Form 10-K
Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

x

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

For the fiscal year ended December 31, 2007

OR

 

¨

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

For the Transition period from              to             

Commission file number 1-08951

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)

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Common Stock, $.01 par value   New York Stock Exchange
7% Senior Notes due December 2012   New York Stock Exchange
5 1/2% Senior Notes due May 2013   New York Stock Exchange
5 3/8% Senior Notes due December 2014   New York Stock Exchange
5 3/8% Senior Notes due July 2015   New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  x    No  ¨

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.     Yes  ¨    No  x

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

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

Large accelerated filer  x    Accelerated filer  ¨    Non-accelerated filer  ¨

Indicated 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, 2007, the aggregate market value of the Registrants’ common stock held by non-affiliates of the Registrants was $1.7 billion based on the closing sales price of $48.36 per share as reported on the New York Stock Exchange.

As of December 31, 2007, the number of shares outstanding of Registrant’s common stock was 46,084,000.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of part III of this Form 10-K are incorporated by reference from the Registrant’s 2008 definitive proxy statement to be filed with the Securities and Exchange Commission no later than 120 days after the end of the Registrant’s fiscal year.

 

 

 


Table of Contents

 

M.D.C. HOLDINGS, INC.

FORM 10-K

FOR THE YEAR ENDED DECEMBER 31, 2007

TABLE OF CONTENTS

 

              Page
No.
PART I        
  Item 1.   

Business

   1
    

(a) General Development of Business

   1
    

(b) Available Information

   2
    

(c) Financial Information About Industry Segments

   3
    

(d) Narrative Description of Business

   3
  Item 1A.   

Risk Factors Relating to our Business

   13
  Item 1B.   

Unresolved Staff Comments

   19
  Item 2.   

Properties

   20
  Item 3.   

Legal Proceedings

   20
  Item 4.   

Submission of Matters to a Vote of Security Holders

   21

PART II

       
  Item 5.   

Market for Registrant’s Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities

   21
  Item 6.   

Selected Financial Data

   22
  Item 7.   

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

   25
  Item 7A.   

Quantitative and Qualitative Disclosures About Market Risk

   69
  Item 8.   

Consolidated Financial Statements

   F-1
  Item 9.   

Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure

   71
  Item 9A.   

Controls and Procedures

   71
  Item 9B.   

Other Information

   73

PART III

       
 

Item 10.

  

Directors and Executive Officers of the Registrant

   73
 

Item 11.

  

Executive Compensation

   73
 

Item 12.

  

Security Ownership of Certain Beneficial Owners and Management

   74
 

Item 13.

  

Certain Relationships and Related Transactions

   74
 

Item 14.

  

Principal Accountant Fees and Services

   74

PART IV

       
 

Item 15.

  

Exhibits and Financial Statement Schedules

   75
  Signatures    82

 

(i)


Table of Contents

 

M.D.C. HOLDINGS, INC.

FORM 10-K

PART I

Forward-Looking Statements.

Certain statements in this Annual Report on Form 10-K, the Company’s Annual Report to Shareowners, 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. Although we believe that the expectations reflected in the forward-looking statements contained in this Annual Report on Form 10-K 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. These factors include those described under the caption “Risk Factors Relating to our Business” in Item 1A of this Annual Report on Form 10-K. 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.

 

Item 1. Business.

 

  (a)

General Development of Business

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 Annual Report on Form 10-K, 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 and Virginia, which includes Virginia and West Virginia); and (4) Other Homebuilding (Florida, Illinois, Delaware Valley, which includes Pennsylvania, Delaware and New Jersey, and Texas, although during 2007 we completed our exit of the Texas market).

Our financial services operations primarily consist of our mortgage lending, title agency and insurance companies. These companies are aggregated together to form our Financial Services and Other reportable segment. 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, Delaware, Florida, Illinois, Nevada, Maryland, Virginia and West Virginia. This segment also includes Allegiant Insurance Company, Inc., A Risk Retention Group (“Allegiant”), which provides to its customers, primarily certain subcontractors of MDC’s homebuilding subsidiaries, general liability coverage during the construction of the Company’s homes and for work performed in completed subdivisions, and StarAmerican Insurance Ltd. (“StarAmerican”), a Hawaii corporation and a wholly owned subsidiary of MDC. StarAmerican has

 

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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.

The following summarizes several significant business developments during the five most recently completed fiscal years:

 

   

Beginning in 2006 and continuing throughout 2007, we reduced our overall operations through Company-wide headcount reductions and reorganized our homebuilding operations through consolidation of homebuilding divisions and elimination of most of our regional offices. This right-sizing of our homebuilding operations included the consolidation of:

 

   

six California divisions into one;

   

two Nevada divisions into one;

   

three Phoenix divisions into one;

   

three Virginia divisions into one;

   

two Florida divisions into one; and

   

three Colorado divisions into two.

 

   

During 2007, we began reducing our homebuilding operations in Tampa through the disposition of a majority of the remaining assets as we initiated the exit of this sub-market.

 

   

During 2006 and 2007, we implemented a new customer service initiative, which is focused on making improvements in our customers’ home buying experience.

 

   

During 2006, we began exiting the Texas market, which we completed during 2007.

 

   

During 2004 and 2005, we initiated our Home Gallery concept, which improved sales support and offered more options and upgrades for homebuyers to personalize their new homes.

 

   

During 2004, we expanded our Florida operations through the purchase of the assets of Watson Home Builders, Inc. in Jacksonville.

 

   

During 2003, we entered the Delaware Valley and Illinois homebuilding markets, and re-entered the Florida homebuilding market through the purchase of assets of Crawford Homes, Inc. in Jacksonville.

 

  (b)

Available Information

We file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission (“SEC”). Anyone seeking information about our business can receive copies of our 2007 Annual Report on Form 10-K, Annual Report to Shareholders, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, all amendments to those reports and other documents filed with the SEC at the public reference section of the SEC at 100 F Street, NE, Room 1580, Washington, D.C. 20549. These documents also may be obtained, free of charge, by: contacting our Investor Relations office at (720) 773-1100; writing to M.D.C. Holdings, Inc., Investor Relations, 4350 South Monaco Street, Suite 400, Denver, Colorado 80237; or accessing our website at www.richmondamerican.com. We make our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, available on our website as soon as reasonably practicable after we file or furnish the materials electronically with the SEC. To obtain any of this information, go to www.richmondamerican.com, select “Investors,” “Financial Reports” and “SEC Filings.” Our website also includes our: (1) Corporate Governance Guidelines; (2) Corporate Code of Conduct; (3) Rules for Senior Financial Officers; (4) Audit Committee Procedures for Handling Confidential Complaints; and (5) charters for the Audit, Compensation and Nominating and Corporate Governance Committees. These materials may be obtained, free of charge, at our website, http://ir.richmondamerican.com (select “Corporate Governance”).

 

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  (c)

Financial Information About Industry Segments

Note 3 to the Consolidated Financial Statements contains information regarding our reportable segments for each of the years ended December 31, 2007, 2006 and 2005.

 

  (d)

Narrative Description of Business

Our business consists of two primary operations, homebuilding and financial services. We build and sell primarily single-family detached homes, that are designed and built to meet local customer preferences. We are the general contractor for all of our projects and retain subcontractors for site development and home construction. The base selling prices for our homes closed during 2007 ranged primarily from approximately $200,000 to 500,000. We maintain a variety of home styles in each of our markets, targeting generally first-time and first-time move-up homebuyers. Also, we build a limited number of homes for the second-time move-up and luxury homebuyers.

When opening a new homebuilding subdivision, we seek to limit our supply of lots with the goal of avoiding overexposure to any single sub-market. When we acquire finished lots, we prefer using option contracts or paying in phases with cash. Also, we acquire entitled land for development into finished lots when we determine that the risk is justified. Additional information about our land acquisition practices may be found in the Homebuilding Operations, Land Acquisition and Development section.

Homebuilding Operations.

At December 31, 2007, our homebuilding operations had subdivisions in multiple sub-markets in ten markets within four reportable segments as follows.

 

Reportable Segment

 

Market

 

Sub-market

 

Reportable Segment

 

Market

 

Sub-market

West

  Arizona   Phoenix East Valley  

Mountain

  Colorado   Denver Metro Area
    Phoenix West Valley       Colorado Springs
    Tucson       Northern Colorado
  California   Bay Area     Utah   Salt Lake City Metro Area
    Central Valley      
    Inland Empire  

Other Homebuilding

  Delaware Valley   Delaware - Dover Area
    Los Angeles       New Jersey - Burlington
    Orange County       Southeastern Pennsylvania
    San Diego       Southern Pennsylvania
  Nevada   Las Vegas     Florida   Jacksonville
          Tampa

East

  Virginia   Northern Virginia      
    Shenandoah Valley     Illinois   Chicago Suburbs
    West Virginia      
  Maryland   Southern Maryland      
    Suburban Maryland      

 

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Our home sales revenue for the years ended December 31, 2007, 2006 and 2005 is set forth in the table below for each market within our homebuilding segments (dollars in thousands).

 

     Total Homes Sales Revenue     Percent of Total
     2007     2006     2005     2007    2006    2005

Arizona

   $ 702,418     $ 980,409     $ 831,796     26%    21%    17%

California

     588,562       998,471       1,075,900     21%    21%    23%

Nevada

     385,751       872,970       920,728     14%    19%    19%
                                      

West

     1,676,731       2,851,850       2,828,424     61%    61%    59%
                                      

Colorado

     284,419       450,392       627,042     10%    10%    13%

Utah

     255,273       277,743       204,496     9%    6%    4%
                                      

Mountain

     539,692       728,135       831,538     19%    16%    17%
                                      

Maryland

     149,917       246,492       191,365     6%    5%    4%

Virginia

     167,194       378,373       539,519     6%    8%    11%
                                      

East

     317,111       624,865       730,884     12%    13%    15%
                                      

Delaware Valley

     80,057       80,966       12,196     3%    2%    0%

Florida

     129,880       262,209       238,054     5%    6%    5%

Illinois

     39,126       63,925       33,490     1%    1%    1%

Texas

     3,369       65,560       128,289     0%    1%    3%
                                      

Other Homebuilding

     252,432       472,660       412,029     9%    10%    9%
                                      

Intercompany adjustments

     (19,985 )     (26,954 )     (10,175 )   -1%    0%    0%
                                      

Total

   $ 2,765,981     $ 4,650,556     $ 4,792,700     100%    100%    100%
                                      

Economies of Scale.  We believe that our scale of operations has afforded us benefits such as:

 

   

the ability to negotiate favorable contract terms associated with lot option contracts;

 

   

the ability to sustain operations in our markets despite limiting or altogether eliminating the acquisition of new land until such time as land becomes available at reasonable prices;

 

   

the ability to negotiate volume contracts with material suppliers and subcontractors;

 

   

access to affordable insurance coverage; and

 

   

access to lower cost capital.

Operating Divisions.  In our homebuilding segments, our primary functions include land acquisition and development, home construction, purchasing, sales and marketing, merchandising and customer service. Operating decisions are made on a subdivision-by-subdivision basis under the oversight of our Chief Operating Decision Makers (“CODMs”), defined as our Chief Executive Officer, Chief Operating Officer and Chief Financial Officer. Generally, each operating division consists of a division president; land procurement, sales, construction, customer service, finance and purchasing personnel; and office staff. The Company’s underlying organizational structure – i.e. the grouping and reporting of subdivisions and divisions – changes based upon the current needs of the Company. At December 31, 2007 and 2006, we had 12 and 23 separate homebuilding operating divisions, respectively. Officers of our divisions generally receive performance-related bonuses based upon achieving targeted financial and operational results in their respective operating divisions.

Corporate Management.  We manage our homebuilding business primarily through members of senior management in our Corporate segment and our Asset Management Committees (each an “AMC”). Each AMC is comprised of the COO and one of the Company’s corporate officers or employees. The AMCs review and approve all

 

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subdivision acquisition transactions in accordance with land resource allocation decisions made by the CODMs. Land acquisition transactions may not proceed without the approval by AMC and/or our CODMs. Generally, the role of our senior management team and/or AMCs includes:

 

   

review and approval of division business plans and budgets;

   

oversight of land and home inventory levels; and

   

review of major personnel decisions.

Additionally, our corporate executives and corporate and national departments generally are responsible for establishing and monitoring compliance with our policies and procedures. Among other things, the corporate office also has primary responsibility for:

 

   

asset management and capital allocation;

   

accounting and internal audit functions;

   

legal matters;

   

information technology;

   

merchandising and marketing;

   

training and development;

   

human resources and payroll;

   

risk management; and

   

treasury.

Housing.  Generally, we build single family detached homes in a number of standardized series, designed to provide variety in the size and style of homes for our potential homebuyers. Within each series, we build several models, each with a different floor plan and standard and optional features. Differences in sales prices of similar models in any series depend primarily upon homebuyer demand, home prices offered by our competitors, location, optional features and design specifications. The series of homes offered at a particular location is based on perceived customer preferences, lot size, the area’s demographics and, in certain cases, the requirements of major land sellers and local municipalities.

We seek to maintain limited levels of inventories of unsold homes in our markets. Unsold homes in various stages of completion allow us to meet the immediate and near-term demands of prospective homebuyers. In order to mitigate the risk of carrying excess inventory, we have procedures and limits on the number of our unsold homes under construction and speculative homes resulting from home order cancellations. 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).

 

     December 31,
2007
   December 31,
2006
   December 31,
2005

Unsold Homes Under Construction - Final

                   515                    476                    258

Unsold Homes Under Construction - Frame

   656    573    520

Unsold Homes Under Construction - Foundation

   229    400    353
              

Total Unsold Homes Under Construction

   1,400    1,449    1,131

Sold Homes Under Construction

   1,350    2,430    5,093

Model Homes

   730    757    667
              

Homes Completed or Under Construction

   3,480    4,636    6,891
              

Land Acquisition and Development.  We acquire our lots with the intention of constructing and selling homes on the acquired land. Generally, we purchase finished lots using option contracts, in phases or in bulk for cash. On a limited basis, we acquire entitled land for development into finished lots when we believe that the risk is justified. In

 

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making land purchases, we consider a number of factors, including projected rates of return, estimated Home Gross Margins (defined as home sales revenue less home cost of sales as a percent of home sales revenue), sales prices of the homes to be built, population and employment growth patterns, proximity to developed areas, estimated costs of development, estimated levels of competition and demographic trends. Generally, we acquire finished lots and land for development only in areas that will have, among other things, available building permits, utilities and suitable zoning. We attempt to maintain a supply of finished lots sufficient to enable us to start homes promptly after a contract for a home sale is executed. This approach is intended to minimize our investment in inventories. See “Forward-Looking Statements” above.

In our option contracts, we generally obtain the right to purchase lots in consideration for an option deposit in the form of cash or letters of credit. In the event we elect not to purchase the lots within a specified period of time, we forfeit the option deposit. Our option contracts generally do not contain provisions requiring our specific performance. During the years ended December 31, 2007, 2006 and 2005, we wrote-off lot option deposits and pre-acquisition costs of $23.4 million, $29.7 million and $10.4 million, respectively. At December 31, 2007, we had the right to acquire 3,615 lots under option contracts, with approximately $6.3 million and $6.5 million in non-refundable cash and letters of credit option deposits at risk, respectively. At December 31, 2007, the total purchase price for lots under option and total capitalized pre-acquisition costs were $419 million and $1.4 million, respectively.

We own or have the right under option contracts to acquire undeveloped parcels of real estate that we intend to develop into finished lots. We develop our land in phases (generally fewer than 100 lots at a time) in order to limit our risk in a particular subdivision and to efficiently employ available resources. Building permits and utilities are available and zoning is suitable for the current intended use of substantially all of our undeveloped land. When developed, these lots generally will be used in our homebuilding activities. See “Forward-Looking Statements” above.

The table below shows the carrying value of land and land under development, by homebuilding segment, at December 31, 2007, 2006 and 2005 (in thousands).

 

     December 31,
     2007    2006    2005

West

   $      226,621    $      980,666    $   1,108,777

Mountain

     205,983      282,063      216,729

East

     87,118      185,627      187,999

Other Homebuilding

     34,614      126,802      164,443
                    

Total

   $ 554,336    $ 1,575,158    $ 1,677,948
                    

 

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The table below shows the number of lots owned and controlled under option (excluding lots in housing completed or under construction), by homebuilding segment, at December 31, 2007, 2006 and 2005 (in units).

 

     December 31,
     2007    2006    2005

Lots Owned

        

West

   6,009    11,917    14,807

Mountain

   3,855    4,664    4,603

East

   671    1,171    1,462

Other Homebuilding

   980    1,658    2,573
              

Total

   11,515    19,410    23,445
              

Lots Controlled Under Option

        

West

   673    1,381    7,055

Mountain

   262    892    2,616

East

   1,869    3,341    4,397

Other Homebuilding

   811    2,483    4,751
              

Total

   3,615    8,097    18,819
              

Total Lots Owned and Controlled

            15,130             27,507             42,264
              

The table below shows the amount of non-refundable option deposits (in thousands).

 

     December 31,
     2007    2006    2005

Cash

   $          6,292    $        20,228    $        48,157

Letters of Credit

     6,547      14,224      23,142
                    

Total Non-refundable Option Deposits

   $ 12,839    $ 34,452    $ 71,299
                    

Labor and Raw Materials.  For the most part, materials used in our homebuilding operations are standard items carried by major suppliers. We generally contract for our materials and labor at a fixed price for the anticipated construction period of our homes. This allows us to mitigate the risks associated with increases in building materials and labor costs between the time construction begins on a home and the time it is closed. Increases in the cost of building materials and subcontracted labor may reduce Home Gross Margins to the extent that market conditions prevent the recovery of increased costs through higher home sales prices. From time to time and to varying degrees, we may experience shortages in the availability of building materials and/or labor in each of our markets. These shortages and delays may result in delays in the delivery of homes under construction, reduced Home Gross Margins, or both. See “Forward-Looking Statements” above.

Warranty.  Our homes are sold with limited third-party warranties that generally provide for ten years of structural coverage (“structural warranty”), two years of coverage for plumbing, electrical, heating, ventilation and air conditioning systems, and one year of coverage for workmanship and materials. Under our agreement with the issuer of the third-party warranties, we are responsible for performing all of the work for the first two years of the warranty coverage, and substantially all of the work required to be performed during years three through ten of the warranties. As a result, warranty reserves are established as homes close on a house-by-house basis in an amount estimated to be adequate to cover expected costs of materials and outside labor during warranty periods. Reserves are determined based upon historical experience with respect to similar home styles and geographical areas. Certain factors are considered in determining the per-house reserve amount, including: (1) the historical range of amounts paid per

 

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house; (2) the historical amount paid as a percent of home construction costs; (3) any warranty expenditures included in (1) and (2) not considered to be normal and recurring; (4) improvements in quality control and construction techniques expected to impact future warranty expenditures; and (5) conditions that may affect certain subdivisions and require higher per-house reserves for those specific subdivisions.

