 million in mortgage loans held in inventory and home sales and other receivables from December 31, 2006. The decline in mortgage loans held in inventory primarily was due to originating a higher volume of mortgage loans during the 2006 fourth quarter, compared with the 2007 third quarter, and the strategy of selling a majority of all Non-Agency mortgage loans faster after the closing of the home. Additionally, we generated $180.2 million from a reduction in homebuilding inventories as we implemented additional operating procedures intended to more closely control cash outflows associated with land purchases, land development and home construction costs, and tighter processes for approving new home starts. Offsetting these cash proceeds

 

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was the use of $67.3 million to reduce accounts payable and accrued liabilities, primarily related to the payment of employee bonuses and homebuilding construction payables. Additionally, we used $44.7 million in cash to reduce income taxes payable, primarily in connection with paying our 2006 tax obligations, and to establish an income taxes receivable balance as a result of our anticipated 2007 net operating loss carryback.

During the first nine months of 2006, we used $41.3 million of cash in our operating activities. We used $264.8 million of cash to increase our homes completed or under construction from December 31, 2005. Our income tax payables decreased $85.6 million from December 31, 2005, primarily relating to payments made in 2006 associated with our 2005 income tax obligations. Additionally, we used $46.7 million to increase prepaid and other assets, net. We used $16.9 million in cash to reduce accounts payable and accrued liabilities, primarily due to the payment of executive bonuses, as well as homebuilding construction payables. These cash uses for operations were offset by $75.5 million in cash provided by changes in mortgage loans held in inventory and home sales receivables, primarily resulting from closing more homes during the 2005 fourth quarter, compared with the 2006 third quarter, and selling the high volume of mortgage loans that were originated for these closed homes in 2006. Also offsetting these cash uses was net income of $220.6 million and non-cash charges of $73.6 million. Our non-cash charges included primarily depreciation and amortization, the write-off of land option deposits and preacquisition costs, impairments of inventory assets and stock-based compensation expense.

During the nine months ended September 30, 2007, we used $8.4 million in cash from investing activities. This cash usage primarily resulted from transactions we closed during the 2007 third quarter with third parties that qualified for tax purposes as a like-kind exchange transaction in accordance with I.R.C. Section 1031. Pursuant to these transactions, we sold an aircraft for approximately $22.0 million (resulting in a pre-tax gain of approximately $8.0 million) and upgraded with the purchase of a new aircraft for approximately $29.0 million. In the first nine months of 2006, we used $7.2 million of cash from investing activities primarily to purchase property and equipment.

During the nine months ended September 30, 2007, we used $105.7 million in cash from financing activities. This cash usage primarily resulted from $88.5 million in net payments on our Mortgage Line and $34.3 million in dividend payments, partially offset by cash proceeds of $10.8 million from the exercise of stock options. Additionally, we received proceeds of $6.3 million with respect to the excess tax benefit from stock-based compensation during the first nine months of 2007.

During the nine months ended September 30, 2006, we used a total of $33.1 million of cash from financing activities. This cash use primarily was the result of dividend payments of $33.7 million and net payments under our lines of credit of $4.2 million, partially offset by $4.7 million in proceeds and tax benefits from the exercise of stock options.

Off-Balance Sheet Arrangements

In the ordinary course of business, we enter into lot option purchase contracts in order to procure lots for the construction of homes. Lot option contracts enable us to control lot positions with a minimal capital investment, which substantially reduces the risks associated with land ownership and development. At September 30, 2007, we had non-refundable option deposits of $8.1 million in the form of cash and $8.3 million in the form of letters of credit to secure option contracts to purchase lots.

 

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In certain cases, in the event that we exercise our right to purchase the lots or land under option, in addition to our purchase price, our obligation also includes certain costs we are required to reimburse the seller. At September 30, 2007, the total purchase price for lots under option and total capitalized pre-acquisition costs were $465 million and $4.0 million, respectively.

At September 30, 2007, we had issued performance bonds and letters of credit totaling approximately $316.0 million and $55.3 million, respectively, including $18.2 million in letters of credit issued by HomeAmerican, with the remaining issued by third parties, to secure our performance under various contracts. We expect that the obligations secured by these performance bonds and letters of credit generally will be performed in the ordinary course of our business and in accordance with the applicable contractual terms. To the extent that the obligations are performed, the related performance bonds and letters of credit should be released and we should not have any continuing obligations.

