Edgar Filing: MDC HOLDINGS INC

mdc20140930_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 September 30, 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 of incorporation or organization)	(I.R.S. employer 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 October 25, 2014, 48,816,639 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 SEPTEMBER 30, 2014

INDEX

			Page No.
Part I. Financial Information:

	Item 1.	Unaudited Consolidated Financial Statements:

		Consolidated Balance Sheets at September 30, 2014 and December 31, 2013	1

		Consolidated Statements of Operations and Comprehensive Income for the three and nine months ended September 30, 2014 and 2013	2

		Consolidated Statements of Cash Flows for the nine months ended September 30, 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	28

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	44

	Item 4.	Controls and Procedures	45

Part II. Other Information:

	Item 1.	Legal Proceedings	46

	Item 1A.	Risk Factors	46

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	47

	Item 3.	Defaults Upon Senior Securities	47

	Item 4.	Mine Safety Disclosures	47

	Item 5.	Other Information	47

	Item 6.	Exhibits	48

	Signature		48

ITEM 1. Unaudited Consolidated Financial Statements

M.D.C. HOLDINGS, INC.

Consolidated Balance Sheets

	September 30,		December 31,
	2014		2013
	(Dollars in thousands, except per share amounts)
	(Unaudited)
ASSETS
Homebuilding:
Cash and cash equivalents	$	56,503	$	148,634
Marketable securities		437,444		569,021
Restricted cash		3,034		2,195
Trade and other receivables		24,958		23,407
Inventories:
Housing completed or under construction		836,520		636,700
Land and land under development		854,677		774,961
Total inventories		1,691,197		1,411,661
Property and equipment, net		30,210		31,248
Deferred tax asset, net		154,542		176,262
Metropolitan district bond securities (related party)		15,379		12,729
Prepaid and other assets		68,810		53,525
Total homebuilding assets		2,482,077		2,428,682
Financial Services:
Cash and cash equivalents		26,616		50,704
Marketable securities		17,195		19,046
Mortgage loans held-for-sale, net		58,132		92,578
Other assets		4,195		4,439
Total financial services assets		106,138		166,767
Total Assets	$	2,588,215	$	2,595,449
LIABILITIES AND EQUITY
Homebuilding:
Accounts payable	$	39,927	$	15,046
Accrued liabilities		128,392		152,821
Revolving credit facility		10,000		-
Senior notes, net		1,096,269		1,095,620
Total homebuilding liabilities		1,274,588		1,263,487
Financial Services:
Accounts payable and accrued liabilities		56,270		55,639
Mortgage repurchase facility		31,782		63,074
Total financial services liabilities		88,052		118,713
Total Liabilities		1,362,640		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; 48,816,639 and 48,788,887 issued and outstanding at September 30, 2014 and December 31, 2013, respectively		488		488
Additional paid-in-capital		912,730		908,090
Retained earnings		304,985		293,096
Accumulated other comprehensive income		7,372		11,575
Total Stockholders' Equity		1,225,575		1,213,249
Total Liabilities and Stockholders' Equity	$	2,588,215	$	2,595,449

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

-1-

M.D.C. HOLDINGS, INC.

Consolidated Statements of Operations and Comprehensive Income

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2014			2013			2014			2013
	(Dollars in thousands, except per share amounts)
	(Unaudited)
Homebuilding:
Home sale revenues	$	405,051		$	433,693		$	1,154,328		$	1,165,768
Land sale revenues		2,653			25			3,171			1,832
Total home and land sale revenues		407,704			433,718			1,157,499			1,167,600
Home cost of sales		(338,037	)		(354,889	)		(953,690	)		(956,892	)
Land cost of sales		(1,985	)		(35	)		(2,507	)		(1,470	)
Inventory impairments		-			(350	)		(850	)		(350	)
Total cost of sales		(340,022	)		(355,274	)		(957,047	)		(958,712	)
Gross margin		67,682			78,444			200,452			208,888
Selling, general and administrative expenses		(50,512	)		(57,753	)		(148,652	)		(157,862	)
Interest and other income		5,926			6,853			24,088			23,602
Interest expense		-			-			(685	)		(1,726	)
Other expense		(841	)		(881	)		(2,534	)		(1,603	)
Loss on early extinguishment of debt		-			-			(9,412	)		-
Other-than-temporary impairment of marketable securities		(4,293	)		-			(4,293	)		-
Homebuilding pretax income		17,962			26,663			58,964			71,299

