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 June 30, 2010

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
(Address of principal executive offices)   (Zip code)

(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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  x  No  ¨

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

Large Accelerated Filer    x    Accelerated Filer    ¨
Non-Accelerated Filer    ¨  (Do not check if a smaller reporting company)    Smaller Reporting Company    ¨

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 June 30, 2010, 47,139,000 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 JUNE 30, 2010

INDEX

 

     Page
No.
Part I.  

Financial Information:

  
  Item 1.  

Unaudited Consolidated Financial Statements:

  
   

Consolidated Balance Sheets at June 30, 2010 and December 31, 2009

   1
   

Consolidated Statements of Operations for the three and six months ended June 30, 2010 and 2009

   2
   

Consolidated Statements of Cash Flows for the six months ended June 30, 2010 and 2009

   3
   

Notes to Unaudited Consolidated Financial Statements

   4
  Item 2.  

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

   28
  Item 3.  

Quantitative and Qualitative Disclosures About Market Risk

   61
  Item 4.  

Controls and Procedures

   61
Part II.  

Other Information:

  
  Item 1.  

Legal Proceedings

   62
  Item 1A.  

Risk Factors

   63
  Item 2.  

Unregistered Sales of Equity Securities and Use of Proceeds

   64
  Item 3.  

Defaults Upon Senior Securities

   64
  Item 4.  

(Removed and Reserved)

   64
  Item 5.  

Other Information

   64
  Item 6.  

Exhibits

   65
 

Signatures

   66

 

(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)

 

     June 30,
2010
    December 31,
2009
 

Assets

    

Cash and cash equivalents

   $ 692,132      $ 1,234,252   

Marketable securities

     941,403        327,944   

Restricted cash

     713        476   

Receivables

    

Home sales receivables

     34,096        10,056   

Income taxes receivable

     641        145,144   

Other receivables

     17,412        5,844   

Mortgage loans held-for-sale, net

     112,065        62,315   

Inventories, net

    

Housing completed or under construction

     382,971        260,324   

Land and land under development

     370,352        262,860   

Property and equipment, net

     41,188        38,421   

Deferred tax asset, net of valuation allowance of $217,455 and $208,144 at June 30, 2010 and December 31, 2009, respectively

     -        -   

Related party assets

     7,856        7,856   

Prepaid expenses and other assets, net

     80,369        73,816   
                

Total Assets

   $ 2,681,198      $ 2,429,308   
                

Liabilities

    

Accounts payable

   $ 51,888      $ 36,087   

Accrued liabilities

     289,614        291,969   

Related party liabilities

     86        1,000   

Mortgage repurchase facility

     65,305        29,115   

Senior notes, net

     1,242,325        997,991   
                

Total Liabilities

     1,649,218        1,356,162   
                

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; 47,195,000 and 47,139,000 issued and outstanding, respectively, at June 30, 2010 and 47,070,000 and 47,017,000 issued and outstanding, respectively, at December 31, 2009

     472        471   

Additional paid-in-capital

     810,929        802,675   

Retained earnings

     222,532        270,659   

Accumulated other comprehensive loss

     (1,294     -   

Treasury stock, at cost; 56,000 and 53,000 shares at June 30, 2010 and December 31, 2009, respectively

     (659     (659
                

Total Stockholders’ Equity

     1,031,980        1,073,146   
                

Total Liabilities and Stockholders’ Equity

   $   2,681,198      $   2,429,308   
                

The accompanying Notes are an integral part of these 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 June 30,     Six Months Ended June 30,  
     2010     2009     2010     2009  

Revenue

        

Home sales revenue

   $      311,276      $      185,554      $      452,219      $      352,536   

Land sales revenue

     5,699        1,954        5,714        4,572   

Other revenue

     9,355        7,758        15,475        14,090   
                                

Total Revenue

     326,330        195,266        473,408        371,198   
                                

Costs and Expenses

        

Home cost of sales

     255,062        152,118        364,452        293,443   

Land cost of sales

     4,974        1,500        5,165        2,841   

Asset impairments, net

     -        1,243        -        15,812   

Marketing expenses

     11,475        7,930        18,535        16,762   

Commission expenses

     11,611        6,953        16,740        13,311   

General and administrative expenses

     44,588        37,800        84,791        76,181   

Other operating expenses

     529        292        1,020        557   

Related party expenses

     -        4        9        9   
                                

Total Operating Costs and Expenses

     328,239        207,840        490,712        418,916   
                                

Loss from Operations

     (1,909     (12,574     (17,304     (47,718
                                

Other income (expense)

        

Interest income

     7,541        2,968        11,969        7,039   

Interest expense

     (9,436     (9,838     (19,810     (19,578

Other income

     105        381        204        121   
                                

Loss before income taxes

     (3,699     (19,063     (24,941     (60,136

Benefit from (provision for) income taxes, net

     15        (10,519     384        (10,299
                                

NET LOSS

   $ (3,684   $ (29,582   $ (24,557   $ (70,435
                                

LOSS PER SHARE

        

Basic

   $ (0.08   $ (0.64   $ (0.53   $ (1.52
                                

Diluted

   $ (0.08   $ (0.64   $ (0.53   $ (1.52
                                

DIVIDENDS DECLARED PER SHARE

   $ 0.25      $ 0.25      $ 0.50      $ 0.50   
                                

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

 

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Table of Contents

M.D.C. HOLDINGS, INC.

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

     Six Months Ended June 30,  
     2010     2009  

Operating Activities

    

Net loss

   $ (24,557   $ (70,435

Adjustments to reconcile net loss to net cash (used in) provided by operating activities Asset impairments, net

     -        15,812   

Amortization of deferred marketing costs

     5,528        3,804   

Write-offs of land option deposits and pre-acquisition costs

     873        557   

Depreciation and amortization of long-lived assets

     2,573        2,920   

Stock-based compensation expense

     8,202        7,325   

Gain on sale of assets, net

     (550     (1,531

Other non-cash expenses

     872        1,223   

Net changes in assets and liabilities:

    

Restricted cash

     (237     51   

Home sales and other receivables

     (35,608     7,620   

Income taxes receivable

     144,503        169,862   

Mortgage loans held-for-sale, net

     (49,750     17,575   

Housing completed or under construction

     (122,647     114,079   

Land and land under development

     (105,669     16,506   

Prepaid expenses and other assets, net

     (14,629     (4,235

Accounts payable

     15,801        (211

Accrued liabilities

     (3,639     (29,104
                

Net cash (used in) provided by operating activities

     (178,934     251,818   
                

Investing Activities

    

Purchase of marketable securities

     (722,159     (81,926

Maturity of marketable securities

     88,287        64,864   

Sale of marketable securities

     19,119        -   

Proceeds from redemption requests on unsettled trades

     1,678        55,554   

Purchase of property and equipment

     (5,072     (4,549
                

Net cash (used in) provided by investing activities

     (618,147     33,943   
                

Financing Activities

    

Proceeds from issuance of senior notes

     242,288        -   

Payment on mortgage repurchase facility

     (45,470     (34,873

Advances on mortgage repurchase facility

     81,660        24,175   

Dividend payments

     (23,570     (23,437

Proceeds from exercise of stock options

     53        3,471   
                

Net cash provided in (used in) financing activities

     254,961        (30,664
                

Net (decrease in) increase in cash and cash equivalents

     (542,120     255,097   

Cash and cash equivalents

    

Beginning of period

     1,234,252        1,304,728   
                

End of period

   $      692,132      $   1,559,825   
                

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

 

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Table of Contents

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. The Company has evaluated subsequent events for recognition or disclosure through the date the Unaudited Consolidated Financial Statements were filed with the SEC. 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 June 30, 2010 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, 2009, filed with the SEC on February 5, 2010.

The Consolidated Statements of Operations for the three and six months ended June 30, 2010 and Consolidated Statement of Cash Flows for the six months ended June 30, 2010 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, 2009 Annual Report on Form 10-K.

 

2.

Asset Impairment

The Company’s held-for-development inventory is included as a component of housing completed or under construction and land and land under development in the Consolidated Balance Sheets.

The Company evaluates its held-for-development inventory for impairment at each quarter end. The Company did not have any impairments of its homebuilding inventory during the three and six months ended June 20, 2010. The following table sets forth, by reportable segment, the asset impairments recorded during the three and six months ended June 30, 2009 (in thousands).

 

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Table of Contents

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (continued)

 

     Three Months
Ended June 30,
2009
    Six Months
Ended June 30,
2009
 

Land and Land Under Development (Held-for-Development)

    

West

   $ -      $ 9,791   

Mountain

     -        254   

East

     1,450        1,600   

Other Homebuilding

     -        17   
                

Subtotal

     1,450        11,662   
                

Housing Completed or Under Construction (Held-for-Development)

    

West

     -        3,276   

Mountain

     -        -   

East

     275        875   

Other Homebuilding

     -        267   
                

Subtotal

     275        4,418   
                

Land and Land Under Development (Held-for-Sale)

    

West

     (557     (557

Mountain

     -        -   

East

     -        -   

Other Homebuilding

     -        -   
                

Subtotal

     (557     (557
                

Other Assets

     75        289   
                

Consolidated Asset Impairments

   $          1,243      $        15,812   
                

During the 2009 second quarter, the Company’s impairments were concentrated in two subdivisions in the East segment and primarily resulted from declines in the demand for homes in these subdivisions.

The 2009 first quarter impairments of the Company’s held-for-development inventories were concentrated in the Nevada market of the West segment. These impairments resulted from a significant decrease in the average selling prices of closed homes during the 2009 first quarter, compared with the 2008 fourth quarter, in response to increased levels of competition in this market and continued high levels of home foreclosures. The impairments in the Mountain, East and Other Homebuilding segments primarily resulted from lower forecasted average selling prices for communities that are in the close out phase.

 

3.

Fair Value Measurements

ASC 820 “Fair Value Measurements and Disclosures” (“ASC 820”) defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. ASC 820 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs for which little or no market data exists, therefore requiring an entity to develop its own assumptions.

The following methods and assumptions were used to estimate the fair value of each class of financial instruments.

Cash and Cash Equivalents.  For cash and cash equivalents, the fair value approximates carrying value.

Marketable securities.  The Company’s marketable securities consist of both held-to-maturity and available-for-sale securities. The Company’s held-to-maturity marketable securities consist of both fixed rate and floating rate interest earning securities, primarily: (1) debt securities, which may include, among others, United States government and government agency debt and corporate debt; and (2) deposit securities, which may include, among others, certificates of deposit and time deposits. For those debt securities that the Company has both the ability and intent to hold to their maturity dates, the Company classifies such debt securities as held-to-maturity. The Company’s held-to-maturity debt securities are reported at amortized cost in the Consolidated Balance Sheets.

 

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (continued)

 

The following table shows the Company’s carrying value of its held-to-maturity marketable securities by both security type and maturity date as well as the estimated fair value for each security type (in thousands).

 

     June 30, 2010    December 31, 2009
     Recorded
Amount
   Estimated Fair
Value
   Recorded
Amount
   Estimated Fair
Value

Debt securities - maturity less than 1 year

   $ 472,106    $ 472,380    $ 160,765    $ 159,752

Debt securities - maturity 1 to 5 years

     140,529      141,733      64,679      64,844

Deposit securities - maturity less than 1 year

     2,500      2,508      2,500      2,558
                           

Total held-to-maturity securities

   $      615,135    $      616,621    $      227,944    $      227,154
                           

Included in the Company’s June 30, 2010 held-to-maturity investment balances are $560.3 million of debt securities that were in a gross unrealized gain position of $1.8 million and $54.8 million of debt securities that were in a gross unrealized loss position of $0.3 million. Because the Company has the intent and ability to hold these securities to maturity and ultimately expects to receive the contractual amounts due to it, the Company has concluded that the decrease in fair value of these securities is not indicative of an other-than-temporary-impairment. Accordingly, the Company has continued to record each of these securities at its amortized cost.

For certain debt securities, primarily corporate debt, the Company may not have the intent to hold them until their maturity date and, as such, the Company classifies such debt securities as available-for-sale. The Company’s available-for-sale securities also include holdings in a fund that invests predominantly in fixed income securities. The Company records all of its available-for-sale marketable securities at fair value with changes in fair value being recorded as a component of accumulated other comprehensive income in the Consolidated Balance Sheets. The fair value of the Company’s marketable securities are based upon Level 1 fair value inputs.

The following table sets forth the amortized cost and estimated fair value of the Company’s available-for-sale marketable securities (in thousands).

 

     June 30, 2010    December 31, 2009
     Amortized
Cost
   Estimated Fair
Value
   Amortized
Cost
   Estimated Fair
Value

Equity security

   $ 101,388    $ 101,209    $ 100,000    $ 100,000

Debt securities

     226,174      225,059      -      -
                           

Total available-for-sale securities

   $      327,562    $      326,268    $      100,000    $      100,000
                           

Mortgage Loans Held-for-Sale, Net.  As of June 30, 2010, the primary components of the Company’s mortgage loans held-for-sale that are measured at fair value on a recurring basis are: (1) mortgage loans held-for-sale under commitments to sell; and (2) mortgage loans held-for-sale not under commitments to sell. At June 30, 2010 and December 31, 2009, the Company had $79.1 million and $42.8 million, respectively, of mortgage loans held-for-sale under commitments to sell for which fair value was based upon a Level 1 input being the quoted market prices for those mortgage loans. At June 30, 2010 and December 31, 2009, the Company had $31.3 million and $19.4 million, respectively, of mortgage loans held-for-sale that were not under commitments to sell and, as such, their fair value was based upon Level 2 fair value inputs, primarily estimated market price received from an outside party.

Inventories.  The Company records its homebuilding inventory (housing completed or under construction and land and land under development) at fair value only when the undiscounted future cash flow of a subdivision is less than its carrying value. For the Company’s held-for-development subdivisions, the Company determines the estimated fair value of each subdivision by calculating the present value of the estimated future cash flows at discount rates that are commensurate with the risk of the subdivision under evaluation. These estimates are dependent on specific market or sub-market conditions for each subdivision. Local market-specific conditions that may impact these estimates for a subdivision include, among other things: (1) forecasted base selling prices and home sales incentives; (2) estimated land development costs and home cost of construction; (3) the current sales pace for active subdivisions; (4) changes by management in the sales strategy of a given subdivision; and (5) the intensity of competition within a market or sub-market, including publicly available home sales prices and home sales incentives offered by our competitors. The Company did not record any impairment to subdivisions during the three and six months ended June 30, 2010.

 

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Table of Contents

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (continued)

 

Related Party Asset.  The Company’s related party assets are debt security bonds that it acquired from a quasi-municipal corporation in the state of Colorado. The Company has estimated the fair value of the related party assets based upon discounted cash flows as the Company does not believe there is a readily available market for such assets. The Company used a 15% discount rate in determining the present value of the estimated future cash flows from the bonds. The estimated cash flows from the bonds are ultimately based upon the Company’s estimated cash flows associated with the building, selling and closing of homes in one of its Colorado subdivisions. The estimated fair values of these assets are based upon Level 3 cash flow inputs. Based upon this evaluation, the estimated fair value of the related party assets approximates its carrying value.

Mortgage Repurchase Facility.  The Company’s Mortgage Repurchase Facility (as defined below) is at floating rates or at fixed rates that approximate current market rates and have relatively short-term maturities. The fair value approximates carrying value.

Senior Notes.  The estimated fair values of the senior notes in the following table are considered to be Level 2 fair value inputs pursuant to ASC 820 and are an estimated fair value of the bonds when compared with bonds in the homebuilding sector (in thousands).

 

     June 30, 2010    December 31, 2009
     Recorded
Amount
   Estimated Fair
Value
   Recorded
Amount
   Estimated Fair
Value

7% Senior Notes due 2012

   $ 149,553    $ 161,977    $ 149,460    $ 161,550

5 1/2 % Senior Notes due 2013

     349,694      361,270      349,642      360,500

5 3/8 % Medium Term Senior Notes due 2014

     249,183      255,242      249,102      240,050

5 3/8 % Medium Term Senior Notes due 2015

     249,804      253,450      249,787      236,800

5 5/8 % Senior Notes due 2020

     244,091      236,508      -      -
                           

Total

   $   1,242,325    $   1,268,447    $      997,991    $      998,900
                           

 

4.

Derivative Financial Instruments

The Company utilizes certain derivative instruments in the normal course of business, which primarily include forward sales securities commitments and private investor sales commitments to hedge changes in fair value of mortgage loan inventory and commitments to originate mortgage loans. At June 30, 2010, the Company had $99.8 million in interest rate lock commitments, which consisted of $70.1 million in loan locks and $29.7 million in 4.25% promotional program commitments. Additionally, the Company had $105.2 million in forward sales of mortgage-backed securities.

The Company records its mortgage loans held-for-sale at fair value to achieve matching of the changes in the fair value of its derivative instruments with the changes in fair values of the loans it is hedging, without having to designate its derivatives as hedging instruments. For forward sales commitments, as well as commitments to originate mortgage loans that are still outstanding at the end of a reporting period, the Company records the fair value of the derivatives in other revenue in the Consolidated Statements of Operations with an offset to either prepaid and other assets or accrued liabilities in the Consolidated Balance Sheets, depending on the nature of the change. The changes in fair value of the Company’s derivatives were not material during the three and six months ended June 30, 2010 and 2009.

 

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (continued)

 

5.