We have made no material guarantees with respect to third-party obligations.

Contractual Obligations

Our contractual obligations have not changed materially from those reported in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2006.

IMPACT OF INFLATION, CHANGING PRICES AND ECONOMIC CONDITIONS

Real estate and residential housing prices are affected by a number of factors, including, but not limited to, inflation, interest rate changes and the supply of new and existing homes to be purchased. Inflation can cause increases in the price of land, raw materials and subcontracted labor. During 2007, these increased costs were not fully recovered through higher sales prices, which negatively impacted our 2007 Home Gross Margins. If interest rates increase, construction and financing costs, as well as the cost of borrowings, could also increase, which can result in lower Home Gross Margins. Increases in home mortgage interest rates make it more difficult for our customers to qualify for home mortgage loans, potentially decreasing home sales revenue. Increases in interest rates also may affect adversely the volume of mortgage loan originations. Increases in the supply of unsold new and existing homes have had an adverse effect on our ability to generate new home orders and maintain home orders in Backlog, and have impacted negatively our Home Gross Margins, homes sales revenue and results of operations.

The volatility of interest rates could have an adverse effect on our future operations and liquidity. Reported gains on sales of mortgage loans may vary significantly from period to period depending on the volatility in the interest rate market. Derivative instruments utilized in the normal course of business by HomeAmerican include forward sales securities commitments, private investor sales commitments and commitments to originate mortgage loans. We utilize these commitments to manage the price risk on fluctuations in interest rates on our mortgage loans held in inventory and commitments to originate mortgage loans. Such contracts are the only significant financial derivative instruments we utilize.

 

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Among other things, an increase in interest rates may affect adversely the demand for housing and the availability of mortgage financing and may reduce the credit facilities offered to us by banks, investment bankers and mortgage bankers.

We continue to have the objective of limiting our lot supply to avoid over-exposure to any single sub-market and to create flexibility to react to changes in market conditions, but a continued slowdown in the pace of net home orders could work contrary to this strategy.

OTHER

Forward-Looking Statements

Certain statements in this Quarterly Report on Form 10-Q, as well as statements made by us in periodic press releases, oral statements made by our officials in the course of presentations about the Company and conference calls in connection with quarterly earnings releases, constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include statements regarding our business, financial condition, results of operation, cash flows, strategies and prospects. These forward-looking statements may be identified by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential” or “continue,” or the negative of such terms and other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements contained in this Report are reasonable, we cannot guarantee future results. These statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company to be materially different from those expressed or implied by the forward-looking statements. 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 subsequent reports on Forms 10-K, 10-Q and 8-K should be consulted. Additionally, information about issues that could lead to material changes in performance and risk factors that have the potential to affect us is contained under the caption “Risk Factors Relating to our Business” in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2006 and Item 1A of Part II of this Quarterly Report on Form 10-Q.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes from the 2006 Annual Report on Form 10-K related to the Company’s exposure to market risk from interest rates.

 

Item 4. Controls and Procedures

(a) Conclusion regarding the effectiveness of disclosure controls and procedures - An evaluation of the effectiveness of the design and operation of our disclosure controls and procedures was performed under the supervision, and with the participation, of our management, including the Chief Executive Officer and the Chief Financial Officer. Based on that evaluation, the Company’s management, including the Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures were effective at September 30, 2007.

(b) Changes in internal control over financial reporting - There were no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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M.D.C. HOLDINGS, INC.

FORM 10-Q

PART II

 

Item 1. Legal Proceedings

The Company and certain of its subsidiaries and affiliates have been named as defendants in various claims, complaints and other legal actions arising in the ordinary course of business, including moisture intrusion and related mold claims. In the opinion of management, the outcome of these matters will not have a material adverse effect upon the financial condition, results of operations or cash flows of the Company. See “Forward-Looking Statements” above.