Financial Services:
Revenues		10,699			14,282			31,413			40,672
Expenses		(5,643	)		(6,921	)		(16,182	)		(19,144	)
Interest and other income		906			885			2,395			2,680
Financial services pretax income		5,962			8,246			17,626			24,208

Income before income taxes		23,924			34,909			76,590			95,507
Benefit from (provision for) income taxes		(8,466	)		1,342			(28,086	)		188,169
Net income	$	15,458		$	36,251		$	48,504		$	283,676

Other comprehensive income (loss) related to available-for-sale securities, net of tax		(2,484	)		1,960			(4,203	)		2,500
Comprehensive income	$	12,974		$	38,211		$	44,301		$	286,176

Earnings per share:
Basic	$	0.32		$	0.74		$	0.99		$	5.80
Diluted	$	0.32		$	0.74		$	0.99		$	5.75

Weighted average common shares outstanding
Basic		48,625,685			48,478,403			48,607,425			48,423,969
Diluted		48,830,790			48,753,649			48,824,871			48,852,870

Dividends declared per share	$	0.25		$	-		$	0.75		$	-

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

-2-

M.D.C. HOLDINGS, INC.

Consolidated Statements of Cash Flows

	Nine Months Ended
	September 30,
	2014			2013
	(Dollars in thousands)
	(Unaudited)
Operating Activities:
Net income	$	48,504		$	283,676
Adjustments to reconcile net income to net cash used in operating activities:
Loss on early extinguishment of debt		9,412			-
Stock-based compensation expense		4,754			8,240
Depreciation and amortization		2,928			2,960
Inventory impairments		850			350
Other-than-temporary impairment of marketable securities		4,293			-
Loss (gain) on sale of marketable securities		(7,622	)		-
Amortization of discount / premiums on marketable debt securities		501			816
Deferred income tax expense (benefit)		28,363			(189,657	)
Net changes in assets and liabilities:
Restricted cash		(839	)		(327	)
Trade and other receivables		(5,821	)		(1,599	)
Mortgage loans held-for-sale		34,446			45,613
Housing completed or under construction		(200,408	)		(121,165	)
Land and land under development		(79,465	)		(210,218	)
Prepaid expenses and other assets		(14,084	)		(14,033	)
Accounts payable and accrued liabilities		932			(30,516	)
Net cash used in operating activities		(173,256	)		(225,860	)

Investing Activities:
Purchases of marketable securities		(409,846	)		(369,887	)
Maturities of marketable securities		165,089			132,492
Sales of marketable securities		372,301			187,083
Purchases of property and equipment		(1,919	)		(1,278	)
Net cash provided by (used in) investing activities		125,625			(51,590	)

Financing Activities:
Payments on mortgage repurchase facility, net		(31,292	)		(37,415	)
Proceeds from issuance of senior notes		248,375			346,938
Repayment of senior notes		(259,118	)		-
Advances on revolving credit facility, net		10,000			-
Dividend payments		(36,616	)		-
Proceeds from exercise of stock options		63			5,118
Net cash provided by (used in) financing activities		(68,588	)		314,641

Net increase (decrease) in cash and cash equivalents		(116,219	)		37,191
Cash and cash equivalents:
Beginning of period		199,338			160,095
End of period	$	83,119		$	197,286

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

-3-

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 September 30, 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. Recently Issued Accounting Standards