Seasonal Nature of Business.  Prior to 2006, the Company experienced seasonality and quarter-to-quarter variability in homebuilding activity levels. The seasonal nature of our business is described in more detail in Item 6 Selected Financial and Other Data.

Backlog.  At December 31, 2007 and 2006, homes under contract but not yet delivered (“Backlog”) totaled 1,947 and 3,638, respectively, with an estimated sales value of $650 million and $1.3 billion, respectively. Our Cancellation Rates (as defined below) were 48% and 43% for the years ended December 31, 2007 and 2006, respectively. We define “Cancellation Rate” as the approximate number of cancelled home order contracts during a reporting period as a percent of total home orders received during such reporting period. We anticipate the estimated Backlog sales value at December 31, 2007 will be realized during 2008 through closing homes in Backlog either under their existing home order contracts or through the replacement of an existing contract with a new home order contract. See “Forward-Looking Statements” above.

The table below discloses our Backlog for the years ended December 31, 2007 and 2006 for each market within our homebuilding segments (dollars in thousands).

 

     December 31,    2007 Increase (Decrease)
     2007    2006    Amount     %

Backlog (Units)

          

Arizona

     592      1,504      (912 )   -61%

California

     203      427      (224 )   -52%

Nevada

     307      315      (8 )   -3%
                        

West

     1,102      2,246      (1,144 )   -51%
                        

Colorado

     213      253      (40 )   -16%

Utah

     178      465      (287 )   -62%
                        

Mountain

     391      718      (327 )   -46%
                        

Maryland

     126      187      (61 )   -33%

Virginia

     100      136      (36 )   -26%
                        

East

     226      323      (97 )   -30%
                        

Delaware Valley

     57      119      (62 )   -52%

Florida

     125      197      (72 )   -37%

Illinois

     46      23      23     100%

Texas

     -      12      (12 )   -100%
                        

Other Homebuilding

     228      351      (123 )   -35%
                        

Total

     1,947      3,638      (1,691 )   -46%
                        

Estimated Backlog Sales Value

   $      650,000    $   1,300,000    $     (650,000 )   -50%
                        

Estimated Average Sales Price in Backlog

   $ 333.8    $ 357.3    $ (23.5 )   -7%
                        

 

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Our Backlog at December 31, 2007 decreased from levels at December 31, 2006 in each of our homebuilding segments and in nearly all markets in these segments. Contributing to the decrease in Backlog at December 31, 2007, were declines in net home orders during the last six months of 2007, compared with the last six months of 2006, in most markets within each homebuilding segment. Additionally, the decrease in Backlog at December 31, 2007 was most notable in our West segment, where Backlog declined by a combined 1,136 units from December 31, 2006 in Arizona and California. Backlog for Nevada at December 31, 2007 remained flat, compared with December 31, 2006, primarily due to sales incentives which were introduced in late November and December of 2007 that resulted in a significant number of new home orders received.

Estimated Backlog sales value at December 31, 2007 decreased from December 31, 2006, primarily due to a 46% decrease in the number of homes in Backlog and a 7% decrease in the estimated average sales price of homes in Backlog. The decline in the estimated average sales price of homes in Backlog is consistent with the decrease in the average selling prices of homes closed during 2007, which were impacted by factors contributing to the downturn in the homebuilding industry, as described in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Customer Service and Quality Control.  Our homebuilding divisions are responsible for pre-closing quality control inspections and responding to customers’ post-closing needs. During 2006, we created a product service and quality control task force, which designed and began implementation of a revised customer experience initiative. This is a multi-year initiative that is focused on making improvements in our customers’ complete home buying and homeownership experience. The initial phase of this initiative was rolled out to our Nevada market in the fourth quarter of 2006 and to all of our other markets during 2007.

Marketing and Sales.  We evaluate our marketing and sales programs and initiatives in order to target homebuyers in a cost effective manner. To communicate our Richmond American brand and sales promotions, we have a centralized in-house advertising and marketing department that controls and monitors the communication of the Company’s brand and promotion efforts. The main objective of this department is to direct potential homebuyers to our sales offices, Home Galleries, Homebuyer Resource Centers and website. We work towards these objectives through various advertising outlets, including, newspapers, magazines, signage, direct mailings and radio. In addition, our in-house corporate communications team manages our public relations and employee communications, and our interactive marketing team maintains our richmondamerican.com website.

To complement our marketing efforts, our in-house merchandising team furnishes our model homes and sales offices with the objective of providing a consistent presentation in furtherance of developing our Richmond American brand.

Home Gallery and Design Center.  Another important part of our marketing presentation takes place in our design centers, which are located in most of our homebuilding markets. Homebuyers are able to customize certain features of their homes by selecting from a variety of options and upgrades. In 2004, we launched our new Home Gallery concept, which provides improved sales support and customized options for prospective homebuyers to personalize their new homes. These retail locations also serve as a resource to homebuyers who are interested in purchasing a new Richmond American home. Prospective homebuyers can receive individualized attention from a trained team of new home specialists, resulting in a more focused, efficient home search.

Competition.  The homebuilding industry is fragmented and highly competitive. The competitive nature of our business is described in more detail in Item 1A, Risk Factors Relating to our Business.

Regulation.  Our homebuilding operations are subject to compliance with applicable laws and regulations, which are described in more detail in Item 1A, Risk Factors Relating to our Business.

 

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Bonds and Letters of Credit.  In many cases, we are required to obtain bonds and/or letters of credit in support of obligations primarily related to subdivision improvements, homeowners association dues and start-up expenses, warranty work, contractors’ license fees and earnest money deposits. At December 31, 2007 and 2006, we had outstanding performance bonds totaling $281.6 million and $388.6 million, respectively, and letters of credit totaling $51.2 million and $83.8 million, respectively, including $16.4 million and $26.8 million, respectively, issued by HomeAmerican.

In certain states, unless we take measures to release state regulatory imposed restrictions on earnest money deposits (“Deposits”) received from a homebuyer in conjunction with a home sale, which may include posting blanket security bonds, we are restricted from using these Deposits for general purposes. In this regard, at December 31, 2007 and 2006, we had $8.5 million and $10.5 million outstanding in blanket security bonds used to release restrictions on certain Deposits. Additionally, we had $1.9 million and $2.6 million in restricted cash related to Deposits at December 31, 2007 and 2006, respectively. We monitor, on a regular basis, the amount of Deposits we hold in certain states to confirm that our blanket security bonds exceed the amount of the Deposits.

In the event 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. See “Forward-Looking Statements” above.

Financial Services and Other Segment.

Mortgage Lending Operations.

General.  HomeAmerican is a full-service mortgage lender and the principal originator of mortgage loans for our homebuyers. HomeAmerican has a centralized loan processing center where it originates mortgage loans primarily for our homebuyers. HomeAmerican also brokers mortgage loans for origination by outside lending institutions for our homebuyers.

HomeAmerican is authorized to originate Federal Housing Administration-insured (“FHA”), Veterans Administration-guaranteed (“VA”), Federal National Mortgage Association (“FNMA”), Federal Home Loan Mortgage Corporation (“FHLMC”) (together “the government sponsored entities”) and other private investor mortgage loans. HomeAmerican also is an authorized loan servicer for FNMA and FHLMC and, as such, is subject to the rules and regulations of these organizations. Additionally, during 2006, HomeAmerican originated a significant number of second mortgage loans and Alternative A (“Alt-A”) loans (as defined below). However, during 2007, in response to the reduced liquidity in the mortgage lending industry, we tightened our mortgage loan underwriting criteria by: (1) discontinuing Alt-A mortgage loans, second mortgage loans, “sub-prime mortgage loans” (as defined below) and Non-Agency (defined as not being FNMA and FHLMC eligible) mortgage loans with combined-loan-to-values in excess of 95%; and (2) requiring larger down payments from homebuyers in communities where the market values of homes have been declining. We define Alt-A loans as loans that would otherwise qualify as prime loans except that they do not comply in all ways with the documentation standards of the government sponsored enterprise guidelines. We define sub-prime mortgage loans as mortgage loans that have Fair, Isaac & Company scores less than or equal to 620.

We use HomeAmerican’s secured warehouse line of credit, other borrowings and Company generated funds to finance the origination of mortgage loans until they are sold. HomeAmerican generally sells originated mortgage loans to third-party purchasers on either a bulk or flow basis. Mortgage loans sold on a bulk basis generally include the sale of a package of substantially similar originated mortgage loans, while sales of mortgage loans on a flow basis generally are completed as HomeAmerican originates each loan. Mortgage loans sold to third-party purchasers

 

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generally include HomeAmerican’s representations and warranties with respect to certain borrower payment defaults, credit quality issues and/or misrepresentations on the part of the Company or our homebuyers. Substantially all of the mortgage loans originated by HomeAmerican are sold to third-party purchasers within 45 days of origination. Additionally, mortgage loans may be sold pursuant to an early purchase program, whereby we sell certain mortgage loans originated by HomeAmerican to a third-party purchaser shortly after the close of a home. This program improves our overall available funds by enabling us to sell mortgage loans originated by HomeAmerican more quickly. Accordingly, for mortgage loans sold pursuant to this program the number of days a loan is held in inventory is reduced from the historical 45 days to less than five days.

Concurrent with the sale of mortgage loans to third-party purchasers, HomeAmerican generally sells the rights to service those loans. HomeAmerican’s portfolio of mortgage loan servicing for others at December 31, 2007 consisted of 597 loans with an unpaid principal balance of approximately $67.4 million, and did not contribute significantly to the results of operations of the Company.

Historically, a substantial portion of mortgage loans originated by HomeAmerican have been sold to one third-party purchaser. During the years ended December 31, 2007, 2006 and 2005, HomeAmerican sold approximately 51%, 54% and 68%, respectively, of the mortgage loans it originated to this third-party purchaser. Additionally, during 2007, HomeAmerican increased the volume of loans sold to a second third-party purchaser to approximately 23% of mortgage loans sold during 2007.

Pipeline.  HomeAmerican’s mortgage loans in process that had not closed (the “Pipeline”) at December 31, 2007 had an aggregate principal balance of approximately $387.6 million, of which $37.6 million were under interest rate lock commitments (“IRLC”) at an average interest rate of 6.0%. In addition, HomeAmerican had $100.1 million of mortgage loans in inventory available for sale at December 31, 2007. HomeAmerican uses forward sales of mortgage-backed securities and commitments to sell whole loans to hedge the interest rate risk inherent in the IRLC and its loan inventory available for sale. See “Forward-Looking Statements” above.

Forward Sales Commitments.  HomeAmerican is exposed to market risks related to fluctuations in interest rates due to its mortgage loan inventory. Derivative instruments utilized in the normal course of business by HomeAmerican include forward sales of mortgage-backed securities, commitments to sell whole loans and commitments to originate mortgage loans. HomeAmerican utilizes forward mortgage securities contracts to manage the price risk due to fluctuations in interest rates on our mortgage loans owned and the IRLC. Such contracts are the only significant financial derivative instruments utilized by us and generally are settled within 60 days of origination. Due to this hedging philosophy, we believe 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.

Competition.  The mortgage industry is fragmented and highly competitive. The competitive nature of our business is described in more detail in Item 1A, Risk Factors Relating to our Business.

Regulation.  Our mortgage lending operations are subject to compliance with applicable laws and regulations, which are described in more detail in Item 1A, Risk Factors Relating to our Business.

Insurance Operations.

Our insurance operations consist of three business divisions: (1) Allegiant; (2) StarAmerican; and (3) American Home Insurance.

Allegiant and StarAmerican were formed to provide insurance coverage for homebuilding risks as to which we believed insurance coverage was either too difficult or too expensive to obtain. Allegiant was organized as a risk

 

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retention group under the Federal Liability Risk Retention Act of 1981. Allegiant, which began operations in June of 2004, is licensed as a Class 3 Stock Insurance Company by the Division of Insurance of the State of Hawaii and is subject primarily to the regulations of its state of incorporation. Allegiant generates revenue by providing to its customers, primarily certain subcontractors of MDC’s homebuilding subsidiaries, general liability coverage during the construction of the Company’s homes and for work performed in completed subdivisions. Allegiant seeks to provide to its customers coverage and insurance rates that are competitive with other insurers.

StarAmerican is a single parent captive insurance company licensed by the Division of Insurance of the State of Hawaii and is a wholly owned subsidiary of MDC. Pursuant to agreements beginning in June 2004, StarAmerican re-insures Allegiant for all claims in excess of $50,000 per occurrence up to $3,000,000 per occurrence, subject to various aggregate limits, which do not exceed $18,000,000 per year.

Allegiant and StarAmerican incur expenses for losses and loss adjustments based on actuarial studies that include known facts and interpretations of circumstances, including the Company’s experience with similar insurance cases and historical trends involving insurance claim payment patterns, pending levels of unpaid insurance claims, mix or concentration of home styles, claim severity, claim frequency patterns such as those caused by natural disasters, fires, or accidents, depending on the business conducted, and changing regulatory and legal environments.

Regulations.  Allegiant and StarAmerican are licensed in the State of Hawaii and, therefore, are subject to the regulation of the Hawaii Insurance Division. This regulation includes restrictions and oversight regarding: types of insurance provided; investment options; required capital and surplus; financial and information reporting; use of auditors, actuaries and other service providers; periodic examinations; and other operational items. As insurance companies organized under Hawaii’s captive insurance laws, Allegiant and StarAmerican are subject to fewer regulations than non-captive insurance companies. As a risk retention group, Allegiant also is registered in other states where certain MDC subsidiaries do business. Allegiant must pay premium taxes and comply with financial and information reporting requirements of the insurance departments in these additional states.

American Home Insurance is an insurance agency, which provides homebuyers with personal lines property and casualty insurance products in the same markets as our homebuilding subsidiaries.

Title Operations.

American Home Title provides title agency services to the Company and our homebuyers in Colorado, Delaware, Florida, Illinois, Maryland, Nevada, Virginia and West Virginia.

Employees.

The table below summarizes the approximate number of employees for our homebuilding, Financial Services and Other and Corporate segments at December 31, 2007.

 

Homebuilding segments

   1,700

Financial Services and Other

   180

Corporate

   290
    

Consolidated

   2,170
    

 

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Item 1A. Risk Factors Relating to our Business.

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

The homebuilding and mortgage lending industries continued to experience uncertainty and reduced demand for new homes, which negatively impacted our financial and operating results during the year ended December 31, 2007. Widespread national and international concern over instability in the credit markets has exacerbated the decline in demand for new homes. The conditions experienced during 2007 included, among other things: reduced consumer confidence; on-going homebuyer concerns about the housing market and the lack of home selling price stabilization; concerns over higher-risk mortgage loan products, such as Alt-A and sub-prime mortgage loans; and reduced availability of mortgage loan financing.

If the downturn in the homebuilding and mortgage lending industries continues, intensifies, or if the national economy weakens further and slips into a recession, we could continue to experience declines in the market value and demand for our homes, which could have a significant negative impact on our Home Gross Margins and financial and operational 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.

The real estate industry is fragmented and highly competitive. Our homebuilding subsidiaries compete with numerous public and private homebuilders, including a number that are substantially larger and have greater financial resources than us. Our homebuilding subsidiaries also compete with subdivision developers and land development companies, some of which are themselves homebuilders or affiliates of homebuilders. Homebuilders compete for customers, land, building materials, subcontractor labor and desirable financing. Competition for home orders primarily is based upon price, home style, financing available to prospective homebuyers, location of property, quality of homes built, customer service and general reputation in the community, and may vary market-by-market and/or submarket-by-submarket. Additionally, competition within the homebuilding industry can be impacted through an excess supply of new and existing homes available for sale resulting from a number of factors including, among other things, increases in speculative homes available for sale and increases in home foreclosures. Increased competition, including lower home sales prices offered by our competitors as experienced during 2007, can result in decreases in our home sales prices and/or increases in home sales incentives in an effort to generate new home sales and maintain homes in Backlog until they close. These competitive pressures are likely to continue for some time and could affect our ability to maintain existing home sales prices and require that we provide additional incentives, which would negatively impact our future financial and operating results.

We, through our mortgage lending subsidiary, HomeAmerican, also compete with numerous banks, thrifts and other mortgage bankers and brokers, many of which are larger and may have greater financial resources than we do. Competitive factors include pricing, mortgage loan terms, underwriting criteria and customer service. To the extent that we are unable to adequately compete with other companies that originate mortgage loans, total revenue and the results of operations from our Financial Services and Other segment may be negatively impacted.

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 homebuilding subsidiaries acquire land for the replacement of land inventory and/or expansion within our current markets and may, from time to time, purchase land for expansion into new markets. The fair value of our land

 

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and land under development and housing completed or under construction inventory depends on market conditions. Factors that can impact our determination of the fair value of our inventory primarily include homes sales prices, levels of home sales incentives and home construction costs. Our home sales prices and/or levels of home sales incentives can be impacted by, among other things, decreased demand for new homes, decreased home prices offered by our competitors, decreased ability of our homebuyers to obtain suitable mortgage loan financing and continued high levels of home order cancellations. Additionally, our home construction costs can be impacted by, among other things, shortages of subcontractor labor and changes in costs associated with subcontracted labor, building materials and other resources. If we are required to decrease home sales prices and/or increase incentives in an effort to generate new home sales, maintain homes in Backlog until they close or remain competitive with the home sales prices offered by our competitors, or if our home construction costs increase, we may not be able to recover the carrying costs of our inventory when our homebuilding subsidiaries build and sell homes. In such circumstances, we would be required to record additional impairments of our inventory. Additionally, due to the uncertainty in the homebuilding and mortgage lending industries, it is reasonably possible for us to experience further declines in the market value of our homes and, as a result, additional inventory impairments could be recorded in future reporting periods. Any such additional inventory impairments would have a negative impact on our financial position and results of operations in the future reporting period in which they were recorded.

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

Our Cancellation Rate increased significantly during 2007 and 2006, compared with 2005 and 2004, which has negatively impacted the number of closed homes, net home orders, home sales revenue and our results of operations during 2007 and 2006, as well as the number of homes in Backlog at the end of each reporting period. Home order cancellations can result from a number of factors, including, declines in the market value of homes and/or slow appreciation in the market value of homes, increases in the supply of homes available to be purchased, increased competition, higher mortgage interest rates, homebuyers’ inability to sell their existing homes, homebuyers’ inability to obtain suitable financing, including providing sufficient down payments, and adverse changes in economic conditions. Continued high levels of home order cancellations would have a negative impact on our home sales revenue and financial and operating results in future reporting periods.

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.

