Edgar Filing: MDC HOLDINGS INC

mdc20140331_10q.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2014

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

Commission File No. 1-8951

M.D.C. HOLDINGS, INC.

(Exact name of Registrant as specified in its charter)

Delaware		84-0622967
(State or other jurisdiction		(I.R.S. employer
of incorporation or organization)		identification no.)

4350 South Monaco Street, Suite 500		80237
Denver, Colorado		(Zip code)
(Address of principal executive offices)

(303) 773-1100

(Registrant's telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

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

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


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

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

As of April 29, 2014, 48,821,676 shares of M.D.C. Holdings, Inc. common stock were outstanding.

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

FORM 10-Q

FOR THE QUARTER ENDED MARCH 31, 2014

INDEX

			Page No.
PartI. Financial Information:

	Item1.	Unaudited Consolidated Financial Statements:

		Consolidated Balance Sheets at March 31, 2014 and December 31, 2013	1

		Consolidated Statements of Operations and Comprehensive Income for the three months ended March 31, 2014 and 2013	2

		Consolidated Statements of Cash Flows for the three months ended March 31, 2014 and 2013	3

		Notes to Unaudited Consolidated Financial Statements	4

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	26

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	39

	Item 4.	Controls and Procedures	40

Part II. Other Information:

	Item 1.	Legal Proceedings	41

	Item1A.	Risk Factors	41

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	42

	Item 3.	Defaults Upon Senior Securities	42

	Item 4.	Mine Safety Disclosures	42

	Item 5.	Other Information	42

	Item 6.	Exhibits	43

	Signature		43

(i)

ITEM 1. Unaudited Consolidated Financial Statements

M.D.C. HOLDINGS, INC.

Consolidated Balance Sheets

	March 31, 2014		December 31, 2013
	(Dollars in thousands, except per share amounts)
	(Unaudited)
ASSETS
Homebuilding:
Cash and cash equivalents	$	68,897	$	148,634
Marketable securities		508,744		569,021
Restricted cash		1,505		2,195
Trade and other receivables		30,134		23,407
Inventories:
Housing completed or under construction		712,069		636,700
Land and land under development		838,703		774,961
Total inventories		1,550,772		1,411,661
Property and equipment, net		30,897		31,248
Deferred tax asset, net of valuation allowance of $8,201 at March 31, 2014 and December 31, 2013, respectively		174,006		176,262
Metropolitan district bond securities (related party)		13,027		12,729
Prepaid and other assets		62,138		53,525
Total homebuilding assets		2,440,120		2,428,682
Financial Services:
Cash and cash equivalents		25,922		50,704
Marketable securities		15,870		19,046
Mortgage loans held-for-sale, net		64,800		92,578
Other assets		3,525		4,439
Total financial services assets		110,117		166,767
Total Assets	$	2,550,237	$	2,595,449
LIABILITIES AND EQUITY
Homebuilding:
Accounts payable	$	31,591	$	15,046
Accrued liabilities		118,524		152,821
Senior notes, net		1,095,958		1,095,620
Total homebuilding liabilities		1,246,073		1,263,487
Financial Services:
Accounts payable and accrued liabilities		55,135		55,639
Mortgage repurchase facility		39,340		63,074
Total financial services liabilities		94,475		118,713
Total Liabilities		1,340,548		1,382,200
Stockholders' Equity
Preferred stock, $0.01 par value; 25,000,000 shares authorized; none issued or outstanding		-		-
Common stock, $0.01 par value; 250,000,000 shares authorized; 48,821,676 and 48,788,887 issued and outstanding at March 31, 2014 and December 31, 2013, respectively		488		488
Additional paid-in-capital		909,278		908,090
Retained earnings		292,394		293,096
Accumulated other comprehensive income		7,529		11,575
Total Stockholders' Equity		1,209,689		1,213,249
Total Liabilities and Stockholders' Equity	$	2,550,237	$	2,595,449

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

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M.D.C. HOLDINGS, INC.