Balance Sheet Components

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

 

     June 30,
2010
   December 31,
2009

Accrued liabilities

     

Liability for unrecognized tax benefits

   $ 60,197    $ 60,226

Warranty reserves

     51,986      59,022

Insurance reserves

     48,312      51,606

Land development and home construction accruals

     20,042      21,236

Accrued compensation and related expenses

     19,535      20,297

Accrued executive deferred compensation

     19,163      17,782

Accrued interest payable

     17,879      12,023

Legal accruals

     14,910      14,489

Loan loss reserves

     8,069      9,641

Customer and escrow deposits

     6,610      5,524

Other accrued liabilities

     22,911      20,123
             

Total accrued liabilities

   $      289,614    $      291,969
             

 

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (continued)

 

6.

Loss Per Share

For purposes of calculating loss per share (“EPS”), as the Company has participating security holders (security holders who receive non-forfeitable dividends on unvested restricted stock) it is required to utilize the two-class method for calculating earnings per share. The two-class method is an allocation of earnings between the holders of common stock and the Company’s participating security holders. Under the two-class method, earnings for the reporting period are allocated between common shareholders and other security holders, based on their respective rights to receive distributed earnings (i.e. dividends) and undistributed earnings (i.e. net income or loss). Currently, the Company has one class of security and has participating security holders consisting of shareholders of unvested restricted stock. The basic and diluted EPS calculations are shown below (in thousands, except per share amounts).

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2010     2009     2010     2009  

Basic and Diluted Loss Per Common Share

        

Net loss

   $         (3,684   $       (29,582   $       (24,557   $       (70,435

Less: distributed and undistributed earnings allocated to participating securities

     (135     (100     (259     (201
                                

Net loss attributable to common stockholders

   $ (3,819   $ (29,682   $ (24,816   $ (70,636
                                

Basic and diluted weighted-average shares outstanding

     46,617        46,548        46,615        46,474   

Basic Loss Per Common Share

   $ (0.08   $ (0.64   $ (0.53   $ (1.52
                                

Dilutive Loss Per Common Share

   $ (0.08   $ (0.64   $ (0.53   $ (1.52
                                

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 reporting period. Common stock equivalents include stock options and unvested restricted stock. Diluted EPS for the three and six months ended June 30, 2010 and 2009 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, the weighted-average common stock equivalents excluded from diluted EPS were 0.4 million shares during the three and six months ended June 30, 2010 and were 0.4 million shares during the three and six months ended June 30, 2009.

 

7.

Interest Activity

The Company capitalizes interest on its senior notes associated with its qualifying assets. The Company has determined that inventory is a qualifying asset during the period of active development and through the completion of construction of a home. When construction of a home is complete, such home is no longer considered to be a qualifying asset and interest is no longer capitalized on that home.

 

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (continued)

 

Interest activity is shown below (in thousands).

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2010     2009     2010     2009  

Total Interest Incurred

        

Corporate and homebuilding segments

   $ 18,158      $ 14,455      $ 35,089      $ 28,948   

Financial Services and Other

     127        83        206        174   
                                

Total interest incurred

   $ 18,285      $ 14,538      $ 35,295      $ 29,122   
                                

Total Interest Capitalized

        

Interest capitalized, beginning of period

   $ 31,773      $ 36,050      $ 28,339      $ 39,239   

Interest capitalized

     8,849        4,700        15,485        9,544   

Previously capitalized interest included in home cost of sales

     (8,202     (8,661     (11,404     (16,694
                                

Interest capitalized, end of period

   $        32,420      $        32,089      $        32,420      $        32,089   
                                

 

8.

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. Warranty payments incurred for an individual house may differ from the related reserve established for the home at the time it home was closed. The actual disbursements for warranty claims are evaluated in the aggregate to determine if an adjustment to the historical warranty reserve should be recorded, that would result in a corresponding adjustment to home cost of sales. During the 2010 second quarter, in light of a continued decrease in the Company’s warranty payments, and similar to its procedure in prior years, the Company engaged a third-party actuary to assist in its analysis of estimated future warranty payments. Based upon the actuarial analysis, the Company refined its methodology of estimating a reasonable range for warranty reserves. The Company believes the refined methodology will result in a better estimate of warranty cost exposure especially in periods of declining payment activity and provide better visibility to the sensitivity of the estimate in the current environment. The Company will continue to periodically engage a third-party actuary for purposes of assisting us in evaluating and determining the reasonableness of our warranty reserves.

The following table summarizes the warranty reserve activity for the three and six months ended June 30, 2010 and 2009 (in thousands).

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2010     2009     2010     2009  

Warranty reserve balance at beginning of period

   $ 54,054      $ 84,911      $ 59,022      $ 89,318   

Warranty expense provisions

     2,220        1,872        3,210        3,346   

Warranty cash payments

     (2,611     (2,327     (4,640     (4,565

Warranty reserve adjustments

     (1,677     (10,904     (5,606     (14,547
                                

Warranty reserve balance at end of period

   $        51,986      $        73,552      $        51,986      $        73,552   
                                

The warranty adjustments recorded during the three and six months ended June 30, 2010 and 2009, primarily were recorded as a reduction to home cost of sales in the Consolidated Statements of Operations and resulted from the improvement in historical warranty payment trends on previously closed homes.

 

9.

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 Allegiant Insurance Company, Inc., A Risk Retention Group (“Allegiant”) and StarAmerican Insurance Ltd. (“StarAmerican”); (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 interpretations 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.

 

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (continued)

 

The following table summarizes the insurance reserve activity for the three and six months ended June 30, 2010 and 2009 (in thousands).

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2010     2009     2010     2009  

Insurance reserve balance at beginning of period

   $ 51,390      $ 59,695      $ 51,606      $ 59,171   

Insurance expense provisions

     1,231        929        1,814        1,827   

Insurance cash payments

     (4,309     (222     (5,108     (596

Insurance reserve adjustments

     -        (1,007     -        (1,007
                                

Insurance reserve balance at end of period

   $        48,312      $        59,395      $        48,312      $        59,395   
                                

The insurance payments incurred during the three and six months ended June 30, 2010, primarily related to payments for certain insurance claims for which a separate case reserve was previously established.

 

10.

Information on Business Segments

The Company’s operating segments are defined 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 as 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)

 

  (2)

Mountain (Colorado and Utah)

 

  (3)

East (Delaware Valley, Maryland and Virginia)

 

  (4)

Other Homebuilding (Florida and Illinois)

The Company’s Financial Services and Other reportable segment consists of the operations of the following operating segments: (1) HomeAmerican Mortgage Corporation (“HomeAmerican”); (2) Allegiant; (3) StarAmerican; (4) American Home Insurance Agency, Inc.; and (5) American Home Title and Escrow Company. 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, earns interest income on its cash, cash equivalents and marketable securities, and incurs interest expense on its senior notes.

 

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (continued)

 

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

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2010     2009     2010     2009  

Homebuilding

        

West

   $ 123,193      $ 81,758      $ 180,330      $ 156,440   

Mountain

     110,112        57,658        156,794        101,775   

East

     72,657        39,479        104,162        79,971   

Other Homebuilding

     16,757        13,117        25,793        26,800   
                                

Total Homebuilding

     322,719        192,012        467,079        364,986   

Financial Services and Other

     9,143        7,006        14,764        12,569   

Corporate

     -        -        -        50   

Intercompany adjustments

     (5,532     (3,752     (8,435     (6,407
                                

Consolidated

   $      326,330      $      195,266      $      473,408      $      371,198   
                                

The following table summarizes (loss) income before income taxes for each of the Company’s six reportable segments (in thousands). Inter-company supervisory fees (“Supervisory Fees”), which are included in (loss) income before income taxes for each reportable segment in the table below, 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.

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2010     2009     2010     2009  

Homebuilding

        

West

   $          6,357      $        10,075      $          8,711      $ (228

Mountain

     4,962        (2,308     6,132        (7,119

East

     1,455        (4,626     (64     (6,997

Other Homebuilding

     295        (677     (224     (1,508
                                

Total Homebuilding

     13,069        2,464        14,555        (15,852

Financial Services and Other

     4,089        2,615        5,935        4,236   

Corporate

     (20,857     (24,142     (45,431     (48,520
                                

Consolidated

   $ (3,699   $ (19,063   $ (24,941   $       (60,136
                                

 

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (continued)

 

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. The assets in the Company’s Corporate segment primarily include cash, cash equivalents and marketable securities.

 

     June 30,
2010
    December 31,
2009
 

Homebuilding

    

West

   $ 300,848      $ 190,204   

Mountain

     328,696        237,702   

East

     170,525        112,964   

Other Homebuilding

     36,457        26,778   
                

Total Homebuilding

     836,526        567,648   

Financial Services and Other

     183,478        133,957   

Corporate

     1,663,851        1,773,660   

Intercompany adjustments

     (2,657     (45,957
                

Consolidated

   $   2,681,198      $   2,429,308   
                

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 June 30,    Six Months Ended June 30,
     2010    2009    2010    2009

Homebuilding

           

West

   $ 2,211    $ 771    $ 3,285    $ 2,517

Mountain

     1,091      640      1,554      1,202

East

     639      443      951      946

Other Homebuilding

     237      72      398      180
                           

Total Homebuilding

     4,178      1,926      6,188      4,845

Financial Services and Other

     170      167      339      386

Corporate

     821      738      1,574      1,493
                           

Consolidated

   $          5,169    $          2,831    $          8,101    $          6,724
                           

 

11.

Commitments and Contingencies

The Company often is required to obtain bonds and letters of credit in support of its obligations for land development and subdivision improvements, homeowner association dues and start-up expenses, warranty work, contractor license fees and earnest money deposits. At June 30, 2010, the Company had issued and outstanding performance bonds and letters of credit totaling $90.7 million and $19.8 million, respectively, including $5.3 million in letters of credit issued by HomeAmerican. In the event any such bonds or letters of credit issued by third parties are called, MDC could be obligated to reimburse the issuer of the bond or letter of credit.

Legal Reserves.  Litigation has been filed by homeowners in West Virginia against MDC, its subsidiary Richmond American Homes of West Virginia, Inc. (“RAH West Virginia”) and various subcontractors alleging a failure to install functional passive radon mitigation systems in their homes. The plaintiffs seek compensatory and punitive damages and medical monitoring costs for alleged negligent construction, failure to warn, breach of warranty or contract, breach of implied warranty of habitability, fraud, and intentional and negligent infliction of emotional distress based upon alleged exposure to radon gas. The litigation includes the following actions:

 

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (continued)

 

Joy, et al. v. Richmond American Homes of West Virginia, Inc., et al., No. 08-C-204, Circuit Court of Jefferson County, West Virginia (“Joy”). This action was filed on May 16, 2008, by sixty-six plaintiffs from sixteen households. The Company and RAH West Virginia have answered and asserted claims against the subcontractors for contractual and implied indemnity and contribution.

Bauer, et al. v. Richmond American Homes of West Virginia, Inc., et al., No. 08-C-431, Circuit Court of Jefferson County, West Virginia (“Bauer”). This action was filed on October 24, 2008, by eighty-six plaintiffs from twenty-one households. This action has been consolidated for discovery and pre-trial proceedings with the Joy action.

Saliba, et al. v. Richmond American Homes of West Virginia, Inc., et al., No. 08-C-447, Circuit Court, Jefferson County, West Virginia (“Saliba”). This action was filed on November 7, 2008, by thirty-five plaintiffs from nine households. This action has been consolidated for discovery and pre-trial proceedings with the Joy action.

By orders dated November 4 and 18, 2009, the trial court struck the answers filed by the Company and RAH West Virginia and entered judgment by default in favor of the plaintiffs on liability, with damages to be determined in a subsequent jury trial. On December 7, 2009, the Company and RAH West Virginia filed with the West Virginia Supreme Court of Appeals a motion seeking to stay the proceedings and a petition for writ of prohibition to vacate the default judgment. On January 15, 2010, the West Virginia Supreme Court of Appeals entered an order agreeing to consider the request to vacate the default judgment. The hearing to consider this request occurred on March 31, 2010.

On June 16, 2010, the West Virginia Supreme Court of Appeals rendered its opinion holding that imposition of a default judgment sanction will be upheld if a trial court’s findings adequately demonstrate and establish willfulness, bad faith or fault. The Supreme Court of Appeals found that the sanctions orders lacked the required specificity. The Supreme Court of Appeals noted that the trial court is authorized to impose sanctions if the action taken is based on specific factual findings of serious misconduct in light of the standards set forth in the opinion. The Supreme Court of Appeals granted the Company and RAH West Virginia a writ of prohibition and vacated the trial court’s sanctions orders.

Pursuant to the rules of the Supreme Court, the underlying proceedings in the Circuit Court had been stayed pending the Supreme Court’s decision. Under the Supreme Court’s applicable rules, the stay expired on July 19, 2010.

Also, a new lawsuit has been filed by homeowners in West Virginia against the Company, RAH West Virginia and individual superintendants who had worked for RAH West Virginia. The new litigation consists of the following:

Thorin, et al. v. Richmond American Homes of West Virginia, Inc., et al., No. 10-C-154, Circuit Court of Jefferson County, West Virginia (“Thorin”). This action was filed on May 12, 2010, by forty plaintiffs from eleven households in Jefferson and Berkeley Counties. To date, this action has not been consolidated for any purposes with the prior three actions. The claims asserted and the relief sought in the Thorin case are substantially similar to the Joy, Bauer and Saliba cases.

MDC and RAH West Virginia believe that they have meritorious defenses to each of the lawsuits and intend to vigorously defend the actions.

Additionally, in the normal course of business, the Company is a defendant in claims primarily relating to construction defects, product liability and personal injury claims. These claims seek relief from the Company under various theories, including breach of implied and express warranty, negligence, strict liability, misrepresentation and violation of consumer protection statutes. The Company has accrued for losses that may be incurred with respect to legal claims based upon information provided to it by its legal counsel, including counsels’ on-going evaluation of the merits of the claims and defenses. Due to uncertainties in the estimation process, actual results could vary from those accruals. The Company had legal accruals of $14.9 million and $14.5 million at June 30, 2010 and December 31, 2009, respectively.

Mortgage Loan Loss Reserves.  In the normal course of business, the Company establishes reserves for potential losses associated with HomeAmerican’s loan sale agreements pursuant to which mortgage loans are sold to third-parties. These reserves are created to address repurchase and indemnity claims by third-party purchasers of the mortgage loans, which claims arise primarily out of allegations of homebuyer fraud at the time of origination of the loan. These reserves are based upon, among other matters: (1) pending claims received from third-party purchasers associated with previously sold mortgage loans; (2) a current assessment of the potential exposure associated with future claims of homebuyer fraud in mortgage loans originated in prior period loans; and (3) historical loss experience. The Company’s mortgage loan loss reserves of $8.1 million and $9.6 million at June 30, 2010 and December 31, 2009, respectively, are reflected as a component of accrued liabilities in the Consolidated Balance Sheets, and the associated expenses are included as a component of general and administrative expenses in the Consolidated Statements of Operations. The Company made cash payments associated with its mortgage loan loss reserve of $1.3 million during the six months ended June 30, 2010.

 

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (continued)

 

12.

Lines of Credit and Total Debt Obligations

Homebuilding.  On June 30, 2010, the Company terminated its homebuilding line of credit (“Homebuilding Line”), which was an unsecured revolving line of credit with a group of lenders that had a maturity date of March 21, 2011. The Company used this facility to provide letters of credit required in the ordinary course of its business and financing in support of its homebuilding segments. There were no penalties associated with the termination of the credit facility and the Company believes that at the time of termination it was in compliance with the covenants under the Homebuilding Line credit agreement. Prior to the termination of the Homebuilding Line, the Company transferred or replaced all letters of credit that had been outstanding. At the time of the termination, the Homebuilding Line had an aggregate commitment of $12.0 million and the Company had no letters of credit and no borrowings outstanding under the line. The Homebuilding Line was terminated as the Company believes that it does not need the Homebuilding Line to meet its liquidity needs.

Mortgage Lending.  As of June 30, 2010 HomeAmerican had, and continues to have, a Master Repurchase Agreement (the “Mortgage Repurchase Facility”) with U.S. Bank National Association (“USBNA”) and other banks that may be parties to the Mortgage Repurchase Facility (collectively with USBNA, the “Buyers”). As of June 30, 2010, USBNA was the only Buyer under the Mortgage Repurchase Facility. The Mortgage Repurchase Facility provides liquidity to HomeAmerican by providing for the sale of eligible mortgage loans to USBNA (as agent for the Buyers) with an agreement by HomeAmerican to repurchase the mortgage loans at a future date. Until such mortgage loans are transferred back to HomeAmerican, the documents relating to such loans are held by USBNA, as agent for the Buyers and as custodian, pursuant to the Custody Agreement (“Custody Agreement”), dated as of November 12, 2008, by and between HomeAmerican and USBNA. The Mortgage Repurchase Facility has a maximum aggregate commitment of $70 million and includes an accordion feature that permits the maximum aggregate commitment to be increased to $150 million, subject to the availability of additional commitments. The Mortgage Repurchase Facility expires on October 28, 2010. Advances under the Mortgage Repurchase Facility carry a Pricing Rate equal to the greater of (i) the LIBOR Rate (as defined in the Mortgage Repurchase Facility) plus 2.5%, or (ii) 4.5%. At HomeAmerican’s option the Balance Funded Rate (equal to 4.5%) may be applied to certain advances under the Mortgage Repurchase Facility provided the applicable Buyer is holding sufficient Qualifying Balances. The foregoing terms are defined in the Mortgage Repurchase Facility. At June 30, 2010 and December 31, 2009, the Company had $65.3 million and $29.1 million, respectively, of mortgage loans that it was obligated to repurchase under the Mortgage Repurchase Facility.

The Mortgage Repurchase Facility is accounted for as a debt financing arrangement. Accordingly, at June 30, 2010 and December 31, 2009, amounts advanced under the Mortgage Repurchase Facility, which were used to finance mortgage loan originations, have been reported as a liability in Mortgage Repurchase Facility in the Consolidated Balance Sheets.