Our operations depend on our homebuilding subsidiaries’ ability to obtain land for the development of our residential communities at reasonable prices and with terms that meet our underwriting criteria. Our ability to obtain land for new residential communities may be adversely affected by changes in the general availability of land, the willingness of land sellers to sell land at reasonable prices given the deterioration in market conditions, competition for available land, availability of financing to acquire land, zoning, regulations that limit housing density and other market conditions. If the supply of land appropriate for development of residential communities becomes more limited because of these factors, or for any other reason, the number of homes that our homebuilding subsidiaries build and sell could be reduced. Additionally, the ability of our homebuilding subsidiaries to open new subdivisions could be impacted if we elect not to purchase lots under option contracts. To the extent that we are unable to timely purchase land or enter into new contracts for the purchase of land at reasonable prices, due to the lag time between the time we acquire land and the time we begin selling homes, 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.

 

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If our potential homebuyers are not able to obtain suitable financing, our results of operations or cash flows may be impacted adversely.

Our business depends on the ability of our homebuyers to obtain affordable mortgages for the purchase of our homes, which includes being able to provide sufficient initial down payments for mortgage loan products currently available. Increases in the cost of mortgage financing and/or reductions in mortgage loan product offerings could prevent potential homebuyers from being able to obtain or qualify for mortgage loans. In addition, if our homebuyers must sell existing homes in order to buy homes from us, increases in mortgage costs or decreases in the market value of homes could interfere with such sales and result in our homebuyers’ inability to buy from us. Additionally, homebuyers’ ability to obtain suitable financing could be adversely impacted by tightening of our mortgage loan underwriting criteria in response to the decreased liquidity in the mortgage lending market. We are unable to predict future changes in home mortgage interest rates or the impact such changes may have on our operating activities and results of operations. However, these conditions can negatively impact our home sales revenue and results of operations through closing fewer homes and/or closing homes with lower average selling prices.

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 the Company’s results of operations, financial position and/or cash flows.

We have financial needs that we meet through the capital markets, including the debt and secondary mortgage markets. The secondary markets currently are experiencing disruptions from reduced investor demand for mortgage loans and mortgage-backed securities, increased investor yield requirements for those loans and securities and the exit of third-party purchasers from the secondary market. In addition, the sources and terms and conditions of warehouse financing arrangements and other lending arrangements for the mortgage lending industry are changing. These changes can impact, among other things, availability of capital, terms and structures for debt and line of credit agreements, collateral requirements and collateral advance rates. Additionally, while certain governmental organizations and other mortgage industry participants have taken steps recently to ease the downturn in the credit and capital markets, the impact of their efforts, if any, on the homebuilding and mortgage lending industries is unknown. The foregoing disruptions and changes may have an adverse impact on the Company’s results of operations, financial position and/or cash flows.

As is customary in the homebuilding industry, we often are required to provide surety bonds to secure our performance under construction contracts, development agreements and other arrangements. Our ability to obtain surety bonds primarily depends upon our credit rating, capitalization, working capital, past performance, management expertise and certain external factors, including the overall capacity of the surety market. While our credit ratings and liquidity position currently are strong, if we were unable to obtain surety bonds when required, our results of operations and/or cash flows could be impacted adversely.

In addition, the pricing matrix and the availability of advances and letters of credit under our homebuilding line of credit are dependent upon our credit ratings. While we currently have an investment grade credit rating from all three major ratings agencies, the lowering of any or all of these credit ratings could have an adverse impact on the cost of advances, letters of credit and unused commitment fees under our homebuilding line of credit. Lower credit ratings for MDC also could subject this line of credit to a borrowing base structure, which could limit our ability to obtain additional advances and issuances of letters of credit under this line. Under certain circumstances, these limitations could have an adverse impact on the Company’s results of operations, financial position and/or cash flows.

 

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

The Company is subject to risks associated with mortgage loans, including, among others, previously originated and sold Alt-A and sub-prime mortgage loans, second mortgage loans, high loan-to-value mortgage loans and jumbo mortgage loans (defined as a mortgage loan with a principal balance in excess of $417,000). These risks may include, among other things, compliance with mortgage loan underwriting criteria and the associated homebuyers’ performance, which could require HomeAmerican to repurchase certain of those mortgage loans or provide indemnification. Repurchased mortgage loans may impact HomeAmerican’s results of operations, liquidity and cash flow as the existence of a defect that necessitated repurchase may require additional effort and expense incurred by HomeAmerican to cure the defect, the passage of time in order to cure or reduce the impact of an identified defect, a discounted sale of the repurchased loan due to the existence of a defect or, in the event that the loan has a defect and is non-performing, foreclosure and re-sale of the subject property.

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

Our homebuilding and mortgage lending operations are impacted by the availability and cost of mortgage financing. Nearly all of our customers finance the purchase of their homes, and a significant number of these customers arrange their financing through HomeAmerican. Increases in home mortgage interest rates may reduce the demand for homes and home mortgages. We are unable to predict the extent to which recent or future changes in home mortgage interest rates will affect our operating activities and results of operations. Additionally, further tightening of mortgage loan underwriting criteria could have an adverse impact on our operating and financial results in future reporting periods.

In addition, we believe that the availability of FNMA, FHLMC, FHA and VA mortgage loans are an important factor in our marketing strategy. Any changes, limitations or restrictions on the availability of these types of financing could reduce our subsidiaries’ home sales and mortgage lending volume.

We depend on certain markets, and reduced home sales orders and closings for homes in these markets could have a negative impact on our revenue and results of operations. Additionally, we are reliant on a limited number of third-party purchasers of mortgage loans originated by HomeAmerican, which could impact our results of operations.

We conduct a significant portion of our business in the Arizona, California, Colorado, Nevada and Virginia markets and generate a disproportionate amount of our revenue in these markets. Demand for new homes and the market value of homes declined during 2007 and 2006 in each of these markets. If we continue to experience a slowdown in our operations within these markets, our results of operations and financial position in future reporting periods will continue to be negatively impacted.

Additionally, there are a limited number of third-party purchasers of mortgage loans and, at any given point in time, our business may be impacted adversely if one of them was no longer able or willing to purchase mortgage loans originated by HomeAmerican. Our operations could be impacted adversely due to reduced competition and having fewer bidders for originated mortgage loans we sell, which could result in us receiving a lower price for such originated mortgage loans.

 

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

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

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

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

The Company also is subject to rules and regulations with respect to originating, processing, selling and servicing mortgage loans, which, among other things: prohibit discrimination and establish underwriting guidelines; provide for audits and inspections; require appraisals, credit reports on prospective borrowers and disclosure of certain information concerning credit and settlement costs; establish maximum loan amounts; prohibit predatory lending practices; and regulate the referral of business to affiliated entities. Over time, the level of complexity in the mortgage lending business has increased significantly due to several factors, including: (1) an increase in the number of mortgage loan products as a result of the evolution of the secondary mortgage market and demand by borrowers; and (2) greater regulation of the industry. New rules and regulations, or revised interpretations of existing rules and regulations applicable to our mortgage lending operations could result in more stringent compliance standards, which may substantially increase costs of compliance.

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

As a homebuilder, we are subject to construction defect and home warranty claims, including moisture intrusion and related mold claims, arising in the ordinary course of business. These claims are common to the homebuilding industry and can be costly. In addition, the costs of insuring against construction defect and product liability claims are high and the amount of coverage offered by insurance companies is currently limited. This coverage may be

 

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further restricted and become more costly. If we are not able to obtain adequate insurance against these claims, we may incur additional expenses that would have a negative impact on our results of operations in future reporting periods.

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. Additionally, continued loss from operations in future reporting periods may require us to adjust the valuation allowance against our deferred tax assets.

From time to time, we are audited by various federal, state and local authorities regarding income tax matters. Significant judgment is required to determine our provision for income taxes and our liabilities for federal, state, local and other taxes. Our audits are in various stages of completion; however, no outcome for a particular audit can be determined with certainty prior to the conclusion of the audit, appeal and, in some cases, litigation process. Although we believe our approach to determining the appropriate tax treatment is supportable and in accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes,” and FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” it is possible that the final tax authority will take a tax position that is materially different than that which is reflected in our income tax provision and other tax reserves. As each audit is conducted, adjustments, if any, are appropriately recorded in our Consolidated Financial Statements in the period determined. Such differences could have a material adverse effect on our income tax provision or benefit, or other tax reserves, in the reporting period in which such determination is made and, consequently, on our results of operations, financial position and/or cash flows for such period.

Our deferred tax assets should be reduced by a valuation allowance, if, based on the weight of available evidence, it is more-likely-than-not that some portion or all of the deferred tax assets will not be realized. In determining the more-likely-than-not criterion, we evaluate all positive and negative evidence as of the end of each reporting period. Future adjustments, either increases or decreases, to our deferred tax asset valuation allowance will be determined based upon changes in the expected realization of our net deferred tax assets. The realization of our deferred tax assets ultimately depends on the existence of sufficient taxable income in either the carryback or carryforward periods under the tax law. Due to significant estimates utilized in establishing the valuation allowance and the potential for changes in facts and circumstances, it is reasonably possible that we will be required to record adjustments to the valuation allowance in future reporting periods. Our results of operations would be impacted negatively if we determine that increases to our deferred tax asset valuation allowance are required in a future reporting period.

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

Prior to 2006, we experienced seasonality and quarter-to-quarter variability in homebuilding activity levels. In general, the number of homes closed and associated home sales revenue increased during the third and fourth quarters, compared with the first and second quarters. We believe that this seasonality reflected the historical tendency of homebuyers to purchase new homes in the spring with closings scheduled in the fall or winter, as well as the scheduling of construction to accommodate seasonal weather conditions in certain markets. During 2007 and 2006, this seasonality pattern in the homebuilding industry was not apparent. The extent to which our historical seasonality pattern contributed to actual 2007 home sales and closing levels is unknown, and there can be no assurances that this seasonality pattern will be present in future reporting periods.

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

The residential construction industry experiences labor and material shortages from time to time, including: work stoppages; labor disputes and shortages in qualified trades people, insulation, drywall, concrete, steel and lumber; lack of availability of adequate utility infrastructure and services; our need to rely on local subcontractors who may not be

 

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adequately capitalized or insured; and shortages, or delays in availability, or fluctuations in prices, of building materials. These labor and material shortages can be more severe during periods of strong demand for housing or during periods in which the markets where we operate experience natural disasters that have a significant impact on existing residential and commercial structures. Any of these circumstances could give rise to delays in the start or completion of our residential communities, increase the cost of developing one or more of our residential communities and increase the construction cost of our homes. To the extent that market conditions prevent the recovery of increased costs, including among other things, subcontracted labor, finished lots, building materials, and other resources, through higher selling prices, our Home Gross Margins and results of operations could be affected negatively.

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

The climates and geology of many of the markets in which we operate, including California and Florida, present increased risks of natural disasters. To the extent that hurricanes, severe storms, earthquakes, droughts, floods, heavy or prolonged precipitation, wildfires or other natural disasters or similar events occur, the financial and operating results of our business, in particular, may be negatively impacted. These, among other natural disasters, can affect an area in which we build, or one nearby, and result in a diversion of labor and materials in the area from new home construction to the rebuilding of the existing homes damaged or destroyed in the natural disaster. This can cause delays in construction and delivery of new homes and/or increase our construction costs.

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

Our future success depends, in part, on our ability to attract, train and retain skilled personnel. If we are unable to retain our key employees or attract, train and retain other skilled personnel in the future, it could have an adverse impact on our financial and operating results.

Increased domestic and international instability could have an adverse effect on our operations.

Adverse developments in the war on terrorism, future terrorist attacks against the United States, or increased domestic and international instability could adversely affect our business.

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

Larry A. Mizel, David D. Mandarich and other of our affiliates own, directly or indirectly, in the aggregate, almost 25% of our outstanding common stock. To the extent they and their affiliates vote their shares in the same manner, their combined stock ownership may effectively give them the power to elect our entire board of directors and control our management, operations and affairs. Circumstances may occur in which the interest of these shareholders could be in conflict with the interests of other shareholders. The large percentage of stock held by these persons could also delay or prevent a change in control of the Company.

 

Item 1B. Unresolved Staff Comments.

None

 

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Item 2. Properties.

Our corporate headquarters is located at 4350 South Monaco Street, Denver, Colorado 80237, where we lease office space in a 144,000 square foot office building. Our homebuilding divisions and, in some markets, other MDC subsidiaries, including HomeAmerican, American Home Insurance and American Home Title, lease additional office space. The table below outlines the number of office facilities that are leased and the approximate square footage leased in each market at December 31, 2007. We are satisfied with the suitability and capacity of our office locations.

 

    

Number of
Leased Facilities

   Total Square
Footage Leased

Arizona

   6    124,000

California

   8    141,000

Colorado

   9    305,000

Delaware Valley

   3    16,000

Florida

   4    43,000

Illinois

   1    10,000

Maryland

   2    16,000

Nevada

   4    63,000

Texas

   1    1,000

Utah

   4    28,000

Virginia

   5    81,000
         

Totals

   47             828,000
         

 

Item 3. Legal Proceedings.

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

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

The EPA issued two Notices of Violation against Richmond American Homes of Arizona, Inc. (“RAH Arizona”) alleging violations of the Clean Air Act. The EPA asserted that RAH Arizona had not controlled dust generated at construction sites in Maricopa County in that it had not operated a water application system or other approved control measures, installed suitable track-out control devices and/or cleaned-up materials tracked-out from project sites. The EPA filed an action in the United States District Court, District of Arizona, against RAH Arizona based on these allegations. On September 17, 2007, RAH Arizona, without admitting any wrongdoing, reached a settlement with a release of civil liability

 

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for all alleged violations. After opportunity for public comment, the settlement agreement was approved by the Court, we paid a civil penalty of $155,000 and commenced implementation of various procedures to abate fugitive dust emissions.

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

 

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

No meetings of the Company’s stockholders were held during the fourth quarter of 2007.

PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

At December 31, 2007, MDC had 773 shareowners of record. The shares of MDC common stock are traded on the New York Stock Exchange. The following table sets forth, for the periods indicated, the price ranges of MDC’s common stock.

 

     Three Months Ended
     March 31    June 30    September 30    December 31

2007

           

High

   $         60.00    $         54.73    $         50.33    $         43.10

Low

   $         47.75    $ 47.54    $ 40.31    $ 32.34

2006

           

High

   $         66.88    $ 68.10    $ 52.07    $ 57.31

Low

   $         58.72    $ 50.07    $ 40.43    $ 47.26

The following table sets forth the cash dividends declared and paid in 2007 and 2006 (dollars in thousands, except per share amounts).

 

     Date of Declaration    Date of Payment    Dividend per
Share
   Total Dividends
Paid

2007

           

First quarter

   January 22, 2007    February 21, 2007    $             0.25    $           11,414

Second quarter

   April 27, 2007    May 23, 2007      0.25      11,438

Third quarter

   July 23, 2007    August 22, 2007      0.25      11,459

Fourth quarter

   October 22, 2007    November 20, 2007      0.25      11,462
                   
         $ 1.00    $ 45,773
                   

2006

           

First quarter

   January 23, 2006    February 23, 2006    $ 0.25    $ 11,217

Second quarter

   April 24, 2006    May 24, 2006      0.25      11,239

Third quarter

   July 24, 2006    August 23, 2006      0.25      11,247

Fourth quarter

   October 23, 2006    November 21, 2006      0.25      11,260
                   
         $ 1.00    $ 44,963
                   

 

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In connection with the declaration and payment of dividends, we are required to comply with certain covenants contained in our unsecured revolving line of credit agreement (as amended on January 24, 2008), which has a total commitment of $1.25 billion. Pursuant to the terms of this amended agreement, dividends may be declared or paid by us if we are in compliance with certain stockholders’ equity and debt coverage tests. As a result, effective January 24, 2008, we had a permitted dividend capacity of approximately $370 million pursuant to the most restrictive of these covenants.

On January 29, 2008, MDC’s board of directors declared a quarterly cash dividend of twenty five cents ($0.25) per share. The dividend will be paid on February 26, 2008 to shareowners of record on February 12, 2008.

There were no shares of MDC common stock repurchased during the year ended December 31, 2007. At December 31, 2007, we were authorized to repurchase up to 4,000,000 shares of our common stock.

Performance Graph

Set forth below is a graph comparing the yearly change in the cumulative total return of the MDC’s common stock with the cumulative total return of the Standard & Poor’s 500 Stock Index and with that of a peer group of other homebuilders over the five-year period ending on December 31, 2007.

It is assumed in the graph that $100 was invested (1) in the Company’s common stock; (2) in the stocks of the companies in the Standard & Poor’s 500 Stock Index; and (3) in the stocks of the peer group companies, just prior to the commencement of the period and that all dividends received within a quarter were reinvested in that quarter. The peer group index is composed of the following companies: Beazer Homes USA, Inc., Centex Corporation, D.R. Horton, Inc., Hovnanian Enterprises, Inc., KB Home, Lennar Corporation, M/I Homes, Inc., Meritage Homes Corporation, NVR, Inc., Pulte Homes, Inc., The Ryland Group, Inc., Standard Pacific Corp. and Toll Brothers, Inc.

The stock price performance shown on the following graph is not indicative of future price performance.

COMPARISON OF CUMULATIVE TOTAL RETURN OF MDC COMMON STOCK, THE S&P 500 STOCK INDEX AND A SELECTED PEER GROUP

LOGO

 

Item 6. Selected Financial and Other Data.

The data in these tables and related footnotes should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Company’s Consolidated Financial Statements (in thousands, except per share and unit amounts).

 

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SELECTED FINANCIAL DATA

 

    Year Ended December 31,
    2007     2006   2005   2004   2003

INCOME STATEMENT DATA

         

Home sales revenue

  $ 2,765,981     $ 4,650,556   $ 4,792,700   $ 3,922,837   $ 2,846,220

Total revenue

  $ 2,933,249     $ 4,801,742   $ 4,892,589   $ 4,012,894   $ 2,922,595

Home cost of sales

  $ 2,380,427     $ 3,619,656   $ 3,436,035   $ 2,834,092   $ 2,159,979

Asset impairments

  $ 726,621     $ 112,027   $ -   $ -   $ -

General and administrative expenses

  $ 306,715     $ 418,879   $ 401,184   $ 327,812   $ 237,648

(Loss) income before income taxes

  $ (756,464 )   $ 333,137   $ 808,763   $ 636,914   $ 348,223

Net (loss) income(1)

  $ (636,940 )   $ 214,253   $ 505,723   $ 391,165   $ 212,229

Basic (loss) earnings per common share

  $ (13.94 )   $ 4.77   $ 11.48   $ 9.19   $ 5.11

Diluted (loss) earnings per common share

  $ (13.94 )   $ 4.66   $ 10.99   $ 8.79   $ 4.90

Weighted-average shares outstanding

         

Basic

    45,687       44,952     44,046     42,560     41,521

Diluted(2)

    45,687       45,971     46,036     44,498     43,333

Dividends declared per share

  $ 1.00     $ 1.00   $ 0.76   $ 0.43   $ 0.28

 

(1)

Net loss for the year ended December 31, 2007 includes the impact of recording a valuation allowance of $160.0 million against our deferred tax assets.