The U.S. Environmental Protection Agency (“EPA”) filed an administrative action against Richmond American Homes of Colorado, Inc. (“RAH Colorado”), alleging that RAH Colorado violated the terms of RAH Colorado’s general permit for discharges of stormwater from construction activities at two of RAH Colorado’s development sites. In its complaint, the EPA sought civil penalties against RAH Colorado in the amount of $0.1 million. On November 11, 2003, the EPA filed a motion to withdraw the administrative action so that it could refile the matter in United States District Court as part of a consolidated action against RAH Colorado for alleged stormwater violations at not only the original two sites, but also two additional sites. The EPA’s motion to withdraw was granted by the Administrative Law Judge on February 9, 2004. The EPA has not yet refiled the matter. The EPA has inspected 21 sites under development in Colorado and by RAH Colorado affiliates in Virginia, Maryland, Arizona and California, and claims to have found additional stormwater permit violations. RAH Colorado has substantial defenses to the allegations made by the EPA and also is exploring methods of resolving this matter with the EPA.

The EPA issued two Notices of Violation against Richmond American Homes of Arizona, Inc. (“RAH Arizona”) alleging violations of the Clean Air Act. The EPA asserted that RAH Arizona had not controlled dust generated at construction sites in Maricopa County in that it had not operated a water application system or other approved control measures, installed suitable track-out control devices and/or cleaned-up materials tracked-out from project sites. The EPA filed an action in the United States District Court, District of Arizona, against RAH Arizona based on these allegations. On September 17, 2007, RAH Arizona, without admitting any wrongdoing, reached a settlement with a release of civil liability for all alleged violations. After the public is given an opportunity to comment and the United States considers any comments received, it may ask the District Court Judge assigned to the case to accept the settlement agreement. If the settlement agreement is accepted by the Court, RAH Arizona will pay a civil penalty of $155,000 and implement various procedures to abate fugitive dust emissions.

Because of the nature of the homebuilding business, and in the ordinary course of its operations, the Company from time to time may be subject to product liability claims.

 

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Item 1A. Risk Factors

There have been no significant changes in the risk factors previously identified as being attendant to our business in our Annual Report on Form 10-K for the year ended December 31, 2006, except with respect to the following:

Adverse changes in general economic conditions could reduce the demand for homes and, as a result, could negatively impact our results of operations.

The homebuilding industry continued to experience uncertainty and reduced demand for new homes, which negatively impacted our financial and operating results during the first nine months of 2007, compared with the first nine months of 2006. Widespread national and international concern over instability in the credit markets has exacerbated the decline in demand for new homes. The conditions experienced during the first nine months of 2007 included, among other things: reduced consumer confidence; on-going homebuyer concerns about the housing market and the lack of home selling price stabilization; concerns over higher-risk mortgage loan products, such as Alt-A and sub-prime; and reduced availability of mortgage loan financing. Further declines during this down cycle in the homebuilding industry could continue to cause demand for our homes to weaken significantly, which would have a significant negative impact on our Home Gross Margins and financial and operational results.

Competition in the homebuilding industry could negatively impact our results of operations.

The real estate industry is fragmented and highly competitive. Our homebuilding subsidiaries compete with numerous homebuilders, including a number that are substantially larger and have greater financial resources. Our homebuilding subsidiaries also compete with subdivision developers and land development companies, some of which are themselves homebuilders or affiliates of homebuilders. Homebuilders compete for customers, desirable financing, land, building materials and subcontractor labor. Competition for home orders primarily is based upon price, style, financing provided to prospective purchasers, location of property, quality of homes built, customer service and general reputation in the community. We, through our mortgage lending subsidiary, HomeAmerican, also compete with numerous banks, thrifts and other mortgage bankers, many of which are larger and have greater financial resources than we do. Additionally, competition within the homebuilding industry can be impacted significantly through an excess supply of new and existing homes available for sale resulting in part from, increases in speculative homes available for sale and increases in home foreclosures. Increased competition, as experienced during the first nine months of 2007, can result in significant decreases in our home sales prices and/or significant increases in incentives in order to generate new home sales and in response to lower home sales prices offered by our competitors. These competitive pressures are likely to continue for some time and could affect our ability to maintain existing home prices and require that we provide additional incentives, which would negatively impact our future financial and operating results.

If the market value of our homes or carrying value of our land drops significantly, we could be required to further write down the carrying value of our inventory, which would negatively impact our results of operations.

The fair value of our land and housing inventories depends on market conditions. Our homebuilding subsidiaries acquire land for the replacement of land inventory and expansion within our current markets and may, from time to time, purchase land for expansion into new markets. If demand

 

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for new homes continues to decrease, we may not be able to recover our costs when our homebuilding subsidiaries build and sell homes, which would have a significant negative impact on our Home Gross Margins and results of operations. Additionally, in future periods, if it should appear that we may not be able to recover our costs of inventory upon building and selling homes, we may be required to record additional impairments of our inventory, which would have a significant negative impact on our results of operations.