Consolidated Statements of Operations and Comprehensive Income

	Three Months Ended March 31,
	2014			2013
	(Dollars in thousands, except per share amounts)
	(Unaudited)
Homebuilding:
Home sale revenues	$	318,534		$	331,748
Home cost of sales		(259,478	)		(274,076	)
Gross margin		59,056			57,672
Selling, general and administrative expenses		(48,341	)		(48,201	)
Interest and other income		13,549			6,549
Interest expense		(685	)		(817	)
Other expense		(614	)		(356	)
Loss on early extinguishment of debt		(9,412	)		-
Homebuilding pretax income		13,553			14,847

Financial Services:
Revenues		9,223			12,506
Expenses		(4,924	)		(5,642	)
Interest and other income		788			875
Financial services pretax income		5,087			7,739

Income before income taxes		18,640			22,586
Provision for income taxes		(7,136	)		(70	)
Net income	$	11,504		$	22,516

Other comprehensive income (loss) related to available for sale securities, net of tax		(4,046	)		2,535
Comprehensive income	$	7,458		$	25,051

Earnings per share:
Basic	$	0.24		$	0.46
Diluted	$	0.23		$	0.45

Weighted average common shares outstanding
Basic		48,585,757			48,342,145
Diluted		48,854,675			48,922,335

Dividends declared per share	$	0.25		$	-

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

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M.D.C. HOLDINGS, INC.

Consolidated Statements of Cash Flows

	Three Months Ended March 31,
	2014			2013
	(Dollars in thousands)
	(Unaudited)
Operating Activities:
Net income	$	11,504		$	22,516
Adjustments to reconcile net income to net cash used in operating activities:
Loss on early extinguishment of debt		9,412			-
Stock-based compensation expense		1,292			3,376
Depreciation and amortization		934			1,078
Amortization of discount (premium) on marketable debt securities		(90	)		619
Deferred income tax		7,103			-
Net changes in assets and liabilities:
Restricted cash		690			(667	)
Trade and other receivables		(8,711	)		(3,970	)
Mortgage loans held-for-sale		27,778			33,524
Housing completed or under construction		(75,190	)		(8,618	)
Land and land under development		(63,718	)		(44,770	)
Prepaid expenses and other assets		(6,881	)		(6,470	)
Accounts payable and accrued liabilities		(18,371	)		(52,036	)
Net cash used in operating activities		(114,248	)		(55,418	)

Investing Activities:
Purchases of marketable securities		(356,287	)		(150,811	)
Maturities of marketable securities		133,724			-
Sales of marketable securities		279,450			44,668
Purchases of property and equipment		(545	)		(926	)
Net cash provided by (used in) investing activities		56,342			(107,069	)

Financing Activities:
Advances (payments) on mortgage repurchase facility, net		(23,734	)		(34,859	)
Proceeds from issuance of senior notes		248,375			247,813
Repayment of senior notes		(259,118	)		-
Dividend payments		(12,207	)		-
Proceeds from exercise of stock options		71			5,118
Net cash provided by (used in) financing activities		(46,613	)		218,072

Net increase (decrease) in cash and cash equivalents		(104,519	)		55,585
Cash and cash equivalents:
Beginning of period		199,338			160,095
End of period	$	94,819		$	215,680

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

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

1.	Basis of Presentation

The Unaudited Consolidated Financial Statements of M.D.C. Holdings, Inc. ("MDC," “the Company," “we,” “us,” or “our” which refers to M.D.C. Holdings, Inc. and its subsidiaries) have been prepared, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC"). Accordingly, they do not include all information and footnotes required by U.S. generally accepted accounting principles (“GAAP”) for complete financial statements. These statements reflect all normal and recurring adjustments which, in the opinion of management, are necessary to present fairly the financial position, results of operations and cash flows of MDC at March 31, 2014 and for all periods presented. These statements should be read in conjunction with MDC’s Consolidated Financial Statements and Notes thereto included in MDC’s Annual Report on Form 10-K for the year ended December 31, 2013. Certain prior year amounts have been reclassified to conform to the current year’s presentation.

2.	Segment Reporting

Our operating segments are defined as a component of an enterprise for which discrete financial information is available and is reviewed regularly by the chief operating decision-maker, or decision-making group, to evaluate performance and make operating decisions. We have identified our chief operating decision-makers (“CODMs”) as two key executives—the Chief Executive Officer and the Chief Operating Officer.