(2)

758,899 shares of common stock equivalents have been excluded from the diluted weighted-average shares outstanding for the year ended December 31, 2007 because the effect of their inclusion would be anti-dilutive, or would decrease the reported diluted loss per share.

 

    December 31,
    2007   2006   2005   2004   2003

BALANCE SHEET DATA

         

Assets

         

Cash and cash equivalents

  $ 1,004,763   $ 507,947   $ 214,531   $ 400,959   $ 170,289

Housing completed or under construction

  $ 902,221   $ 1,178,671   $ 1,320,106   $ 887,002   $ 769,762

Land and land under development

  $ 554,336   $ 1,575,158   $ 1,677,948   $ 1,129,266   $ 785,541

Total assets

  $ 2,956,237   $ 3,909,875   $ 3,859,850   $ 2,844,731   $ 2,028,790

Debt and Lines of Credit

         

Senior notes

  $ 997,091   $ 996,682   $ 996,297   $ 746,310   $ 497,700

Notes payable

    -     -     -     -     2,479

Homebuilding line of credit

    -     -     -     -     -

Mortgage line of credit

    70,147     130,467     156,532     135,478     79,240
                             

Total debt and lines of credit

  $ 1,067,238   $ 1,127,149   $ 1,152,829   $ 881,788   $ 579,419
                             

Stockholders’ Equity

  $ 1,476,013   $ 2,161,882   $ 1,952,109   $ 1,418,821   $ 1,015,920

Stockholders’ Equity per Outstanding Share

  $ 32.05   $ 47.87   $ 43.74   $ 32.80   $ 24.06
         

 

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    Year Ended December 31,  
    2007     2006     2005     2004     2003  

OPERATING DATA

         

Homes closed (units)

    8,195       13,123       15,307       13,876       11,211  

Average selling price per home closed

  $ 337.5     $ 354.4     $ 313.1     $ 282.7     $ 253.9  

Orders for homes, net (units)

    6,504       10,229       15,334       14,248       12,630  

Homes in Backlog at period end (units)

    1,947       3,638       6,532       6,505       5,593  

Estimated Backlog sales value at period end

  $ 650,000     $ 1,300,000     $ 2,440,000     $ 1,920,000     $ 1,600,000  

Estimated average selling price of homes in Backlog

  $ 333.8     $ 357.3     $ 373.5     $ 295.2     $ 286.1  

Active subdivisions at year-end

    278       306       292       242       198  

Average active subdivisions

    302       298       273       222       195  

Cash Flows From

         

Operating activities

  $ 592,583     $ 363,048     $ (424,929 )   $ (27,779 )   $ 82,322  

Investing activities

  $ (1,447 )   $ (10,221 )   $ (22,889 )   $ (29,917 )   $ (6,785 )

Financing activities

  $ (94,320 )   $ (59,411 )   $ 261,390     $ 288,366     $ 67,481  

Seasonality and Variability in Quarterly Results

Prior to 2006, the Company experienced seasonality and quarter-to-quarter variability in homebuilding activity levels. During 2007, this seasonal pattern in the homebuilding industry was not apparent. The seasonal nature of our homebuilding and mortgage lending business are described in more detail in Item 1A, Risk Factors Relating to Our Business. The following table reflects our unaudited summarized quarterly consolidated financial and operational information for the two years ended December 31, 2007 (in thousands, except per share and unit amounts). See “Forward-Looking Statements” above.

 

     Quarter  
     Fourth     Third     Second     First  

2007

        

Home sales revenue

   $ 715,244     $ 651,124     $ 687,813     $ 711,800  

Total revenue

   $ 784,756     $ 686,661     $ 716,708     $ 745,124  

Asset impairments

   $ 175,199     $ 248,950     $ 161,050     $ 141,422  

General and administrative expenses(1)

   $ 59,486     $ 76,482     $ 80,090     $ 90,657  

Net loss(2)

   $ (281,092 )   $ (155,378 )   $ (106,072 )   $ (94,398 )

Orders for homes, net (units)

     748       1,228       1,970       2,558  

Homes closed (units)

     2,200       1,963       2,031       2,001  

Homes in Backlog at period end (units)

     1,947       3,399       4,134       4,195  

Estimated Backlog sales value at period end

   $ 650,000     $ 1,210,000     $ 1,480,000     $ 1,500,000  

Loss per share

        

Basic

   $ (6.14 )   $ (3.40 )   $ (2.32 )   $ (2.07 )

Diluted

   $ (6.14 )   $ (3.40 )   $ (2.32 )   $ (2.07 )

Weighted-Average Shares Outstanding

        

Basic

     45,772       45,751       45,722       45,501  

Diluted

     45,772       45,751       45,722       45,501  

 

(1)

General and administrative expenses for the 2007 fourth quarter include the impact of approximately $10 million of accruals from prior quarters which were reversed in the fourth quarter due to changes in the estimated and actual 2007 bonus payments.

(2)

Net loss in the 2007 fourth quarter includes the impact of recording a valuation allowance of $160.0 million against our deferred tax assets.

 

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     Quarter
     Fourth     Third    Second    First

2006

          

Home sales revenue

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

Total revenue

   $ 1,343,413     $ 1,080,923    $ 1,231,981    $ 1,145,425

Asset impairments

   $ 91,252     $ 19,915    $ 260    $ 600

General and administrative expenses

   $ 92,284     $ 99,779    $ 115,551    $ 111,265

Net (loss) income

   $ (6,365 )   $ 48,706    $ 76,491    $ 95,421

Orders for homes, net (units)

     1,571       2,120      2,738      3,800

Homes closed (units)

     3,594       2,955      3,376      3,198

Homes in Backlog at period end (units)

     3,638       5,661      6,496      7,134

Estimated Backlog sales value at period end

   $ 1,300,000     $ 2,100,000    $ 2,440,000    $ 2,700,000

(Loss) earnings per share

          

Basic

   $ (0.14 )   $ 1.08    $ 1.70    $ 2.13

Diluted

   $ (0.14 )   $ 1.06    $ 1.66    $ 2.08

Weighted-Average Shares Outstanding

          

Basic

     45,073       44,972      44,939      44,820

Diluted

     45,073       45,868      45,972      45,970

 

Item 7. 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 Consolidated Financial Statements and Notes thereto included elsewhere in this Annual Report on Form 10-K. 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.”

EXECUTIVE SUMMARY

The 2006 calendar year reflected the acceleration of a dramatic downturn in the homebuilding industry. The challenges we encountered intensified significantly during 2007 and expanded beyond homebuilding into the mortgage lending industry and the credit and capital markets. As a result, during 2007, the homebuilding sector experienced what appeared to be an extraordinary absence of consumer demand for new homes. We responded to these conditions in a number of ways. However, we were not immune to the uncertainties in the wider credit and capital markets. We believe that the stability of these markets will play a major role in the timing, strength and sustainability of a turnaround in the homebuilding and mortgage lending industries. Additionally, while certain governmental agencies and other mortgage industry participants have taken steps recently to ease the downturn in the credit, capital and homebuilding markets, we cannot provide any assurance as to the impact their efforts will have on our Company or the homebuilding industry as a whole, as the on-going severity and duration of this downturn continues to be unknown. See “Forward-Looking Statements” below.

Each of our homebuilding segments and our Financial Services and Other segment continued to be impacted by the downturn in the homebuilding and mortgage lending industries, which we believe included, among other things, on-going homebuyer concerns about declines in the market value of homes, as well as reduced availability of credit for homebuyers caused by tightening mortgage loan underwriting criteria and an overall reduction in liquidity in the mortgage industry. We believe these and other factors contributed to, among other things: (1) significant increases in competition for new home orders driven by builders that significantly cut 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 (as defined below) until they close; (3) high levels of foreclosures, which contributed to an excess supply of homes available to be purchased; (4) prospective homebuyers

 

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having a more difficult time selling their existing homes in this increasingly competitive environment; and (5) reduced affordability of homes, partially due to the increased difficulty confronted by homebuyers in trying to qualify for mortgage loans or provide sufficient down payments for mortgage loans for which they qualify.

For MDC, these conditions resulted in an increased Cancellation Rate (as defined below), fewer closed homes, decreased new home orders, reduced year-over-year Backlog and lower Home Gross Margins (as defined below) in 2007, resulting in asset impairments of $726.6 million recorded during the year ended December 31, 2007. As a consequence, we incurred a pre-tax loss of $756.5 million during 2007, compared with pre-tax income of $333.1 million during 2006. Additionally, we incurred a net loss of $636.9 million during 2007, which includes the impact of a $160.0 million valuation allowance recorded against our deferred tax assets, compared with net income of $214.3 million during 2006. Because of the uncertainty surrounding the severity and duration of the downturn in the homebuilding and mortgage lending industries, we are unable to determine the potential for net losses in future reporting periods. See “Forward-Looking Statements” below.

Recognizing the challenges presented by the downturn in the homebuilding and mortgage lending businesses, our management focused on the following throughout 2007:

 

   

We continued our efforts to right-size our operations in an attempt to reduce our general and administrative expenses in response to significant decreases in the number of homes sold and closed by:

 

   

consolidating homebuilding divisions in several of our markets;

 

   

eliminating most of our regional homebuilding offices;

 

   

consolidating office space and vacating a number of office facilities in many of our markets; and

 

   

reducing Company-wide headcount across all departments.

 

   

We increased our efforts to control costs through continued renegotiations of material and labor costs with our suppliers and subcontractors.

 

   

We lowered our portfolio of lots owned and controlled in each market by:

 

   

limiting the purchase of lots;

 

   

selling land that no longer met our strategic objectives;

 

   

terminating option contracts to purchase lots that no longer satisfied our underwriting criteria; and

 

   

constructing, selling and closing homes in the ordinary course of business;

 

   

We limited our cash outflows through tighter controls over:

 

   

land acquisition expenditures;

 

   

land development and home construction costs; and

 

   

construction of speculative inventories and new home starts.

 

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We strengthened our management of risks associated with the origination and subsequent sales of mortgage loan products by:

 

   

tightening our mortgage loan underwriting criteria;

 

   

originating mortgage loan products for which our customers might qualify, such as government loans, that conform to HomeAmerican’s tightened mortgage underwriting criteria;

 

   

limiting representations and warranties, including certain borrower payment default provisions on mortgage loans HomeAmerican sold to third-party purchasers; and

 

   

reducing and/or eliminating the origination of higher risk mortgage loans, including Alt-A (as defined below), second mortgages and sub-prime (as defined below) loans.

 

   

We focused more closely on sales initiatives intended to generate traffic, new home orders and maintain home orders in Backlog until they close, including targeted sales and marketing programs and increased home sales incentives.

 

   

We expanded the scope of our national customer experience initiative, which is intended to improve the home buying and home ownership experience.

CRITICAL ACCOUNTING ESTIMATES AND POLICIES

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

Listed below are those estimates and policies that we believe are critical and require the use of complex judgment in their application. Our critical accounting estimates and policies are as follows and should be read in conjunction with the Notes to our Consolidated Financial Statements.

Homebuilding Inventory Valuation (Held-for-Development). Our homebuilding inventories accounted for on a held-for-development basis include assets associated with subdivisions in which we intend to construct and sell homes on the land. Each such subdivision represents the lowest level of identifiable cash flows. The inventory in our held-for-development subdivisions also includes assets associated with model and speculative homes. Homebuilding inventories that are accounted for as held-for-development are carried at cost unless events and circumstances indicate that the carrying value of the underlying subdivision may not be recoverable. In making this determination, we review, among other things, the following for each subdivision:

 

   

actual and trending “Operating Profit” (which is defined as home sales revenue less home cost of sales and all direct incremental costs associated with the home closing) for homes closed in the (1) prior two completed fiscal quarters on an individual basis; (2) current fiscal quarter; (3) last six months; and (4) last twelve months;

   

estimated future undiscounted cash flows and Operating Profit;

   

forecasted Operating Profit for homes in Backlog;

   

actual and trending net and gross home orders;

 

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base sales price and home sales incentive information for homes that (1) closed in the prior two completed fiscal quarters; (2) closed in the current fiscal quarter; (3) are in Backlog as of the end of the current fiscal quarter; and (4) are forecasted to close over the remaining life of the subdivision;

   

market information for each sub-market, including competition levels and the size and style of homes currently being offered for sale; and

   

known or probable events indicating that the carrying value may not be recoverable.

On a quarterly basis, if events or circumstances indicate that the carrying value of our held-for-development inventory may not be recoverable, such assets are reviewed for impairment by comparing the undiscounted estimated future cash flows from an individual subdivision to its carrying value in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”). The evaluation for the recoverability of the carrying value of the assets for each individual subdivision can be impacted significantly by the following:

 

   

estimates of future base selling prices;

   

estimates of future home sales incentives; and

   

estimates of future home construction and land development costs.

These estimates are dependent on specific market or sub-market conditions for each subdivision. While we consider available information to determine what we believe to be our best estimates as of the end of a reporting period, these estimates are subject to change in future reporting periods as facts and circumstances change. Local market-specific conditions that may impact these estimates for a subdivision include:

 

   

historical subdivision results, and actual and trending Operating Profit, base selling prices and home sales incentives;

 

   

forecasted Operating Profit for homes in Backlog;

 

   

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 current sales pace for active subdivisions;

 

   

subdivision specific attributes, such as location, availability of lots in the sub-market, desirability and uniqueness of subdivision location and the size and style of homes currently being offered;

 

   

potential for alternative home styles to respond to local market conditions;

 

   

changes by management in the sales strategy of a given subdivision; and

 

   

current local market economic and demographic conditions and related trends and forecasts.

These and other local market-specific conditions that may be present are considered by personnel in our homebuilding divisions as they prepare or update the forecasted assumptions for each subdivision. Quantitative and qualitative factors other than home sales prices could significantly impact the potential for future impairments. The sales objectives can differ between subdivisions, even within a given sub-market. For example, facts and circumstances in a given subdivision may lead us to price our homes with the objective of yielding a higher sales absorption pace, while facts and circumstances in another subdivision may lead us to price our homes to minimize deterioration in our Home Gross Margins, although, it may result in a slower sales absorption pace. Furthermore, the key assumptions included in our estimated future undiscounted cash flows may be interrelated. For example, a decrease in estimated base sales price or an increase in home sales incentives may result in a corresponding increase in sales absorption pace. Additionally, a decrease in the average sales price of homes to be sold and closed in future reporting periods for one subdivision that has not been generating what management believes to be an adequate sales

 

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absorption pace may impact the estimated cash flow assumptions of a nearby subdivision. Changes in our key assumptions, including estimated construction and development costs, absorption pace, selling strategies or discount rates could materially impact future cash flow and fair value estimates. Due to the number of possible scenarios that would result from various changes in these factors, we do not believe it is possible to develop a sensitivity analysis with a level of precision that would be meaningful to an investor.

If the undiscounted future cash flows of a subdivision are less than its carrying value, the carrying value of the subdivision is written down to its then estimated fair value. For subdivisions that continue to be held-for-development, the carrying value is not written up for increases in the estimated fair value of such subdivisions in subsequent reporting periods.

Management determines the estimated fair value of each held-for-development subdivision by determining the present value of the estimated future cash flows at discount rates that are commensurate with the risk of the subdivision under evaluation. The estimated future cash flows are the same for both our recoverability and fair value assessments. Factors we consider when determining the discount rate to be used for each subdivision include, among others:

 

   

the number of lots in a given subdivision;

 

   

the amount of future land development costs to be incurred;

 

   

risks associated with the home construction process, including the stage of completion for the entire subdivision and the number of owned lots under construction;

 

   

market risks, including volatility in home prices and risks associated with markets with high average selling prices of homes; and

 

   

the estimated remaining lifespan of the subdivision.

For the year ended December 31, 2007, discount rates used in our estimated discounted cash flow assessments ranged from 10% to 18%. For our held-for-development inventory, we recorded $169.9 million and $515.6 million, respectively, of impairments to our housing completed or under construction and land and land under development during the year ended December 31, 2007. The Company allocates the impairments recorded between housing completed or under construction and land and land under development for each impaired subdivision based upon the status of construction of a home on each lot (i.e. if the lot is in housing completed or under construction, the impairment for that lot is recorded against housing completed or under construction). The allocation of impairment is the same to each lot in a given subdivision. These impairments, together with impairments of our held-for-sale inventory and intangible assets, are presented as a separate line in the Consolidated Statements of Operations. Changes in management’s estimates, particularly the timing and amount of the estimated future cash inflows and outflows, forecasted average selling prices of homes to be sold and closed and the present value discount rate used in the fair value calculation, can materially affect any impairment calculation. Because our forecasted cash flows are impacted significantly by changes in market conditions, it is reasonably possible that actual results could differ from those estimates.

Homebuilding Inventory Valuation (Held-for-Sale).  We record land held-for-sale at the lower of its carrying value or fair value less costs to sell. In accordance with SFAS 144, the classification of land as held-for-sale is based on the following criteria:

 

   

management, having the authority to approve the action, commits to a plan to sell the asset;

 

   

the asset is available for immediate sale in its present condition, subject only to terms that are usual and customary for sales of such assets;

 

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an active program to locate a buyer and other actions required to complete the plan to sell the asset have been initiated;

 

   

the sale of the asset is probable, and transfer of the asset is expected to qualify for recognition as a completed sale, within one year;

 

   

the asset is being actively marketed for sale at a price that is reasonable in relation to its current fair value; and

 

   

actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn.

Additionally, in certain circumstances, management will re-evaluate the best use of an asset that is currently being accounted for as held-for-development. In such situations, management will review, among other things: (1) average sales prices for homes that have closed, are in Backlog and forecasted for future sales; (2) current competition levels and estimated levels of competition in future reporting periods; (3) estimated development costs that have yet to be incurred; and (4) the total number of lots owned in each subdivision and surrounding areas. If, based upon this evaluation, management believes that the best use of the asset is the sale of the asset in its current condition, all or portions of the subdivision will be accounted for as held-for-sale, assuming all of the foregoing held-for-sale criteria have been met at the end of the applicable reporting period.

In performing the impairment evaluation for land accounted for on a held-for-sale basis, management considers, among other things, prices for land in recent comparable sale transactions, market analysis studies, which include the estimated price a willing buyer would pay for the land (other than in a forced liquidation) and recent bona fide offers received from outside third-parties. If the estimated fair value less cost to sell an asset is less than the current carrying value, the asset is written down to its estimated fair value less cost to sell. We monitor the fair value of held-for-sale assets on a periodic basis through the disposition date. Subsequent increases in the fair value less cost to sell of a held-for-sale asset, if any, is recognized as a decrease to impairments in our Consolidated Statements of Operations during such subsequent period, but not in excess of the cumulative impairment that was recorded previously while it was a held-for-sale asset. During the years ended December 31, 2007 and 2006, we recorded impairments on our held-for-sale inventories of $40.7 million and $2.5 million, respectively.