General.  The agreement for the Company’s Mortgage Repurchase Facility requires compliance with certain representations, warranties and covenants. The Company believes that it is in compliance with these representations, warranties and covenants and the Company is not aware of any covenant violations.

The Mortgage Repurchase Facility contains various representations, warranties and affirmative and negative covenants customary for agreements of this type. The negative covenants include, among others, (i) an Adjusted Tangible Net Worth (as defined) requirement, (ii) a minimum Adjusted Tangible Net Worth Ratio, (iii) an Adjusted Net Income requirement, and (iv) a minimum Liquidity (as defined) requirement (the foregoing terms are defined in the Mortgage Repurchase Facility). Adjusted Tangible Net Worth means the sum of (a) all assets of HomeAmerican less (b) the sum of (i) all Debt and all Contingent Indebtedness of HomeAmerican, (ii) all assets of HomeAmerican that would be classified as intangible assets under generally accepted accounting principles, and (iii) receivables from Affiliates. HomeAmerican’s Adjusted Tangible Net Worth Ratio is the ratio of HomeAmerican’s total liabilities (excluding Permitted Letters of Credit) to the Adjusted Tangible Net Worth. HomeAmerican’s Adjusted Net Income is a rolling twelve consecutive months of net income for HomeAmerican. HomeAmerican’s Liquidity is defined as its unencumbered and unrestricted cash and Cash Equivalents plus the amount by which the aggregate Purchase Value of all Purchased Mortgage Loans at such time exceeds the aggregate Purchase Price outstanding for all Open Transactions at such time. The foregoing terms are defined in the Mortgage Repurchase Facility.

 

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (continued)

 

Failure to meet the foregoing negative covenants would constitute an event of default. In the event of default, USBNA may, at its option, declare the Repurchase Date for any or all Transactions to be deemed immediately to occur. Upon such event of default, and if USBNA exercises its right to terminate any Transactions, then (a) HomeAmerican’s obligation to repurchase all Purchased Loans in such Transactions will become immediately due and payable; (b) the Repurchase Price for each such Transaction shall be increased by the aggregate amount obtained by daily multiplication of (i) the greater of the Pricing Rate for such Transaction and the Default Pricing Rate by (ii) the Purchase Price for the Transaction as of the Repurchase Date, (c) all Income paid after the event of default will be payable to and retained by USBNA and applied to the aggregate unpaid Repurchase Prices owed by HomeAmerican, and (d) HomeAmerican shall deliver any documents relating to Purchased Loans subject to such Transactions to USBNA. Upon the occurrence of an event of default, USBNA may (a) sell any or all Purchased Loans subject to such Transactions on a servicing released or servicing retained basis and apply the proceeds to the unpaid amounts owed by HomeAmerican, (b) give HomeAmerican credit for such Purchased Loans in an amount equal to the Market Value and apply such credit to the unpaid amounts owed by HomeAmerican, (c) replace HomeAmerican as Servicer, (d) exercise its right under the Mortgage Repurchase Facility with respect to the Income Account and Escrow Account, and (e) with notice to HomeAmerican, declare the Termination Date to have occurred. The foregoing terms are defined in the Mortgage Repurchase Facility.

In January 2010, the Company completed a public offering of $250 million principal amount of 5 5/8% senior notes due February 2020 (the “2020 Notes”). The 2020 Notes, which pay interest in February and August of each year, are general unsecured obligations of MDC and rank equally and ratably with its other general unsecured and unsubordinated indebtedness. The Company is not required to make any principal payments until February 2020. In addition, the Notes are fully guaranteed on an unsecured basis, jointly and severally, by most of the Company’s homebuilding subsidiaries. The 2020 Notes may be redeemed, at the election of the Company, in whole at any time or in part from time to time, at a redemption price equal to the greater of (1) 100% of their principal amount; or (2) the present value of the remaining scheduled payments on the notes being redeemed on the redemption date discounted on a semiannual basis at the Treasury Rate (as defined) plus 0.35%, plus, in each case, accrued and unpaid interest. Upon the occurrence of both a change of control and a below investment grade rating event, the Company is required to offer to repurchase the 2020 Notes at a repurchase price in cash equal to 101% of the aggregate principal amount of the notes. The Company received proceeds of $242.3 million, net of discounts and issuance costs of $6.1 million and $1.6 million, respectively. The Company is using the proceeds of the offering for general corporate purposes.

The Company’s senior notes are not secured and, while the senior note indentures contain some restrictions on secured debt and other transactions, they do not contain financial covenants. The Company’s senior notes are fully and unconditionally guaranteed on an unsecured basis, jointly and severally, by most of its homebuilding segment subsidiaries. The Company’s debt obligations at June 30, 2010 and December 31, 2009 are as follows (in thousands):

 

     June 30,
2010
   December 31,
2009

7% Senior Notes due 2012

   $ 149,553    $ 149,460

5 1/2 % Senior Notes due 2013

     349,694      349,642

5 3/8 % Medium-Term Senior Notes due 2014

     249,183      249,102

5 3/8 % Medium-Term Senior Notes due 2015

     249,804      249,787

5 5/8 % Senior Notes due 2020

     244,091      -
             

Total Senior Notes, net

   $ 1,242,325    $ 997,991

Mortgage repurchase facility

     65,305      29,115
             

Total Debt

   $   1,307,630    $   1,027,106
             

 

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Table of Contents

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (continued)

 

13.

Income Taxes

The Company is required, at the end of each interim period, to estimate its annual effective tax rate for the fiscal year and use that rate to provide for income taxes for the current year-to-date reporting period. Based on these estimates, the Company’s overall effective income tax rates were 0.4% and 1.5% during the three and six months ended June 30, 2010, respectively, and -55.2% and -17.1% during the three and six months ended June 30, 2009, respectively. The change in the effective tax rates during the 2010 second quarter and first six months, compared with the same periods during 2009, resulted primarily from recording during the 2009 second quarter a $9.7 million income tax expense related to an IRS examination of the Company’s 2008 net operating loss carryback to 2006.

The Company is required to recognize the financial statement effects of a tax position when it is more likely than not (defined as a likelihood of more than 50%), based on the technical merits, that the position will be sustained upon examination. Any difference between the income tax return position and the benefit recognized in the financial statements results in a liability for unrecognized tax benefits. During the three and six months ended June 30, 2010, there have been no material changes in the Company’s liability for unrecognized tax benefits.

During the 2010 first quarter, the Company reached a settlement with the IRS on the audit of its 2004 and 2005 federal income tax returns, which settlement is subject to review by the Joint Committee on Taxation (“Joint Committee”). The settlement is expected to result in a decrease of approximately $35 million in the Company’s gross unrecognized tax benefits. The settlement is also expected to result in an increase of approximately $13 million to additional paid-in-capital in the Company’s Consolidated Statements of Stockholders’ Equity and an income tax benefit of approximately $1 million in the Company’s Consolidated Statement of Operations. Finally, since the Company made a deposit of $35.6 million, included in Prepaid Expenses and Other Assets in the Consolidated Balance Sheets, with the IRS during 2008 related to this audit, the settlement is expected to result in an increase of approximately $12 million to cash in the Company’s Consolidated Balance Sheets. At June 30, 2010, the Company was still awaiting final review by the Joint Committee.

Also during the 2010 first quarter, the Company received a $142.1 million federal income tax refund, which was generated by a 2009 federal net operating loss carry back to the 2004 and 2005 tax years in accordance with the provisions contained in the Worker, Homeownership, and Business Assistance Act of 2009.

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 increase in the Company’s total deferred tax asset at June 30, 2010 (per the table below) resulted primarily from an increase in the Company’s federal and state net operating loss carry forwards, offset by a decrease in the Company’s asset impairment charges.

A valuation allowance is recorded against a deferred tax asset if, based on the weight of available evidence, it is more-likely-than-not (a likelihood of more than 50%) that some portion, or all, of the deferred tax asset will not be realized. The Company had a valuation allowance of $217.5 million and $208.1 million at June 30, 2010 and December 31, 2009, respectively, resulting in a net deferred tax asset of zero. The Company’s future realization of its deferred tax assets ultimately depends upon the existence of sufficient taxable income in the carryback or carryforward periods under the tax laws. The Company will continue analyzing, in subsequent reporting periods, the positive and negative evidence in determining the expected realization of its deferred tax assets.

 

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Table of Contents

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (continued)

 

The tax effects of significant temporary differences that give rise to the net deferred tax asset are as follows (in thousands).

 

     June 30,
2010
    December 31,
2009
 

Deferred tax assets

    

Asset impairment charges

   $        55,245      $        87,121   

State net operating loss carryforward

     45,676        41,845   

Federal net operating loss carryforward

     43,688        5,716   

Warranty, litigation and other reserves

     35,282        38,789   

Stock-based compensation expense

     20,392        17,510   

Alternative minimum tax credit carryforward

     9,679        9,679   

Accrued liabilities

     8,628        7,921   

Inventory, additional costs capitalized for tax purposes

     6,961        7,317   

Property, equipment and other assets, net

     2,151        2,622   

Charitable contribution carryforward

     932        934   

Deferred revenue

     351        321   
                

Total deferred tax assets

     228,985        219,775   

Valuation allowance

     (217,455     (208,144
                

Total deferred tax assets, net of valuation allowance

     11,530        11,631   
                

Deferred tax liabilities

    

Deferred revenue

     6,256        5,820   

Inventory, additional costs capitalized for financial statement purposes

     627        681   

Accrued liabilities

     406        926   

Other, net

     4,241        4,204   
                

Total deferred tax liabilities

     11,530        11,631   
                

Net deferred tax asset

   $ -      $ -   
                

 

14.

Variable Interest Entities

In the normal course of business, the Company enters into lot option purchase contracts (“Option Contracts”), generally through a deposit of cash or letter of credit, for the right to purchase land or lots at a future point in time with predetermined terms. The use of such land option and other contracts generally allows the Company to reduce the risks associated with direct land ownership and development, reduces the Company’s capital and financial commitments, including interest and other carrying costs, and minimizes the amount of the Company’s land inventories on its consolidated balance sheets.

In compliance with ASC 810, the Company analyzes its land option contracts and other contractual arrangements to determine whether the corresponding land sellers are variable interest entities (“VIE”) and, if so, whether the Company is the primary beneficiary. Although the Company does not have legal title to the optioned land, ASC 810 requires the Company to consolidate a VIE if the Company is determined to be the primary beneficiary. As a result of its analyses, the Company determined that as of June 30, 2010 it was not the primary beneficiary of any VIEs from which it is purchasing land under land option contracts. In determining whether it is the primary beneficiary, the Company considers, among other things, whether it has the power to direct the activities of the VIE that most significantly impact the entity’s economic performance, including, but not limited to, determining or limiting the scope or purpose of the VIE, selling or transferring property owned or controlled by the VIE, or arranging financing for the VIE. The Company also considers whether it has the obligation to absorb losses of, or the right to receive benefits from, the VIE.

The Company’s financial exposure with respect to VIEs is limited to the forfeiture of non-refundable deposit of cash or letters of credit. As of June 30, 2010 the Company had cash deposits and letters of credit totaling $7.9 million and $2.7 million, respectively, associated with the right to acquire 3,606 lots under Option Contracts.

 

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Table of Contents

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (continued)

 

The Company cash deposits for Option Contracts are included in Prepaid Expenses and Other Assets in the Consolidated Balance Sheets.

 

15.

Other Comprehensive Loss

Total other comprehensive loss includes net loss plus $2.4 million and $1.3 million, respectively, during the three and six months ended June 30, 2010 of unrealized loss on the Company’s available-for-sale marketable securities. Accordingly, the Company’s other comprehensive loss was $6.1 million and $25.9 million, respectively, during the three and six months ended June 30, 2010.

 

16.

Supplemental Guarantor Information

The Company’s senior notes 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 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 (collectively, the “Non-Guarantor Subsidiaries”) primarily include:

 

   

American Home Insurance

   

American Home Title

   

HomeAmerican

   

StarAmerican

   

Allegiant

The Company has determined that separate, full financial statements of the Guarantor Subsidiaries would not be material to investors and, accordingly, supplemental financial information for the Guarantor Subsidiaries is presented.

 

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Table of Contents

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (continued)

 

Supplemental Condensed Combining Balance Sheet

June 30, 2010

(In thousands)

 

     MDC     Guarantor
Subsidiaries
   Non-
Guarantor
Subsidiaries
   Eliminating
Entries
    Consolidated
MDC

Asset

            

Cash and cash equivalents

   $ 655,241      $ 5,485    $ 31,406    $ -      $ 692,132

Marketable securities

     911,863        -      29,540      -        941,403

Restricted cash

     -        713      -      -        713

Receivables

     11,371        40,832      2,603      (2,657     52,149

Mortgage loans held-for-sale, net

     -        -      112,065      -        112,065

Inventories, net

            

Housing completed or under construction

     -        382,971      -      -        382,971

Land and land under development

     -        370,352      -      -        370,352

Investment in subsidiaries

     106,192        -      -      (106,192     -

Other assets, net

     87,049        36,396      5,968      -        129,413
                                    

Total Assets

   $ 1,771,716      $ 836,749    $ 181,582    $ (108,849   $ 2,681,198
                                    

Liabilities

            

Accounts payable and related party liabilities

   $ 2,743      $ 51,331    $ 557    $ (2,657   $ 51,974

Accrued liabilities

     135,367        91,493      62,754      -        289,614

Advances and notes payable to parent and subsidiaries

     (640,699     638,903      1,796      -        -

Mortgage repurchase facility

     -        -      65,305      -        65,305

Senior notes, net

     1,242,325        -      -      -        1,242,325
                                    

Total Liabilities

     739,736        781,727      130,412      (2,657     1,649,218
                                    

Stockholders’ Equity

     1,031,980        55,022      51,170      (106,192     1,031,980
                                    

Total Liabilities and Stockholders’ Equity

   $   1,771,716      $      836,749    $      181,582    $     (108,849   $   2,681,198
                                    

 

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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, 2009

(In thousands)

 

     MDC     Guarantor
Subsidiaries
   Non-
Guarantor
Subsidiaries
    Eliminating
Entries
    Consolidated
MDC

Asset

           

Cash and cash equivalents

   $   1,210,123      $ 3,258    $ 20,871      $ -      $ 1,234,252

Marketable securities

     327,944        -      -        -        327,944

Restricted cash

     -        476      -        -        476

Receivables

     137,688        24,740      44,573        (45,957     161,044

Mortgage loans held-for-sale, net

     -        -      62,315        -        62,315

Inventories, net

           

Housing completed or under construction

     -        260,324      -        -        260,324

Land and land under development

     -        262,860      -        -        262,860

Investment in subsidiaries

     90,413        -      -        (90,413     -

Other assets, net

     87,121        29,629      3,343        -        120,093
                                     

Total Assets

   $ 1,853,289      $ 581,287    $ 131,102      $ (136,370   $ 2,429,308
                                     

Liabilities

           

Accounts payable and related party liabilities

   $ 48,331      $ 34,017    $ 696      $ (45,957   $ 37,087

Accrued liabilities

     133,226        95,705      63,038        -        291,969

Advances and notes payable to parent and subsidiaries

     (399,405     410,285      (10,880     -        -

Mortgage repurchase facility

     -        -      29,115        -        29,115

Senior notes, net

     997,991        -      -        -        997,991
                                     

Total Liabilities

     780,143        540,007      81,969        (45,957     1,356,162
                                     

Stockholders’ Equity

     1,073,146        41,280      49,133        (90,413     1,073,146
                                     

Total Liabilities and Stockholders’ Equity

   $ 1,853,289      $      581,287    $      131,102      $     (136,370   $   2,429,308
                                     

 

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Table of Contents

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (continued)

 

Supplemental Condensed Combining Statements of Operations

Three Months Ended June 30, 2010

(In thousands)

 

     MDC     Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
    Eliminating
Entries
    Consolidated
MDC
 

REVENUE

          

Home sales revenue

   $ -      $ 316,809      $ -      $ (5,533   $ 311,276   

Land sales and other revenue

     -        5,910        9,144        -        15,054   

Equity in (loss) income of subsidiaries

     15,307        -        -        (15,307     -   
                                        

Total Revenue

     15,307        322,719        9,144        (20,840     326,330   
                                        

COSTS AND EXPENSES

          

Home cost of sales

     -        260,614        (19     (5,533     255,062   

Asset impairments, net

     -        -        -        -        -   

Marketing and commission expenses

     -        23,086        -        -        23,086   

General and administrative and other expenses

     18,607        25,828        5,656        -        50,091   
                                        

Total Operating Costs and Expenses

     18,607        309,528        5,637        (5,533     328,239   
                                        

(Loss) income from Operations

     (3,300     13,191        3,507        (15,307     (1,909

Other income (expense)

     (2,422     28        604        -        (1,790
                                        

(Loss) income before income taxes

     (5,722     13,219        4,111        (15,307     (3,699

Provision for income taxes

     2,038        (245     (1,778     -        15   
                                        

NET (LOSS) INCOME

   $         (3,684   $        12,974      $          2,333      $       (15,307   $         (3,684
                                        

 

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Table of Contents

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (continued)

 

Supplemental Condensed Combining Statements of Operations

Three Months Ended June 30, 2009

(In thousands)

 

     MDC     Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
    Eliminating
Entries
    Consolidated
MDC
 

REVENUE

          

Home sales revenue

   $ -      $      189,306      $ -      $ (3,752   $      185,554   

Land sales and other revenue

     -        2,706        7,006        -        9,712   

Equity in (loss) income of subsidiaries

     (4,778     -        -        4,778        -   
                                        

Total Revenue

     (4,778     192,012        7,006        1,026        195,266   
                                        

COSTS AND EXPENSES

          