We have identified each homebuilding division as an operating segment. Our operating segments have been aggregated into the reportable segments noted below 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. Our homebuilding reportable segments are as follows:

●

West (Arizona, California, Nevada and Washington)

●

Mountain (Colorado and Utah)

●

East (Virginia, Florida and Maryland, which includes Pennsylvania, Delaware and New Jersey)

Our financial services business consists of the operations of the following operating segments: (1) HomeAmerican Mortgage Corporation (“HomeAmerican”); (2) Allegiant Insurance Company, Inc., A Risk Retention Group (“Allegiant”); (3) StarAmerican Insurance Ltd. (“StarAmerican”); (4) American Home Insurance Agency, Inc.; and (5) American Home Title and Escrow Company. Due to its contributions to consolidated pretax income we consider HomeAmerican to be a reportable segment (“Mortgage operations”). The remaining operating segments have been aggregated into one reportable segment (“Other”) because they do not individually exceed 10 percent of: (1) consolidated revenue; (2) the greater of (A) the combined reported profit of all operating segments that did not report a loss or (B) the positive value of the combined reported loss of all operating segments that reported losses; or (3) consolidated assets.

Corporate is a non-operating segment that develops and implements strategic initiatives and supports our operating divisions by centralizing key administrative functions such as finance and treasury, information technology, insurance and risk management, litigation and human resources. Corporate also provides the necessary administrative functions to support MDC as a publicly traded company. A portion of the expenses incurred by Corporate are allocated to the homebuilding operating segments based on their respective percentages of assets, and to a lesser degree, a portion of Corporate expenses are allocated to the financial services segments. A majority of Corporate’s personnel and resources are primarily dedicated to activities relating to the homebuilding segments, and, therefore, the balance of any unallocated Corporate expenses is included in the homebuilding segment.

The table set forth below summarizes home sale revenues for our homebuilding operations and revenues for our financial services operations.

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

	Three Months Ended March 31,
	2014		2013
	(Dollars in thousands)
Homebuilding
West	$	136,422	$	134,979
Mountain		100,945		133,377
East		81,167		63,392
Total home sale revenues	$	318,534	$	331,748

Financial Services
Mortgage operations	$	5,119	$	9,044
Other		4,104		3,462
Total financial services revenues	$	9,223	$	12,506

The following table summarizes pretax income for our homebuilding and financial services operations.

	Three Months Ended March 31,
	2014			2013
	(Dollars in thousands)
Homebuilding
West	$	12,650		$	10,611
Mountain		7,359			12,996
East		2,661			1,528
Corporate		(9,117	)		(10,288	)
Total homebuilding pretax income	$	13,553		$	14,847

Financial Services
Mortgage operations	$	2,559		$	5,999
Other		2,528			1,740
Total financial services pretax income	$	5,087		$	7,739

Total pretax income	$	18,640		$	22,586

The table set forth below summarizes total assets for our homebuilding and financial services operations. The assets in our West, Mountain and East segments consist primarily of inventory while the assets in our Corporate segment consist primarily of cash and cash equivalents, marketable securities and our deferred tax asset. The assets in our financial services segment consist mostly of cash and cash equivalents, marketable securities and mortgage loans held-for-sale.

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

	March 31, 2014		December 31, 2013
	(Dollars in thousands)
Homebuilding assets
West	$	837,792	$	760,450
Mountain		467,630		418,796
East		325,042		297,627
Corporate		809,656		951,809
Total homebuilding assets	$	2,440,120	$	2,428,682

Financial services assets
Mortgage operations	$	70,848	$	99,065
Other		39,269		67,702
Total financial services assets	$	110,117	$	166,767

Total assets	$	2,550,237	$	2,595,449

3.	Earnings Per Share

A company that has participating securities (for example, holders of unvested restricted stock that has nonforfeitable dividend rights) is required to utilize the two-class method to calculate earnings per share (“EPS”) unless the treasury stock method results in lower EPS. The two-class method is an allocation of earnings/(loss) between the holders of common stock and a company’s participating security holders. Under the two-class method, earnings/(loss) for the reporting period are allocated between common shareholders and other security holders based on their respective rights to receive distributed earnings (i.e., dividends) and undistributed earnings (i.e., net income/(loss)). Currently, we have one class of security and we have participating security holders consisting of shareholders of unvested restricted stock. Basic EPS is calculated by dividing income or loss attributable to common stockholders by the weighted average number of shares of common stock outstanding. To calculate diluted EPS, basic EPS is further adjusted to include the effect of potential dilutive stock options outstanding. The following table shows basic and diluted EPS calculations:

	Three Months Ended March 31,
	2014			2013
	(Dollars in thousands, except per share amounts)
Numerator
Net income	$	11,504		$	22,516
Less: distributed earnings allocated to participating securities		(52	)		-
Less: undistributed earnings allocated to participating securities		-			(375	)
Net income attributable to common stockholders (numerator for basic earnings per share)		11,452			22,141
Add back: undistributed earnings allocated to participating securities		-			375
Less: undistributed earnings reallocated to participating securities		-			(370	)
Numerator for diluted earnings per share under two class method	$	11,452		$	22,146

Denominator
Weighted-average common shares outstanding		48,585,757			48,342,145
Add: dilutive effect of stock options		268,918			580,190
Denominator for diluted earnings per share under two class method		48,854,675			48,922,335

Basic Earnings Per Common Share	$	0.24		$	0.46
Diluted Earnings Per Common Share	$	0.23		$	0.45

Diluted EPS for the quarters ended March 31, 2014 and 2013 excluded options to purchase approximately 3.7 million and 2.9 million shares, respectively, of common stock because the effect of their inclusion would be anti-dilutive.

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

4.	Accumulated Other Comprehensive Income

The following table sets forth our changes in accumulated other comprehensive income:

	Three Months Ended March 31,
	2014			2013
	(Dollars in thousands)
Unrealized gains (losses) on available-for-sale marketable securities ⁽¹⁾ :
Beginning balance	$	7,655		$	4,838
Other comprehensive income (loss) before reclassifications		(33	)		2,221
Amounts reclassified from accumulated other comprehensive income ⁽²⁾		(4,013	)		314
Ending balance	$	3,609		$	7,373

Unrealized gains on available-for-sale metropolitan district bond securities ⁽¹⁾ :
Beginning balance	$	3,920		$	-
Other comprehensive income before reclassifications		-			-
Amounts reclassified from accumulated other comprehensive income		-			-
Ending balance	$	3,920		$	-

Total ending accumulated other comprehensive income	$	7,529		$	7,373

⁽¹⁾

All amounts net-of-tax.

⁽²⁾

See separate table below for details about these reclassifications.

The following table sets forth the activity related to reclassifications out of accumulated other comprehensive income (loss) related to available for sale securities:

	Three Months Ended March 31,
Affected Line Item in the Statements of Operations	2014			2013
	(Dollars in thousands)
Homebuilding interest and other income	$	6,537		$	(295	)
Financial services interest and other income		(12	)		(19	)
Income before income taxes		6,525			(314	)
Provision for income taxes		(2,512	)		-
Net income	$	4,013		$	(314	)

5.	Fair Value Measurements

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

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

The following table sets forth the fair values and methods used for measuring the fair values of financial instruments on a recurring basis:

		Fair Value
Financial Instrument	Hierarchy	March 31, 2014		December 31, 2013
		(Dollars in thousands)
Marketable securities (available-for-sale)
Equity securities	Level 1	$	459,314	$	389,323
Debt securities - maturity less than 1 year	Level 2		14,053		72,577
Debt securities - maturity 1 to 5 years	Level 2		34,653		106,566
Debt securities - maturity greater than 5 years	Level 2		16,594		19,601
Total available-for-sale securities		$	524,614	$	588,067

Mortgage loans held-for-sale, net	Level 2	$	64,800	$	92,578

Metropolitan district bond securities (related party) (available-for-sale)	Level 3	$	13,027	$	12,729

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

The fair value of our cash and cash equivalents, restricted cash, trade and other receivables, inventories, prepaid and other assets, accounts payable, and accrued liabilities approximate their carrying value.

Marketable Securities. We have marketable debt and equity securities. Our equity securities consist primarily of holdings in mutual fund securities, which invest mostly in debt securities. The remaining equity securities in our investment portfolio are holdings in corporate equities. Our debt securities consist primarily of fixed and floating rate interest earning debt securities, which may include, among others, United States government and government agency debt and corporate debt. We measure the fair value of our debt securities using a third party pricing service that either provides quoted market prices in active markets for identical or similar securities which are level 1 inputs, or uses observable inputs for their pricing, which are level 2 inputs. As of March 31, 2014 and December 31, 2013, all of our marketable securities were treated as available-for-sale investments and, as such, we have recorded all of our marketable securities at fair value with changes in fair value being recorded as a component of accumulated other comprehensive income.

The following tables set forth the amortized cost and estimated fair value of our available-for-sale marketable securities.