Further uncertainty in the mortgage lending industry regarding the origination of mortgage loans could negatively impact our results of operations.

The Company is subject to risks associated with mortgage loans, including, among others, Alt-A, sub-prime, second mortgage loans, high loan-to-value mortgage loans and jumbo mortgage loans (defined as a mortgage loan with a principal balance in excess of $417,000). These risks may include the willingness of third-parties to purchase mortgage loan products from HomeAmerican, or HomeAmerican’s ability to sell mortgage loans at market prices that are deemed acceptable. The Company also is subject to risks associated with previously sold mortgage loans originated by HomeAmerican, depending upon, among other things, compliance with mortgage loan underwriting criteria and the associated homebuyers’ performance, which could require HomeAmerican to re-purchase certain of those mortgage loans. These risks may affect HomeAmerican’s ability to realize the full value of its investment in these re-purchased mortgage loans either through sales, collections or foreclosure proceedings, which would negatively impact our results of operations and cash from operations.

Our business is subject to numerous federal, local, state laws and regulations concerning land development, construction of homes, sales, mortgage lending, environmental and other aspects of our business. These laws and regulations could give rise to significant additional liabilities or expenditures, or restrictions on our business.

Our operations are subject to continuing compliance requirements mandated by applicable federal, state and local statutes, ordinances, rules and regulations, including zoning and land use ordinances, building, plumbing and electrical codes, contractors’ licensing laws, state insurance laws, federal and state human resources laws and regulations and health and safety laws and regulations (including, but not limited to, those of the Occupational Safety & Health Administration). Various localities in which we operate have imposed (or may impose in the future) fees on developers to fund schools, road improvements and low and moderate income housing.

From time to time, various municipalities in which our homebuilding subsidiaries operate restrict or place moratoria on the availability of utilities, including water and sewer taps. Additionally, certain jurisdictions in which our homebuilding subsidiaries operate have proposed or enacted “slow growth” or “no growth” initiatives and other measures that may restrict the number of building permits available in any given year. These initiatives or other slow or no growth measures could reduce our ability to open new home communities and build and sell homes in the affected markets and may create additional costs and administration requirements, which in turn could negatively impact our future home sales and net income. Although future conditions or governmental actions may impact our ability to obtain necessary permits or water and sewer taps, we currently believe that we have, or can obtain, water and sewer taps and building permits for our homebuilding subsidiaries’ land inventory and land held for development.

 

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Our homebuilding operations also are affected by environmental laws and regulations pertaining to availability of water, municipal sewage treatment capacity, stormwater discharges, land use, hazardous waste disposal, dust controls, building materials, population density and preservation of endangered species, natural terrain and vegetation. Due to these considerations, our homebuilding subsidiaries generally obtain an environmental site assessment for parcels of land that they acquire. The particular environmental laws and regulations that apply to any given homebuilding project vary greatly according to a particular site’s location, the site’s environmental conditions and the present and former uses. These environmental laws may result in project delays, cause us to incur substantial compliance and other costs and/or prohibit or severely restrict homebuilding activity in certain environmentally sensitive regions or areas.

The Company also is subject to the rules and regulations with respect to originating, processing, selling and servicing mortgage loans, which, among other things, prohibit discrimination and establish underwriting guidelines; provide for audits and inspections; require appraisals, credit reports on prospective borrowers and disclosure of certain information concerning credit and settlement costs; establish maximum loan amounts; prohibit predatory lending practices; and regulate the referral of business to affiliated entities. New rules and regulations, or revised interpretations of existing rules and regulations applicable to our mortgage lending operations, could result in more stringent compliance standards, which may substantially increase costs of compliance.

If our potential homebuyers are not able to obtain suitable financing or if the capital markets, including the debt and secondary mortgage markets, become more restricted, our results of operations or cash flows may be impacted adversely.