Income Taxes—Valuation Allowance.  In accordance with SFAS No. 109, “Accounting for Income Taxes,” 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 realization of a deferred tax asset ultimately depends on the existence of sufficient taxable income in either the carryback or carryforward periods under tax law. The four sources of taxable income to be considered in determining whether a valuation allowance is required include:

 

   

future reversals of existing taxable temporary differences (i.e., offset gross deferred tax assets against gross deferred tax liabilities);

 

   

taxable income in prior carryback years;

 

   

tax planning strategies; and

 

   

future taxable income exclusive of reversing temporary differences and carryforwards.

Determining whether a valuation allowance for deferred tax assets is necessary requires an analysis of both positive and negative evidence regarding realization of the deferred tax assets. Examples of positive evidence may include:

 

   

a strong earnings history exclusive of the loss that created the deductible temporary differences, coupled with evidence indicating that the loss is the result of an aberration rather than a continuing condition;

 

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an excess of appreciated asset value over the tax basis of a company’s net assets in an amount sufficient to realize the deferred tax asset; and

 

   

existing Backlog that will produce more than enough taxable income to realize the deferred tax asset based on existing sales prices and cost structures.

Examples of negative evidence may include:

 

   

the existence of “cumulative losses” (defined as a pre-tax cumulative loss for the current and previous two years);

 

   

an expectation of being in a cumulative loss position in a future reporting period;

 

   

a carryback or carryforward period that is so brief that it would limit the realization of tax benefits;

 

   

a history of operating loss or tax credit carryforwards expiring unused; and

 

   

unsettled circumstances that, if unfavorably resolved, would adversely affect future operations and profit levels on a continuing basis.

The weight given to the potential effect of negative and positive evidence should be commensurate with the extent to which it can be objectively verified. A company must use judgment in considering the relative impact of positive and negative evidence. At December 31, 2007, after considering a number of factors, most notably our expectation of being in a three-year cumulative operating loss position during 2008, we established a valuation allowance of $160.0 million against our deferred tax assets.

Future adjustments, either increases or decreases, to our deferred tax asset valuation allowance will be determined based upon changes in the expected realization of our net deferred tax assets. For example, the valuation allowance could change significantly if the $160.6 million of net deferred tax assets still remaining at December 31, 2007 is not realized during fiscal 2008 through federal or state carryback or reversals of existing taxable temporary differences. This could occur if actual levels of home closings and/or land sales during 2008 are less than currently projected. Additionally, our December 31, 2007 valuation allowance may be further impacted by, among other things:

 

   

additional inventory impairments;

 

   

additional pre-tax operating losses; or

 

   

the utilization of tax planning strategies that could accelerate the realization of certain deferred tax assets (for example, funding certain accrued liabilities such as employee vacation accruals or pension liabilities).

Because our valuation allowance can be impacted by any one or a combination of the foregoing factors, we do not believe it is possible to develop a sensitivity analysis associated with potential adjustments to the valuation allowance on our deferred tax assets. Additionally, due to the considerable estimates utilized in establishing the valuation allowance and the potential for changes in facts and circumstances in future reporting periods, it is reasonably possible that we will be required to either increase or decrease our valuation allowance in future reporting periods.

Income Taxes—FIN 48 (as defined below).  We apply the interpretations prescribed by FASB Interpretation No. (“FIN”) 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”) in accounting for the uncertainty in income taxes recognized in our Consolidated Financial Statements. FIN 48 provides guidance for the recognition and measurement in financial statements for uncertain tax positions taken or expected to be taken in a tax return.

 

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The evaluation of a tax position in accordance with FIN 48 is a two-step process, the first step being recognition. We determine whether it is more-likely-than-not that a tax position will be sustained upon tax examination, including resolution of any related appeals or litigation, based on only the technical merits of the position. The technical merits of a tax position derive from both statutory and judicial authority (legislation and statutes, legislative intent, regulations, rulings, and case law) and their applicability to the facts and circumstances of the tax position. If a tax position does not meet the more-likely-than-not recognition threshold, the benefit of that position is not recognized in the financial statements.

The second step is measurement. A tax position that meets the more-likely-than-not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate resolution with a taxing authority.

Revenue Recognition.  We recognize revenue from home closings and land sales in accordance with SFAS No. 66, “Accounting for Sales of Real Estate” (“SFAS 66”). Accordingly, revenue is recognized when: (1) the closing has occurred; (2) title has passed to the buyer; (3) possession and other attributes of ownership have been transferred to the buyer; (4) we are not obligated to perform significant additional activities after closing and delivery; and (5) the buyer demonstrates a commitment to pay for the property through an adequate initial and continuing investment. In accordance with SFAS 66, the buyer’s initial investment shall include: (1) cash paid as a down payment; (2) the buyer’s notes supported by irrevocable letters of credit; (3) payments made by the buyer to third-parties to reduce existing indebtedness on the property; and (4) other amounts paid by the buyer that are part of the sales value of the property. For home closings, we evaluate the initial investment for home purchase financing provided under Federal Housing Administration (“FHA”)-insured and Veterans Administration (“VA”)-guaranteed loans in accordance with Emerging Issues Task Force (“EITF”) No. 87-9, “Profit Recognition on Sales of Real Estate with Insured Mortgages or Surety Bonds,” and for all other home purchase financing in accordance with SFAS 66 and EITF No. 88-24, “Effect of Various Forms of Financing under FASB Statement No. 66.”

For home closings, if the homebuyer has sufficient initial and continuing investment, and all other revenue recognition criteria have been met, revenue is recognized using the full accrual method as provided in SFAS 66 on the date of closing. For a home closing in which HomeAmerican originates the mortgage loan and the homebuyer does not provide a sufficient initial and continuing investment, we utilize the installment method of accounting in accordance with SFAS 66. Accordingly, the corresponding Operating Profit is deferred and subsequently recognized on the date that HomeAmerican sells the homebuyer’s loan, or loans, to a third-party purchaser. We had $1.4 million and $23.1 million in deferred Operating Profits associated with homes that closed for which the initial or continuing investment criteria were not met as of December 31, 2007 and December 31, 2006, respectively. The deferral of Operating Profits is recorded as a reduction to home sales revenue in the Consolidated Statements of Operations.

In accordance with SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“SFAS 140”), a sale of a homebuyer loan has occurred when the following criteria have been met: (1) the payment from the third-party purchaser is not subject to future subordination; (2) we have transferred all the usual risks and rewards of ownership that is in substance a sale; and (3) we do not have a substantial continuing involvement with the loan. Factors that we consider in assessing whether a sale of a mortgage loan has occurred in accordance with SFAS 140 include, among other things: (1) the recourse, if any, to HomeAmerican for credit and interest rate risk; (2) the right or obligation, if any, of HomeAmerican to repurchase the loan; and (3) the control HomeAmerican retains, or is perceived to retain, over the administration of the loan post-closing.

Income with respect to loan origination fees, net of certain direct loan origination costs incurred, and loan commitment fees are deferred and amortized over the life of the loan. Revenue from the sale of mortgage loan

 

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servicing is recognized upon the exchange of consideration for the mortgage loans and related servicing rights between us and the third-party purchaser in accordance with the provisions of SFAS 140. Based upon the current terms of HomeAmerican’s contracts, exchange of consideration is deemed effective when we receive the proceeds from the third-party purchaser and when the specified records are delivered, either electronically or manually, to the third-party purchaser.

Segment Reporting.  The application of SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information” (“SFAS 131”), requires significant judgment in determining our operating segments. SFAS 131 defines operating segments as a component of an enterprise for which discrete financial information is available and is reviewed regularly by the chief operating decision-maker, or decision-making group, to evaluate performance and make operating decisions. We have identified our chief operating decision-makers (“CODMs”) as three key executives—the Chief Executive Officer, Chief Operating Officer and Chief Financial Officer.

We have identified each homebuilding subdivision as an operating segment in accordance with SFAS 131. Each homebuilding subdivision engages in business activities from which it earns revenue primarily from the sale of single-family detached homes, generally to first-time and first-time move-up homebuyers. Subdivisions in the reportable segments noted below have been aggregated because they are similar in the following regards: (1) economic characteristics; (2) housing products; (3) class of homebuyer; (4) regulatory environments; and (5) methods used to construct and sell homes. In making the determination of whether or not our markets demonstrate similar economic characteristics, we review, among other things, actual and trending Home Gross Margins for homes closed within each market and forecasted Home Gross Margins. Accordingly, we may be required to reclassify our reportable segments if markets that currently are being aggregated do not continue to demonstrate similar economic characteristics.

Our homebuilding reportable segments are as follows:

 

   

West (Arizona, California and Nevada);

   

Mountain (Colorado and Utah);

   

East (Virginia and Maryland); and

   

Other Homebuilding (Delaware Valley, Florida and Illinois)

Stock-Based Compensation.  We account for share-based payment awards, generally grants of stock options and restricted stock, in accordance with the provisions of SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123(R)”), which can require significant judgment in estimating the fair value of the share-based payment awards and related compensation. Stock-based compensation expense was $12.5 million and $16.6 million for the years ended December 31, 2007 and 2006, respectively, and was recorded to general and administrative expenses in the Consolidated Statements of Operations. See Note 14 to the Consolidated Financial Statements for a further discussion on share-based payment awards.

Determining the appropriate fair value model and calculating the fair value of share-based payment awards requires judgment, including estimating stock price volatility, annual forfeiture rates and the expected life of an award. We estimated the fair value for stock options granted during the twelve months ended December 31, 2007 and 2006 using the Black-Scholes option pricing model. The Black-Scholes option pricing model calculates the estimated fair value of stock options based upon the following inputs: (1) closing price of the Company’s common stock on the measurement date (generally the date of grant); (2) exercise price; (3) expected stock option life; (4) expected volatility; (5) risk-free interest rate; and (6) dividend yield rate. The expected volatility is based on the historical volatility in the price of our common stock over the most recent period commensurate with the estimated expected life of our employee stock options, adjusted for the impact of unusual fluctuations not reasonably expected to recur and other relevant factors. The risk-free interest rate assumption is determined based upon observed interest rates appropriate for the expected term of our employee stock options. The dividend yield assumption is based on our

 

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historical and expected dividend payouts. The expected life of employee stock options represents the weighted-average period for which the stock options are expected to remain outstanding and is derived primarily from historical exercise patterns. We determine the estimated fair value of the share-based payment awards in accordance with the provisions of SFAS 123(R) on the date they were granted. The fair values of previously granted share-based payment awards are not adjusted as subsequent changes in the foregoing assumptions occur, for example, an increase or decrease in the price of the Company’s common stock. However, changes in the foregoing inputs, particularly the price of the Company’s common stock, expected stock option life and expected volatility, significantly change the estimated fair value of future grants of stock options.

SFAS 123(R) requires an annual forfeiture rate to be estimated at the time of grant for all awards granted subsequent to January 1, 2006, and revised, if necessary, in subsequent periods if the actual forfeiture rate differs from our estimate. In accordance with SFAS 123(R), we have estimated an annual forfeiture rate to be applied to all share-based payment awards that were unvested at December 31, 2005 in determining the number of awards expected to vest in the future. We estimated the annual forfeiture rate generally to be 25% for share-based payment awards granted to Non-Executives (as defined in Note 14 to our Consolidated Financial Statements) and 0% for share-based payment awards granted to Executives and Directors (as defined in Note 14 to our Consolidated Financial Statements), based on the terms of their awards, as well as historical forfeiture experience.

Home Cost of Sales.  Home cost of sales includes the specific construction costs of each home and all applicable land acquisition, land development and related costs, both incurred and estimated to be incurred, warranty costs and finance and closing costs. We use the specific identification method for the purpose of accumulating home construction costs and an average cost method to allocate land acquisition and development costs to each home. We record all home cost of sales when a home is closed on a house-by-house basis.

When a home is closed, we generally have not yet paid and recorded all costs necessary to complete the construction of the home and certain land development costs. At the time of a home closing, we compare our home construction budgets to actual recorded costs to determine the additional costs remaining to be paid on each closed home. For amounts not incurred or paid as of the time of closing a home, we record an estimated accrual associated with certain land development and home construction costs. Generally, these accruals are established based upon contracted work for which payment has yet to be made, open work orders not paid at the time of home closing, punch list items identified during the course of the homebuyer’s final walkthrough of the home, as well as land completion costs. These accruals represent estimates believed to be adequate to cover the expected remaining home construction and land development costs. We monitor the adequacy of these accruals on a house-by-house basis and in the aggregate on both a market-by-market and consolidated basis. At December 31, 2007 and 2006, we had $42.3 million and $64.2 million, respectively, of land development and home construction accruals for closed homes. Actual results could differ from such estimates.

Warranty Costs.  Our homes are sold with limited third-party warranties. Warranty reserves are established as homes close on a house-by-house basis in an amount estimated to be adequate to cover expected costs of materials and outside labor during warranty periods. Reserves are determined based upon historical experience with respect to similar home designs and geographical areas. Certain factors are considered in determining the per-house reserve amount, including (1) the historical range of amounts paid per house; (2) the historical amount paid as a percent of home construction costs; (3) any warranty expenditures included in (1) and (2) not considered to be normal and recurring; (4) improvements in quality control and construction techniques expected to impact future warranty expenditures; and (5) conditions that may affect certain subdivisions and require higher per-house reserves for those specific subdivisions. Accordingly, the process of determining our warranty reserves balance necessarily requires estimates associated with various assumptions, each of which can positively or negatively impact the warranty reserves balance.

 

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Warranty payments are tracked on a house-by-house basis and are charged against the warranty reserve established for the house. Payments incurred after the close of a home are monitored to determine their nature and, to the extent they are warranty-related payments, they are recorded against the warranty reserve. To the extent this evaluation determines the payments made are related to completion of a home or land development, the payments are then recorded against our land development and home construction accruals. Additional reserves are established for known, unusual warranty-related expenditures not covered by the general warranty reserves. General warranty reserves not utilized for a particular house are evaluated on a monthly basis for reasonableness in the aggregate on both a market-by-market and consolidated basis. Warranty payments for an individual house may exceed the related reserve. Payments in excess of the reserve are evaluated on a monthly basis in the aggregate to determine if an adjustment to the warranty reserve should be recorded, which could result in a corresponding adjustment to home cost of sales.

Generally, warranty reserves are reviewed monthly, using historical data and other relevant information, to determine the reasonableness and adequacy of both the aggregate reserve and the per unit reserve amount originally included in home cost of sales, as well as the timing of any reversals of the original reserve. We continue to evaluate the adequacy of the warranty reserves and, based on historical results, believe that our existing estimation process is materially accurate and do not anticipate the process to change materially in the future. Because our warranty reserves can be impacted by a significant number of factors, we do not believe it is possible to develop a sensitivity analysis with a level of precision that would be meaningful to an investor. However, it is at least reasonably possible that changes to our assumptions could have a material impact on our warranty reserves balance.

Insurance Reserves.  We record expenses and liabilities for losses and loss adjustment expenses for claims associated with: (1) insurance policies issued by StarAmerican and Allegiant; (2) self-insurance; and (3) deductible amounts under the Company’s insurance policies. The establishment of the provisions for outstanding losses and loss adjustment expenses is based on actuarial studies that include known facts and interpretation of circumstances, including our experience with similar cases and historical trends involving claim payment patterns, pending levels of unpaid claims, product mix or concentration, claim severity, frequency patterns (such as those caused by natural disasters), fires or accidents, depending on the business conducted and changing regulatory and legal environments. The process of determining our insurance reserve balances necessarily requires estimates associated with various assumptions, each of which can positively or negatively impact our insurance reserve balances. Accordingly, we do not believe it is possible to develop a sensitivity analysis with a level of precision that would be meaningful to an investor. However, it is at least reasonably possible that changes in the claim rate or the average cost per claim used to estimate the self-insured reserves could have a material impact on our insurance reserve balances.

Land Option Contracts.  In the normal course of business, we enter into lot option purchase 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. Option deposits and pre-acquisition costs we incur related to our lot option purchase contracts are capitalized in accordance with SFAS No. 67, “Accounting for Costs and Initial Rental Operations of Real Estate Projects,” if all of the of the following conditions have been met: (1) the costs are directly identifiable with the specific property; (2) the costs would be capitalized if the property were already acquired; and (3) acquisition of the property is probable meaning we are actively seeking and have the ability to acquire the property and there is no indication that the property is not available for sale. We also consider the following when determining if the acquisition of the property is probable: (1) changes in market conditions subsequent to contracting for the purchase of the land; (2) current contract terms, including, per lot price and required purchase dates; and (3) our current land position in the given market or sub-market. Option deposits and capitalized pre-acquisition costs are expensed to general and administrative expense in the Consolidated Statements of Operations when we believe it is no longer probable that we will acquire the lots under option. We expensed $23.4 million, $29.7 million and $10.4 million for the years ended December 31, 2007, 2006 and 2005, respectively, related to the write-off of option deposits and

 

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capitalized pre-acquisition costs. At December 31, 2007, we had the right to acquire 3,615 lots under option contracts, with approximately $6.3 million and $6.5 million in non-refundable cash and letters of credit option deposits at risk, respectively, and $1.4 million in capitalized pre-acquisition costs.

We also evaluate these transactions in accordance with revised FIN 46, “Consolidation of Variable Interest Entities,” as amended (“FIN 46R”). Our obligation with respect to option contracts generally is limited to forfeiture of the related non-refundable cash deposits and/or letters of credit. At December 31, 2007, the total purchase price for lots under option was $419 million. Pursuant to FIN 46R, certain of these contracts could create a variable interest, with the land seller being the variable interest entity (“VIE”) and, as such, could require us to consolidate the assets and liabilities of the VIE. We have evaluated all lot option purchase contracts that were executed or had significant modifications during 2007 pursuant to FIN 46R, and considered (1) what investments were at risk; (2) contractual obligations to perform; (3) expected changes in market prices of land over a given period; and (4) annual risk free interest rates. Based on these evaluations, we determined that our interests in these VIEs did not result in significant variable interests or require us to consolidate the VIEs. Due to the nature of the assumptions used in our evaluation process, it is possible that our evaluation of lot option contracts in the future could result in MDC being identified as the primary beneficiary, which could result in our consolidation of a VIE.

Since we own no equity interest in any of the unaffiliated VIEs that we must evaluate pursuant to FIN 46R, certain assumptions about the assets and liabilities of such entities are required. In most cases, the fair values of the assets of the evaluated VIEs have been assumed to be the remaining contractual purchase price of the land or lots we are purchasing.

We periodically enter into lot option arrangements with third-parties that will purchase or have purchased property at our direction which we may later acquire. We evaluate these transactions in accordance with FIN 46R, as well as under SFAS No. 49, “Accounting for Product Financing Arrangements” (“SFAS 49”), to determine if we should record an asset and liability at the time we enter into the lot option contract. Factors considered include (1) amount of deposit at risk; (2) loss of anticipated future operating income associated with selling homes; (3) unreimbursed commitments to incur costs associated with lots; and (4) the uniqueness or location of the lots. Based upon these evaluations of lot option purchase contracts executed during 2007, we determined that no asset or liability was required to be recorded prior to the date of purchase.