	March 31, 2014				December 31, 2013
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
	(Dollars in thousands)
Homebuilding:
Equity securities	$	450,095	$	455,214	$	375,142	$	385,303
Debt securities		53,125		53,530		181,635		183,718
Total homebuilding available-for-sale securities	$	503,220	$	508,744	$	556,777	$	569,021

Financial Services:
Equity securities	$	4,000	$	4,100	$	4,000	$	4,020
Debt securities		11,482		11,770		14,721		15,026
Total financial services available-for-sale debt securities	$	15,482	$	15,870	$	18,721	$	19,046

Total available-for-sale marketable securities	$	518,702	$	524,614	$	575,498	$	588,067

As of March 31, 2014 and December 31, 2013, our marketable securities were in net unrealized gain positions totaling $5.9 million and $12.6 million, respectively. Our marketable securities that are in unrealized loss positions aggregated to unrealized losses of $1.3 million and $1.1 million as of March 31, 2014 and December 31, 2013, respectively. The table below sets forth the debt and equity securities that were in an aggregate loss position. We do not believe that the aggregate unrealized loss related to our debt or equity securities as of March 31, 2014 is material to our operations.

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

	March 31, 2014							December 31, 2013
	Number of Securities in Loss Position		Aggregate Loss Position			Aggregate Fair Value of Securities in a Loss Position		Number of Securities in Loss Position		Aggregate Loss Position			Aggregate Fair Value of Securities in a Loss Position
	(Dollars in thousands)
Type of Investment
Debt		39	$	(211	)	$	26,628		72	$	(430	)	$	46,440
Equity		6		(1,052	)		202,183		7		(713	)		14,174
Total		45	$	(1,263	)	$	228,811		79	$	(1,143	)	$	60,614

The followings table sets forth gross realized gains and losses from the sale of available-for-sale marketable securities, which were included in either interest and other income in the homebuilding section or interest and other income in the financial services section of our consolidated statements of operations.

	Three Months Ended March 31,
	2014			2013
	(Dollars in thousands)
Gross realized gains on sales of available-for-sale securities
Equity securities	$	5,431		$	-
Debt securities		1,261			46
Total	$	6,692		$	46

Gross realized losses on sales of available-for-sale securities
Equity securities	$	(154	)	$	-
Debt securities		(12	)		(404	)
Total	$	(166	)	$	(404	)

Net realized gain (loss) on sales of available-for-sale securities	$	6,526		$	(358	)

Mortgage Loans Held-for-Sale, Net. As of March 31, 2014, the primary components of our mortgage loans held-for-sale that are measured at fair value on a recurring basis are: (1) mortgage loans held-for-sale under commitments to sell; and (2) mortgage loans held-for-sale not under commitments to sell. At March 31, 2014 and December 31, 2013, we had $46.4 million and $66.1 million, respectively, of mortgage loans held-for-sale under commitments to sell for which fair value was based upon Level 2 inputs, which were the quoted market prices for those mortgage loans. At March 31, 2014 and December 31, 2013, we had $18.4 million and $26.5 million, respectively, of mortgage loans held-for-sale that were not under commitments to sell. The fair value for those loans was primarily based upon the estimated market price received from an outside party which is a Level 2 fair value input.

Metropolitan District Bond Securities (Related Party). The Metropolitan district bond securities (the “Metro Bonds”) are included in the homebuilding section of our accompanying consolidated balance sheets. We acquired the Metro Bonds from a quasi-municipal corporation in the state of Colorado (the “Metro District”), which was formed to help fund and maintain the infrastructure associated with a master-planned community being developed by our Company. Cash flows received by the Company from these securities reflect principal and interest payments from the Metro District that are supported by an annual levy on the taxable value of real estate and personal property within the Metro District’s boundaries and a one-time fee assessed on permits obtained by MDC in the Metro District. The stated year of maturity for the Metro Bonds is 2037. However, if the unpaid principal and all accrued interest are not paid off by the year 2037, the Company will continue to receive principal and interest payments into perpetuity until the unpaid principal and accrued interest is paid in full. Since 2007 and through the first quarter of 2013, we accounted for these securities under the cost recovery method and they were not carried at fair value in accordance with ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (“ASC 310-30”).