Home cost of sales

     -        155,876        (6     (3,752     152,118   

Asset impairments

     -        1,243        -        -        1,243   

Marketing and commission expenses

     -        14,883        -        -        14,883   

General and administrative and other expenses

     16,851        17,909        4,836        -        39,596   
                                        

Total Operating Costs and Expenses

     16,851        189,911        4,830        (3,752     207,840   
                                        

(Loss) income from Operations

     (21,629     2,101        2,176        4,778        (12,574

Other income (expense)

     (7,046     147        410        -        (6,489
                                        

(Loss) income before income taxes

     (28,675     2,248        2,586        4,778        (19,063

Benefit from (provision for) income taxes

     (907     (8,443     (1,169     -        (10,519
                                        

NET (LOSS) INCOME

   $       (29,582   $ (6,195   $          1,417      $          4,778      $ (29,582
                                        

 

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Table of Contents

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (continued)

 

Supplemental Condensed Combining Statements of Operations

Six Months Ended June 30, 2010

(In thousands)

 

     MDC     Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
    Eliminating
Entries
    Consolidated
MDC
 

REVENUE

          

Home sales revenue

   $ -      $      460,655      $ -      $ (8,436   $      452,219   

Land sales and other revenue

     -        6,424        14,765        -        21,189   

Equity in (loss) income of subsidiaries

     17,661        -        -        (17,661     -   
                                        

Total Revenue

     17,661        467,079        14,765        (26,097     473,408   
                                        

COSTS AND EXPENSES

          

Home cost of sales

     -        372,925        (37     (8,436     364,452   

Asset impairments, net

     -        -        -        -        -   

Marketing and commission expenses

     -        35,275        -        -        35,275   

General and administrative and other expenses

     36,789        44,451        9,745        -        90,985   
                                        

Total Operating Costs and Expenses

     36,789        452,651        9,708        (8,436     490,712   
                                        

(Loss) income from Operations

     (19,128     14,428        5,057        (17,661     (17,304

Other income (expense)

     (8,630     76        917        -        (7,637
                                        

(Loss) income before income taxes

     (27,758     14,504        5,974        (17,661     (24,941

Provision for income taxes

     3,201        (223     (2,594     -        384   
                                        

NET (LOSS) INCOME

   $       (24,557   $ 14,281      $          3,380      $       (17,661   $ (24,557
                                        

 

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Table of Contents

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (continued)

 

Supplemental Condensed Combining Statements of Operations

Six Months Ended June 30, 2009

(In thousands)

 

     MDC     Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
    Eliminating
Entries
    Consolidated
MDC
 

REVENUE

          

Home sales revenue

   $ -      $ 358,943      $ -      $ (6,407   $      352,536   

Land sales and other revenue

     50        6,043        12,569        -        18,662   

Equity in (loss) income of subsidiaries

     (22,104     -        -        22,104        -   
                                        

Total Revenue

     (22,054     364,986        12,569        15,697        371,198   
                                        

COSTS AND EXPENSES

          

Home cost of sales

     -        299,856        (6     (6,407     293,443   

Asset impairments

     -        15,812        -        -        15,812   

Marketing and commission expenses

     -        30,073        -        -        30,073   

General and administrative and other expenses

     34,822        35,490        9,276        -        79,588   
                                        

Total Operating Costs and Expenses

     34,822        381,231        9,270        (6,407     418,916   
                                        

(Loss) income from Operations

     (56,876     (16,245     3,299        22,104        (47,718

Other income (expense)

     (13,365     (20     967        -        (12,418
                                        

(Loss) income before income taxes

     (70,241     (16,265     4,266        22,104        (60,136

Benefit from (provision for) income taxes

     (194     (8,343     (1,762     -        (10,299
                                        

NET (LOSS) INCOME

   $       (70,435   $       (24,608   $          2,504      $        22,104      $ (70,435
                                        

 

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Table of Contents

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (continued)

 

Supplemental Condensed Combining Statements of Cash Flows

Six Months Ended June 30, 2010

(In thousands)

 

     MDC     Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
    Eliminating
Entries
    Consolidated
MDC
 

Net cash provided by (used in) operating activities

   $ 71,574      $ (225,398   $ (7,449   $ (17,661   $ (178,934
                                        

Net cash used in investing activities

     (588,283     (454     (29,410     -        (618,147
                                        

Financing activities

          

Payments from (advances to) subsidiaries

     (256,944     228,079        11,204        17,661        -   

Proceeds from issuance of senior notes, net

     242,288        -        -        -        242,288   

Mortgage repurchase facility

     -        -        36,190        -        36,190   

Dividend payments

     (23,570     -        -        -        (23,570

Proceeds from exercise of stock options

     53        -        -        -        53   
                                        

Net cash provided by (used in) financing activities

     (38,173     228,079        47,394        17,661        254,961   
                                        

Net (decrease) increase in cash and cash equivalents

     (554,882     2,227        10,535        -        (542,120

Cash and cash equivalents

          

Beginning of period

     1,210,123        3,258        20,871        -        1,234,252   
                                        

End of period

   $     655,241      $         5,485      $       31,406      $                 -      $     692,132   
                                        

 

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements (continued)

 

Supplemental Condensed Combining Statements of Cash Flows

Six Months Ended June 30, 2009

(In thousands)

 

     MDC     Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
    Eliminating
Entries
    Consolidated
MDC
 

Net cash (used in) provided by operating activities

   $ 103,162      $ 110,484      $ 16,068      $ 22,104      $ 251,818   
                                        

Net cash provided by (used in) investing activities

     33,977        (34     -        -        33,943   
                                        

Financing activities

          

Payments from (advances to) subsidiaries

     138,545        (110,257     (6,184     (22,104     -   

Mortgage repurchase facility

     -        -        (10,698     -        (10,698

Dividend payments

     (23,437     -        -        -        (23,437

Proceeds from exercise of stock options

     3,471        -        -        -        3,471   

Excess tax benefit from stock-based compensation

     -        -        -        -        -   
                                        

Net cash provided by (used in) financing activities

     118,579        (110,257     (16,882     (22,104     (30,664
                                        

Net increase (decrease) in cash and cash equivalents

     255,718        193        (814     -        255,097   

Cash and cash equivalents

          

Beginning of period

     1,279,684        3,536        21,508        -        1,304,728   
                                        

End of period

   $   1,535,402      $         3,729      $       20,694      $                 -      $   1,559,825   
                                        

 

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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, 2009 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. We have two primary operations, homebuilding and financial services. Our homebuilding operations consist of wholly-owned subsidiary companies that generally purchase finished lots for the construction and sale of single-family detached homes to first-time and first-time move-up homebuyers under the name “Richmond American Homes.” Our homebuilding operations are comprised of many homebuilding subdivisions that we consider to be our operating segments. Homebuilding subdivisions in a given market are aggregated into reportable segments as follows: (1) West (Arizona, California and Nevada); (2) Mountain (Colorado and Utah); (3) East (Maryland, Virginia, which includes Virginia and West Virginia, and Delaware Valley, which includes Pennsylvania, Delaware and New Jersey); and (4) Other Homebuilding (Florida and Illinois).

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 the Company and our homebuyers in Colorado, Florida, Maryland, Nevada and Virginia. This segment also includes Allegiant Insurance Company, Inc., A Risk Retention Group (“Allegiant”), which provides to its customers, primarily many of our homebuilding subsidiaries and certain subcontractors of these homebuilding subsidiaries, general liability coverage for construction work performed associated with closed homes, and StarAmerican Insurance Ltd. (“StarAmerican”), a Hawaii corporation and a wholly-owned subsidiary of MDC. StarAmerican has agreed to re-insure: (1) all claims pursuant to two policies issued to the Company by a third-party; and (2) pursuant to agreements beginning in June 2004, 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, through June 30, 2009. Effective July 1, 2009, StarAmerican re-insures Allegiant for all claims in excess of $50,000 per occurrence, up to $3.0 million per occurrence, subject to various aggregate limits, not to exceed $6.0 million per year.

EXECUTIVE SUMMARY

During the six months ended June 30, 2010, our homebuilding operations experienced an 18% increase in net orders, a 33% increase in home closings, a 260 basis point increase in Home Gross Margins (as defined below) and an 18% increase in Backlog (as defined below) from June 30, 2009. Additionally, for the second consecutive quarter, we did not have any inventory impairments, compared with inventory impairments of $1.2 million and $15.8 million during the three and six months ended June 30, 2009. Contributing to our improved operational and financial performance during the three and six months ended June 30, 2010 were sales programs, which focused on offering low mortgage interest rates, and the federal homebuyer tax credit. All of these items contributed to reducing our loss from operations from $12.6 million and $47.7 million during the three and six months ended June 30, 2009, respectively, to losses of $1.9 million and $17.3 million during the same periods in 2010.

Despite these improvements, we continued to be faced with challenges, which include: (1) significant deterioration in the new orders for homes following the expiration of the federal homebuyer tax credit, which required the sale of a home to be completed by April 30, 2010; (2) high levels of foreclosures and resale home inventories; and (3) high unemployment levels. Additionally, despite the increased affordability of new housing products and low interest rates, economic conditions continued to create uncertainty in the timing, strength and sustainability of any recovery in the new home sales market. We believe that stability in the credit and capital markets, improvement in U.S. employment levels and an eventual renewal of confidence in the United States and global economies will play a major role in any turnaround in the homebuilding and mortgage lending industries. See “Forward-Looking Statements” below.

 

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During the first six months of 2010, we received $144.5 million of our income tax receivable and completed the issuance of senior notes that generated $242.3 million in cash. Additionally, we continued to strengthen our sales and marketing operations with training and special sales promotions, in an effort to improve sales velocity both before and after the April 30, 2010 expiration of the federal homebuyer tax credit. We continued to manage our inventory levels by limiting the number of finished spec and model homes, yet increased levels of unsold homes under construction at the foundation and framing stages to meet the needs of homebuyers who, before the deadline for closings under the federal homebuyer tax credit was extended to September 30, 2010, were required to close on their home purchases by June 30, 2010. While competition for the acquisition of finished lots continued to be intense during the first six months of 2010, we were able to increase the total number of lots controlled through acquisition and lot option contracts by approximately 1,900 in 36 new subdivisions. Additionally, during the first six months of 2010, we continued to rebuild and improve our processes and business practices seeking to increase efficiency and standardized business practices nationwide. To that end, at our corporate office and for certain of our non-homebuilding subsidiaries of MDC, we began operating under our new enterprise resource planning system in May 2010. Finally, we invested $722.2 million of cash into various debt and equity securities during the first six months of 2010.

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 if conditions are significantly different in the future. Additionally, using different estimates or assumptions in our critical accounting estimates and policies could have a material impact to our consolidated financial statements. See “Forward-Looking Statements” below.

The accounting policies and estimates, which we believe are critical and require the use of complex judgment in their application, are those related to:

 

   

homebuilding inventory valuation (held-for-development);

 

   

homebuilding inventory valuation (held-for-sale);

 

   

warranty costs;

 

   

insurance reserves;

 

   

legal accruals;

 

   

income taxes—valuation allowance;

 

   

income tax reserves;

 

   

revenue recognition;

 

   

home cost of sales;

 

   

mortgage loan loss reserves;

 

   

stock-based compensation;

 

   

segment reporting; and

 

   

land option contracts.

Except for warranty reserves noted below, 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, 2009.

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. Warranty payments incurred for an individual house may differ from the related reserve established for the home at the time it home was closed. The actual disbursements for warranty claims are evaluated in the aggregate to determine if an adjustment to the historical warranty reserve should be recorded, that would result in a corresponding adjustment to home cost of sales. During the 2010 second quarter, in light of a continued decrease in our warranty payments, and similar to our procedure in prior years, we engaged a third-party actuary to assist in our analysis of estimated future warranty payments. Based upon the actuarial analysis, we refined our methodology of estimating a reasonable range for warranty reserves. We believe the refined methodology will result in a better estimate of warranty cost exposure especially in periods of declining payment activity and provide better visibility to the sensitivity of the estimate in the current environment. We will continue to periodically engage a third-party actuary for purposes of assisting us in evaluating and determining the reasonableness of our warranty reserves.

 

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Warranty reserve adjustments are recorded as an increase or reduction to home cost of sales in the Consolidated Statement of Operations. It is possible we could be required to record further adjustments to our warranty reserve balance in future reporting periods if the current favorable warranty payment trend continues. A 1% change in our estimated ultimate warranty losses for homes that closed over the last ten years would result in an adjustment to our warranty reserve balance of approximately $2.0 million. See “Forward-Looking Statements” below.

KEY HOMEBUILDING MEASURES

The table below sets forth information relating to orders for homes (dollars in thousands).

 

     Three Months
Ended June 30,
   Change    Six Months
Ended June 30,
   Change
     2010    2009    Amount     %    2010    2009    Amount     %

Orders For Homes, net (units)

Arizona

     184      214      (30   -14%      352      372      (20   -5%

California

     109      112      (3   -3%      135      187      (52   -28%

Nevada

     195      153      42      27%      365      248      117      47%
                                                 

West

     488      479      9      2%      852      807      45      6%
                                                 

Colorado

     232      206      26      13%      502      340      162      48%

Utah

     110      86      24      28%      235      127      108      85%
                                                 

Mountain

     342      292      50      17%      737      467      270      58%
                                                 

Delaware Valley

     2      19      (17   -89%      16      33      (17   -52%

Maryland

     60      54      6      11%      93      91      2      2%

Virginia

     76      61      15      25%      142      117      25      21%
                                                 

East

     138      134      4      3%      251      241      10      4%
                                                 

Florida

     47      64      (17   -27%      106      122      (16   -13%

Illinois

     -      8      (8   -100%      -      16      (16   -100%
                                                 

Other Homebuilding

     47      72      (25   -35%      106      138      (32   -23%
                                                 

Total

     1,015      977      38      4%      1,946      1,653      293      18%
                                                 

Estimated Value of Orders for Homes, net

   $ 281,000    $ 289,000    $ (8,000   -3%    $ 539,000    $ 480,000    $ 59,000      12%

Estimated Average Selling Price of Order for Homes, net

   $          276.8    $          295.8    $           (19.0   -6%    $          277.0    $          290.4    $           (13.4   -5%

Orders for Homes, net.  During the three months ended June 30, 2010, net orders for homes increased to 1,015 homes with an estimated sales value of $281.0 million, compared with net orders for 977 homes within an estimated sales value of $289.0 million during the same period in 2009. The improvement in net orders is attributable to a 25% increase in the average rate of sales per active community, partially offset by a 17% decline in the average number of active communities. During the six months ended June 30, 2010, net orders for homes increased to 1,946 homes with an estimated sales value of $539.0 million, compared with net orders for 1,653 homes within an estimated sales value of $480.0 million during the same period in 2009. The increase in the average rate of sales per active community is primarily attributable to continued low interest rate levels, decreases in the average selling prices of homes, making them more affordable, the federal homebuyer tax credit and our strengthened sales department. Although our net orders increased, our cancellation rate also increased to 25% compared with 20% during the same period in 2009. Additionally, following the expiration of the federal homebuyer tax credit on April 30, 2010, we experienced significant decreases in net orders for homes.

 

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

 

     Three Months
Ended June 30,
   Change    Six Months
Ended June 30,
   Change
     2010    2009    Amount     %    2010    2009    Amount     %

Arizona

   242    181    61      34%    350    353    (3   -1%

California

   68    52    16      31%    114    111    3      3%

Nevada

   221    114    107      94%    319    188    131      70%
                                     

West

   531    347    184      53%    783    652    131      20%
                                     

Colorado

   230    113    117      104%    338    204    134      66%

Utah

   147    56    91      163%    199    96    103      107%
                                     

Mountain

   377    169    208      123%    537    300    237      79%
                                     

Delaware Valley

   12    11    1      9%    16    30    (14   -47%

Maryland

   75    39    36      92%    101    65    36      55%

Virginia

   68    45    23      51%    108    86    22      26%
                                     

East

   155    95    60      63%    225    181    44      24%
                                     

Florida

   72    44    28      64%    113    93    20      22%

Illinois

   -    10    (10   -100%    -    19    (19   -100%
                                     

Other Homebuilding

   72    54    18      33%    113    112    1      1%
                                     

Total

               1,135                   665                   470      71%                1,658                1,245                   413      33%
                                     

Homes closed during the three months ended June 30, 2010 increased for each homebuilding segment, primarily due to more homes being in Backlog at the beginning of the 2010 second quarter, compared with those at the beginning of the 2009 second quarter. During the six months ended June 30, 2010, home closings increased in the Mountain and East segments as most of the markets within these segments had a higher Backlog at the beginning of the 2010 year, compared with the beginning of the 2009 year.

 

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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. The following table sets forth our Home Gross Margins by reportable segment.