 

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RESULTS OF OPERATIONS

The following discussion compares results for the year ended December 31, 2007 with the year ended December 31, 2006.

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

 

     Years Ended December 31,     2007 Increase (Decrease)
     2007     2006     Amount     %

Homebuilding

        

West

   $    (621,774 )   $      235,954     $     (857,728 )   -364%

Mountain

     (11,395 )     43,490       (54,885 )   -126%

East

     (38,748 )     104,706       (143,454 )   -137%

Other Homebuilding

     (92,251 )     (12,709 )     (79,542 )   -626%
                          

Total Homebuilding

     (764,168 )     371,441       (1,135,609 )   -306%

Financial Services and Other

     23,062       45,186       (22,124 )   -49%

Corporate

     (15,358 )     (83,490 )     68,132     82%
                          

Consolidated

   $ (756,464 )   $ 333,137     $ (1,089,601 )   -327%
                          

We recognized a loss before income taxes in our homebuilding segments during the year ended December 31, 2007, primarily resulting from: (1) asset impairments of $726.6 million; (2) significant decreases in Home Gross Margins in most of our homebuilding segments; and (3) closing fewer homes in each of our homebuilding segments during the twelve months ended December 31, 2007. Partially offsetting these items were decreases in general and administrative, commission and marketing expenses of $69.7 million, $53.2 million and $11.8 million, respectively, during 2007.

In our West segment, the loss before income taxes during 2007 primarily was due to: (1) asset impairments of $581.5 million; (2) a 1,000 basis point decrease in Home Gross Margins; and (3) closing 2,670 fewer homes. These items partially were offset by a combined decrease in general and administrative, marketing and commission expenses of $75.9 million during the year ended December 31, 2007. In our Mountain segment, the loss before income taxes during the twelve months ended December 31, 2007 primarily resulted from asset impairments of $30.1 million and closing 854 fewer homes. These items in our Mountain segment partially were offset by a combined decrease in general and administrative and commission expenses of $5.9 million.

In our East segment, we recognized losses before income taxes during 2007 primarily due to: (1) asset impairments of $42.1 million; (2) a decrease in Home Gross Margins of 1,290 basis points; and (3) closing 519 fewer homes. These items partially were offset by a combined decrease in general and administrative and commission expenses of $27.3 million during the year ended December 31, 2007. We recognized losses before income taxes during 2007 in our Other Homebuilding segment primarily resulting from: (1) asset impairments of $73.0 million; (2) closing 885 fewer homes; and (3) a decrease in Home Gross Margins of 380 basis points. These items partially were offset by a combined decrease in general and administrative, marketing and commission expenses of $26.1 million during 2007.

Income before income taxes in our Financial Services and Other segment was lower during the twelve months ended December 31, 2007 due to a combined decrease of $30.2 million in gains on sales of mortgage loans and broker origination fees. These declines partially were offset by decreases of $17.6 million in general and administrative expenses during 2007.

 

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Loss before income taxes in our Corporate segment during the year ended December 31, 2007 decreased primarily as a result of: (1) a $29.0 million increase in interest income, net; (2) $10.3 million in gains recognized on the sale of two aircraft; and (3) decreases of $24.9 million in general and administrative expense.

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

 

     Years Ended December 31,     2007 Increase (Decrease)
     2007     2006     Amount     %

Homebuilding

        

West

   $   1,725,766     $   2,871,040     $  (1,145,274 )   -40%

Mountain

     549,771       730,489       (180,718 )   -25%

East

     318,723       628,508       (309,785 )   -49%

Other Homebuilding

     253,627       493,628       (240,001 )   -49%
                          

Total Homebuilding

     2,847,887       4,723,665       (1,875,778 )   -40%

Financial Services and Other

     63,508       103,243       (39,735 )   -38%

Corporate

     41,839       1,788       40,051     N/A

Intercompany adjustments

     (19,985 )     (26,954 )     6,969     26%
                          

Consolidated

   $ 2,933,249     $ 4,801,742     $ (1,868,493 )   -39%
                          

The decrease in total revenue for our homebuilding segments during the year ended December 31, 2007 resulted from a significant decline in home sales revenue primarily due to: (1) closing a combined 4,928 fewer homes in our homebuilding segments, most notably in our West segment; and (2) decreases in the average sales price of homes closed in most of our markets. Total revenue during 2007 for our Financial Services and Other segment decreased primarily from lower gains on sales of mortgage loans, which were driven by: (1) originating significantly fewer mortgage loans as a result of the declines in our home closing levels; (2) lower Capture Rates (as defined below) during 2007; and (3) a shift to a less profitable, but risk-mitigating, strategy of selling mortgage loan products faster after origination. Total revenue in our Corporate segment improved during the twelve months ended December 31, 2007 due to an increase in interest income generated from significantly higher cash balances throughout 2007, as well as the recognized gains on sale of two aircraft.

Inter-company adjustments relate to mortgage loan origination fees paid at the time of home closings by our homebuilding subsidiaries to HomeAmerican on behalf of our homebuyers. The 2007 decrease primarily resulted from lower levels of home closings in each of our reportable segments.

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

 

     Years Ended December 31,     2007 Increase (Decrease)
      2007     2006     Amount     %

Homebuilding

        

West

     $  1,676,731     $   2,851,850     $  (1,175,119 )   -41%

Mountain

     539,692       728,135       (188,443 )   -26%

East

     317,111       624,865       (307,754 )   -49%

Other Homebuilding

     252,432       472,660       (220,228 )   -47%
                          

Total Homebuilding

     2,785,966       4,677,510       (1,891,544 )   -40%

Intercompany adjustments

     (19,985 )     (26,954 )     6,969     26%
                          

Consolidated

   $ 2,765,981     $ 4,650,556     $ (1,884,575 )   -41%
                          

In our West segment, the 2007 decrease in home sales revenue primarily resulted from closing 2,670 fewer homes, as well as lower average selling prices for homes closed in each market within this segment. Home sales

 

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revenue in our Mountain segment decreased during the year ended December 31, 2007 due to closing 854 fewer homes. This decrease partially was offset by higher average selling prices for homes closed in this segment during 2007.

The decline in home sales revenue for the year ended December 31, 2007 in our East segment primarily was due to lower average selling prices of closed homes in each market within this segment and the impact of closing 519 fewer homes. Home sales revenue in our Other Homebuilding segment decreased during 2007 primarily due to closing 885 fewer homes and lower average selling prices for homes closed in our Florida market. These items partially were offset by higher average selling prices of homes closed in our Delaware Valley market.

Land Sales Revenue.  Land sales revenue was $50.1 million and $34.6 million during the years ended December 31, 2007 and 2006, respectively. Land sales revenue during 2007 primarily related to the sale of nearly 2,000 lots in more than 20 subdivisions located primarily in California, Arizona, Nevada and Utah. The increase during 2007 primarily resulted from the continued deterioration in new home sales market that led us to the conclusion that the best use of these assets was to sell them in their current condition.

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

 

     Years Ended December 31,    2007 Increase
(Decrease)
     2007    2006    Amount     %

Gains on sales of mortgage loans, net

   $ 30,682    $ 58,262    $   (27,580 )   -47%

Broker origination fees

     7,014      9,632      (2,618 )   -27%

Insurance revenue

     17,241      25,367      (8,126 )   -32%

Interest income, net

     37,322      8,303      29,019     350%

Title and other

     24,879      15,011      9,868     66%
                        

Total other revenue

   $   117,138    $   116,575    $ 563     0%
                        

Other revenue remained relatively constant during the year ended December 31, 2007 and primarily resulted from increases in interest income, net and title and other revenue. Interest income, net increased due to our cash balances being significantly higher throughout 2007, resulting from our on-going efforts to limit inventory acquisitions during the current homebuilding down cycle. Our cash and cash equivalents consisted of funds in highly liquid, cash equivalents. Title and other revenue increased during 2007 primarily due to the sale of two aircraft, which resulted in $10.3 million in gains. These increases to other revenue partially were offset by lower gains on sales of mortgage loans as we originated fewer mortgage loans during 2007, due to MDC closing 38% fewer homes and a decline in our Capture Rate (as defined below).

 

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Home Cost of Sales.  Home cost of sales primarily includes land and construction costs, capitalized interest, closing costs and reserves for warranty, and excludes commissions, amortization of deferred marketing costs and inventory impairments. The table below sets forth the home cost of sales by reportable segment (dollars in thousands).

 

     Years Ended December 31,     2007 Increase (Decrease)
     2007     2006     Amount     %

Homebuilding

        

West

   $   1,465,437     $   2,207,255     $   (741,818 )   -34%

Mountain

     449,219       603,246       (154,027 )   -26%

East

     261,057       433,594       (172,537 )   -40%

Other Homebuilding

     224,699       402,515       (177,816 )   -44%
                          

Total Homebuilding

     2,400,412       3,646,610       (1,246,198 )   -34%

Intercompany adjustments

     (19,985 )     (26,954 )     6,969     -26%
                          

Consolidated

   $ 2,380,427     $ 3,619,656     $ (1,239,229 )   -34%
                          

The decrease in home cost of sales during the year ended December 31, 2007, primarily resulted from closing fewer homes in each of our homebuilding segments, particularly in our West segment, where we closed 34% fewer homes.

The decrease in our West segment primarily resulted from closing 2,670 fewer homes and closing homes in subdivisions for which we recorded $99.8 million of inventory impairments, as the inventory impairments resulted in lower lot cost bases and are not included in home cost of sales when initially recorded. The decrease in our Mountain segment primarily resulted from closing 854 fewer homes and the impact of closing homes in subdivisions for which we recorded $3.8 million of inventory impairments. Partially offsetting these decreases were increases in finished lot costs and home construction costs primarily due to changes in the size and style of homes being closed during 2007.

In our East segment, home cost of sales decreased primarily due to closing 519 fewer homes and the impact of closing homes in subdivisions for which we recorded $7.1 million of inventory impairments. These decreases partially were offset by increases in finished lot costs for closed homes. The decrease in home cost of sales in our Other Homebuilding segment primarily resulted from closing 885 fewer homes and the impact of closing homes in subdivisions for which we recorded $10.9 million of inventory impairments. Partially offsetting these decreases were increases in the finished lot cost and home construction costs on homes closed during 2007.

Land Cost of Sales.  Land cost of sales was $59.5 million and $33.5 million at December 31, 2007 and 2006, respectively. The 2007 increase primarily related to the sale of nearly 2,000 lots in more than 20 subdivisions located primarily in California, Arizona, Nevada and Utah. Additionally, land cost of sales during the year ended December 31, 2007 was impacted positively by our selling lots for which we previously had recorded $93.5 million of inventory impairments.

 

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Asset Impairments.  The following tables set forth, by reportable segment, the asset impairments recorded for the twelve months ended December 31, 2007 and 2006 (in thousands).

 

     Year Ended December 31,    2007 Increase  
     2007    2006    (Decrease)  

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

        

West

   $   419,471    $ 69,231    $ 350,240  

Mountain

     24,194      1,010      23,184  

East

     29,057      6,331      22,726  

Other Homebuilding

     42,832      5,265      37,567  
                      

Subtotal

     515,554      81,837      433,717  
                      

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

        

West

     135,081      20,636      114,445  

Mountain

     5,912      882      5,030  

East

     12,998      1,905      11,093  

Other Homebuilding

     15,901      1,618      14,283  
                      

Subtotal

     169,892      25,041      144,851  
                      

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

        

West

     26,942      937      26,005  

Mountain

     —        —        —    

East

     —        —        —    

Other Homebuilding

     13,765      1,600      12,165  
                      

Subtotal

     40,707      2,537      38,170  
                      

Intangible Assets

     468      2,612      (2,144 )
                      

Consolidated Asset Impairments

   $ 726,621    $   112,027    $   614,594  
                      

The impairments recorded during 2007 increased significantly for each of our reportable segments, and most notably in our West segment. For each of our segments, the impairments on our held-for-development inventory primarily resulted from decreases in home sales prices and/or increases in home sales incentives offered in an effort to: (1) remain competitive with home sales prices currently being offered by the Company’s competitors; (2) stimulate new home orders; (3) maintain homes in Backlog until they close; and (4) address affordability issues for new homes as homebuyers have been experiencing difficulty in qualifying for mortgage loans. The impairments on our held-for-development inventory in the West segment were significantly higher than impairments recorded in our other homebuilding segments. This primarily resulted from the following: (1) the fact that our owned lots and active subdivisions in our West segment comprised nearly 53% of our consolidated owned lots and active subdivisions at December 31, 2007, and 61% and 50%, respectively, at December 31, 2006, resulting in approximately 48% and 62% of our total inventory being concentrated in our West segment at December 31, 2007 and 2006, respectively; (2) competition within the sub-markets of our West segment appeared to be more pronounced than in our other homebuilding segments and, as a result, we saw significant home price reductions offered by our competitors; (3) the homebuyers in our West segment are comprised largely of entry level homebuyers, compared with a wider range of homebuyers in our other homebuilding segments, and their ability to obtain suitable mortgage loan financing has been impacted more adversely from the decreased availability of mortgage loan products; and (4) the market value of homes in Arizona, California and Nevada increased more significantly than in other segments during 2004 and 2005, in large part due to a greater number of investors purchasing homes on a speculative basis, resulting in the values of homes in these markets being susceptible to greater declines, due to, among other factors, the exit of investors from the new home sales market. Consequently, a majority of the active subdivisions within each market of our West segment were impaired during 2007.

 

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During 2007, we recorded impairments of $40.7 million on our held-for-sale inventory. These impairments primarily relate to inventory in the California market of our West segment and the Florida market of our Other Homebuilding segment. The impairments in our West segment relate to approximately 400 lots in 6 subdivisions and primarily resulted from a deterioration in related market conditions that led us to the conclusion that the best use of these assets is to sell them in their current condition. The impairments recorded in our Other Homebuilding segment primarily relate to assets in our Tampa sub-market, which we are in the process of exiting.

The following table sets forth the inventory impairments that were recorded on a quarterly basis during 2007 and 2006, as well as the fair value of those inventories and the number of lots and subdivisions at the period end to which the impairments relate (dollars in thousands). The inventory impairments that we recorded during 2007 and 2006 related primarily to inventories that were contracted for in 2004 and 2005.

 

     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
Impaired
During the
Quarter
     Held-for-
Development
   Held-for-Sale    Total
Inventory
Impairments
        

March 31, 2007

   $ 136,422    $ 5,000    $ 141,422    $ 381,117    3,284    52

June 30, 2007

     158,642      2,408      161,050      448,372    4,427    83

September 30, 2007

     242,782      6,168      248,950      873,038    7,074    132

December 31, 2007

     147,600      27,131      174,731      397,045    4,891    153
                             

Consolidated

   $ 685,446    $ 40,707    $ 726,153         
                             

March 31, 2006

   $    $ 600    $ 600    $ 16,394    301    6

June 30, 2006 .

          260      260      2,457    11    1

September 30, 2006

     19,175      740      19,915      86,125    399    13

December 31, 2006

     87,703      937      88,640      353,758    2,287    52
                             

Consolidated

   $ 106,878    $ 2,537    $ 109,415         
                             

Marketing Expenses.   The following table summarizes our marketing expenses by reportable segment (in thousands).

 

     Year Ended December 31,    2007 Increase (Decrease)
     2007    2006    Amount     %

Homebuilding

          

West

   $         70,539    $         77,572    $           (7,033 )   -9%

Mountain

     21,019      20,739      280     1%

East

     13,395      13,045      350     3%

Other Homebuilding

     12,135      17,500      (5,365 )   -31%
                        

Consolidated

   $ 117,088    $ 128,856    $ (11,768 )   -9%
                        

Marketing expenses primarily include advertising, amortization of deferred marketing costs, model home expenses, compensation related expenses and other selling costs. Marketing expenses were lower in both our West and Other Homebuilding segments during 2007, primarily resulting from decreases of $3.3 million and $2.5 million, respectively, in advertising costs as we modified our marketing approach by shifting to lower cost advertising methods, and decreases of $5.2 million and $1.3 million, respectively, in amortization of deferred marketing costs resulting from closing fewer homes in each of these segments.

 

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Commission Expenses.   The following table summarizes our commission expenses by reportable segment (in thousands).

 

     Year Ended December 31,    2007 Increase (Decrease)
     2007    2006    Amount     %

Homebuilding

          

West

   $         59,890    $         90,457    $         (30,567 )   -34%

Mountain

     18,925      23,784      (4,859 )   -20%

East

     10,358      19,646      (9,288 )   -47%

Other Homebuilding

     8,778      17,221      (8,443 )   -49%
                        

Consolidated

   $ 97,951    $ 151,108    $ (53,157 )   -35%
                        

Commission expenses primarily include direct incremental commissions paid for closed homes. Commission expenses within each of our homebuilding segments decreased during 2007, primarily resulting from declines in commission fees paid to both in-house and outside brokers for each segment. These decreases primarily were due to a corresponding decline of 41% in home sales revenue and were slightly offset by increases in the commission rates paid to outside brokers.

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

 

     Year Ended December 31,    2007 Increase (Decrease)
     2007    2006    Amount     %

Homebuilding

          

West

   $       117,743    $       156,062    $         (38,319 )   -25%

Mountain

     35,855      36,862      (1,007 )   -3%

East

     29,781      47,819      (18,038 )   -38%

Other Homebuilding

     27,076      39,386      (12,310 )   -31%
                        

Total Homebuilding

     210,455      280,129      (69,674 )   -25%

Financial Services and Other

     40,445      58,059      (17,614 )   -30%

Corporate

     55,815      80,691      (24,876 )   -31%
                        

Consolidated

   $ 306,715    $ 418,879    $ (112,164 )   -27%
                        

General and administrative expenses for each of our homebuilding segments decreased during the year ended December 31, 2007. These reduced expenses resulted from various initiatives associated with right-sizing our operations in response to the reduced levels of homebuilding activity in each of our markets, including consolidating a number of our homebuilding divisions and reducing employee headcount. Through these efforts, we have reduced our homebuilding divisions to 12 as of December 31, 2007 from 27 and 23 at December 31, 2005 and 2006, respectively, allowing us to consolidate office space in many of our markets. Additionally, our employee headcount has decreased throughout 2007 to approximately 2,200 at December 31, 2007, from a peak of approximately 4,200 at December 31, 2005 and approximately 3,200 at December 31, 2006.