In the second quarter of 2013, we determined that these securities no longer were required to be accounted for under the cost recovery method due to an increase in the number of new homes delivered in the community coupled with improvements in property values within the Metro District. In accordance with ASC 310-30, we will adjust the bond principal balance on a prospective basis using an interest accretion model that utilizes future cash flows expected to be collected. Furthermore, as this investment is accounted for as an available-for-sale asset, we will update its fair value on a quarterly basis, with the adjustment being recorded through other comprehensive income. The fair value is based upon a discounted future cash flow model, which uses Level 3 inputs. The two primary unobservable inputs used in our discounted cash flow model are the forecasted number of homes to be closed, as they drive any increases to the tax base for the Metro District, and the discount rate. The table below provides quantitative data regarding each unobservable input and the sensitivity of fair value to potential changes in those unobservable inputs.

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

Quantitative Data

Sensitivity Analysis

Unobservable Input

Range

Weighted Average

Movement in
Fair Value from
Increase in Input

Movement in
Fair Value from
Decrease in Input

Number of homes closed per year

0 to 155

Increase

Decrease

Discount rate

6% to 16%

10.0

Decrease

Increase

The table set forth below summarizes the activity for our Metro Bonds:

	Three Months Ended March 31,
	2014		2013
	(Dollars in thousands)
Balance at beginning of period	$	12,729	$	5,818
Increase in fair value (recorded in other comprehensive income)		-		-
Change due to accretion of principal		298		-
Cash receipts		-		-
Balance at end of period	$	13,027	$	5,818

Mortgage Repurchase Facility. The debt associated with our Mortgage Repurchase Facility is at floating rates or at fixed rates that approximate current market rates and have relatively short-term maturities, generally within 30 days. The fair value approximates carrying value and is based on Level 2 inputs.

Senior Notes. The estimated values of the senior notes in the following table are based on Level 2 inputs, including market prices of other homebuilder bonds.

	March 31, 2014				December 31, 2013
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
	(Dollars in thousands)
5⅜% Senior Notes due December 2014, net		-		-		249,814		258,750
5⅜% Senior Notes due July 2015, net		249,946		260,313		249,935		262,562
5⅝% Senior Notes due February 2020, net		246,012		266,250		245,871		259,688
5½% Senior Notes due January 2024, net		250,000		255,313		-		-
6% Senior Notes due January 2043		350,000		309,750		350,000		305,083
Total	$	1,095,958	$	1,091,626	$	1,095,620	$	1,086,083

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

6.	Inventories

The following table sets forth, by reportable segment, information relating to our homebuilding inventories:

	March 31, 2014		December 31, 2013
	(Dollars in thousands)
Housing Completed or Under Construction:
West	$	313,078	$	270,778
Mountain		225,403		194,101
East		173,588		171,821
Subtotal		712,069		636,700
Land and Land Under Development:
West		492,603		459,512
Mountain		219,944		211,526
East		126,156		103,923
Subtotal		838,703		774,961
Total Inventories	$	1,550,772	$	1,411,661

Our inventories are primarily associated with communities where we intend to construct and sell homes on the land, including models and unsold started homes. Costs capitalized to land and land under development primarily include: (1) land costs; (2) land development costs; (3) entitlement costs; (4) capitalized interest; (5) engineering fees; and (6) title insurance, real property taxes and closing costs directly related to the purchase of the land parcel. Components of housing completed or under construction primarily include: (1) land costs transferred from land and land under development; (2) direct construction costs associated with a house; (3) real property taxes, engineering fees, permits and other fees; (4) capitalized interest; and (5) indirect construction costs, which include field construction management salaries and benefits, utilities and other construction related costs. Land costs are transferred from land and land under development to housing completed or under construction at the point in time that construction of a home on an owned lot begins.

In accordance with ASC 360, Property, Plant, and Equipment (“ASC 360”), homebuilding inventories are carried at cost unless events and circumstances indicate that the carrying value of the underlying subdivision may not be recoverable. We evaluate inventories for impairment at each quarter end on a subdivision level basis as each such subdivision represents the lowest level of identifiable cash flows. In making this determination, we review, among other things, the following for each subdivision:

•

actual and trending “Operating Margin” (which is defined as home sale revenues less home cost of sales and all direct incremental costs associated with the home closing, including sales commissions) for homes closed;

•

estimated future undiscounted cash flows and Operating Margin;

•

forecasted Operating Margin for homes in backlog;

•

actual and trending net and gross home orders;

•

base sales price and home sales incentive information for homes closed, homes in backlog and homes available for sale;

•

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

•

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

If events or circumstances indicate that the carrying value of our inventory may not be recoverable, assets are reviewed for impairment by comparing the undiscounted estimated future cash flows from an individual subdivision to its carrying value. If the undiscounted future cash flows are less than the subdivision’s carrying value, the carrying value of the subdivision is written down to its then estimated fair value. We generally determine the estimated fair value of each 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. For each of the three months ended March 31, 2014 and 2013, we did not record any inventory impairment charges.