In July 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists ("ASU 2013-11"). This update requires companies to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, unless certain conditions exist. ASU 2013-11 was effective for our interim and annual periods beginning January 1, 2014. The adoption of ASU 2013-11 did not have a material impact on our consolidated financial position or results of operations.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers ("ASU 2014-09"), which is a comprehensive new revenue recognition model. Under ASU 2014-09, a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods and services. ASU 2014-09 is effective for our interim and annual reporting periods beginning after December 15, 2016, and is to be applied retrospectively, with early application not permitted. We are currently evaluating the impact the pronouncement will have on our consolidated financial statements and related disclosures.

In June 2014, the FASB issued ASU 2014-11, Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures ("ASU 2014-11"), which makes limited amendments to Accounting Standards Codification (“ASC”) Topic 860, "Transfers and Servicing." ASU 2014-11 requires entities to account for repurchase-to-maturity transactions as secured borrowings, eliminates accounting guidance on linked repurchase financing transactions, and expands disclosure requirements related to certain transfers of financial assets. ASU 2014-11 is effective for our fiscal periods beginning January 1, 2015 and interim periods beginning April 1, 2015. Early adoption is not permitted. This guidance is not expected to have a material impact on our consolidated financial statements.

3. 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-maker as two key executives— our Chief Executive Officer and 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.

-4-

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

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.

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2014		2013		2014		2013
	(Dollars in thousands)
Homebuilding
West	$	184,627	$	188,456	$	510,710	$	487,949
Mountain		144,442		134,992		392,052		402,137
East		78,635		110,270		254,737		277,514
Total home and land sale revenues	$	407,704	$	433,718	$	1,157,499	$	1,167,600

Financial Services
Mortgage operations	$	6,416	$	9,694	$	18,887	$	29,232
Other		4,283		4,588		12,526		11,440
Total financial services revenues	$	10,699	$	14,282	$	31,413	$	40,672

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

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2014			2013			2014			2013
	(Dollars in thousands)
Homebuilding
West	$	12,402		$	19,539		$	41,747		$	46,929
Mountain		11,031			12,203			30,572			39,341
East		1,138			6,657			9,095			12,708
Corporate		(6,609	)		(11,736	)		(22,450	)		(27,679	)
Total homebuilding pretax income	$	17,962		$	26,663		$	58,964		$	71,299

Financial Services
Mortgage operations	$	3,327		$	5,936		$	10,387		$	18,790
Other		2,635			2,310			7,239			5,418
Total financial services pretax income	$	5,962		$	8,246		$	17,626		$	24,208

Total pretax income	$	23,924		$	34,909		$	76,590		$	95,507

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

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.

	September 30,		December 31,
	2014		2013
	(Dollars in thousands)
Homebuilding assets
West	$	911,952	$	760,450
Mountain		519,332		418,796
East		342,766		297,627
Corporate		708,027		951,809
Total homebuilding assets	$	2,482,077	$	2,428,682

Financial services assets
Mortgage operations	$	64,062	$	99,065
Other		42,076		67,702
Total financial services assets	$	106,138	$	166,767

Total assets	$	2,588,215	$	2,595,449

4. 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						Nine Months Ended
	September 30,						September 30,
	2014			2013			2014			2013
	(Dollars in thousands, except per share amounts)
Numerator
Net income	$	15,458		$	36,251		$	48,504		$	283,676
Less: distributed earnings allocated to participating securities		(48	)		-			(150	)		-
Less: undistributed earnings allocated to participating securities		(13	)		(294	)		(51	)		(2,609	)
Net income attributable to common stockholders (numerator for basic earnings per share)		15,397			35,957			48,303			281,067
Add back: undistributed earnings allocated to participating securities		13			294			51			2,609
Less: undistributed earnings reallocated to participating securities		(13	)		(293	)		(51	)		(2,586	)
Numerator for diluted earnings per share under two class method	$	15,397		$	35,958		$	48,303		$	281,090