The 2007 decrease in general and administrative expenses for the homebuilding segments was most notable within the West segment, which primarily resulted from the following decreases: (1) $28.2 million in employee compensation and other employee-related benefit costs; (2) $9.8 million of inter-company supervisory fees (“Supervisory Fees”); and (3) $7.8 million in write-offs of pre-acquisition costs and deposits on lot option contracts that we elected not to exercise. These items partially were offset by approximately $5.8 million in restructuring expenses incurred in 2007 in connection with consolidating 12 divisions to four at December 31, 2006 and 2007, respectively. General and administrative expenses decreased during 2007 in our East segment primarily due to:

 

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(1) decreases of $12.6 million in employee compensation and other employee-related benefit costs, as we lowered our headcount throughout 2007 by 33% from December 31, 2006 in this segment; and (2) a combined decrease of $2.6 million in depreciation and amortization and write-offs of pre-acquisition costs and deposits on lot option contracts that we elected not to exercise.

General and administrative expenses in our Other Homebuilding segment was lower during 2007, resulting primarily from decreases of: (1) $7.5 million in employee compensation and other employee-related benefit costs, as we lowered our headcount throughout 2007 by 39% from December 31, 2006 in this segment; (2) $3.0 million in depreciation and amortization of our long-lived and intangible assets; and (3) $2.1 million in Supervisory Fees. In our Mountain segment, general and administrative expenses decreased slightly due to lower employee compensation and other employee-related benefit costs, as we decreased our headcount throughout 2007 by 25% from December 31, 2006 in this segment, partially offset by a $2.3 million increase in write-offs of pre-acquisition costs and deposits on lot option contracts that we elected not to exercise.

In our Financial Services and Other segment, general and administrative expenses declined during the year ended December 31, 2007, primarily due to decreases in: (1) compensation-related costs of approximately $9.4 million, as we reduced our employee headcount for this segment during 2007 by 33% from December 31, 2006; and (2) insurance premium expenses of $9.3 million.

In our Corporate segment, general and administrative expenses decreased during the twelve months ended December 31, 2007, primarily resulting from decreases of: (1) $15.1 million in executive bonuses; (2) $15.0 million in employee compensation and other employee benefit-related costs, as we reduced the headcount of our Corporate segment throughout 2007 by approximately 31% during 2007; and (3) $3.6 million associated with stock-based compensation expense, also due in part to fewer Corporate employees and a decrease in the fair market value of stock-options granted during 2007, compared with 2006. These items partially were offset by a $12.0 million decrease in Supervisory Fees. See Note 3 to our Consolidated Financial Statements regarding Supervisory Fees.

Related Party Expenses.   Related party expenses were $1.4 million and $4.6 million for the years ended December 31, 2007 and 2006, respectively, and primarily relate to contributions we made or pledged to the MDC/Richmond American Homes Foundation (the “Foundation”). We committed to contributing $1.0 million and $3.3 million in the form of MDC common stock for 2007 and 2006, respectively, to the Foundation.

The Foundation is a nonprofit organization operated exclusively for charitable, educational and other purposes beneficial to social welfare within the meaning of section 501(c)(3) of the Internal Revenue Code (“I.R.C.”). Certain directors and officers of the Company are the trustees and officers of the Foundation. The Foundation takes action with respect to shares held by it, including the voting of such shares, by majority vote of at least three members of the board of trustees and, accordingly, none of the trustees should be deemed to beneficially own such shares.

Income Taxes.   Our overall effective income tax rates were 15.8% and 35.7% for the years ended December 31, 2007 and 2006, respectively. The decrease in our effective tax rate during 2007 resulted primarily from recording a $160.0 million valuation allowance against our deferred tax assets, as well as the impact of reductions in the benefits from I.R.C. Section 199, “Income Attributable to Domestic Production Activities,” (“Section 199”) deduction and an increase in permanent differences primarily related to accruals for non-deductible excess compensation under I.R.C. Section 162(m), “Certain Excessive Employee Remuneration.”

The following discussion compares results for the year ended December 31, 2006 with the year ended December 31, 2005.

 

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

 

     Year Ended December 31,     2006 Increase (Decrease)
     2006     2005     Amount     %

Homebuilding

        

West

   $      235,954     $      611,603     $    (375,649 )   -61%

Mountain

     43,490       70,348       (26,858 )   -38%

East

     104,706       203,853       (99,147 )   -49%

Other Homebuilding

     (12,709 )     6,538       (19,247 )   -294%
                          

Total Homebuilding

     371,441       892,342       (520,901 )   -58%

Financial Services and Other

     45,186       34,964       10,222     29%

Corporate

     (83,490 )     (118,543 )     35,053     -30%
                          

Consolidated

   $ 333,137     $ 808,763     $ (475,626 )   -59%
                          

Income before income taxes in our homebuilding segments decreased during 2006, primarily resulting from: (1) significant decreases in Home Gross Margins in each homebuilding segment; (2) closing fewer homes during 2006 in each homebuilding segment; and (3) increases in marketing, commissions and general and administrative expenses in each homebuilding segment except for our Mountain segment. Additionally, during 2006 we incurred asset impairments in our West, Mountain, East and Other Homebuilding segments of $90.8 million, $1.9 million, $8.2 million and $11.1 million, respectively. We did not have any asset impairments during 2005. These decreases partially were offset by higher average selling prices for homes closed in each of our homebuilding segments.

Income before income taxes in our Financial Services and Other segment was $10.2 million higher during 2006, compared with 2005, primarily due to higher gains on sales of mortgage loans. Additionally, the loss before income taxes in our Corporate segment decreased $35.1 million during the year ended December 31, 2006, compared with 2005, primarily resulting from lower general and administrative expenses.

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

 

     Year Ended December 31,     2006 Increase (Decrease)
     2006     2005     Amount     %

Homebuilding

        

West

   $   2,871,040     $   2,833,398     $        37,642     1%

Mountain

     730,489       834,270       (103,781 )   -12%

East

     628,508       732,132       (103,624 )   -14%

Other Homebuilding

     493,628       413,628       80,000     19%
                          

Total Homebuilding

     4,723,665       4,813,428       (89,763 )   -2%

Financial Services and Other

     103,243       87,849       15,394     18%

Corporate

     1,788       1,487       301     20%

Intercompany adjustments

     (26,954 )     (10,175 )     (16,779 )   165%
                          

Consolidated

   $ 4,801,742     $ 4,892,589     $ (90,847 )   -2%
                          

The increase in total revenue for our West and Other Homebuilding segments, resulted from increases in home sales revenue primarily due to increases in the average selling prices of closed homes in each market within the West segment and most markets within the Other Homebuilding segment, partially offset by closing 892 and 311 fewer homes, respectively, during 2006. Additionally, we sold certain land in Texas, as we continued to exit this market

 

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during 2006, and in Arizona, which resulted in increased land sales revenue in these two segments. Total revenue in our Mountain and East segments decreased primarily due to lower home sales revenue, primarily resulting from closing fewer homes and was partially offset by increases in the average selling prices of closed homes in each market within these segments.

Total revenue in our Financial Services and Other segment increased $15.4 million during 2006, resulting from an increase in the dollar volume of mortgage loan originations and mortgage loans sold during 2006.

During 2006, our homebuilding subsidiaries paid more mortgage loan origination fees on behalf of our homebuyers as a means of increasing incentives, resulting in the higher intercompany adjustments.

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

 

     Years Ended December 31,     2006 Increase (Decrease)
     2006     2005     Amount     %

Homebuilding

        

West

   $   2,851,850     $   2,828,424     $ 23,426     1%

Mountain

     728,135       831,538       (103,403 )   -12%

East

     624,865       730,884       (106,019 )   -15%

Other Homebuilding

     472,660       412,029       60,631     15%
                          

Total Homebuilding

     4,677,510       4,802,875       (125,365 )   -3%

Intercompany adjustments

     (26,954 )     (10,175 )     (16,779 )   165%
                          

Consolidated

   $ 4,650,556     $ 4,792,700     $    (142,144 )   -3%
                          

Home sales revenue in our West segment increased slightly during 2006, primarily resulting from a $67,400 increase in the average selling price of closed homes in Arizona. Also contributing to the increase were moderately higher average selling prices of closed homes in California and Nevada. These improvements partially were offset by closing 10% fewer homes in this segment during 2006. Home sales revenue decreased in our Mountain segment during 2006 as a result of closing 727 fewer homes in Colorado. This decrease partially was offset by increases in the average selling prices of closed homes in each market within the Mountain segment and a slight increase in the number of homes we closed in our Utah market.

Home sales revenue in our East segment decreased $106.0 million during the year ended December 31, 2006, primarily as a result of closing 319 fewer homes in Virginia during 2006. This decrease partially was offset by increases in the average selling price of closed homes and the number of homes we closed in Maryland of 16% and 12%, respectively. The increase in our Other Homebuilding segment primarily was due to an increase in the average selling price of closed homes in each market within the segment except for Illinois, which more than offset closing 311 fewer homes within this segment during 2006.

Land Sales Revenue.   Land sales revenue was $34.6 million and $3.0 million for the years ended December 31, 2006 and 2005, respectively. The increase in 2006 primarily resulted from the sale of land in our Texas market, as we continued to exit this market during 2006, and the sale of certain land in Arizona.

 

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

 

     Years Ended December 31,    2006 Increase (Decrease)
     2006    2005    Amount     %

Gains on sales of mortgage loans, net

   $ 58,262    $        42,919    $        15,343     36%

Broker origination fees

     9,632      12,478      (2,846 )   -23%

Insurance revenue

     25,367      21,956      3,411     16%

Interest income, net

     8,303      4,650      3,653     79%

Title and other

     15,011      14,891      120     1%
                        

Total other revenue

   $      116,575    $ 96,894    $ 19,681     20%
                        

Other revenue increased $19.7 million during the year ended December 31, 2006, primarily due to a $15.3 million increase in gains on the sales of mortgage loans, net. Increased dollar volumes of mortgage loan originations and mortgage loans sold during 2006 drove the higher gains. We achieved these increased volumes by improving our mortgage Capture Rate, largely as a result of expanding the mortgage loan products that HomeAmerican could originate during 2006 directly for our homebuyers, increases in the average loan amounts in connection with our higher 2006 average selling prices of closed homes and incentives offered to more of our homebuyers during 2006, for using HomeAmerican mortgage products.

Insurance revenue consists primarily of insurance policy premiums Allegiant receives from its policyholders and commission revenue received by American Home Insurance. The 2006 increase primarily resulted from premium rate increases.

Title and other revenue primarily consist of revenue from American Home Title and the forfeiture of homebuyer deposits upon the cancellation of home sales contracts. The increase during 2006 primarily was due to an increase in forfeited deposits resulting from our higher Cancellation Rate during 2006, partially offset by a decrease in revenue from American Home Title.

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

 

     Years Ended December 31,     2006 Increase (Decrease)
     2006     2005     Amount     %

Homebuilding

        

West

   $   2,207,255     $   1,969,608     $      237,647     12%

Mountain

     603,246       676,392       (73,146 )   -11%

East

     433,594       458,601       (25,007 )   -5%

Other Homebuilding

     402,515       341,609       60,906     18%
                          

Total Homebuilding

     3,646,610       3,446,210       200,400     6%

Intercompany adjustments

     (26,954 )     (10,175 )     (16,779 )   165%
                          

Consolidated

   $ 3,619,656     $ 3,436,035     $ 183,621     5%
                          

Home cost of sales increased $183.6 million, or 5%, during 2006, compared with 2005. This increase primarily was due to (1) higher land costs per home closed, as more of the lots we closed homes on during 2006 were purchased in the higher priced 2005 period; (2) building larger homes; and (3) more options and upgrades provided as incentives to our homebuyers. These increases more than offset the impact of closing 14% fewer homes during 2006, compared with 2005, and lower commodity costs and subcontractors fees incurred when building our homes.

 

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Asset Impairments.  The following table sets forth by homebuilding segment the 2006 asset impairments (dollars in thousands). We did not have any impairments during 2005.

 

West

   $ 90,802

Mountain

     1,891

East

     8,236

Other Homebuilding

     11,098
      

Consolidated

   $      112,027
      

These impairments primarily were associated with nearly 2,500 owned lots in 57 subdivisions, which were accounted for on a held-for-development basis, across all homebuilding segments. The impairments recorded in the West segment related to subdivisions in each market within the segment, most notably in California, which accounted for $60.3 million of the total impairment in the West segment. Impairments recorded in our Mountain and East segments primarily related to subdivisions in our Colorado and Virginia markets, respectively. Additionally, the impairments we recorded in our Other Homebuilding segment primarily related to subdivisions in our Florida and Delaware Valley markets. These impairments, which relate to assets primarily contracted for during 2004 and 2005, were the result of continued slow sales paces and significant increases in the level of incentives offered to generate net home orders and maintain homes in Backlog until closing.

Marketing Expenses.  The following table summarizes our marketing expenses by reportable segment (in thousands).

 

     Year Ended December 31,    2006 Increase (Decrease)
     2006    2005    Amount     %

Homebuilding

          

West

   $        77,572    $        58,578    $       18,994     32%

Mountain

     20,739      22,745      (2,006 )   -9%

East

     13,045      10,222      2,823     28%

Other Homebuilding

     17,500      14,470      3,030     21%
                        

Consolidated

   $ 128,856    $ 106,015    $ 22,841     22%
                        

The increase in marketing expenses during 2006 for our West segment primarily was attributable to increases of: (1) $10.1 million in advertising expenses incurred in an effort to generate homebuyer traffic in our subdivisions; (2) $3.6 million in sales office expenses associated with the increase in our active subdivisions and model homes from 2005; and (3) $2.5 million in salaries and benefits as this segment implemented an initiative that required two full-time sales personnel for each subdivision, compared with one full-time sales personnel and one who is assigned to multiple subdivisions Marketing expenses were higher during 2006 in our East and Other Homebuilding segments, primarily resulting from increases in advertising expenses of $1.6 million and $2.0 million, respectively, in an effort to generate homebuyer traffic. In our Mountain segment, marketing expenses decreased, primarily due to a decline of $1.4 million in amortization of deferred marketing costs, as we closed 709 fewer home during 2006, and $1.0 million decreases in salaries and benefits as a result of consolidating three Denver metro divisions into two Denver metro divisions and an overall reduction in sales personnel in response to fewer new home orders.

 

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Commission Expenses.  The following table summarizes our commission expenses by reportable segment (in thousands).

 

     Year Ended December 31,    2006 Increase (Decrease)
     2006    2005    Amount     %

Homebuilding

          

West

   $        90,457    $        68,491    $        21,966     32%

Mountain

     23,784      25,114      (1,330 )   -5%

East

     19,646      21,070      (1,424 )   -7%

Other Homebuilding

     17,221      15,632      1,589     10%
                        

Consolidated

   $ 151,108    $ 130,307    $ 20,801     16%
                        

Commission expenses was higher during 2006 in our West segment, primarily resulting from a practice initiated during 2006 of paying outside brokers a significantly higher commission rate, generally 6% during 2006, compared with 3% during 2005, in response to more competitive markets, as well as higher outside and in-house commissions resulting from increases in the average selling prices of homes closed during 2006. These increases partially were offset as a result of closing 892 fewer homes during 2006. Commission expenses decreased in both our Mountain and East segment due to closing 709 and 272 fewer homes, respectively, during 2006, partially offset by increases to outside and in-house commissions resulting from increases in the average selling prices of homes closed during 2006 and higher commission rates. In our Other Homebuilding segment, commission expenses increased due to higher rates paid to outside brokers and increased outside and in-house commissions resulting from higher average selling prices of closed homes in our Delaware Valley and Florida markets. These increases partially were offset by the impact of closing 311 fewer homes during 2006.

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

 

     Year Ended December 31,    2007 Increase (Decrease)
     2006    2005    Amount     %

Homebuilding

          

West

   $      156,062    $      125,119    $        30,943     25%

Mountain

     36,862      38,583      (1,721 )   -4%

East

     47,819      38,382      9,437     25%

Other Homebuilding

     39,386      34,611      4,775     14%
                        

Total Homebuilding

     280,129      236,695      43,434     18%

Financial Services and Other

     58,059      52,883      5,176     10%

Corporate

     80,691      111,606      (30,915 )   -28%
                        

Consolidated

   $ 418,879    $ 401,184    $ 17,695     4%
                        

General and administrative expenses for our West segment rose in 2006, primarily resulting from increases of (1) $12.0 million in write-offs of pre-acquisition costs and deposits on lot option contracts that we elected not to exercise; (2) $6.8 million in Supervisory Fees; (3) $3.1 million in facility lease payments, as we expanded our Home Gallery locations and incurred a full year’s rent expense associated with our Inland Empire division, which was formed during 2005; (4) $2.1 million in depreciation and stock-based compensation; and (5) $4.4 million in legal related expenses. The increase in general and administrative expenses in our East segment primarily is attributable to increases of $5.1 million in write-offs of pre-acquisition costs and deposits on lot option contracts that we elected not to exercise, $2.1 million in facility lease payments, and $1.4 million in deprecation and stock-based compensation

 

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expense. In our Other Homebuilding segment, general and administrative expenses increased during 2006, primarily due to a $4.6 million increase in other general and administrative expenses and a $1.4 million increase in depreciation and stock-based compensation expense. Theses increases partially were offset by a decrease of $1.1 million in write-offs of pre-acquisition costs and deposits on lot option contracts that we elected not to exercise.

The increases in general and administrative expenses for these segments partially were offset by a decrease in our Mountain segment. This decline, primarily resulted from a decrease of $2.9 million in compensation and benefit-related costs, as we consolidated three Denver metro divisions into two divisions and reduced employee headcount in response to fewer home orders and closings in Colorado, partially offset by a $0.9 million increase in Supervisory Fees.

General and administrative expenses in our Financial Services and Other segment increased $5.2 million during the year ended December 31, 2006, primarily due to a $4.7 million increase in insurance claim expenses resulting from actuarial adjustments in our insurance reserves.

Corporate general and administrative expenses decreased by $30.9 million, primarily attributable to: (1) a $21.8 million decrease in executive bonuses, including amounts paid pursuant to the Company’s executive bonus plan and discretionary bonuses; (2) a $7.0 million decrease in salaries and non-executive bonuses, as we reduced our employee headcount in response to the downturn in the homebuilding industry; and (3) an increase of $8.7 million in Supervisory Fees charged to the homebuilding segments and the Financial Services and Other segment. The cost reductions more than offset the impact of the adoption of SFAS 123(R) in January 2006, which resulted in $14.8 in stock-based compensation expense associated with stock options during 2006.

Related Party Expenses.  Related party expenses were $4.6 million and $8.4 million for the years ended December 31, 2006 and 2005, respectively, and primarily relate to contributions we made to the Foundation. We contributed $3.3 million and $8.1 million in the form of MDC common stock for 2006 and 2005, respectively, to the Foundation.

Income Taxes.  Our overall effective income tax rates were 35.7% and 37.5% for the years ended December 31, 2006 and 2005, respectively. The decrease in our effective tax rate during 2006 primarily was due to the reversal of previously accrued taxes and the increased benefit resulting from the Section 199 deduction. These decreases to our effective tax rate reduced our income tax expense for 2006 by approximately $6.0 million.