- 11 -

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

7.	Capitalization of Interest

We capitalize interest to inventories during the period of development in accordance with ASC Topic 835, Interest (“ASC 835”). Homebuilding interest capitalized as a cost of inventories is included in cost of sales as related units or lots are sold. To the extent our homebuilding debt exceeds our qualified assets, as defined in ASC 835, we expense a portion of interest incurred. Qualified homebuilding assets consist of all lots and homes, excluding finished unsold homes or finished models, within projects that are actively selling or under development. The table set forth below summarizes homebuilding interest activity.

The homebuilding interest expensed in the table below relates to the portion of interest incurred where our homebuilding debt exceeded our qualified inventory for such periods in accordance with ASC 835.

	Three Months Ended March 31,
	2014			2013
	(Dollars in thousands)
Homebuilding interest incurred	$	19,182		$	14,339
Less: Interest capitalized		(18,497	)		(13,522	)
Homebuilding interest expensed	$	685		$	817

Interest capitalized, beginning of period	$	74,155		$	69,143
Interest capitalized during period		18,497			13,522
Less: Previously capitalized interest included in home cost of sales		(11,724	)		(9,874	)
Interest capitalized, end of period	$	80,928		$	72,791

8.	Homebuilding Prepaid Expenses and Other Assets

The following table sets forth the components of homebuilding prepaid expenses and other assets.

	March 31, 2014		December 31, 2013
	(Dollars in thousands)
Land option deposits	$	17,908	$	15,221
Deferred marketing costs		20,272		15,830
Prepaid expenses		4,260		4,349
Goodwill		6,008		6,008
Deferred debt issuance costs, net		13,047		11,527
Other		643		590
Total	$	62,138	$	53,525

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

9.	Homebuilding Accrued Liabilities and Financial Services Accounts Payable and Accrued Liabilities

The following table sets forth information relating to homebuilding accrued liabilities.

	March 31, 2014		December 31, 2013
	(Dollars in thousands)
Accrued compensation and related expenses	$	12,127	$	35,990
Accrued executive deferred compensation		30,796		30,796
Accrued interest		14,391		24,198
Warranty reserves		21,447		22,238
Customer and escrow deposits		11,758		10,759
Land development and home construction accruals		8,168		9,592
Other accrued liabilities		19,837		19,248
Total accrued liabilities	$	118,524	$	152,821

The following table sets forth information relating to financial services accounts payable and accrued liabilities.

	March 31, 2014		December 31, 2013
	(Dollars in thousands)
Insurance reserves	$	49,076	$	49,637
Accounts payable and other accrued liabilities		6,059		6,002
Total accounts payable and accrued liabilities	$	55,135	$	55,639

10.

Warranty Accrual

Our homes are sold with limited third-party warranties. We record expenses and warranty reserves for general and structural warranty claims, as well as reserves for known, unusual warranty-related expenditures. Warranty reserves are established based upon historical payment experience in an amount estimated to be adequate to cover expected costs of materials and outside labor during warranty periods. The establishment of warranty reserves for closed homes and the evaluation of our warranty reserve balance is based on an internally developed analysis that includes known facts and interpretations of circumstances, including, among other things, our trends in historical warranty payment levels and warranty payments for claims not considered to be normal and recurring.

Warranty reserves are included in accrued liabilities in the homebuilding section of our consolidated balance sheets and adjustments to our warranty reserves are recorded as an increase or reduction to home cost of sales in the homebuilding section of our consolidated statements of operations.

The table set forth below summarizes warranty accrual and payment activity for the three months ended March 31, 2014 and 2013. Adjustments in the three month periods ended March 31, 2014 and 2013 were not material to our operations. Furthermore, the impact of the change in our warranty expense provision rate from the first quarter of 2013 to the first quarter of 2014 did not materially affect our warranty expense or our gross margin from home sales for the three months ended March 31, 2014.

- 13 -

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

	Three Months Ended March 31,
	2014			2013
	(Dollars in thousands)
Balance at beginning of period	$	22,238		$	23,151
Expense provisions		991			1,122
Cash payments		(982	)		(1,475	)
Adjustments		(800	)		300
Balance at end of period	$	21,447		$	23,098

11.