 

     Three Months Ended June 30,     
     2010    2009    Change

Homebuilding

        

West

   20.0%    26.5%    -6.5%

Mountain

   15.6%    8.5%    7.1%

East

   16.9%    14.5%    2.4%

Other Homebuilding

   19.9%    10.8%    9.1%
              

Consolidated

              18.1%               18.0%    0.1%
              
     Six Months Ended June 30,     
     2010    2009    Change

Homebuilding

        

West

   22.1%    24.1%    -2.0%

Mountain

   16.5%    7.9%    8.6%

East

   17.2%    14.3%    2.9%

Other Homebuilding

   21.4%    11.1%    10.3%
              

Consolidated

   19.4%    16.8%    2.6%
              

Home Gross Margins can be impacted positively or negatively in a reporting period by adjustments in our warranty reserves. Beginning in 2007 and continuing into the first six months of 2010, the Company experienced a significant favorable trend in the amount of warranty payments incurred on its previously closed homes. Because our warranty reserve balance at each period end is generally determined based upon historical warranty payment patterns, the foregoing favorable trend in warranty payments impacted significantly our warranty reserves during the 2009 and 2010 first quarters. As a result of the significant decline in warranty payments incurred on previously closed homes, we recorded reductions to our warranty reserves for previously closed homes totaling $10.9 million and $14.5 million during the three and six months ended June 30, 2009, respectively. The trend in lower warranty payments on previously closed homes continued into 2010. As a result, we recorded reductions totaling $5.6 million during the six months ended June 30, 2010, of which $3.9 million was recorded during the 2010 first quarter.

The following table sets forth our Home Gross Margins excluding warranty adjustments and interest in cost of sales during the three and six months ended June 30, 2010 and 2009.

 

     Three Months Ended June 30,     
     2010    2009    Change

West

   21.8%    19.5%    2.3%

Mountain

   17.9%    13.5%    4.4%

East

   19.2%    16.4%    2.8%

Other

   20.8%    10.5%    10.3%
              

Consolidated

              20.2%               16.8%    3.4%
              

 

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Table of Contents
     Six Months Ended June 30,     
     2010    2009    Change

West

   22.6%    16.0%    6.6%

Mountain

   18.4%    8.4%    10.0%

East

   19.3%    11.8%    7.5%

Other

   21.1%    8.5%    12.6%
              

Consolidated

              20.7%               12.6%    8.1%
              

During the three and six months ended June 30, 2010, Home Gross Margins for each of our homebuilding segments were generally favorably impacted by decreases in home cost of construction as we have been closing more of our smaller and redesigned homes that are more cost efficient to build. This improvement has been partially offset by increases in the lot cost per closed home.

Future Home Gross Margins may be impacted negatively by, among other things: (1) a weaker economic environment, including recurring effects of the recession in the United States, as well as homebuyers’ reluctance to purchase new homes based on concerns about employment conditions; (2) continued and/or increases in home foreclosure levels; (3) on-going tightening of mortgage loan origination requirements; (4) increased competition and increases in the level of home order cancellations, which could affect our ability to maintain existing home prices and/or home sales incentive levels; (5) deterioration in the demand for new homes in our markets; (6) fluctuating energy costs, including oil and gasoline; (7) 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; (8) increases in interest expense included in home cost of sales; (9) increases in the costs of finished lots; (10) changes in our warranty payment experiences and/or increases in warranty expenses or litigation expenses associated with construction defect claims; and (11) other general risk factors. See “Forward-Looking Statements” below.

 

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The following table sets forth by reportable segment a reconciliation of our home cost of sales, as reported, to home cost of sales excluding warranty adjustments and interest in cost of sales, which is used in the calculation of Home Gross Margins, excluding warranty adjustments and interest in cost of sales.

 

      Home Sales
Revenue - As
reported
    Home Cost of
Sales - As
reported
    Warranty
Adjustments
    Interest in
Cost of Sales
   Home Cost of
Sales -
Excluding
Warranty
Adjustments and
Interest
    Home Gross
Margins -
Excluding
Warranty
Adjustments  and
Interest (1)

Three Months Ended June 30, 2010

             

West

   $ 117,752      $ 94,218      $ (1,255   $ 3,387    $ 92,086      21.8%

Mountain

     110,072        92,926        119        2,492      90,315      17.9%

East

     72,622        60,339        (374     2,004      58,709      19.2%

Other

     16,362        13,111        (167     319      12,959      20.8%

Intercompany adjustments

     (5,532     (5,532     -        -      (5,532   N/A
                                         

Consolidated

   $ 311,276      $ 255,062      $ (1,677   $ 8,202    $ 248,537      20.2%
                                         

Three Months Ended June 30, 2009

             

West

   $ 81,304      $ 59,739      $ (9,250   $ 3,539    $ 65,450      19.5%

Mountain

     55,489        50,760        42        2,709      48,009      13.5%

East

     39,398        33,669        (1,008     1,759      32,918      16.4%

Other

     13,115        11,702        (688     654      11,736      10.5%

Intercompany adjustments

     (3,752     (3,752     -        -      (3,752   N/A
                                         

Consolidated

   $      185,554      $      152,118      $        (10,904   $          8,661    $      154,361      16.8%
                                         

 

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      Home Sales
Revenue - As
reported
    Home Cost of
Sales - As
reported
    Warranty
Adjustments
    Interest in
Cost of Sales
   Home Cost of
Sales -
Excluding
Warranty
Adjustments and
Interest
    Home Gross
Margins -
Excluding
Warranty
Adjustments  and
Interest (1)

Six Months Ended June 30, 2010

             

West

   $ 174,479      $ 135,963      $ (3,827   $ 4,715    $ 135,075      22.6%

Mountain

     156,671        130,805        (681     3,566      127,920      18.4%

East

     104,108        86,156        (570     2,661      84,065      19.3%

Other

     25,396        19,963        (528     462      20,029      21.1%

Intercompany adjustments

     (8,435     (8,435     -        -      (8,435   N/A
                                         

Consolidated

   $ 452,219      $ 364,452      $ (5,606   $ 11,404    $ 358,654      20.7%
                                         

Six Months Ended June 30, 2009

             

West

   $ 152,932      $ 116,027      $ (12,423   $ 6,140    $ 128,450      16.0%

Mountain

     99,495        91,666        555        5,730      91,111      8.4%

East

     79,774        68,376        (1,991     3,705      70,367      11.8%

Other

     26,742        23,781        (688     1,119      24,469      8.5%

Intercompany adjustments

     (6,407     (6,407     -        -      (6,407   N/A
                                         

Consolidated

   $      352,536      $      293,443      $        (14,547   $        16,694    $      307,990      12.6%
                                         

 

(1)

Home Gross Margins excluding the impact of warranty adjustments and interest in cost of sales is a non-GAAP financial measure. We believe this information is meaningful as it isolates the impact that warranty adjustments and interest has on our Home Gross Margins.

 

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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).

 

      June  30,
2010
   December 31,
2009
   June  30,
2009

Backlog (units)

        

Arizona

     105      103      177

California

     97      76      125

Nevada

     134      88      113
                    

West

     336      267      415
                    

Colorado

     371      207      208

Utah

     130      94      73
                    

Mountain

     501      301      281
                    

Delaware Valley

     23      23      30

Maryland

     95      103      84

Virginia

     107      73      67
                    

East

     225      199      181
                    

Florida

     52      59      64

Illinois

     -      -      -
                    

Other Homebuilding

     52      59      64
                    

Total

     1,114      826      941
                    

Backlog Estimated Sales Value

   $      351,000    $      265,000    $      295,000
                    

Estimated Average Selling Price of Homes in Backlog

   $ 315.1    $ 320.8    $ 313.5
                    

We define “Backlog” as homes under contract but not yet delivered. Our Backlog at June 30, 2010 increased in most of our homebuilding segments as our net orders for homes during the first six months of 2010 exceeded our home closings in each market. Contributing to the improvement in our June 30, 2010 Backlog was the impact of the federal homebuyer tax credit, which stimulated improvement in our net orders for homes during the first six months of 2010. The Backlog estimated sales value also increased from December 31, 2009 due to the 35% increase in the number of homes in Backlog at June 30, 2010, slightly offset by the 2% decrease in the estimated average selling price of homes in Backlog.

 

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Cancellation Rate.  We define our home order “Cancellation Rate” as the approximate number of cancelled home order contracts during a reporting period as a percentage of total home order contracts received during such reporting period. The following tables set forth our Cancellation Rate by segment.

 

     Three Months Ended June 30,    Increase
(Decrease)
     2010    2009   

Homebuilding

        

West

   20%    16%    4%

Mountain

   31%    25%    6%

East

   25%    25%    0%

Other Homebuilding

   31%    24%    7%
              

Consolidated

   25%    20%    5%
              
     Six Months Ended June 30,    Increase
(Decrease)
     2010    2009   

Homebuilding

        

West

   20%    18%    2%

Mountain

   26%    24%    2%

East

   26%    27%    -1%

Other Homebuilding

   32%    22%    10%
              

Consolidated

              24%               22%               2%
              

The increase in the Cancellation Rate in our Other Homebuilding segment during the three and six months ended June 30, 2010 and our Mountain segment during the three months ended June 30, 2010 primarily resulted from a higher volume of home orders cancellations as a result of homebuyers not being able to qualify for mortgage loans.

 

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Active Subdivisions.  The following table displays the number of our active subdivisions for each market within our homebuilding segments. We define an active subdivision as a subdivision that has more than five homes available to be sold and closed, and has sold at least five homes.

 

     June 30,
2010
   December 31,
2009
   June 30,
2009

Arizona

   26    28    27

California

   6    3    10

Nevada

   15    18    19
              

West

   47    49    56
              

Colorado

   41    42    43

Utah

   18    16    18
              

Mountain

   59    58    61
              

Delaware Valley

   1    1    1

Maryland

   9    8    9

Virginia

   9    7    7
              

East

   19    16    17
              

Florida

   9    10    8

Illinois

   -    -    -
              

Other Homebuilding

   9    10    8
              

Total

                  134                   133                   142
              

Average Selling Price Per Home Closed.  The average selling price for our closed homes includes the base sales price, any purchased options and upgrades, reduced by any Sales Price Incentives (defined as discounts on the sales price of a home) or Mortgage Loan Origination Fees (defined as mortgage loan origination fees paid by Richmond American Homes to HomeAmerican). The following tables set forth our average selling price per home closed, by market (dollars in thousands).

 

     Three Months Ended June 30,    Change
     2010    2009    Amount     %

Arizona

   $            190.7    $          197.9    $         (7.2   -4%

California

     444.7      414.0      30.7      7%

Colorado

     303.0      341.7      (38.7   -11%

Delaware Valley

     377.1      393.6      (16.5   -4%

Florida

     227.3      227.1      0.2      0%

Illinois

     -      312.1      N/A      N/A

Maryland

     476.2      381.7      94.5      25%

Nevada

     187.2      210.3      (23.1   -11%

Utah

     274.7      301.5      (26.8   -9%

Virginia

     476.2      451.3      24.9      6%

Average

   $ 274.3    $ 279.0    $ (4.7   -2%

 

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     Six Months Ended June 30,    Change
     2010    2009    Amount     %

Arizona

   $          194.7    $          195.3    $ (0.6   0%

California

     407.3      405.6      1.7      0%

Colorado

     302.0      346.4      (44.4   -13%

Delaware Valley

     366.4      413.4      (47.0   -11%

Florida

     224.8      223.0      1.8      1%

Illinois

     -      316.0      N/A      N/A

Maryland

     462.9      405.2      57.7      14%

Nevada

     187.8      207.4                (19.6   -9%

Utah

     274.4      300.3      (25.9   -9%

Virginia

     476.8      478.5      (1.7   0%

Average

   $ 272.7    $ 283.2    $ (10.5   -4%

During the three months ended June 30, 2010, we experienced increases in the average selling price per closed home in our Maryland, California and Virginia markets. The increase in these markets resulted primarily from a shift in product mix as we closed a higher concentration of homes in higher priced subdivisions. We experienced decreases in the average selling price per closed home in our Colorado, Utah and Nevada markets as we closed on more of our newer and smaller products, which were introduced into the market in late 2009.

During the six months ended June 30, 2010, we experienced declines in the average selling price per closed home in our Delaware Valley, Colorado, Nevada and Utah markets as we closed on more of our newer and smaller products, which were introduced into the market in late 2009. Additionally, we experienced an increase in the average selling price of closed homes in Maryland, primarily from a shift in product mix as we closed homes in higher priced subdivisions.

RESULTS OF OPERATIONS

The following discussion compares results for the three months ended June 30, 2010 with the three months ended June 30, 2009 and compares results for the six months ended June 30, 2010 with the six months ended June 30, 2009.

 

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Home Sales Revenue.  Home sales revenue from a home closing includes the base sales price and any purchased options and upgrades and is reduced for any Sales Price Incentives (defined as discounts on the sales price of a home) or Mortgage Loan Origination Fees (defined as mortgage loan origination fees paid by Richmond American Homes to HomeAmerican). The table below summarizes home sales revenue by reportable segment (dollars in thousands).

 

     Three Months Ended June 30,     Change
     2010     2009     Amount     %

West

   $ 117,752      $ 81,304      $ 36,448      45%

Mountain

     110,072        55,489        54,583      98%

East

     72,622        39,398        33,224      84%

Other Homebuilding

     16,362        13,115        3,247      25%
                          

Total Homebuilding

     316,808        189,306        127,502      67%

Intercompany adjustments

     (5,532     (3,752     (1,780   -47%
                          

Consolidated

   $      311,276      $      185,554      $      125,722      68%
                          
     Six Months Ended June 30,     Change
     2010     2009     Amount     %

West

   $ 174,479      $ 152,932      $ 21,547      14%

Mountain

     156,671        99,495        57,176      57%

East

     104,108        79,774        24,334      31%

Other Homebuilding

     25,396        26,742        (1,346   -5%
                          

Total Homebuilding

     460,654        358,943        101,711      28%

Intercompany adjustments

     (8,435     (6,407     (2,028   -32%
                          

Consolidated

   $ 452,219      $ 352,536      $ 99,683      28%
                          

In our West segment, home sales revenue increased during the three months ended June 30, 2010, primarily due to closing 184 more homes and a $30,700 increase in the average selling prices of closed homes in California. These items partially were offset by decreases of $23,100 and $7,200 in the average selling prices of homes in Nevada and Arizona, respectively. In our Mountain segment, home sales revenue increased during the three months ended June 30, 2010, primarily due to closing 208 more homes, partially offset by decreases of $38,700 and $26,800 in the average selling price of closed homes in Colorado and Utah, respectively. In our East segment, home sales revenue increased due to closing 60 more homes during the three months ended June 30, 2010 and from increases of $94,500 and $24,900 in the average selling prices of closed homes in Maryland and Virginia, respectively. Home sales revenue in our Other Homebuilding segment increased due to closing 18 more homes.

In our West segment, home sales revenue increased during the six months ended June 30, 2010, primarily due to closing 131 more homes, partially offset by a decrease of $19,600 in the average selling prices of homes in Nevada. In our Mountain segment, home sales revenue increased during the three months ended June 30, 2010, primarily due to closing 237 more homes, partially offset by decreases of $44,400 and $25,900 in the average selling price of closed homes in Colorado and Utah, respectively. In our East segment, home sales revenue increased due to closing 44 more homes during the three months ended June 30, 2010 and from increases of $57,700 in the average selling prices of closed homes in Maryland. These items partially were offset by a decrease of $47,000 in the average selling price of closed homes in Delaware Valley. Home sales revenue in our Other Homebuilding segment decreased due to a shift in the market in which we closed homes during the six months ended June 30, 2010.

Land Sales.  Land sales revenue was $5.7 million during the three and six months ended June 30, 2010. During the three and six months ended June 30, 2009, land sales revenue was $2.0 million and $4.6 million, respectively, and related to the sale of 35 and 150 lots, respectively.

 

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Other Revenue.  Gains on the sale of mortgage loans and broker origination fees, net, primarily represent revenue earned by HomeAmerican from the sale of HomeAmerican’s originated mortgage loans to third-parties and fees that HomeAmerican earns upon brokering a mortgage loan for a home closing. Insurance premiums collected by StarAmerican and Allegiant from our homebuilding subcontractors in connection with the construction of homes primarily comprise insurance revenue. Title and other revenue primarily consists of forfeiture of homebuyer deposits on home sales contracts and revenue associated with our American Home Title operations. The table below sets forth the components of other revenue (dollars in thousands).

 

     Three Months Ended June 30,    Change
     2010    2009    Amount     %

Gains on sales of mortgage loans and broker origination fees, net

   $ 6,593    $ 5,585    $ 1,008      18%

Insurance revenue

     1,888      1,046      842      80%

Title and other revenue

     874      1,127      (253   -22%
                        

Total other revenue

   $ 9,355    $ 7,758    $ 1,597      21%
                        
     Six Months Ended June 30,    Change
     2010    2009    Amount     %

Gains on sales of mortgage loans and broker origination fees, net

   $ 10,603    $ 9,068    $ 1,535      17%

Insurance revenue

     3,177      2,861      316      11%

Title and other revenue

     1,695      2,161      (466   -22%
                        

Total other revenue

   $        15,475    $        14,090    $          1,385      10%
                        

Gains on sales of mortgage loans and broker origination fees and insurance revenue increased during the three and six months ended June 30, 2010 primarily due to closing 470 and 413 more homes, respectively.

Home Cost of Sales.  Home cost of sales primarily includes land acquisition, land development and related costs (both incurred and estimated to be incurred), warranty costs and finance and closing costs, including Closing Cost Incentives (defined as homebuyer closing costs assistance paid by Richmond American Homes to a third-party). Home cost of sales excludes expenses associated with commissions, amortization of deferred marketing costs and inventory impairment charges. However, while inventory impairment charges recorded during a reporting period do not impact home cost of sales, they do impact future home cost of sales as they lower the lot cost basis of the impaired inventory.

 

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The table below sets forth the home cost of sales by reportable segment (dollars in thousands).