 

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Homebuilding Operating Activities—2007 Compared With 2006 (dollars in thousands).

The table below sets forth information relating to orders for homes.

 

     Year Ended December 31,    2007 Increase (Decrease)
     2007    2006    Amount     %

Orders For Homes, net (Units)

          

Arizona

     1,889      2,758      (869 )   -32%

California

     912      1,450      (538 )   -37%

Nevada

     1,282      2,048      (766 )   -37%
                        

West

     4,083      6,256      (2,173 )   -35%
                        

Colorado

     778      1,139      (361 )   -32%

Utah

     426      1,049      (623 )   -59%
                        

Mountain

     1,204      2,188      (984 )   -45%
                        

Maryland

     227      380      (153 )   -40%

Virginia

     308      462      (154 )   -33%
                        

East

     535      842      (307 )   -36%
                        

Delaware Valley

     116      138      (22 )   -16%

Florida

     424      519      (95 )   -18%

Illinois

     128      117      11     9%

Texas

     14      169      (155 )   -92%
                        

Other Homebuilding

     682      943      (261 )   -28%
                        

Total

     6,504      10,229      (3,725 )   -36%
                        

Estimated Value of Orders for Homes, net

   $   2,107,000    $   3,467,000    $  (1,360,000 )   -39%
                        

Estimated Average Selling Price of Orders for Homes, net

   $ 324.0    $ 338.9    $ (14.9 )   -4%
                        

Cancellation Rate

     48%      43%      5%    

Orders for Homes.  Most of our homebuilding segments experienced declines in net home orders during the year ended December 31, 2007. Net home orders in each of our markets were impacted adversely by the overall deterioration in the homebuilding market. Factors which contributed to this market decline in each of our homebuilding segments have been outlined in the Executive Summary section of this Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (“Item 7”) The 2007 decrease in our total new home orders was driven in large part by fewer net home orders in our West segment, as this market experienced the highest decrease in units sold, primarily resulting from our concentration within the markets of this segment. Additionally, our Utah market experienced a higher percentage decrease in 2007 than in our other markets as the demand for new home orders in Utah reached its peak during 2006.

Cancellation Rate.  We define our home order “Cancellation Rate” as the approximate number of cancelled home order contracts during a reporting period as a percent of total home order contracts received during such reporting period. The Cancellation Rate was 48% on a consolidated basis, as well as for each of our homebuilding segments. The Cancellation Rate increased during the year ended December 31, 2007 for the Company as a whole and in each of our reportable segments, primarily resulting from: (1) certain mortgage loan products no longer being available; (2) homebuyers having difficulty in qualifying for available mortgage loan

 

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

Home Gross Margins.  We define “Home Gross Margins” to mean home sales revenue less home cost of sales (which primarily includes land and construction costs, capitalized interest, closing costs, and reserves for warranty expenses, and excludes commissions, amortization of deferred marketing costs and impairment charges) as a percent of home sales revenue. Accordingly, refer to explanations associated with home sales revenue and home cost of sales in Item 7 for purposes of understanding the changes in our 2007 Home Gross Margins. The following table sets forth our Home Gross Margins by reportable segment.

 

     Year Ended December 31,    2007
(Decrease)
     2007    2006   

West

           12.6%            22.6%            -10.0%

Mountain

   16.8%    17.2%    -0.4%

East

   17.7%    30.6%    -12.9%

Other Homebuilding

   11.0%    14.8%    -3.8%
              

Total

   13.9%    22.2%    -8.3%
              

Our Home Gross Margins in all of our homebuilding reportable segments were impacted negatively by significantly higher sales incentives offered to our homebuyers, and higher land and construction costs as a percentage of home sales revenue, partially offset by recognizing $23.1 million in Operating Profits that had been deferred under SFAS 66 at December 31,2006, less $1.4 million in Operating Profits deferred at December 31, 2007.

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

 

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

 

     Year Ended December 31,    2007 Increase (Decrease)
     2007    2006    Amount     %

Arizona

   2,801    3,353    (552 )   -16%

California

   1,136    1,788    (652 )   -36%

Nevada

   1,290    2,756    (1,466 )   -53%
                  

West

   5,227    7,897    (2,670 )   -34%
                  

Colorado

   818    1,463    (645 )   -44%

Utah

   713    922    (209 )   -23%
                  

Mountain

   1,531    2,385    (854 )   -36%
                  

Maryland

   288    444    (156 )   -35%

Virginia

   344    707    (363 )   -51%
                  

East

   632    1,151    (519 )   -45%
                  

Delaware Valley

   178    200    (22 )   -11%

Florida

   496    921    (425 )   -46%

Illinois

   105    174    (69 )   -40%

Texas

   26    395    (369 )   -93%
                  

Other Homebuilding

   805    1,690    (885 )   -52%
                  

Total

              8,195             13,123              (4,928 )   -38%
                  

Our home closings were down during the year ended December 31, 2007 in each market of our homebuilding segments, primarily due to significantly lower Backlogs at the beginning of 2007, compared with the beginning of 2006. These declines in Backlogs primarily resulted from decreases in new home orders during the second half of 2007, compared with the second half of 2006, partially as a result of homebuyer concerns about declines in the market value of homes and the lack of stabilization in home sales prices, as well as increases in the number of home order cancellations.

 

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Backlog.  The following table sets forth information relating to Backlog within each market of our homebuilding segments.

 

     December 31,    2007 Increase (Decrease)
     2007    2006    Amount     %

Arizona

     592      1,504      (912 )   -61%

California

     203      427      (224 )   -52%

Nevada

     307      315      (8 )   -3%
                        

West

     1,102      2,246      (1,144 )   -51%
                        

Colorado

     213      253      (40 )   -16%

Utah

     178      465      (287 )   -62%
                        

Mountain

     391      718      (327 )   -46%
                        

Maryland

     126      187      (61 )   -33%

Virginia

     100      136      (36 )   -26%
                        

East

     226      323      (97 )   -30%
                        

Delaware Valley

     57      119      (62 )   -52%

Florida

     125      197      (72 )   -37%

Illinois

     46      23      23     100%

Texas

     -      12      (12 )   -100%
                        

Other Homebuilding

     228      351      (123 )   -35%
                        

Total

     1,947      3,638      (1,691 )   -46%
                        

Backlog Estimated Sales Value

   $      650,000    $   1,300,000    $    (650,000 )   -50%
                        

Estimated Average Selling Price of

          

Homes in Backlog

   $ 333.8    $ 357.3    $ (23.5 )   -7%
                        

We define “Backlog” as homes under contract but not yet delivered. Our Backlog at December 31, 2007 decreased from levels at December 31, 2006 in each of our homebuilding segments and in most markets of these segments. Contributing to the decrease in Backlog at December 31, 2007 were declines in net home orders during the last six months of 2007, compared with the last six months of 2006 in most markets within each homebuilding segment and most markets within these segments. The decrease in Backlog at December 31, 2007 was most notable in our West segment, where Backlog declined by a combined 1,136 units from December 31, 2006 in Arizona and California. Backlog for Nevada at December 31, 2007 remained flat, compared with December 31, 2006, primarily due to sales incentives introduced in November and December of 2007, resulting in a significant number of new home orders received.

Estimated Backlog sales value at December 31, 2007 decreased from December 31, 2006, primarily resulting from a 46% decrease in the number of homes in Backlog and a 7% decrease in the estimated average sales price of homes in Backlog. The decline in the estimated average sales price of homes in Backlog is consistent with the decrease in the average selling prices of homes closed during 2007, which were impacted by the factors contributing to the downturn in the homebuilding industry, as further discussed in the Executive Summary section of this Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

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

 

     Year Ended December 31,    2007 Increase (Decrease)
     2007    2006    Amount     %

Arizona

   $         247.4    $         294.6    $          (47.2 )     -16%

California

     516.5      558.7      (42.2 )   -8%

Colorado

     346.3      308.7      37.6     12%

Delaware Valley

     448.8      405.7      43.1     11%

Florida

     261.5      284.8      (23.3 )   -8%

Illinois

     372.4      367.5      4.9     1%

Maryland

     515.2      558.0      (42.8 )   -8%

Nevada

     296.2      317.5      (21.3 )   -7%

Texas

     129.6      165.9      (36.3 )   -22%

Utah

     355.5      303.3      52.2     17%

Virginia

     480.4      536.3      (55.9 )   -10%

Total

   $ 337.5    $ 354.4    $ (16.9 )   -5%

The average selling price of homes closed for the Company decreased during the year ended December 31, 2007, with the declines being most notable for each market within our West and East segments. These decreases resulted in part from increased levels of incentives and reductions in sales prices required to close homes in response to lower demand for new homes and increased levels of competition in these markets. Additionally, during the year ended December 31, 2007, we experienced increases in the number of home order cancellations, which resulted in these homes being resold and closed as speculative homes, generally with lower prices or higher incentives. We experienced increases in average selling prices in our Delaware Valley, Colorado, Utah and Illinois markets during the year ended December 31, 2007, primarily related to changes in the style and size of our single-family detached homes that were closed during these periods. Also contributing to the higher average selling prices of homes closed in Utah was our ability to raise home sales prices due to the higher demand for new homes in the second half of 2006, compared with the same period during 2005.

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

 

     Year Ended December 31,    2007 Increase (Decrease)
     2007    2006    Amount     %

Arizona

                      66                        67                        (1 )   -1%

California

   41    45    (4 )   -9%

Nevada

   39    41    (2 )   -5%
                  

West

   146    153    (7 )   -5%
                  

Colorado

   47    47    -     0%

Utah

   23    22    1     5%
                  

Mountain

   70    69    1     1%
                  

Maryland

   15    19    (4 )   -21%

Virginia

   18    19    (1 )   -5%
                  

East

   33    38    (5 )   -13%
                  

Delaware Valley

   4    8    (4 )   -50%

Florida

   20    30    (10 )   -33%

Illinois

   5    6    (1 )   -17%

Texas

   -    2    (2 )   -100%
                  

Other Homebuilding

   29    46    (17 )   -37%
                  

Total

   278    306    (28 )   -9%
                  

 

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

 

     December 31,    2007 Increase (Decrease)
     2007    2006    Amount     %

Arizona

   $          96,631    $        284,407    $       (187,776 )   -66%

California

     35,305      391,170      (355,865 )   -91%

Nevada

     94,685      305,089      (210,404 )   -69%
                        

West

     226,621      980,666      (754,045 )   -77%
                        

Colorado

     131,962      191,456      (59,494 )   -31%

Utah

     74,021      90,607      (16,586 )   -18%
                        

Mountain

     205,983      282,063      (76,080 )   -27%
                        

Maryland

     33,339      76,981      (43,642 )   -57%

Virginia

     53,779      108,646      (54,867 )   -51%
                        

East

     87,118      185,627      (98,509 )   -53%
                        

Delaware Valley

     13,232      29,345      (16,113 )   -55%

Florida

     12,548      74,149      (61,601 )   -83%

Illinois

     8,834      23,105      (14,271 )   -62%

Texas

     -      203      (203 )   -100%
                        

Other Homebuilding

     34,614      126,802      (92,188 )   -73%
                        

Total

   $ 554,336    $ 1,575,158    $ (1,020,822 )   -65%
                        

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

 

     December 31,    2007 Increase (Decrease)
     2007    2006    Amount     %

Arizona

   $      169,394    $      217,051    $       (47,657 )   -22%

California

     221,571      392,210      (170,639 )   -44%

Nevada

     76,695      129,681      (52,986 )   -41%
                        

West

     467,660      738,942      (271,282 )   -37%
                        

Colorado

     143,108      115,183      27,925     24%

Utah

     73,118      98,081      (24,963 )   -25%
                        

Mountain

     216,226      213,264      2,962     1%
                        

Maryland

     63,089      49,367      13,722     28%

Virginia

     71,277      60,137      11,140     19%
                        

East

     134,366      109,504      24,862     23%
                        

Delaware Valley

     27,987      31,849      (3,862 )   -12%

Florida

     35,569      67,794      (32,225 )   -48%

Illinois

     20,413      13,867      6,546     47%

Texas

     -      3,451      (3,451 )   -100%
                        

Other Homebuilding

     83,969      116,961      (32,992 )   -28%
                        

Total

   $ 902,221    $ 1,178,671    $ (276,450 )   -23%
                        

 

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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).

 

     December 31,    2007 Increase (Decrease)
     2007    2006    Amount     %

Lots Owned

          

Arizona

   2,969    6,368    (3,399 )   -53%

California

   1,491    2,802    (1,311 )   -47%

Nevada

   1,549    2,747    (1,198 )   -44%
                  

West

   6,009    11,917    (5,908 )   -50%
                  

Colorado

   2,992    3,479    (487 )   -14%

Utah

   863    1,185    (322 )   -27%
                  

Mountain

   3,855    4,664    (809 )   -17%
                  

Maryland

   302    528    (226 )   -43%

Virginia

   369    643    (274 )   -43%
                  

East

   671    1,171    (500 )   -43%
                  

Delaware Valley

   151    265    (114 )   -43%

Florida

   638    1,093    (455 )   -42%

Illinois

   191    287    (96 )   -33%

Texas

   -    13    (13 )   -100%
                  

Other Homebuilding

   980    1,658    (678 )   -41%
                  

Total

           11,515             19,410              (7,895 )   -41%
                  

 

Lots Controlled Under Option

          

Arizona

               512                  744                  (232 )   -31%

California

   157    387    (230 )   -59%

Nevada

   4    250    (246 )   -98%
                  

West

   673    1,381    (708 )   -51%
                  

Colorado

   262    801    (539 )   -67%

Utah

   -    91    (91 )   -100%
                  

Mountain

   262    892    (630 )   -71%
                  

Maryland

   558    960    (402 )   -42%

Virginia

   1,311    2,381    (1,070 )   -45%
                  

East

   1,869    3,341    (1,472 )   -44%
                  

Delaware Valley

   327    683    (356 )   -52%

Florida

   484    1,800    (1,316 )   -73%

Illinois

   -    -    -     0%

Texas

   -    -    -     0%
                  

Other Homebuilding

   811    2,483    (1,672 )   -67%
                  

Total

   3,615    8,097    (4,482 )   -55%
                  

Total Lots Owned and Controlled

   15,130    27,507    (12,377 )   -45%
                  

 

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During the twelve months ended December 31, 2007, in view of the reduced pace of new home orders experienced in our markets, we focused on reducing the total number of lots owned and controlled under option. Accordingly, the total number of lots owned (excluding homes completed or under construction) at December 31, 2007 declined 41%, including decreases in each of our homebuilding segments. The 2007 decrease in lots owned and land and land under development resulted from: (1) the transfer of lots from land to homes completed or under construction; (2) minimizing the number of land acquisitions; and (3) the sale of nearly 2,000 lots, particularly in our West segment where we sold more than 1,700 lots, resulting from a deterioration in the new home sales market that led us to the conclusion that the best use of these assets was to sell them in their current condition. As a result of these efforts, and the impact of recording $556.3 million of impairments on our land inventory during 2007, we reduced our land and land under development by $1.0 billion since December 31, 2006.

Our total lots controlled under option at December 31, 2007 decreased by 55% from December 31, 2006, including declines within each of our homebuilding segments. These decreases primarily related to: (1) the termination of lot option contracts with terms that no longer met our underwriting criteria, resulting in approximately $23.4 million in write-offs of lot option deposits and pre-acquisition costs during the year ended December 31, 2007; (2) limiting the number of new contracts for the purchase of lots under option; and (3) the termination of lot option purchase contracts in Tampa as we initiated the process of exiting this sub-market.

Homebuilding Operating Activities—2006 Compared With 2005 (dollars in thousands).

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

 

     Year Ended December 31,    2006 Increase (Decrease)
     2006    2005    Amount     %

Home Gross Margin

     22.2%      28.3%      -6.1%    

Orders For Homes, net (Units)

          

Arizona

     2,758      3,627      (869 )   -24%

California

     1,450      2,060      (610 )   -30%

Nevada

     2,048      3,293      (1,245 )   -38%
                        

West

     6,256      8,980      (2,724 )   -30%
                        

Colorado

     1,139      2,075      (936 )   -45%

Utah

     1,049      953      96     10%
                        

Mountain

     2,188      3,028      (840 )   -28%
                        

Maryland

     380      423      (43 )   -10%

Virginia

     462      739      (277 )   -37%
                        

East

     842      1,162      (320 )   -28%
                        

Delaware Valley

     138      191      (53 )   -28%

Florida

     519      1,044      (525 )   -50%

Illinois

     117      148      (31 )   -21%

Texas

     169      781      (612 )   -78%
                        

Other Homebuilding

     943      2,164      (1,221 )   -56%
                        

Total

     10,229      15,334      (5,105 )   -33%
                        

Estimated Value of Orders for Homes, net

   $     3,467,000    $     5,233,000    $     (1,766,000 )   -34%
                        

Estimated Average Selling Price of Orders for Homes, net

   $ 338.9    $ 341.3    $ (2.4 )   -1%
                        

Cancellation Rate

     43%      24%      19%    

 

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Orders for Homes.  During the year ended December 31, 2006 and 2005, we received 10,299 and 15,334 net home orders, respectively. Each of our homebuilding segments experienced year-over-year declines in net home orders, driven in part by significant increases in our Cancellation Rate, fewer gross orders taken in each market within our homebuilding segments except Utah, Arizona, Maryland and Delaware Valley, and increases in competition resulting from higher inventory levels of new and existing homes. Prospective homebuyers began delaying home purchases during this period of uncertainty. We continued to respond to the increases in our Cancellation Rate and the uncertainty in the homebuilding market by increasing incentives and offering limited time sales promotions, with the objective of improving our sales velocity.

Home Gross Margins.  Home Gross Margins decreased during 2006 primarily due to offering higher sales incentives in order to generate net home orders and subsequent home closings, increases in the cost of land and higher home construction costs incurred in building larger homes which we were unable to recover through increases in the average selling prices for our closed homes. These factors contributed to significant reductions in 2006 to Home Gross Margins in California, Nevada and Virginia.

Cancellation Rate.  Our Cancellation Rates were 43% and 24% for the years ended December 31, 2006 and 2005, respectively. The 2006 Cancellation Rate increased significantly in nearly all markets, most notably Arizona, California, Florida and Virginia. The increases in these markets resulted primarily from: (1) the exit of speculators from the new home market; (2) an increased supply of new and previously owned homes available to be purchased, which made it more difficult for homebuyers to sell their existing homes; (3) increased uncertainty regarding the housing market and the lack of home price appreciation; and (4) increased incentives being offered by competitors.

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

 

     Year Ended December 31,    2006 Increase (Decrease)
     2006    2005    Amount     %

Arizona

   3,353    3,671    (318 )   -9%

California

   1,788    2,102    (314 )   -15%

Nevada

   2,756    3,016    (260 )   -9%