Denominator
Weighted-average common shares outstanding		48,625,685			48,478,403			48,607,425			48,423,969
Add: dilutive effect of stock options		205,105			275,246			217,446			428,901
Denominator for diluted earnings per share under two class method		48,830,790			48,753,649			48,824,871			48,852,870

Basic Earnings Per Common Share	$	0.32		$	0.74		$	0.99		$	5.80
Diluted Earnings Per Common Share	$	0.32		$	0.74		$	0.99		$	5.75

Diluted EPS for the three and nine months ended September 30, 2014 excluded options to purchase approximately 4.3 million and 4.5 million shares, respectively, of common stock because the effect of their inclusion would be anti-dilutive. For the same periods in 2013, diluted EPS excluded options to purchase approximately 4.2 million and 3.4 million shares, respectively.

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

5. Accumulated Other Comprehensive Income

The following table sets forth our changes in accumulated other comprehensive income (“AOCI”):

	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2014			2013		2014			2013
	(Dollars in thousands)
Unrealized gains (losses) on available-for-sale marketable securities ¹ :
Beginning balance	$	5,346		$	884	$	7,655		$	4,838
Other comprehensive income (loss) before reclassifications		(4,836	)		1,766		(3,236	)		(1,195	)
Amounts reclassified from AOCI ²		1,862			194		(2,047	)		(799	)
Ending balance	$	2,372		$	2,844	$	2,372		$	2,844

Unrealized gains on available-for-sale metropolitan district bond securities ¹ :
Beginning balance	$	4,510		$	4,494	$	3,920		$	-
Other comprehensive income before reclassifications		490			-		1,080			4,494
Amounts reclassified from AOCI		-			-		-			-
Ending balance	$	5,000		$	4,494	$	5,000		$	4,494

Total ending AOCI	$	7,372		$	7,338	$	7,372		$	7,338

___________________

^1.

All amounts net-of-tax.

^2.

See separate table below for details about these reclassifications which include gains or losses on sales of available-for-sale securities sold as well as any other-than-temporary impairments taken on available-for-sale securities during the period.

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						Nine Months Ended
	September 30,						September 30,
Affected Line Item in the Statements of Operations	2014			2013			2014			2013
	(Dollars in thousands)
Homebuilding interest and other income	$	1,167		$	(311	)	$	7,528		$	560
Other-than-temporary impairment of marketable securities		(4,293	)		-			(4,293	)		-
Financial services interest and other income		99			(4	)		94			118
Income before income taxes		(3,027	)		(315	)		3,329			678
Benefit from (provision for) income taxes		1,165			121			(1,282	)		121
Net income	$	(1,862	)	$	(194	)	$	2,047		$	799

-7-

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

6. Fair Value Measurements

Accounting Standards Codification (“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.

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	September 30, 2014		December 31, 2013
		(Dollars in thousands)
Marketable securities (available-for-sale)
Equity securities	Level 1	$	426,453	$	389,323
Debt securities - maturity less than 1 year	Level 2		2,060		72,577
Debt securities - maturity 1 to 5 years	Level 2		10,167		106,566
Debt securities - maturity greater than 5 years	Level 2		15,959		19,601
Total available-for-sale securities		$	454,639	$	588,067

Mortgage loans held-for-sale, net	Level 2	$	58,132	$	92,578

Metropolitan district bond securities (related party) (available-for-sale)	Level 3	$	15,379	$	12,729

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

Cash and cash equivalents, restricted cash, trade and other receivables, inventories, prepaid and other assets, accounts payable, and accrued liabilities. Fair value approximates 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 September 30, 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 AOCI.