 

     Three Months Ended June 30,     Change
     2010     2009     Amount     %

Homebuilding

        

West

   $ 94,218      $ 59,739      $ 34,479      58%

Mountain

     92,926        50,760        42,166      83%

East

     60,339        33,669        26,670      79%

Other Homebuilding

     13,111        11,702        1,409      12%
                          

Total Homebuilding

     260,594        155,870        104,724      67%

Intercompany adjustments

     (5,532     (3,752     (1,780   -47%
                          

Consolidated

   $      255,062      $      152,118      $      102,944      68%
                          
     Six Months Ended June 30,     Change
     2010     2009     Amount     %

Homebuilding

        

West

   $ 135,963      $ 116,027      $ 19,936      17%

Mountain

     130,805        91,666        39,139      43%

East

     86,156        68,376        17,780      26%

Other Homebuilding

     19,963        23,781        (3,818   -16%
                          

Total Homebuilding

     372,887        299,850        73,037      24%

Intercompany adjustments

     (8,435     (6,407     (2,028   -32%
                          

Consolidated

   $ 364,452      $ 293,443      $ 71,009      24%
                          

During the three months ended June 30, 2010, the increase in our consolidated home cost of sales resulted primarily from the following: (1) closing 470 more homes, which resulted in a $107.5 million increase to home cost of sales; (2) $25.2 million due to increases in the lot cost basis of our inventory; and (3) reductions to our warranty reserves of $10.9 million during the 2009 second quarter, compared with reductions to our warranty reserves of only $1.7 million during the 2010 second quarter. These items partially were offset by a decrease in the cost of home construction for our closed homes, as we closed more of our smaller sized product that is generally more cost efficient to build, which resulted in a $45.1 million reduction to home cost of sales.

The increase in our West segment during the three months ended June 30, 2010, is due primarily to closing 184 more homes during the 2010 second quarter, which resulted in a $31.7 million increase in home cost of sales and an increase in the lot cost basis of our inventory, which contributed to an $11.3 million increase to home cost of sales. Additionally, we recorded reductions to warranty reserves of $9.3 million during the 2009 second quarter, compared with reductions to our warranty reserves of only $1.3 million during the 2010 second quarter. These items partially were offset by a decrease in the cost of home construction for our closed homes, as we closed more of our smaller sized product that is generally more cost efficient to build, which resulted in a $19.4 million reduction to home cost of sales. The increase in our Mountain segment during the three months ended June 30, 2010, is due primarily from closing 208 more homes during the 2010 second quarter, which resulted in a $62.5 million increase in home cost of sales. This increase partially was offset by a $22.0 million decrease associated with a decrease in the cost of home construction for our closed homes, as we closed more of our smaller sized product, which is generally more cost efficient to build.

In our East segment, home cost of sales increased during the three months ended June 30, 2010, due primarily to closing 60 more homes during the 2010 second quarter, which resulted in a $21.3 million increase in home cost of sales. Additionally, we had an increase in the lot cost basis of our inventory, which contributed to an $8.5 million increase to home cost of sales. These items partially were offset by a decrease in the cost of home construction for our closed homes, as we closed more of our smaller sized product that is generally more cost efficient to build, which resulted in a $4.0 million reduction to home cost of sales. In our Other Homebuilding segment, home cost of sales increased during the three months ended June 30, 2010 from the following: (1) closing 18 more homes during the 2010 second quarter, which resulted in a $3.9 million increase in home cost of sales; and (2) an increase in the lot cost basis of our inventory, which contributed to a $2.5 million increase to home cost of sales. These items partially were offset by a decrease in the cost of home construction for our closed homes, as we closed more of our smaller sized product that is generally more cost efficient to build, which resulted in a $5.1 million reduction to home cost of sales.

 

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The increase in our West segment during the six months ended June 30, 2010, is due primarily to the following: (1) closing 131 more homes during the first six months of 2010, which resulted in a $23.3 million increase in home cost of sales; and (2) an increase in the lot cost basis of our inventory, which contributed to an $14.2 million increase to home cost of sales. Additionally, we recorded reductions to warranty reserves of $12.4 million during the first six months of 2009, compared with reductions to our warranty reserves of only $3.8 million during the same period in 2010. These items partially were offset by a decrease in the cost of home construction for our closed homes, as we closed more of our smaller sized product that is generally more cost efficient to build, which resulted in a $26.6 million reduction to home cost of sales. The increase in our Mountain segment during the six months ended June 30, 2010, is due primarily to closing 237 more homes during the first six months of 2010, which resulted in a $72.4 million increase in home cost of sales. This increase was partially offset by a $30.0 million decrease associated with a decrease in the cost of home construction for our closed homes, as we closed more of our smaller sized product that is generally more cost efficient to build.

In our East segment, home cost of sales increased during the six months ended June 30, 2010, primarily resulting from the following: (1) closing 44 more homes during the first six months of 2010, which resulted in a $16.6 million increase in home cost of sales; and (2) an increase in the lot cost basis of our inventory, which contributed to a $9.0 million increase to home cost of sales. These items partially were offset by a decrease in the cost of home construction for our closed homes, as we closed more of our smaller sized product that is generally more cost efficient to build, which resulted in an $8.4 million reduction to home cost of sales. In our Other Homebuilding segment, home cost of sales decreased during the six months ended June 30, 2010, primarily resulting from a decrease in the cost of home construction for our closed homes, as we closed more of our smaller sized product that is generally more cost efficient to build, which resulted in a $7.2 million reduction to home cost of sales. This decrease was partially offset by an in increase in the lot cost basis of our inventory, which contributed to a $3.7 million increase to home cost of sales.

Land Cost of Sales.  Land cost of sales during the three and six months ended June 30, 2010 was $5.0 million and $5.2 million, respectively, and related to the sale of 106 lots, primarily in our West segment. Land cost of sales was $1.5 million and $2.8 million during the three and six months ended June 30, 2009, respectively, and the decrease primarily resulted from our sale of approximately 35 and 150 lots, respectively.

 

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Asset Impairments.  We did not have any asset impairments during the three and six months ended June 30, 2010. The following table sets forth, by reportable segment, the asset impairments recorded for the three and six months ended June 30, 2009 (in thousands).

 

     Three Months
Ended June 30,
2009
 

Land and Land Under Development (Held-for-Development)

  

West

   $ -   

Mountain

     -   

East

     1,450   

Other Homebuilding

     -   
        

Subtotal

     1,450   
        

Housing Completed or Under Construction (Held-for-Development)

  

West

     -   

Mountain

     -   

East

     275   

Other Homebuilding

     -   
        

Subtotal

     275   
        

Land and Land Under Development (Held-for-Sale)

  

West

     (557

Mountain

     -   

East

     -   

Other Homebuilding

     -   
        

Subtotal

     (557
        

Other Assets

     75   
        

Consolidated Asset Impairments

   $           1,243   
        

 

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Table of Contents
     Six Months
Ended June 30,
2009
 

Land and Land Under Development (Held-for-Development)

  

West

   $ 9,791   

Mountain

     254   

East

     1,600   

Other Homebuilding

     17   
        

Subtotal

     11,662   
        

Housing Completed or Under Construction (Held-for-Development)

  

West

     3,276   

Mountain

     -   

East

     875   

Other Homebuilding

     267   
        

Subtotal

     4,418   
        

Land and Land Under Development (Held-for-Sale)

  

West

     (557

Mountain

     -   

East

     -   

Other Homebuilding

     -   
        

Subtotal

     (557
        

Other Assets

     289   
        

Consolidated Asset Impairments

   $        15,812   
        

During the 2009 second quarter, the Company’s impairments were concentrated in two subdivisions in the East segment, primarily resulting from a continued decline in the demand for homes in these subdivisions. The 2009 first quarter impairments of our held-for-development inventories were concentrated in the Nevada market of the West segment. These impairments resulted from significant decreases in the average selling prices of closed homes during the 2009 first quarter, compared with those in the 2008 fourth quarter, in response to increased levels of competition in this market and continued high levels of home foreclosures. The impairments in the Mountain, East and Other Homebuilding segments primarily resulted from lower forecasted average selling prices for communities that were in the close out phase.

 

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The following table sets forth the inventory impairments that were recorded on a quarterly basis over the last six quarters, as well as the fair value of these inventories and the number of lots and subdivisions at the period end to which the impairments relate (dollars in thousands).

 

     Inventory Impairments for the
Three Months Ended
   Fair Value of
Impaired
Inventory at
Quarter End
   Number of
Lots
Impaired
During the

Quarter
   Number of
Subdivisions
During the

Quarter
     Held-for-
Development
   Held-for-
Sale
    Total Inventory
Impairments
        

June 30, 2010

   $ -    $ -      $ -    $ -    -    -

March 31, 2010

     -      -        -      -    -    -

December 31, 2009

     12,276      234        12,510      29,536    336    10

September 30, 2009

     1,103      -        1,103      4,172    61    3

June 30, 2009

     1,725                (557     1,168      2,978    53    2

March 31, 2009

             14,355      -                14,355              38,602                719                  46

Marketing Expenses.  Marketing expenses primarily include advertising, amortization of deferred marketing costs, model home expenses, compensation related expenses and other selling costs. The following table summarizes our marketing expenses by reportable segment (in thousands).

 

     Three Months Ended June 30,    Change
     2010    2009    Amount    %

Homebuilding

           

West

   $ 5,179    $ 3,570    $ 1,609    45%

Mountain

     3,467      2,192      1,275    58%

East

     2,030      1,597      433    27%

Other Homebuilding

     799      571      228    40%
                       

Consolidated

   $        11,475    $ 7,930    $          3,545    45%
                       
     Six Months Ended June 30,    Change
     2010    2009    Amount    %

Homebuilding

           

West

   $ 8,248    $ 8,103    $ 145    2%

Mountain

     5,646      4,227      1,419    34%

East

     3,294      3,285      9    0%

Other Homebuilding

     1,347      1,147      200    17%
                       

Consolidated

   $ 18,535    $        16,762    $ 1,773    11%
                       

The $3.5 million increase in marketing expenses during the three months ended June 30, 2010 primarily resulted from increases of: (1) $2.3 million in amortization of deferred marketing costs resulting from closing 470 more homes; and (2) $1.2 million in product advertising, primarily resulting from new advertising signs purchased in most of our subdivisions.

The $1.8 million increase in marketing expenses during the six months ended June 30, 2010 primarily resulted from increases of: (1) $1.7 million in amortization of deferred marketing costs resulting from closing 413 more homes; and (2) $1.2 million in product advertising, primarily resulting from new advertising signs purchased in most of our subdivisions. These items partially were offset by a $0.6 million decrease in salaries and benefits.

 

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Commission Expenses.  Commission expenses primarily include direct commissions paid for closed homes. The following table summarizes our commission expenses by reportable segment (in thousands).

 

     Three Months Ended June 30,    Change
     2010    2009    Amount    %

Homebuilding

           

West

   $ 4,526    $ 2,781    $ 1,745    63%

Mountain

     3,901      2,018      1,883    93%

East

     2,420      1,612      808    50%

Other Homebuilding

     764      542      222    41%
                       

Consolidated

   $        11,611    $          6,953    $          4,658    67%
                       
     Six Months Ended June 30,    Change
     2010    2009    Amount    %

Homebuilding

           

West

   $ 6,665    $ 5,348    $ 1,317    25%

Mountain

     5,473      3,686      1,787    48%

East

     3,525      3,220      305    9%

Other Homebuilding

     1,077      1,057      20    2%
                       

Consolidated

   $        16,740    $        13,311    $          3,429    26%
                       

Commission expense increased in each of our segments during the three and six months ended June 30, 2010, primarily due to closing more homes in each segment during the 2010 periods.

 

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

 

     Three Months Ended June 30,    Change
     2010    2009    Amount    %

Homebuilding

           

West

   $ 7,980    $ 6,068    $ 1,912    32%

Mountain

     4,748      3,395      1,353    40%

East

     6,402      5,509      893    16%

Other Homebuilding

     1,359      934      425    46%
                       

Total Homebuilding

     20,489      15,906      4,583    29%

Financial Services and Other

     5,658      4,845      813    17%

Corporate

     18,441      17,049      1,392    8%
                       

Consolidated

   $        44,588    $        37,800    $          6,788    18%
                       
     Six Months Ended June 30,    Change
     2010    2009    Amount    %

Homebuilding

           

West

   $ 15,320    $ 12,963    $ 2,357    18%

Mountain

     8,472      7,445      1,027    14%

East

     11,238      9,280      1,958    21%

Other Homebuilding

     3,185      1,997      1,188    59%
                       

Total Homebuilding

     38,215      31,685      6,530    21%

Financial Services and Other

     9,746      9,343      403    4%

Corporate

     36,830      35,153      1,677    5%
                       

Consolidated

   $ 84,791    $ 76,181    $ 8,610    11%
                       

Our consolidated general and administrative expense increased during the three months ended June 30, 2010, primarily resulting from the following increases: (1) $5.2 million in other employee-related benefit costs; and (2) $0.8 million in legal-related costs.

General and administrative expenses in our West segment increased during the three months ended June 30, 2010, primarily due to a $1.1 million increase in employee compensation and other employee-related benefit costs. In our Mountain segment, general and administrative expenses during the three months ended June 30, 2010 increased, primarily due to a $0.7 million increase in employee compensation and other employee-related benefit costs.

In our East and Other Homebuilding segment, general and administrative expenses were higher during the three months ended June 30, 2010, primarily resulting from increases in employee compensation and other employee-related benefit and legal-related costs.

In our Financial Services and Other segment, general and administrative expenses increased, primarily due to a $0.9 million increase in employee compensation and other employee-related benefit costs, and $0.6 million in insurance related expenses. These items partially were offset by a $0.7 million decrease in expenses associated with our mortgage loan loss reserve. In our Corporate segment, general and administrative costs were higher during the three months ended June 30, 2010, primarily due to a $2.0 million increase in employee compensation and other employee-related benefit costs, partially offset by a $0.6 million decrease in Supervisory Fees.

 

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Our consolidated general and administrative expense increased during the six months ended June 30, 2010, primarily resulting from the following increases: (1) $6.9 million in employee compensation and other employee-related benefit costs; (2) $3.9 million in legal-related costs; and (3) $0.9 million in other general and administrative expenses, consisting primarily of homeowner association dues. These items partially were offset by a $1.6 million decrease in fees on our Homebuilding Line and $1.1 million decrease in expenses associated with our mortgage loan loss reserve.

General and administrative expenses in our West segment increased during the six months ended June 30, 2010, primarily due to a $1.0 million increase in employee compensation and other employee-related benefit costs and $0.9 million in legal-related costs. In our Mountain segment, general and administrative costs were higher during the six months ended June 30, 2010, primarily due to employee compensation and other employee-related benefit costs.

In our East and Other Homebuilding segments, general and administrative costs were higher during the first six months of 2010, primarily due to increased legal-related costs.

In our Financial Services and Other segment, general and administrative expenses increased slightly, primarily due to the following: (1) an increase of $1.0 million in employee compensation and other employee-related benefit costs; and (2) $0.7 million in insurance related expenses. These items partially were offset by a $1.1 million decrease in expense associated with our mortgage loan loss reserves. In our Corporate segment, general and administrative costs were higher during the six months ended June 30, 2010, primarily due to a $3.2 million increase in employee compensation and other employee-related benefit costs, partially offset by a $1.6 million decrease in fees on our Homebuilding Line.

Other Operating Expenses.  Other operating expenses of $0.5 million and $0.3 million during the three months ended June 30, 2010 and 2009, respectively, and $1.0 million and $0.6 million during the six months ended June 30, 2010 and 2009, respectively, primarily relate to write-offs of pre-acquisition costs and deposits on lot option contracts that we elected not to exercise.

Other Income (Expense).  Other income (expense) primarily includes interest income on our cash, cash equivalents and marketable securities, interest expense, primarily on our senior notes, and gain or loss on the sale of other assets. Interest income during the three and six months ended June 30, 2010 increased, primarily from an increase in our cash, cash equivalents and marketable securities balances during 2010. Interest expense was also higher during the three and six months ended June 30, 2010, primarily resulting from an increase in our debt level due to the issuance of $250 million in senior notes in January 2010.

 

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

 

     Three Months Ended June 30,     Change
     2010     2009     Amount     %

Homebuilding

        

West

   $ 6,357      $ 10,075      $          (3,718   -37%

Mountain

     4,962        (2,308     7,270      315%

East

     1,455        (4,626     6,081      131%

Other Homebuilding

     295        (677     972      144%
                          

Total Homebuilding

     13,069        2,464        10,605      430%

Financial Services and Other

     4,089        2,615        1,474      56%

Corporate

            (20,857     (24,142     3,285      14%
                          

Consolidated

   $ (3,699   $        (19,063   $ 15,364      81%
                          
     Six Months Ended June 30,     Change
     2010     2009     Amount     %

Homebuilding

        

West

   $ 8,711      $ (228   $ 8,939      N/A

Mountain

     6,132        (7,119     13,251      186%

East

     (64     (6,997     6,933      99%

Other Homebuilding

     (224     (1,508     1,284      85%
                          

Total Homebuilding

     14,555        (15,852     30,407      192%

Financial Services and Other

     5,935        4,236        1,699      40%

Corporate

     (45,431     (48,520     3,089      6%
                          

Consolidated

   $ (24,941   $ (60,136   $ 35,195      59%
                          

Overall, the financial performance in most of our homebuilding segments improved during the three and six months ended June 30, 2010. During these periods, we did not have any inventory impairments, compared with $1.2 million and $15.8 million of inventory impairments during the three and six months ended June 30, 2009. The absence of impairments, together with closing 470 and 413 more homes during the three and six months ended June 30, 2010 and slight improvements in Home Gross Margins, contributed to the improvement in income (loss) before income taxes for most of our segments. However, while our overall financial performance did improve during the three and six months ended June 30, 2010, we have been impacted by a significant decline in the level of new home orders, due to a number of factors; among those are the expiration of the homebuyer tax credit, and unprecedented changes that occurred in the mortgage finance, banking and insurance industries during 2008 and 2009, including the failure or takeover of a number of major industry leaders, as well as governmental intervention in, and support of, the businesses of many surviving entities. These factors contributed to the following, which impacted our financial results during the three and six months ended June 30, 2010: (1) high levels of competition for new home orders, driven by builders that significantly reduced new home sales prices; (2) continued high levels of home sales incentives and, in many cases, increased home sales incentives offered to stimulate new home orders and maintain previous home orders in Backlog until they close; (3) high levels of home foreclosures, which contributed to an excess supply of homes available to be purchased; and (4) prospective homebuyers experiencing difficulty in selling their existing homes in this competitive environment.