Insurance Reserves

The establishment of reserves for estimated losses associated with insurance policies issued by Allegiant and re-insurance agreements issued by StarAmerican are based on actuarially developed studies that include known facts and interpretations 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 depending on the business conducted, and changing regulatory and legal environments.

The table set forth below summarizes the insurance reserve activity for the three months ended March 31, 2014 and 2013. The insurance reserve is included as a component of accrued liabilities in the financial services section of the accompanying consolidated balance sheets.

	Three Months Ended March 31,
	2014			2013
	(Dollars in thousands)
Balance at beginning of period	$	49,637		$	47,852
Expense provisions		1,310			1,527
Cash payments, net of recoveries		(1,871	)		(430	)
Balance at end of period	$	49,076		$	48,949

In the ordinary course of business, we make payments from our insurance reserves to settle litigation claims arising primarily from our homebuilding activities. These payments are irregular in both their timing and their magnitude. As a result, the cash payments, net of recoveries shown for the three months ended March 31, 2014 and 2013 are not necessarily indicative of what future cash payments will be for subsequent periods.

12.

Deferred Compensation Retirement Plans

Effective August 1, 2008, the Company entered into amended and restated employment agreements (as amended on March 8, 2012, the “Employment Agreements”) with Larry A. Mizel, Chairman of the Board and Chief Executive Officer, and David D. Mandarich, President and Chief Operating Officer (collectively, the “Executive Officers”), which provided certain annual post-retirement pension benefits (the “Retirement Benefits”) depending on the year of retirement. In response to concerns expressed by significant institutional investors, and in accordance with the recommendation of an independent compensation consultant to the Company’s Compensation Committee, the Company announced that it had reached agreements (collectively, the “Second Amendments”) with the Executive Officers for the early termination, effective on October 18, 2013, of the Retirement Benefits contained in their respective Employment Agreements. Pursuant to the Second Amendments, the Company will pay each of Mr. Mizel and Mr. Mandarich a deferred lump sum in the amount of $14.8 million and $16.0 million, respectively, in full satisfaction of their past, present and future Retirement Benefits. The Company’s termination of the Retirement Benefits is irrevocable. These payments, which equal the amounts accrued on the books of the Company as of June 30, 2013 with respect to the Company’s estimated liability to pay Retirement Benefits, will be made to the Executive Officers on October 20, 2014. As a result of the termination of the Retirement Benefits, the Company no longer accrues additional expenses relating to Retirement Benefits.

- 14 -

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

13.

Income Taxes

At the end of each interim period, we are required to estimate our annual effective tax rate for the fiscal year and use that rate to provide for income taxes for the current year-to-date reporting period. As a result, we recorded income tax expense of $7.1 million and $0.1 million for the three months ended March 31, 2014 and 2013, respectively, while our overall effective income tax rates were 38.3% and 0.3% for the three months ended March 31, 2014 and 2013, respectively. The increase in the effective tax rate during the 2014 first quarter, compared with the same period during 2013, resulted primarily from the reversal of substantially all of our deferred tax asset valuation allowance of $227.3 million in the second quarter of 2013. As a result of the valuation allowance release during 2013 and changes in unrecognized tax benefits, our effective tax rate during the first quarter of 2013 was not meaningful as the income tax benefit was not directly correlated to the amount of pretax income generated in such period.

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

	March 31, 2014			December 31, 2013
	(Dollars in thousands)
Deferred tax assets:
Federal net operating loss carryforwards	$	75,706		$	72,915
State net operating loss carryforwards		42,909			40,227
Alternative minimum tax and other tax credit carryforwards		24,196			24,196
Stock-based compensation expense		25,443			26,651
Warranty, litigation and other reserves		15,313			15,543
Accrued compensation		1,823			11,136
Asset impairment charges		4,965			5,889
Inventory, additional costs capitalized for tax purposes		7,021			7,064
Other, net		3,986			3,446
Total deferred tax assets		201,362			207,067
Valuation allowance		(8,201	)		(8,201	)
Total deferred tax assets, net of valuation allowance		193,161			198,866

Deferred tax liabilities:
Property, equipment and other assets		5,422			5,512
Discount on notes receivable		4,204			4,204
Deferred revenue		3,110			3,985
Unrealized gain on marketable securities