Each quarter we assess all of our securities in an unrealized loss position for potential other-than-temporary impairment (“OTTI”). Our assessment includes a consideration of many factors, both qualitative and quantitative, including the amount of the unrealized loss, the period of time the security has been in a loss position, the financial condition of the issuer and whether we have the intent and ability to hold the securities, among other factors. During the three and nine months ended September 30, 2014, we recorded a pre-tax OTTI of $4.3 million for certain of our mutual funds that were in a loss position as of quarter end. The OTTI is included in other-than-temporary impairment of marketable securities in the homebuilding section of our consolidated statements of operations.

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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

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

	September 30, 2014
	Amortized Cost		OTTI			Net Amortized Cost		Fair Value
	(Dollars in thousands)
Homebuilding:
Equity securities	$	417,688	$	(4,293	)		413,395	$	417,242
Debt securities		20,426		-			20,426		20,202
Total homebuilding available-for-sale marketable securities	$	438,114	$	(4,293	)	$	433,821	$	437,444

Financial Services:
Equity securities	$	9,028		-			9,028	$	9,211
Debt securities		7,934		-			7,934		7,984
Total financial services available-for-sale marketable securities	$	16,962	$	-		$	16,962	$	17,195

Total available-for-sale marketable securities	$	455,076	$	(4,293	)	$	450,783	$	454,639

	December 31, 2013
	Amortized Cost		OTTI		Net Amortized Cost		Fair Value
	(Dollars in thousands)
Homebuilding:
Equity securities	$	375,142	$	-	$	375,142	$	385,303
Debt securities		181,635		-		181,635		183,718
Total homebuilding available-for-sale marketable securities	$	556,777	$	-	$	556,777	$	569,021

Financial Services:
Equity securities	$	4,000	$	-	$	4,000	$	4,020
Debt securities		14,721		-		14,721		15,026
Total financial services available-for-sale marketable securities	$	18,721	$	-	$	18,721	$	19,046

Total available-for-sale marketable securities	$	575,498	$	-	$	575,498	$	588,067

During the three and nine months ended September 30, 2014, we recorded a pre-tax OTTI of $4.3 million for certain of our mutual funds that were in a loss position as of quarter end. The OTTI is included in other-than-temporary impairment of marketable securities in the homebuilding section of our consolidated statements of operations.

As of September 30, 2014 and December 31, 2013, our marketable securities were in a net unrealized loss position totaling $0.4 million and a net unrealized gain position totaling $12.6 million, respectively. Our marketable securities that were in unrealized loss positions, excluding those that were impaired as part of the OTTI, aggregated to unrealized losses of $2.2 million and $1.1 million as of September 30, 2014 and December 31, 2013, respectively. The table below sets forth the debt and equity securities, for which an OTTI had not been recognized, that were in an aggregate loss position in AOCI as of September 30, 2014 and December 31, 2013. We do not believe that the aggregate unrealized loss related to our debt or equity securities as of September 30, 2014 is material to our operations.

-9-

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

	September 30, 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
Type of Investment	(Dollars in thousands)
Debt		82	$	(294	)	$	17,758		72	$	(430	)	$	46,440
Equity		9		(1,901	)		76,720		7		(713	)		14,174
Total		91	$	(2,195	)	$	94,478		79	$	(1,143	)	$	60,614

The following tables set 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						Nine Months Ended
	September 30,						September 30,
	2014			2013			2014			2013
	(Dollars in thousands)
Gross realized gains on sales of available-for-sale securities
Equity securities	$	979		$	498		$	6,496		$	714
Debt securities		466			116			2,386			376
Total	$	1,445		$	614		$	8,882		$	1,090

Gross realized losses on sales of available-for-sale securities
Equity securities	$	(92	)	$	-		$	(801	)	$	-
Debt securities		(87	)		(293	)		(459	)		(1,518	)
Total	$	(179	)	$	(293	)	$	(1,260	)	$	(1,518	)

Net realized gain (loss) on sales of available-for-sale securities	$	1,266		$	321		$	7,622		$	(428	)

Mortgage Loans Held-for-Sale, Net. As of September 30, 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 September 30, 2014 and December 31, 2013, we had $52.1 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 September 30, 2014 and December 31, 2013, we had $6.0 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 in 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”).