In our West segment, we reported income before income taxes of $6.4 million during the three months ended June 30, 2010, compared to $10.1 million during the same period in 2009. This decline resulted from a 650 basis point reduction in Home Gross Margins and a $5.3 million increase in general and administrative, marketing and commission expenses. These items were partially offset by closing 184 more homes during the 2010 second quarter.

 

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In our Mountain segment, we reported income before income taxes of $5.0 million during the three months ended June 30, 2010, compared with a loss before income taxes of $2.3 million during the same period in 2009. This improvement was primarily due to: (1) a 710 basis point improvement in our Home Gross Margins; and (2) closing 208 more homes, a 123% improvement over closings in the 2009 second quarter. These items partially were offset by a $4.5 million increase in general and administrative, marketing and commission expenses.

In our East segment, we reported income before income taxes of $1.5 million during the three months ended June 30, 2010, compared with a loss before income taxes of $4.6 million during the same period in 2009. This improvement was primarily due to: (1) a 240 basis point improvement in our Home Gross Margins; (2) closing 60 more homes, a 63% improvement over closings in the 2009 second quarter; and (3) the absence of any inventory impairments during the 2010 second quarter, compared with $1.7 million of impairments during the same period in 2009. These items partially were offset by a $2.1 million increase in general and administrative, marketing and commission expenses.

In our Other Homebuilding segment, we reported income before income taxes of $0.3 million during the three months ended June 30, 2010, compared with a loss of $0.7 million for the same period in 2009. This improvement was primarily due to: (1) a 910 basis point improvement in our Home Gross Margins; and (2) closing 18 more homes, a 33% improvement over closings in the 2009 second quarter. These items partially were offset by a $0.9 million increase in general and administrative, marketing and commission expenses.

In our Financial Services and Other segment, income before income taxes during the three months ended June 30, 2010, increased primarily due to a $2.1 increase in revenue, partially offset by a $0.8 million increase in general and administrative expenses.

Loss before income taxes in our Corporate segment during the three months ended June 30, 2010 decreased, primarily due to a $4.4 million increase in interest income and a $0.5 decrease in interest expense. These items were partially offset by a $1.4 million increase in general and administrative expenses.

In our West segment, we reported income before income taxes of $8.7 million during the six months ended June 30, 2010, compared to a loss of $0.2 million during the same period in 2009. This improvement primarily resulted from: (1) the absence of any inventory impairments during the first six months of 2010, compared with $12.5 million of impairments during the same period in 2009; and (2) the impact of closing 131 more homes during the 2010 period. These improvements partially were offset by an increase of $3.8 million in general and administrative, marketing and commission expenses and a 200 basis point reduction in Home Gross Margins.

In our Mountain segment, we reported income before income taxes of $6.1 million during the six months ended June 30, 2010, compared with a loss before income taxes of $7.1 million during the same period in 2009. This improvement was primarily due to: (1) an 860 basis point improvement in our Home Gross Margins; and (2) closing 237 more homes, a 79% improvement over closings in the same period in 2009. These items partially were offset by a $4.2 million increase in general and administrative, marketing and commission expenses.

In our East segment, we reported a loss before income taxes of $0.1 million during the six months ended June 30, 2010, compared with a loss before income taxes of $7.0 million during the same period in 2009. This improvement was primarily due to: (1) a 290 basis point improvement in our Home Gross Margins; (2) closing 44 more homes, a 24% improvement over closings during the first six months of the 2009; and (3) the absence of any inventory impairments during the six months ended June 30, 2010, compared with $2.5 million of impairments during the same period in 2009. These items partially were offset by a $2.3 million increase in general and administrative, marketing and commission expenses.

In our Other Homebuilding segment, we reported a loss before income taxes of $0.2 million during the six months ended June 30, 2010, compared with a loss of $1.5 million for the same period in 2009. This improvement was primarily due to a 1,030 basis point improvement in our Home Gross Margins, partially offset by a $1.4 million increase in general and administrative, marketing and commission expenses.

 

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In our Financial Services and Other segment, income before income taxes during the six months ended June 30, 2010, increased primarily due to a $2.2 increase in revenue, partially offset by a $0.4 million increase in general and administrative expenses.

Loss before income taxes in our Corporate segment during the six months ended June 30, 2010 was lower, primarily due to a $5.1 million increase in interest income. These items were partially offset by a $1.7 million increase in general and administrative expenses.

Income Taxes.  We are required, at the end of each interim period, to estimate our annual effective tax rate for the fiscal year and use that rate to provide for income taxes for the current year-to-date reporting period. Based on these estimates, our overall effective income tax rates were 0.4% and 1.5% during the three and six months ended June 30, 2010, respectively, and -55.2% and -17.1% during the three and six months ended June 30, 2009, respectively. The change in the effective tax rates during the 2010 second quarter and first six months, compared with the same periods during 2009, resulted primarily from recording during the 2009 second quarter a $9.7 million income tax expense related to an IRS examination of our 2008 net operating loss carryback to 2006.

OTHER HOMEBUILDING MEASURES

Inventory. Our inventory consists of land and land under development and housing completed or under construction. Land and land under development on our Consolidated Balance Sheets primarily includes land acquisition costs and land development costs associated with subdivisions for which we have the intent to construct and sell homes. Also, we include land that is accounted for as held-for-sale as a component of land and land under development in our Consolidated Balance Sheets. Housing completed or under construction in our Consolidated Balance Sheets primarily includes: (1) land costs transferred from land and land under development; (2) hard costs associated with the construction of a house; (3) overhead costs, which include real property taxes, engineering and permit fees; (4) capitalized interest; and (5) certain indirect fees.

The following table shows the carrying value of land and land under development for each market within our homebuilding segments (dollars in thousands).

 

     June 30,
2010
   December 31,
2009
   June 30,
2009

Arizona

   $ 48,957    $ 32,839    $ 19,704

California

     87,374      36,790      1,596

Nevada

     20,393      27,591      19,442
                    

West

     156,724      97,220      40,742
                    

Colorado

     120,748      97,406      83,728

Utah

     30,298      24,093      22,913
                    

Mountain

     151,046      121,499      106,641
                    

Delaware Valley

     1,669      2,909      3,414

Maryland

     14,111      6,592      11,897

Virginia

     36,071      26,071      26,046
                    

East

     51,851      35,572      41,357
                    

Florida

     7,580      5,329      3,503

Illinois

     3,151      3,240      3,535
                    

Other Homebuilding

     10,731      8,569      7,038
                    

Total

   $      370,352    $      262,860    $      195,778
                    

 

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The following table shows the carrying value of housing completed or under construction for each market within our homebuilding segments (dollars in thousands).

 

     June 30,
2010
   December 31,
2009
   June 30,
2009

Arizona

   $ 41,374    $ 30,838    $ 38,793

California

     39,411      23,890      52,111

Nevada

     32,495      23,714      29,704
                    

West

     113,280      78,442      120,608
                    

Colorado

     121,558      85,537      87,656

Utah

     31,826      19,239      17,600
                    

Mountain

     153,384      104,776      105,256
                    

Delaware Valley

     5,894      3,907      8,508

Maryland

     41,914      26,729      20,834

Virginia

     45,127      29,739      27,854
                    

East

     92,935      60,375      57,196
                    

Florida

     23,372      16,731      13,075

Illinois

     -      -      957
                    

Other Homebuilding

     23,372      16,731      14,032
                    

Total

   $      382,971    $      260,324    $      297,092
                    

 

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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).

 

     June 30,
2010
   December 31,
2009
   June 30,
2009

Lots Owned

        

Arizona

   1,165    1,075    1,247

California

   1,130    581    618

Nevada

   681    966    936
              

West

   2,976    2,622    2,801
              

Colorado

   2,893    2,514    2,541

Utah

   569    545    568
              

Mountain

   3,462    3,059    3,109
              

Delaware Valley

   55    82    101

Maryland

   144    100    169

Virginia

   371    241    210
              

East

   570    423    480
              

Florida

   184    138    213

Illinois

   134    141    141
              

Other Homebuilding

   318    279    354
              

Total

   7,326    6,383    6,744
              

Lots Controlled Under Option

        

Arizona

   499    328    416

California

   152    113    145

Nevada

   570    222    95
              

West

   1,221    663    656
              

Colorado

   644    537    157

Utah

   156    117    12
              

Mountain

   800    654    169
              

Delaware Valley

   -    -    -

Maryland

   655    575    409

Virginia

   272    192    251
              

East

   927    767    660
              

Florida

   658    500    486

Illinois

   -    -    -
              

Other Homebuilding

   658    500    486
              

Total

   3,606    2,584    1,971
              

Total Lots Owned and Controlled

          10,932             8,967             8,715
              

As of June 30, 2010, our total number of lots owned (excluding homes completed or under construction) increased from the total at December 31, 2009, primarily due to the purchase of approximately 3,300 lots across most of our markets during the first six months of 2010 partially offset by the transfer of lots from land to homes completed or under construction. Despite the impact of transferring of lots to work in process, we increased our land and land under development by $107.5 million since December 31, 2009. The acquisition of lots during the first six months of 2010 relates to approximately 75 existing and new subdivisions that have or we expect will become active. Additionally, our housing completed and under construction increased by $122.6 million, as we increased the total homes under construction from 1,321 at December 31, 2009 to 1,982 at June 30, 2010. This increase was primarily attributable to a 65% increase in the number of unsold homes under construction, mostly at the framing stage of construction, and a 52% increase in sold homes under construction. See “Forward-Looking Statements” below.

 

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Our total number of lots under option increased in each of our homebuilding segments and within most of our markets from December 2009. The increase in each homebuilding segment resulted from entering into lot option agreements that we believe meet our underwriting criteria within each market of this segment. This increase was partially offset by exercising our right to purchase lots under existing option contracts.

The table below shows the amount of deposits we have made in connection with our lot option contracts that are beyond the due diligence period (in thousands).

 

     June 30,
2010
   December 31,
2009
   June 30,
2009

Option Deposits

        

Cash

   $ 7,933    $ 7,654    $ 5,295

Letters of Credit

     2,727      2,134      3,383
                    

Total Option Deposits

   $        10,660    $          9,788    $          8,678
                    

The table below shows the stage of construction for our homes completed or under construction, number of sold homes under construction and model homes (in units).

 

     June 30,
2010
   December 31,
2009
   June 30,
2009

Unsold Homes Under Construction - Final

   47    41    82

Unsold Homes Under Construction - Frame

   720    389    248

Unsold Homes Under Construction - Foundation

   124    109    122
              

Total Unsold Homes Under Construction

   891    539    452

Sold Homes Under Construction

   865    570    664

Model Homes

   226    212    246
              

Homes Completed or Under Construction

          1,982             1,321             1,362
              

During the first six months of 2010, we experienced a significant increase in the number of sold and unsold homes under construction. The building of our sold and unsold homes under construction resulted primarily from the anticipation of selling homes prior to the expiration of the federal homebuyer tax credit, which required the sale of a home to be completed by April 30, 2010 with a closing date by June 30, 2010. (The Homebuyer Assistance and Improvement Act, signed into law July 2, 2010, extended the closing date requirement to September 30, 2010.)

 

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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 Rate (dollars in thousands). The “Capture Rate” is defined as the number of mortgage loans originated by HomeAmerican for our homebuyers as a percent of total Company home closings.

 

     Three Months Ended June 30,    Change
     2010    2009    Amount     %

Principal amount of mortgage loans originated

   $      240,693    $      142,191    $       98,502      69%

Principal amount of mortgage loans brokered

   $ 882    $ 6,030    $ (5,148   -85%

Capture Rate

     87%      82%      5%     

Including brokered loans

     88%      85%      3%     

Mortgage products (% of mortgage loans originated)

          

Fixed rate

     97%      100%      -3%     

Adjustable rate - other

     3%      0%      3%     

Prime loans (1)

     26%      27%      -1%     

Government loans (2)

     74%      73%      1%     
     Six Months Ended June 30,    Change
     2010    2009    Amount     %

Principal amount of mortgage loans originated

   $ 348,783    $ 268,698    $ 80,085      30%

Principal amount of mortgage loans brokered

   $ 3,738    $ 18,995    $ (15,257   -80%

Capture Rate

     86%      80%      6%     

Including brokered loans

     87%      85%      2%     

Mortgage products (% of mortgage loans originated)

          

Fixed rate

     96%      100%      -4%     

Adjustable rate - other

     4%      0%      4%     

Prime loans

     25%      34%      -9%     

Government loans

     75%      66%      9%     

 

(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)

Government loans are loans either insured by the FHA or guaranteed by the VA.

The principal amount of mortgage loans originated increased during the three and six months ended June 30, 2010, primarily due to the Company closing 470 and 413 more homes, respectively, than in the same periods in 2009.

Forward Sales Commitments.  HomeAmerican originates mortgage loans that generally are sold forward and subsequently delivered to third-party purchasers within approximately 45 days. Forward commitments are used for non-trading purposes to sell mortgage loans and hedge price risk due to fluctuations in interest rates on rate-locked mortgage loans in process that have not closed. Due to this economic hedging philosophy, the market risk associated with these mortgages is limited. We apply the fair value option under ASC 825 for our mortgage loans held-for-sale and attempt to achieve a matching of the changes in the fair value of our derivatives with the changes in fair values of the loans we are hedging without having to designate our derivatives as hedging instruments. For forward sales commitments, as well as commitments to originate mortgage loans that are still outstanding at the end of a reporting period, we record the fair value of the derivatives in the Consolidated Statements of Operations with an offset to either derivative assets or liabilities, depending on the nature of the change. Due to this hedging philosophy, we believe that 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 the volatility in the interest rate market. See “Forward-Looking Statements” above.

 

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LIQUIDITY AND CAPITAL RESOURCES

We use our liquidity and capital resources to (1) support our operations, including the purchase of land, land development and construction of homes; (2) provide working capital; and (3) provide mortgage loans for our homebuyers. Liquidity, which includes our balances of cash and cash equivalents, marketable securities and capital resources, is currently being generated internally through cash flows from operations and from external sources, primarily our senior notes and Mortgage Repurchase Facility (as defined below). Additionally, we have an existing effective shelf registration statement that, after the issuance of $250 million of senior notes in January 2010, allows us to issue equity, debt or hybrid securities up to $750 million.

In January 2010, we completed a public offering of $250 million principal amount of 5 5/8% senior notes due February 2020 (the “Notes”). The Notes, which pay interest February and August of each year, are general unsecured obligations of MDC and rank equally and ratably with our other general unsecured and unsubordinated indebtedness. In addition, the Notes are fully guaranteed on an unsecured basis, jointly and severally, by most of our homebuilding subsidiaries. We received proceeds of $242.3 million, net of discounts and issuance costs of $6.1 million and $1.6 million, respectively. The Company is using the proceeds of the offering for general corporate purposes. With respect to our current liquidity, we are managing our cash and investments as we begin to redeploy our cash back into homebuilding through acquisition of land. It continues to be unclear, however, when such a recovery will occur and how rapidly homebuilding activities will resume.

On June 30, 2010, we terminated our homebuilding line of credit (“Homebuilding Line”), which was an unsecured revolving line of credit with a group of lenders that had a maturity date of March 21, 2011. We used this facility to provide letters of credit required in the ordinary course of our business and financing in support of our homebuilding segments. There were no penalties associated with the termination of the credit facility and we believe that at the time of termination we were in compliance with the covenants under the Homebuilding Line credit agreement. Prior to the termination of the Homebuilding Line, we transferred or replaced all letters of credit that had been outstanding. At the time of the termination, the Homebuilding Line had an aggregate commitment of $12.0 million and we had no letters of credit and no borrowings outstanding under the line. The Homebuilding Line was terminated as we believed that we did not need it to meet our liquidity needs.

Capital Resources

Our capital structure is a primarily 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 5 5/8% senior notes due 2020; and (3) our Mortgage Repurchase Facility. Because of our current balance of cash, cash equivalents, marketable securities and available capacity under our Mortgage Repurchase Facility, we believe that our capital resources are adequate to satisfy our near and intermediate term capital requirements. Additionally, we believe that we can meet our long-term capital needs (including meeting future payments on our senior notes as they become due) from operations and external financing sources, assuming that no significant adverse changes in our business or our country’s capital or credit markets occurs as a result of the various risk factors described in Item 1A Risk Factors. See “Forward-Looking Statements” below.

 

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Mortgage Repurchase Facility and Senior Notes

General.  The agreement for our Mortgage Repurchase Facility 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.