Our business depends on interest rates and the ability of our homebuyers to obtain affordable mortgages for the purchase of our homes. Increases in the cost of mortgage financing could prevent homebuyers from purchasing our homes. In addition, if our homebuyers must sell existing homes in order to buy homes from us, increases in mortgage costs or decreases in the market value of homes could interfere with such sales and result in our homebuyers’ inability to buy from us. Additionally, decreased liquidity in the mortgage lending market could affect the ability of existing homeowners to obtain suitable financing for their homes. These conditions have negatively impacted, and may continue to negatively impact, our home sales revenue and net income.

We have financial needs that we meet through the capital markets, including the debt and secondary mortgage markets. The secondary markets are currently experiencing disruptions from reduced investor demand for mortgage loans and mortgage-backed securities, increased investor yield requirements for those loans and securities and the exit of third-party purchasers from the secondary market. In addition, the sources, terms and conditions of warehouse financing arrangements for the mortgage lending industry are changing. These changes impact, among other things, availability of capital, arrangement structures, collateral requirements and collateral advance rates. The foregoing disruptions and changes may have an adverse impact on the Company’s results of operations, financial position and/or cash flows.

Additionally, as is customary in the homebuilding industry, we often are required to provide surety bonds to secure our performance under construction contracts, development agreements and other arrangements. Our ability to obtain surety bonds primarily depends upon our credit rating, capitalization, working capital, past performance, management expertise and certain external factors, including the overall capacity of the surety market. While our credit rating and liquidity positions are

 

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currently strong, if we are unable to obtain surety bonds when required, our results of operations and cash flows could be impacted adversely.

For a more complete discussion of other risk factors that affect our business, see “Risk Factors Relating to our Business” in our Form 10-K for the year ended December 31, 2006, which also include the following:

 

   

The homebuilding industry historically has been cyclical and has been experiencing the first downturn in a number of years. Continuation of this downturn may result in a further reduction in our home sales revenue and negatively impact our results of operations.

 

   

Increases in our Approximate Cancellation Rate could have a significant negative impact on our Home Gross Margins and home sales revenue.

 

   

If land is not available at reasonable prices, our sales could decrease and negatively impact our results of operations.

 

   

Our homebuilding operations are concentrated in certain markets, and reduced demand for homes in these markets could reduce home sales revenue.

 

   

Interest rate increases or changes in federal lending programs could lower demand for our homes and our mortgage lending services.

 

   

We are reliant on a limited number of third party purchasers of mortgage loans originated by HomeAmerican, which could impact our results of operations.

 

   

If our potential homebuyers are not able to obtain suitable financing, our business may decline.

 

   

Labor and material shortages could cause delays in the construction of our homes.

 

   

Natural disasters could cause an increase in home construction costs, as well as delays, and could negatively impact our results of operations.

 

   

Because of the seasonal nature of our business, our quarterly operating results fluctuate.

 

   

Product liability litigation and warranty claims that arise in the ordinary course of business may be costly.

 

   

Future terrorist attacks against the United States or increased domestic and international instability could have an adverse effect on our operations.

 

   

The interests of certain controlling shareholders may be adverse to investors.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The Company did not repurchase any shares during the third quarter of 2007. Additionally, there were no sales of unregistered equity securities during the third quarter of 2007.

 

Item 3. Defaults Upon Senior Securities

None.

 

Item 4. Submission of Matters to a Vote of Security Holders

None.

 

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Item 5. Other Information

On October 22, 2007, MDC’s Board of Directors declared a quarterly cash dividend of twenty five cents ($0.25) per share. The dividend will be paid on November 20, 2007 to shareowners of record on November 6, 2007.

 

Item 6. Exhibits

 

  10.1   First Amendment to Second Amended and Restated Credit Agreement, dated as of October 24, 2007 (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed October 24, 2007). *
  12   Ratio of Earnings to Fixed Charges Schedule.
  31.1   Certification of Chief Executive Officer required by 17 CFR 240.13a-14(a), pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  31.2   Certification of Chief Financial Officer required by 17 CFR 240.13a-14(a), pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  32.1   Certification of Chief Executive Officer required by 17 CFR 240.13a-14(b), pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  32.2   Certification of Chief Financial Officer required by 17 CFR 240.13a-14(b), pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

*

Incorporate by reference.

 

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Date: October 31, 2007

  M.D.C. HOLDINGS, INC.
 

(Registrant)

 

By:

 

/s/ Paris G. Reece III

   

Paris G. Reece III,

   

Executive Vice President,

   

Chief Financial Officer and

   

Principal Accounting Officer

 

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