-10-

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

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 AOCI. 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, as of September 30, 2014, regarding each unobservable input and the sensitivity of fair value to potential changes in those unobservable inputs.

	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 132			93		Increase	Decrease
Discount rate		6% to 16	%		11.5	%	Decrease	Increase

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

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2014		2013		2014		2013
	(Dollars in thousands)
Balance at beginning of period	$	14,291	$	13,835	$	12,729	$	5,818
Increase in fair value (recorded in other comprehensive income)		798		-		1,757		7,354
Change due to accretion of principal		290		332		893		995
Cash receipts		-		-		-		-
Balance at end of period	$	15,379	$	14,167	$	15,379	$	14,167

Mortgage Repurchase Facility. The debt associated with our mortgage repurchase facility (see Note 19 for further discussion) 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.

	September 30, 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		249,967		258,125		249,935		262,562
5⅝% Senior Notes due February 2020, net		246,302		258,125		245,871		259,688
5½% Senior Notes due January 2024, net		250,000		246,250		-		-
6% Senior Notes due January 2043		350,000		317,188		350,000		305,083
Total	$	1,096,269	$	1,079,688	$	1,095,620	$	1,086,083

-11-

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

7. Inventories

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

	September 30,		December 31,
	2014		2013
	(Dollars in thousands)
Housing Completed or Under Construction:
West	$	411,524	$	270,778
Mountain		238,187		194,101
East		186,809		171,821
Subtotal		836,520		636,700
Land and Land Under Development:
West		459,218		459,512
Mountain		261,493		211,526
East		133,966		103,923
Subtotal		854,677		774,961
Total Inventories	$	1,691,197	$	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. We recognized no inventory impairments during the three months ended September 30, 2014. For the nine months ended September 30, 2014, we recorded $0.9 million of inventory impairment charges related to two projects in our East segment. We recognized $0.4 million in impairments for the three and nine months ended September 30, 2013.

-12-

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

8. 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						Nine Months Ended
	September 30,						September 30,
	2014			2013			2014			2013
	(Dollars in thousands)
Homebuilding interest incurred	$	16,499		$	15,852		$	52,211		$	45,536
Less: Interest capitalized		(16,499	)		(15,852	)		(51,526	)		(43,810	)
Homebuilding interest expensed	$	-		$	-		$	685		$	1,726

Interest capitalized, beginning of period	$	80,936		$	74,547		$	74,155		$	69,143
Plus: Interest capitalized during period		16,499			15,852			51,526			43,810
Less: Previously capitalized interest included in home cost of sales		(14,966	)		(15,567	)		(43,212	)		(38,121	)
Interest capitalized, end of period	$	82,469		$	74,832		$	82,469		$	74,832

9. Homebuilding Prepaid Expenses and Other Assets

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

	September 30,		December 31,
	2014		2013
	(Dollars in thousands)
Land option deposits	$	16,593	$	15,221
Deferred marketing costs		27,598		15,830
Prepaid expenses		5,967		4,349
Goodwill		6,008		6,008
Deferred debt issuance costs, net		12,111		11,527
Other		533		590
Total	$	68,810	$	53,525

-13-

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

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

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

	September 30,		December 31,
	2014		2013
	(Dollars in thousands)
Accrued compensation and related expenses	$	21,484	$	35,990
Accrued executive deferred compensation		30,796		30,796
Accrued interest		14,391		24,198
Warranty reserves		19,101		22,238
Customer and escrow deposits		17,944		10,759
Land development and home construction accruals		7,422		9,592
Other accrued liabilities		17,254		19,248
Total accrued liabilities	$	128,392	$	152,821

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

	September 30,		December 31,
	2014		2013
	(Dollars in thousands)
Insurance reserves	$	49,469	$	49,637
Accounts payable and other accrued liabilities		6,801		6,002
Total accounts payable and accrued liabilities	$	56,270	$	55,639

11. Warranty Reserves

Our homes are sold with limited third-party warranties. We record accruals for general and structural warranty claims, as well as accruals for known, unusual warranty-related expenditures. Warranty accruals are recorded 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 determination of the warranty accrual rate for closed homes and the evaluation of our warranty reserve balance at period end are 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.