Mortgage Lending.  As of June 30, 2010, HomeAmerican has a Master Repurchase Agreement (the “Mortgage Repurchase Facility”) with U.S. Bank National Association (“USBNA”) and other banks that may be parties to the Mortgage Repurchase Facility (collectively with USBNA, the “Buyers”). As of June 30, 2010, USBNA was the only Buyer under the Mortgage Repurchase Facility. The Mortgage Repurchase Facility provides liquidity to HomeAmerican by providing for the sale of eligible mortgage loans to USBNA (as agent for the Buyers) with an agreement by HomeAmerican to repurchase the mortgage loans at a future date. Until such mortgage loans are transferred back to HomeAmerican, the documents relating to such loans are held by USBNA, as agent for the Buyers and as custodian, pursuant to the Custody Agreement (“Custody Agreement”), dated as of November 12, 2008, by and between HomeAmerican and USBNA. The Mortgage Repurchase Facility has a maximum aggregate commitment of $70 million and includes an accordion feature that permits the maximum aggregate commitment to be increased to $150 million, subject to the availability of additional commitments. The Mortgage Repurchase Facility expires on October 28, 2010. At June 30, 2010 and December 31, 2009, we had $65.3 million and $29.1 million, respectively, of mortgage loans that we are obligated to repurchase under our Mortgage Repurchase Facility. Mortgage loans that we are obligated to repurchase under the Mortgage Repurchase Facility are accounted for as a debt financing arrangement and are reported as mortgage repurchase facility on the Consolidated Balance Sheets. Advances under the Mortgage Repurchase Facility carry a Pricing Rate equal to the greater of (i) the LIBOR Rate (as defined in the Mortgage Repurchase Facility) plus 2.5%, or (ii) 4.5%. At HomeAmerican’s option the Balance Funded Rate (equal to 4.5%) may be applied to advances under the Mortgage Repurchase Facility provided that Buyer is holding sufficient Qualifying Balances. The foregoing terms are defined in the Mortgage Repurchase Facility.

The Mortgage Repurchase Facility contains various representations, warranties and affirmative and negative covenants customary for agreements of this type. The negative covenants include, among others, (i) an Adjusted Tangible Net Worth (as defined) requirement, (ii) a minimum Adjusted Tangible Net Worth Ratio, (iii) an Adjusted Net Income requirement, and (iv) a minimum Liquidity (as defined) requirement (the foregoing terms are defined in the Mortgage Repurchase Facility). Adjusted Tangible Net Worth means the sum of (a) all assets of HomeAmerican less (b) the sum of (i) all Debt and all Contingent Indebtedness of HomeAmerican, (ii) all assets of HomeAmerican that would be classified as intangible assets under generally accepted accounting principles, and (iii) receivables from Affiliates. HomeAmerican’s Adjusted Tangible Net Worth Ratio is the ratio of HomeAmerican’s total liabilities (excluding Permitted Letters of Credit) to the Adjusted Tangible Net Worth. HomeAmerican’s Adjusted Net Income is a rolling twelve consecutive months of net income for HomeAmerican. HomeAmerican’s Liquidity is defined as its unencumbered and unrestricted cash and Cash Equivalents plus the amount by which the aggregate Purchase Value of all Purchased Mortgage Loans at such time exceeds the aggregate Purchase Price outstanding for all Open Transactions at such time. The foregoing terms are defined in the Mortgage Repurchase Facility.

Failure to meet the foregoing negative covenants would constitute an event of default. In the event of default, USBNA may, at its option, declare the Repurchase Date for any or all Transactions to be deemed immediately to occur. Upon such event of default, and if USBNA exercises its right to terminate any Transactions, then (a) HomeAmerican’s obligation to repurchase all Purchased Loans in such Transactions will become immediately due and payable; (b) the Repurchase Price for each such Transaction shall be increased by the aggregate amount obtained by daily multiplication of (i) the greater of the Pricing Rate for such Transaction and the Default Pricing Rate by (ii) the Purchase Price for the Transaction as of the Repurchase Date, (c) all Income paid after the event of default will be payable to and retained by USBNA and applied to the aggregate unpaid Repurchase Prices owed by HomeAmerican and (d) HomeAmerican shall deliver any documents relating to Purchased Loans subject to such Transactions to USBNA. Upon the occurrence of default, USBNA may (a) sell any or all Purchased Loans subject to such Transactions on a servicing released or servicing retained basis and apply the proceeds to the unpaid amounts owed by HomeAmerican, (b) give HomeAmerican credit for such Purchased Loans in an amount equal to the Market Value and apply such credit to the unpaid amounts owed by HomeAmerican, (c) replace HomeAmerican as Servicer, (d) exercise its right under the Mortgage Repurchase Facility with respect to the Income Account and Escrow Account, and (e) with notice to HomeAmerican, declare the Termination Date to have occurred. The foregoing terms are defined in the Mortgage Repurchase Facility.

 

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The table below sets forth the actual results of the covenant calculations and covenant requirements under the Mortgage Repurchase Facility at June 30, 2010.

 

     Covenant Test    Covenant Results

Adjusted Tangible Net Worth (minimum)

   $   18,000,000    $   27,671,000

Adjusted Tangible Net Worth Ratio (maximum)

     8.0 : 1.0      3.3 : 1.0

Adjusted Net Income (minimum)

   $ 1    $ 7,494,000

Liquidity Test (minimum)

   $ 8,000,000    $ 39,102,000

MDC Common Stock Repurchase Program

At June 30, 2010, 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 or six months ended June 30, 2010 and 2009.

Consolidated Cash Flow

During the six months ended June 30, 2010, we used $178.9 million of cash from operating activities, primarily due to the increase of our homebuilding inventory, which resulted in the use of $228.3 million of cash during the first six months of 2010 as we purchased more than 3,300 lots and increased the total sold and unsold homes under construction from 1,109 at December 31, 2009 to 1,756 at June 30, 2010. Additionally, we used $85.4 million as a result of an increase in our home sales and other receivable and mortgage loans held-for-sale. These items partially were offset by the reduction of $144.5 million in our income tax receivable.

During the six months ended June 30, 2009, we generated $251.8 million of cash from operating activities, primarily resulting from the following: (1) $169.9 million due to collecting a significant portion of our 2008 income tax receivable; (2) $130.6 million by reducing our inventory levels, which primarily resulted from closing 1,245 homes; and (3) decreasing our mortgage loans-held-for-sale by $17.6 million. These items partially were offset by $40.3 million of net loss before non-cash charges of $30.1 million and $29.1 million of cash used to decrease our accrued liabilities, primarily due to payments of certain employee bonuses.

During the six months ended June 30, 2010, we invested $722.2 million into marketable securities and spent $5.1 million for property and equipment relating to our new enterprise resource planning system. These items partially were offset by the $107.4 million of marketable securities that matured or were sold during the six months ended June 30, 2010 and the collection of $1.7 million associated with our investments in The Reserve’s Primary Fund.

We generated $33.9 million of cash from investing activities during the six months ended June 30, 2009, primarily attributable to $55.6 million of settlements associated with our investments in The Reserve’s Primary and Government money market funds, and $64.9 million of marketable securities, which matured during the first six months of 2009. Partially offsetting these sources of cash were $81.9 million of additional purchases of marketable securities and $4.5 million of property and equipment purchases, primarily attributable to the purchase of our new enterprise resource planning system.

During the first six months of 2010, we generated $255.0 million in cash from financing activities, primarily due to the issuance of senior notes that raised $242.3 million. The proceeds from the issuance of the senior notes is being used for general corporate purposes. Additionally, we had a net borrowing under our Mortgage Repurchase Facility of $36.2 million. Partially offsetting these items was $23.6 million in dividend payments. We used $30.7 million of cash from financing activities during the six months ended June 30, 2009, primarily resulting from a net payment on our mortgage repurchase facility of $10.7 million and $23.4 million of dividend payments, partially offset by cash proceeds of $3.5 million from the exercise of stock options.

 

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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 June 30, 2010, we had deposits with respect to our option contracts that were beyond the due diligence period of $7.9 million in the form of cash and $2.7 million in the form of letters of credit to secure option contracts to purchase lots. At June 30, 2010, the total purchase price for lots under option was approximately $620 million.

At June 30, 2010, we had outstanding performance bonds and letters of credit totaling approximately $90.7 million and $19.8 million, respectively, including $5.4 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 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. However, in the event any such performance bonds or letters of credit issued by third parties are called, our indemnity obligations could require us to reimburse the issuer of the performance bond or letter of credit.

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

Contractual Obligations

Our contractual obligations have not changed materially from those at December 31, 2009, except for the additional interest to be paid pursuant to our $250 million 5 5/8% senior notes due 2020. Our contractual obligations associated with the 5 5/8% senior notes due 2020 are as follows (in thousands):

 

     Payments due by Period (in thousands)
     Total    Less than
1 Year
   1 - 3 Years    4 - 5 Years    After 5
Years

Interest

   $      140,402    $        13,839    $        28,125    $        28,125    $ 70,313

Principal

     250,000      -      -      -      250,000
                                  

Total

   $ 390,402    $ 13,839    $ 28,125    $ 28,125    $      320,313
                                  

 

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IMPACT OF INFLATION AND CHANGING PRICES

The impact of inflation and changing prices have not changed materially from the disclosure in our December 31, 2009 Annual Report on Form 10-K.

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 “likely,” “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, 2009 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 2009 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 June 30, 2010.

(b) Changes in internal control over financial reporting - At our corporate office and for certain of our non-homebuilding subsidiaries, we began operating under our new enterprise resource planning (“ERP”) system in May 2010. As a result, our financial reporting is now taking place in the new ERP system. The full implementation is scheduled to take place over the course of the next several quarters. There were no other changes in our internal control over financial reporting that occurred during the quarter ended June 30, 2010 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

Because of the nature of the homebuilding business, we and certain of our subsidiaries and affiliates have been named as defendants in various claims, complaints and other legal actions arising in the ordinary course of business, including product liability claims and claims associated with the sale and financing of our homes. In the opinion of management, the outcome of these ordinary course matters will not have a material adverse effect upon our financial condition, results of operations or cash flows.

Litigation has been filed by homeowners in West Virginia against MDC, its subsidiary Richmond American Homes of West Virginia, Inc. (“RAH West Virginia”) and various subcontractors alleging a failure to install functional passive radon mitigation systems in their homes. The plaintiffs seek compensatory and punitive damages and medical monitoring costs for alleged negligent construction, failure to warn, breach of warranty or contract, breach of implied warranty of habitability, fraud, and intentional and negligent infliction of emotional distress based upon alleged exposure to radon gas. The litigation consists of the following actions:

Joy, et al. v. Richmond American Homes of West Virginia, Inc., et al., No. 08-C-204, Circuit Court of Jefferson County, West Virginia (“Joy”). This action was filed on May 16, 2008, by sixty-six plaintiffs from sixteen households. The Company and RAH West Virginia have answered and asserted claims against the subcontractors for contractual and implied indemnity and contribution.

Bauer, et al. v. Richmond American Homes of West Virginia, Inc., et al., No. 08-C-431, Circuit Court of Jefferson County, West Virginia (“Bauer”). This action was filed on October 24, 2008, by eighty-six plaintiffs from twenty-one households. This action has been consolidated for discovery and pre-trial proceedings with the Joy action.

Saliba, et al. v. Richmond American Homes of West Virginia, Inc., et al., No. 08-C-447, Circuit Court, Jefferson County, West Virginia (“Saliba”). This action was filed on November 7, 2008, by thirty-five plaintiffs from nine households. This action has been consolidated for discovery and pre-trial proceedings with the Joy action.

By orders dated November 4 and 18, 2009, the trial court struck the answers filed by the Company and RAH West Virginia and entered judgment by default in favor of the plaintiffs on liability, with damages to be determined in a subsequent jury trial. On December 7, 2009, the Company and RAH West Virginia filed with the West Virginia Supreme Court of Appeals a motion seeking to stay the proceedings and a petition for writ of prohibition to vacate the default judgment. On January 15, 2010, the West Virginia Supreme Court of Appeals entered an order agreeing to consider the request to vacate the default judgment. The hearing to consider this request occurred on March 31, 2010.

On June 16, 2010, the West Virginia Supreme Court of Appeals rendered its opinion holding that imposition of a default judgment sanction will be upheld if a trial court’s findings adequately demonstrate and establish willfulness, bad faith or fault. The Supreme Court of Appeals found that the sanctions orders lacked the required specificity. The Supreme Court of Appeals noted that the trial court is authorized to impose sanctions if the action taken is based on specific factual findings of serious misconduct in light of the standards set forth in the opinion. The Supreme Court of Appeals granted the Company and RAH West Virginia a writ of prohibition and vacated the trial court’s sanctions orders.

Pursuant to the rules of the Supreme Court, the underlying proceedings in the Circuit Court had been stayed pending the Supreme Court’s decision. Under the Supreme Court’s applicable rules, the stay expired on July 19, 2010.

 

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Also, a new lawsuit has been filed by homeowners in West Virginia against the Company, RAH West Virginia and individual superintendants who had worked for RAH West Virginia. The new litigation consists of the following:

Thorin, et al. v. Richmond American Homes of West Virginia, Inc., et al., No. 10-C-154, Circuit Court of Jefferson County, West Virginia (“Thorin”). This action was filed on May 12, 2010, by forty plaintiffs from eleven households in Jefferson and Berkeley Counties. To date, this action has not been consolidated for any purposes with the prior three actions. The claims asserted and the relief sought in the Thorin case are substantially similar to the Joy, Bauer and Saliba cases.

MDC and RAH West Virginia believe that they have meritorious defenses to each of the lawsuits and intend to vigorously defend the actions.

We can give no assurance as to the final outcomes of these cases, or whether they would have a material adverse effect on our financial condition, results of operations or cash flows.

 

Item 1A. Risk Factors

Except as noted below, 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, 2009. For a more complete discussion of risk factors that affect our business, see “Risk Factors Relating to our Business” in our Form 10-K for the year ended December 31, 2009, which include the following:

Decreases in the market value of the Company’s investments in marketable securities could have an adverse impact on its results of operations.

The Company has invested $941.4 million in marketable securities whose market value is subject to changes from period to period. Decreases in the market value of the Company’s marketable securities could have an adverse impact on the Company’s results of operations.

 

   

The homebuilding industry has experienced a significant downturn, and although there have been recent signs of improvement, its duration and ultimate severity remain uncertain. A continuation or further deterioration in industry conditions or in the broader economic conditions could have additional adverse effects on our business and financial results.

 

   

Increased competition levels in the homebuilding and mortgage lending industries could result in lower net home orders, closings and decreases in the average selling prices of sold and closed homes, which could have a negative impact on our home sales revenue and results of operations.

 

   

Further decline in the market value of our homes or carrying value of our land would have a negative impact on our results of operations and financial position.

 

   

Our strategies in responding to the adverse conditions in the homebuilding industry and overall recession in the U.S. economy have had limited success, and the continued implementation of these and other strategies may not be successful.

 

   

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

 

   

If land is not available at reasonable prices, our homes sales revenue and results of operations could be negatively impacted and/or we could be required to scale back our operations in a given market.

 

   

If mortgage interest rates rise or if mortgage financing otherwise becomes less affordable, it could adversely affect our sales and business, and the duration and ultimate severity of the effects are uncertain.

 

   

We have financial needs that we meet through the capital markets, including the debt and secondary mortgage markets, and continued disruptions in these markets could have an adverse impact on our results of operations, financial position and/or cash flows.

 

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In the ordinary course of business, we are required to obtain performance bonds, the unavailability of which could adversely affect our results of operations and/or cash flows.

 

   

Further uncertainty in the mortgage lending industry, including repurchase requirements associated with HomeAmerican’s sale of mortgage loans, could negatively impact our results of operations.

 

   

Our homebuilding and financial services operations have concentration risks that could impact our results of operations.

 

   

Our business is subject to numerous federal, local and 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 additional liabilities or expenditures, or restrictions on our business.

 

   

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

 

   

Our income tax provision and other tax liabilities may be insufficient if taxing authorities are successful in asserting tax positions that are contrary to our position.

 

   

The homebuilding industry is cyclical and affected by changes in general economic, real estate or other business conditions that could adversely affect our business or financial results.

 

   

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

 

   

Supply shortages and other risks related to the demand for skilled labor and building materials could increase costs and delay deliveries.

 

   

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

 

   

We are dependent on the services of key employees, and the loss of their services could hurt our business.

 

   

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 second quarter of 2010. Additionally, there were no sales of unregistered equity securities during the second quarter of 2010.

 

Item 3. Defaults Upon Senior Securities

None.

 

Item 4. (Removed and Reserved)

 

Item 5. Other Information

None.

 

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Item 6. Exhibits

 

       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.
     101   The following financial statements, formatted in XBRL: (i) Consolidated Balance Sheets as of June 30, 2010 and December 31, 2009, (ii) Consolidated Statements of Operations for the three and six months ended June 30, 2010 and 2009, (iii) Consolidated Statements of Cash Flows for the six months ended June 30, 2010 and 2009; and (iv) Notes to the Consolidated Financial Statements, tagged as blocks of text. The information in Exhibit 101 is “furnished” and not “filed,” as provided in Rule 402 of Regulation S-T.

 

 

*

Incorporated by reference.

 

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SIGNATURES

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: July 30, 2010

 

M.D.C. HOLDINGS, INC.

(Registrant)

   

By:

 

/s/ Christopher M. Anderson

       

Christopher M. Anderson,

Senior Vice President and

Chief Financial Officer

   

By:

 

/s/ Vilia Valentine

       

Vilia Valentine,

Vice President – Finance, Corporate

Controller and Chief Accounting Officer

 

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EXHIBIT INDEX

 

       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.
     101   The following financial statements, formatted in XBRL: (i) Consolidated Balance Sheets as of June 30, 2010 and December 31, 2009, (ii) Consolidated Statements of Operations for the three and six months ended June 30, 2010 and 2009, (iii) Consolidated Statements of Cash Flows for the six months ended June 30, 2010 and 2009; and (iv) Notes to the Consolidated Financial Statements, tagged as blocks of text. The information in Exhibit 101 is “furnished” and not “filed,” as provided in Rule 402 of Regulation S-T.

 

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