Our 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 accrual, adjustment and payment activity related to our warranty reserve for the three and nine months ended September 30, 2014 and 2013. As a result of favorable warranty payment experience relative to our estimates at the time of home closing, we reduced our warranty reserve by $0.5 million and $2.6 million for the three and nine months ended September 30, 2014, respectively. We had no adjustments during the three months ended September 30, 2013 and a $0.3 million increase to our warranty reserve for the nine months ended September 30, 2013.

The impact of the change in our warranty accrual rates from the three months ended September 30, 2014, as compared to three months ended September 30, 2013, and the nine months ended September 30, 2014, as compared to nine months ended September 30, 2013, did not materially affect our warranty expense or gross margin from home sales for the three and nine months ended September 30, 2014.

-14-

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2014			2013			2014			2013
	(Dollars in thousands)
Balance at beginning of period	$	20,178		$	22,725		$	22,238		$	23,151
Expense provisions		1,206			1,367			3,363			3,643
Cash payments		(1,758	)		(1,649	)		(3,900	)		(4,651	)
Adjustments		(525	)		-			(2,600	)		300
Balance at end of period	$	19,101		$	22,443		$	19,101		$	22,443

12. 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 and nine months ended September 30, 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						Nine Months Ended
	September 30,						September 30,
	2014			2013			2014			2013
	(Dollars in thousands)
Balance at beginning of period	$	49,363		$	47,834		$	49,637		$	47,852
Expense provisions		1,530			1,885			4,577			5,187
Cash payments, net of recoveries		(1,424	)		(557	)		(4,745	)		(3,877	)
Balance at end of period	$	49,469		$	49,162		$	49,469		$	49,162

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 and nine months ended September 30, 2014 and 2013 are not necessarily indicative of what future cash payments will be for subsequent periods.

13. 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. The Company’s termination of the Retirement Benefits is irrevocable. No further accruals of expenses related to Retirement Benefits were recorded subsequent to the 2013 third quarter. Pursuant to the Second Amendments, on October 20, 2014, the Company paid each of Mr. Mizel and Mr. Mandarich a 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.

-15-

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

14. 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 $8.5 million and $28.1 million for the three and nine months ended September 30, 2014, respectively, compared to a benefit of $1.3 million and $188.2 million for the same respective periods in 2013. Our overall effective income tax rates were 35.4% and 36.7% for the three and nine months ended September 30, 2014, respectively, while our effective tax rates for the same periods in 2013 were not meaningful as the income tax benefit was not directly correlated to the amount of pretax income in such periods due to a $187.6 million benefit from the reversal of our deferred tax asset valuation allowance in the 2013 second quarter.

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:

	September 30,			December 31,
	2014			2013
	(Dollars in thousands)
Deferred tax assets:
Federal net operating loss carryforwards	$	51,956		$	72,700
State net operating loss carryforwards		40,485			38,082
Alternative minimum tax and other tax credit carryforwards		25,539			24,196
Stock-based compensation expense		26,753			26,651
Warranty, litigation and other reserves		12,527			15,543
Receivables from related party		11,915			12,132
Accrued compensation		4,957			11,136
Asset impairment charges		4,728			5,496
Inventory, additional costs capitalized for tax purposes		3,183			1,700
Other, net		4,030			3,446
Total deferred tax assets		186,073			211,082
Valuation allowance		(14,988	)		(14,669	)
Total deferred tax assets, net of valuation allowance		171,085			196,413

Deferred tax liabilities: