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Table of Contents

 

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, 2017

 

OR

 

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

 

Commission File No. 1-8951

 

M.D.C. HOLDINGS, INC.

(Exact name of Registrant as specified in its charter)

 

Delaware

 

84-0622967

(State or other jurisdiction

 

(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, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definition of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth 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

  

Emerging growth company

  

 

       

 

If an emerging growth company, indicate by check mark if the registrant has elected to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

 

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 May 8, 2017, 51,561,322 shares of M.D.C. Holdings, Inc. common stock were outstanding.

 

 

M.D.C. HOLDINGS, INC.

FORM 10-Q

FOR THE QUARTER ENDED MARCH 31, 2017

 

INDEX

       

 

 

 

Page
No.

Part I. Financial Information:

 

       

 

Item 1.

Unaudited Consolidated Financial Statements:

 

       

 

 

Consolidated Balance Sheets at March 31, 2017 and December 31, 2016

1

       

 

 

Consolidated Statements of Operations and Comprehensive Income for the three months ended March 31, 2017 and 2016

2

       

 

 

Consolidated Statements of Cash Flows for the three months ended March 31, 2017 and 2016

3

       

 

 

Notes to Unaudited Consolidated Financial Statements

4

       

 

Item 2.

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

25

       

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

38

       

 

Item 4.

Controls and Procedures

39

   

Part II. Other Information:

 

       

 

Item 1.

Legal Proceedings

40

       

 

Item 1A.

Risk Factors

40

       

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

41

       

 

Item 6.

Exhibits

42

     

 

Signature

42

 

 
(i) 

Table of Contents
 

 

PART I

 

ITEM 1.  Unaudited Consolidated Financial Statements

 

M.D.C. HOLDINGS, INC.

Consolidated Balance Sheets.

 

   

March 31,

   

December 31,

 
   

2017

   

2016

 
   

(Dollars in thousands, except

 
   

per share amounts)

 
   

(Unaudited)

         
ASSETS                
Homebuilding:                

Cash and cash equivalents

  $ 296,731     $ 259,087  

Marketable securities

    62,316       59,770  

Restricted cash

    4,229       3,778  

Trade and other receivables

    36,210       42,492  

Inventories:

               

Housing completed or under construction

    890,883       874,199  

Land and land under development

    855,208       884,615  

Total inventories

    1,746,091       1,758,814  

Property and equipment, net

    27,984       28,041  

Deferred tax asset, net

    70,451       74,888  

Metropolitan district bond securities (related party)

    31,004       30,162  

Prepaid and other assets

    63,419       60,463  

Total homebuilding assets

    2,338,435       2,317,495  

Financial Services:

               

Cash and cash equivalents

    23,331       23,822  

Marketable securities

    37,549       36,436  

Mortgage loans held-for-sale, net

    97,373       138,774  

Other assets

    9,860       12,062  

Total financial services assets

    168,113       211,094  

Total Assets

  $ 2,506,548     $ 2,528,589  

LIABILITIES AND EQUITY

               

Homebuilding:

               

Accounts payable

  $ 52,351     $ 42,088  

Accrued liabilities

    141,707       144,566  

Revolving credit facility

    15,000       15,000  

Senior notes, net

    841,937       841,646  

Total homebuilding liabilities

    1,050,995       1,043,300  

Financial Services:

               

Accounts payable and accrued liabilities

    51,401       50,734  

Mortgage repurchase facility

    70,542       114,485  

Total financial services liabilities

    121,943       165,219  

Total Liabilities

    1,172,938       1,208,519  

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; 51,649,695 and 51,485,090 issued and outstanding at March 31, 2017 and December 31, 2016, respectively

    516       515  

Additional paid-in-capital

    985,733       983,532  

Retained earnings

    323,304       313,952  

Accumulated other comprehensive income

    24,057       22,071  

Total Stockholders' Equity

    1,333,610       1,320,070  

Total Liabilities and Stockholders' Equity

  $ 2,506,548     $ 2,528,589  

 

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

 

 
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Table of Contents
 

 

M.D.C. HOLDINGS, INC.

Consolidated Statements of Operations and Comprehensive Income

 

   

Three Months Ended

 
   

March 31,

 
   

2017

   

2016

 
   

(Dollars in thousands, except

per share amounts)

 
   

(Unaudited)

 

Homebuilding:

               

Home sale revenues

  $ 563,479     $ 394,420  

Land sale revenues

    247       2,324  

Total home and land sale revenues

    563,726       396,744  

Home cost of sales

    (468,942 )     (330,026 )

Land cost of sales

    (211 )     (1,663 )

Inventory impairments

    (4,850 )     -  

Total cost of sales

    (474,003 )     (331,689 )

Gross margin

    89,723       65,055  

Selling, general and administrative expenses

    (66,298 )     (56,277 )

Interest and other income

    2,327       1,850  

Other expense

    (351 )     (1,541 )

Other-than-temporary impairment of marketable securities

    (50 )     (431 )

Homebuilding pretax income

    25,351       8,656  
                 

Financial Services:

               

Revenues

    17,979       11,017  

Expenses

    (7,898 )     (6,241 )

Interest and other income

    979       841  

Other-than-temporary impairment of marketable securities

    (51 )     -  

Financial services pretax income

    11,009       5,617  
                 

Income before income taxes

    36,360       14,273  

Provision for income taxes

    (14,111 )     (4,710 )

Net income

  $ 22,249     $ 9,563  
                 

Other comprehensive income related to available for sale securities, net of tax

    1,986       1,948  

Comprehensive income

  $ 24,235     $ 11,511  
                 

Earnings per share:

               

Basic

  $ 0.43     $ 0.19  

Diluted

  $ 0.43     $ 0.19  
                 

Weighted average common shares outstanding

               

Basic

    51,340,890       51,269,370  

Diluted

    51,590,017       51,275,117  
                 

Dividends declared per share

  $ 0.25     $ 0.24  

 

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,

 
   

2017

   

2016

 
   

(Dollars in thousands)

 
   

(Unaudited)

 

Operating Activities:

               

Net income

  $ 22,249     $ 9,563  

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

               

Stock-based compensation expense

    595       2,987  

Depreciation and amortization

    1,328       1,073  

Inventory impairments

    4,850       -  

Other-than-temporary impairment of marketable securities

    101       431  

Loss (gain) on sale of marketable securities

    (561 )     915  

Deferred income tax expense

    3,220       1,788  

Net changes in assets and liabilities:

               

Restricted cash

    (451 )     401  

Trade and other receivables

    7,326       (15,251 )

Mortgage loans held-for-sale

    41,401       33,477  

Housing completed or under construction

    (20,866 )     (115,357 )

Land and land under development

    29,030       68,311  

Prepaid expenses and other assets

    (2,407 )     911  

Accounts payable and accrued liabilities

    8,071       (4,234 )

Net cash provided by (used in) operating activities

    93,886       (14,985 )
                 

Investing Activities:

               

Purchases of marketable securities

    (5,361 )     (5,482 )

Sales of marketable securities

    4,983       20,600  

Purchases of property and equipment

    (1,122 )     (1,944 )

Net cash provided by (used in) investing activities

    (1,500 )     13,174  
                 

Financing Activities:

               

Payments on mortgage repurchase facility, net

    (43,943 )     (28,390 )

Dividend payments

    (12,897 )     (12,252 )

Proceeds from exercise of stock options

    1,607       -  

Net cash used in financing activities

    (55,233 )     (40,642 )
                 

Net increase (decrease) in cash and cash equivalents

    37,153       (42,453 )

Cash and cash equivalents:

               

Beginning of period

    282,909       180,988  

End of period

  $ 320,062     $ 138,535  

  

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

 

 
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Table of Contents
 

 

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

 

1.

Basis of Presentation

 

The Unaudited Consolidated Financial Statements of M.D.C. Holdings, Inc. ("MDC," “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, 2017 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, 2016.

 

On November 21, 2016, MDC’s board of directors declared a 5% stock dividend that was distributed on December 20, 2016 to shareholders of record on December 6, 2016. In accordance with Accounting Standards Codification (“ASC”) Topic 260, Earnings Per Share (“ASC 260”), basic and diluted earnings per share amounts, share amounts and dividends declared per share have been restated for any periods or dates prior to the stock dividend record date.

 

Included in these footnotes are certain statements that constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include statements regarding our business, financial condition, results of operations, cash flows, strategies and prospects. These forward-looking statements may be identified by terminology such as “likely,” “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential” or “continue,” or the negative of such terms and other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements contained in this section are reasonable, we cannot guarantee future results. These statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company to be materially different from those expressed or implied by the forward-looking statements. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise. However, any further disclosures made on related subjects in subsequent reports on Forms 10-K, 10-Q and 8-K should be considered.

 

2.

Recently Issued Accounting Standards

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“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 January 1, 2018, and is to be adopted using either a full retrospective or modified retrospective transition method. Early adoption is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. We expect to adopt the new standard under the modified retrospective approach in the 2018 first quarter. Although we are still in the process of evaluating our contracts, we do not believe the adoption of ASU 2014-09 will have a material impact on the amount or timing of our recognition of revenues. While we are still evaluating the accounting for marketing costs under ASC 606, there is a possibility that the adoption of ASU 2014-09 will impact the timing of recognition and classification in our consolidated financial statements of certain marketing costs we incur to obtain sales contracts from our customers. For example, there are various marketing costs that we currently capitalize and amortize with each home delivered in a community. Under the new guidance, these costs may need to be expensed immediately. We are continuing to evaluate the exact impact ASU 2014-09 will have on recording revenue and our marketing costs in our consolidated financial statements and related disclosures.

 

In January 2016, the FASB issued ASU 2016-01, Financial Instruments–Overall: Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”), which makes a number of changes to the current GAAP model, including changes to the accounting for equity investments and financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. Under ASU 2016-01, we will primarily be impacted by the changes to accounting for equity instruments with readily determinable fair values as they will no longer be permitted to be classified as available-for-sale (changes in fair value reported through other comprehensive income) and instead, all changes in fair value will be reported in earnings. ASU 2016-01 is effective for our interim and annual reporting periods beginning January 1, 2018 and is to be applied using a modified retrospective transition method. Early adoption of the applicable guidance from ASU 2016-01 is not permitted. Given the significant amount of our investments in equity securities, and assuming we still have a similar level of investments when this guidance is adopted, we would expect that the impact to our consolidated statements of operations and comprehensive income from this update could be material. Furthermore, depending on trends in the stock market, we may see increased volatility in our consolidated statements of operations and comprehensive income.

 

 
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Table of Contents
 

 

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

 

In February 2016, the FASB issued ASU 2016-02, Leases (“ASU 2016-02”), which requires a lessee to recognize a right-of-use asset and a corresponding lease liability for virtually all leases. The liability will be equal to the present value of the remaining lease payments while the right-of-use asset will be based on the liability, subject to adjustment, such as for initial direct costs. In addition, ASU 2016-02 expands the disclosure requirements for lessees. Upon adoption, we will be required to record a lease asset and lease liability related to our operating leases. ASU 2016-02 is effective for our interim and annual reporting periods beginning January 1, 2019 and is to be applied using a modified retrospective transition method. Early adoption is permitted. We do not plan to early adopt the guidance and we are currently evaluating the impact the update will have on our consolidated financial statements and related disclosures.

 

In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation: Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”), which amends ASC Topic 718, Compensation – Stock Compensation (“ASC 718”). The standard is intended to simplify several areas of accounting for share-based compensation arrangements, including the accounting for income taxes, classification of excess tax benefits on the statement of cash flows, forfeitures, statutory tax withholding requirements, classification of awards as either equity or liabilities, and classification of employee taxes paid on the statement of cash flows when an employer withholds shares for tax-withholding purposes. ASU 2016-09 became effective for us in the 2017 first quarter. The primary impact from this guidance, on a prospective basis, will be to our provision for income taxes line item on our consolidated statements of operations and comprehensive income. Any excess tax benefits or deficiencies from (1) the exercise or expiration of options or (2) the vesting of stock awards will now be recognized through our income tax provision as opposed to additional paid-in capital (to the extent we had a sufficient pool of windfall tax benefits). As a result of exercises of stock options and vesting of stock awards during the three months ended March 31, 2017, a $0.1 million excess tax benefit was recognized in our tax provision. Furthermore, as of March 31, 2017, we had options covering approximately 575,000 shares (1) with exercise prices above the MDC closing share price at March 31, 2017 and (2) that will have their ability to exercise expire at some point during 2017. If the exercise price continues to be greater than the share price of MDC throughout 2017, these options will likely expire unexercised and as a result, we could recognize approximately $2.7 million in additional expense in our provision for income taxes line item on our consolidated statements of operations and comprehensive income in 2017. Another provision of ASU 2016-09 that is relevant to the Company is the classification of excess tax benefits on the statement of cash flows, which was adopted on a prospective basis as such, prior periods have not been adjusted. This provision did not have a material effect on the statement of cash flows and is not expected to have a material impact on the statement of cash flows in future quarterly or annual filings. Adoption of ASU 2016-09 was not material to our statement of cash flows for the periods presented and we do not anticipate it will be material in 2017.

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”), which requires measurement and recognition of expected credit losses for financial assets held. The amendments in ASU 2016-13 eliminate the probable threshold for initial recognition of a credit loss in current GAAP and reflect an entity’s current estimate of all expected credit losses. ASU 2016-13 is effective for our interim and annual reporting periods beginning January 1, 2021, and is to be applied using a modified retrospective transition method. Earlier adoption is permitted. We do not plan to early adopt ASU 2016-13 and with our current holdings of financial instruments that are subject to credit losses, we do not believe adoption of this guidance will be material to our financial statements.

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (a consensus of the Emerging Issues Task Force) (“ASU 2016-15”), which amends ASC Topic 230, Statement of Cash Flows, to clarify guidance on the classification of certain cash receipts and payments in the statement of cash flows. The amendments in ASU 2016-15 are intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. ASU 2016-15 is effective for our interim and annual reporting periods beginning January 1, 2018, and is to be applied using a retrospective transition method. Earlier adoption is permitted. We do not plan to early adopt ASU 2016-15 and do not believe the guidance will have a material impact on our financial statements upon adoption.

 

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (a consensus of the FASB Emerging Issues Task Force (“ASU 2016-18”), which requires restricted cash to be included with cash and cash equivalents when reconciling the beginning and ending amounts on the statement of cash flows. ASU 2016-18 is effective for our interim and annual reporting periods beginning January 1, 2018, and is to be applied using a retrospective transition method. Earlier adoption is permitted. We do not plan to early adopt ASU 2016-18 and do not believe the guidance will have a material impact on our financial statements upon adoption.

 

3.

Segment Reporting

 

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

 

 
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Table of Contents
 

 

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

 

We have identified each homebuilding division as an operating segment. Our homebuilding 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)

 

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, treasury, information technology, insurance, 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 operations section of our consolidated statements of operations and comprehensive income.

 

The following table summarizes home and land sale revenues for our homebuilding operations and revenues for our financial services operations.

 

   

Three Months Ended

 
   

March 31,

 
   

2017

   

2016

 

Homebuilding

 

(Dollars in thousands)

 

West

  $ 309,079     $ 191,375  

Mountain

    173,136       137,824  

East

    81,511       67,545  

Total homebuilding revenues

  $ 563,726     $ 396,744  
                 

Financial Services

               

Mortgage operations

  $ 12,183     $ 6,870  

Other

    5,796       4,147  

Total financial services revenues

  $ 17,979     $ 11,017  

 

 
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Table of Contents
 

 

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

 

The following table summarizes pretax income (loss) for our homebuilding and financial services operations:

 

   

Three Months Ended

 
   

March 31,

 
   

2017

   

2016

 

Homebuilding

 

(Dollars in thousands)

 

West

  $ 15,455     $ 9,698  

Mountain

    18,230       10,084  

East

    2,642       1,367  

Corporate

    (10,976 )     (12,493 )

Total homebuilding pretax income

  $ 25,351     $ 8,656  
                 

Financial Services

               

Mortgage operations

  $ 7,566     $ 3,323  

Other

    3,443       2,294  

Total financial services pretax income

  $ 11,009     $ 5,617  
                 

Total pretax income

  $ 36,360     $ 14,273  

 

The following table 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 primarily include our cash and cash equivalents, marketable securities and deferred tax assets. The assets in our financial services segment consist mostly of cash and cash equivalents, marketable securities and mortgage loans held-for-sale.

 

   

March 31,

   

December 31,

 
   

2017

   

2016

 
   

(Dollars in thousands)

 
Homebuilding assets                

West

  $ 987,835     $ 1,035,033  

Mountain

    613,068       571,139  

East

    247,896       256,816  

Corporate

    489,636       454,507  

Total homebuilding assets

  $ 2,338,435     $ 2,317,495  
                 

Financial services assets

               

Mortgage operations

  $ 108,988     $ 153,182  

Other

    59,125       57,912  

Total financial services assets

  $ 168,113     $ 211,094  
                 

Total assets

  $ 2,506,548     $ 2,528,589  

 

 
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Table of Contents
 

 

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

 

4.

Earnings Per Share     

 

ASC 260 requires a company that has participating security holders (for example, holders of unvested restricted stock that has nonforfeitable dividend rights) to utilize the two-class method for calculating 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)). Our common shares outstanding are comprised of shareholder owned common stock and 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, excluding participating shares in accordance with ASC 260. To calculate diluted EPS, basic EPS is further adjusted to include the effect of potential dilutive stock options outstanding. The following table shows our basic and diluted EPS calculations:

 

   

Three Months Ended

 
   

March 31,

 
   

2017

   

2016

 
   

(Dollars in thousands, except

per share amounts)

 

Numerator

               

Net income

  $ 22,249     $ 9,563  

Less: distributed earnings allocated to participating securities

    (68 )     (40 )

Less: undistributed earnings allocated to participating securities

    (43 )     -  

Net income attributable to common stockholders (numerator for basic earnings per share)

    22,138       9,523  

Add back: undistributed earnings allocated to participating securities

    43       -  

Less: undistributed earnings reallocated to participating securities

    (43 )     -  

Numerator for diluted earnings per share under two class method

  $ 22,138     $ 9,523  
                 

Denominator

               

Weighted-average common shares outstanding

    51,340,890       51,269,370  

Add: dilutive effect of stock options

    249,127       5,747  

Denominator for diluted earnings per share under two class method

    51,590,017       51,275,117  
                 

Basic Earnings Per Common Share

  $ 0.43     $ 0.19  

Diluted Earnings Per Common Share

  $ 0.43     $ 0.19  

 

Diluted EPS for the three months ended March 31, 2017 and 2016 excluded options to purchase approximately 4.2 million and 6.5 million shares of common stock, respectively, because the effect of their inclusion would be anti-dilutive.

 

5.

Accumulated Other Comprehensive Income

 

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

 

   

Three Months Ended

 
   

March 31,

 
   

2017

   

2016

 
   

(Dollars in thousands)

 

Unrealized gains on available-for-sale marketable securities 1 :

               

Beginning balance

  $ 7,730     $ 3,657  

Other comprehensive income before reclassifications

    2,034       524  

Amounts reclassified from AOCI 2

    (285 )     835  

Ending balance

  $ 9,479     $ 5,016  
                 

Unrealized gains on available-for-sale metropolitan district bond securities 1 :

               

Beginning balance

  $ 14,341     $ 12,058  

Other comprehensive income before reclassifications

    237       589  

Amounts reclassified from AOCI

    -       -  

Ending balance

  $ 14,578     $ 12,647  
                 

Total ending AOCI

  $ 24,057     $ 17,663  

 

                                                                                                               

 

(1)

All amounts net-of-tax.

 

(2)

See separate table below for details about these reclassifications

 

 
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Table of Contents
 

 

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

 

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

 

   

Three Months Ended

 
   

March 31,

 

Affected Line Item in the Statements of Operations

 

2017

   

2016

 
   

(Dollars in thousands)

 

Homebuilding: Interest and other income

  $ 522     $ (915 )

Homebuilding: Other-than-temporary impairment of marketable securities

    (50 )     (431 )

Financial services: Interest and other income

    39       -  

Financial services: Other-than-temporary impairment of marketable securities

    (51 )     -  

Income before income taxes

    460       (1,346 )

Provision for income taxes

    (175 )     511  

Net income

  $ 285     $ (835 )

 

6.

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.

 

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,

2017

   

December 31,

2016

 
       

(Dollars in thousands)

 

Marketable equity securities (available-for-sale)

 

Level 1

  $ 99,865     $ 96,206  

Mortgage loans held-for-sale, net

 

Level 2

  $ 97,373     $ 138,774  

Metropolitan district bond securities (related party) (available-for-sale)

 

Level 3

  $ 31,004     $ 30,162  

 

The following methods and assumptions were used to estimate the fair value of each class of financial instruments as of March 31, 2017 and December 31, 2016.

 

Cash and cash equivalents, restricted cash, trade and other receivables, prepaid and other assets, accounts payable, accrued liabilities and borrowings on our revolving credit facility. Fair value approximates carrying value. 

 

Marketable securities.  As of March 31, 2017 and December 31, 2016, we held marketable equity securities, which consist of holdings in corporate equities, preferred stock and exchange traded funds. As of March 31, 2017 and December 31, 2016, all of our equity securities were treated as available-for-sale investments and as such, are recorded at fair value with all changes in fair value initially recorded through AOCI, subject to an assessment to determine if an unrealized loss, if applicable, is other-than-temporary.

 

Each quarter we assess all of our securities in an unrealized loss position for a potential other-than-temporary impairment (“OTTI”). If the unrealized loss is determined to be other-than-temporary, an OTTI is recorded in other-than-temporary impairment of marketable securities in the homebuilding or financial services sections of our consolidated statements of operations and comprehensive income. During the three months ended March 31, 2017 and 2016, we recorded pretax OTTI’s of $0.1 million and $0.4 million, respectively, for certain of our equity securities that were in an unrealized loss position as of the end of each respective period.

 

 
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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

 

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

 

   

March 31, 2017

 
   

Cost Basis

   

OTTI

   

Net Cost

Basis

   

Fair Value

 
   

(Dollars in thousands)

 

Homebuilding equity securities

  $ 49,944     $ (730 )   $ 49,214     $ 62,316  

Financial services equity securities

    35,710       (348 )     35,362       37,549  

Total marketable equity securities

  $ 85,654     $ (1,078 )   $ 84,576     $ 99,865  

 

   

December 31, 2016

 
   

Cost Basis

   

OTTI

   

Net Cost

Basis

   

Fair Value

 
   

(Dollars in thousands)

 

Homebuilding equity securities

  $ 48,910     $ (685 )   $ 48,225     $ 59,770  

Financial services equity securities

    35,885       (373 )     35,512       36,436  

Total marketable equity securities

  $ 84,795     $ (1,058 )   $ 83,737     $ 96,206  

 

As of March 31, 2017 and December 31, 2016, our marketable equity securities were in net unrealized gain positions totaling $15.3 million and $12.5 million, respectively. Our individual marketable equity securities that were in unrealized loss positions, excluding those that were impaired as part of any OTTI, aggregated to an unrealized loss of $0.5 million and $0.5 million as of March 31, 2017 and December 31, 2016, respectively. The table below sets forth the aggregated unrealized losses for individual equity securities that were in unrealized loss positions but did not have OTTIs recognized. We do not believe the decline in the value of these marketable securities as of March 31, 2017 is other-than-temporary.

 

   

March 31, 2017

   

December 31, 2016

 
   

Number of

Securities in a

Loss Position

   

Aggregate

Loss Position

   

Aggregate

Fair Value of

Securities in

a Loss

Position

   

Number of

Securities in a

Loss Position

   

Aggregate

Loss Position

   

Aggregate

Fair Value of

Securities in

a Loss

Position

 
   

(Dollars in thousands)

 

Marketable equity securities

    2     $ (500 )   $ 3,000       5     $ (457 )   $ 6,045  

 

The following table sets forth gross realized gains and losses from the sale of available-for-sale marketable securities. We record the net amount of these gains and losses to either other expense or interest and other income, dependent upon whether there is a net realized loss or gain, respectively, in the homebuilding section or financial services section of our consolidated statements of operations and comprehensive income.

 

   

Three Months Ended

 
   

March 31,

 
   

2017

   

2016

 
   

(Dollars in thousands)

 

Gross realized gains on sales of available-for-sale securities

  $ 590     $ 91  

Gross realized losses on sales of available-for-sale securities

    (29 )     (1,006 )

Net realized gain (loss) on sales of available-for-sale securities

  $ 561     $ (915 )

 

Mortgage loans held-for-sale, net.  Our mortgage loans held-for-sale, which are measured at fair value on a recurring basis, include (1) mortgage loans held-for-sale that are under commitments to sell and (2) mortgage loans held-for-sale that are not under commitments to sell. At March 31, 2017 and December 31, 2016, we had $67.7 million and $96.2 million, respectively, of mortgage loans held-for-sale under commitments to sell. The fair value for those loans was based on quoted market prices for those mortgage loans, which are Level 2 fair value inputs. At March 31, 2017 and December 31, 2016, we had $29.7 million and $42.6 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.    

 

 
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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

 

Gains on sales of mortgage loans, net, were $8.5 million and $5.6 million for the three months ended March 31, 2017 and 2016, respectively, and are included as a component of revenues in the financial services section of our consolidated statements of operations and comprehensive income.

 

Metropolitan district bond securities (related party).  The metropolitan district bond securities (the “Metro Bonds”) are included in the homebuilding section of our 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, which are generally received in the fourth quarter, and are supported by an annual levy on the taxable assessed value of real estate and personal property within the Metro District’s boundaries. 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.

 

In accordance with ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (“ASC 310-30”), we adjust the bond principal balance 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 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 primary unobservable inputs used in our discounted cash flow model are (1) the forecasted number of homes to be closed, as they drive increases to the tax paying base for the Metro District, (2) the forecasted assessed value of those closed homes and (3) the discount rate. Cash receipts, which are scheduled to be received in the fourth quarter, reduce the carrying value of the Metro Bonds. The increases in the value of the Metro Bonds during the past two years are primarily based on a larger percentage of future cash flows coming from homes that have closed, which utilize a lower discount rate as those cash flows have a reduced amount of risk. The table below provides quantitative data, as of March 31, 2017, 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

Forecasted number of homes closed per year

  0 to 120       107  

Increase

 

Decrease

Forecasted assessed value

  $401,000 to $1,200,000     $ 558,000  

Increase

 

Decrease

Discount rates

  5% to 12%       7.5 %

Decrease

 

Increase

 

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

 

   

Three Months Ended

 
   

March 31,

 
   

2017

   

2016

 
   

(Dollars in thousands)

 

Balance at beginning of period

  $ 30,162     $ 25,911  

Increase in fair value (recorded in other comprehensive income)

    382       950  

Change due to accretion of principal

    460       416  

Cash receipts

    -       -  

Balance at end of period

  $ 31,004     $ 27,277  

 

Mortgage Repurchase Facility. The debt associated with our mortgage repurchase facility (see Note 18 for further discussion) is at floating 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.

 

 
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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

 

Senior Notes. The estimated values of the senior notes in the following table are based on Level 2 inputs, which primarily reflect estimated prices for our senior notes which were provided by multiple sources.

 

   

March 31, 2017

   

December 31, 2016

 
   

Carrying
Amount

   

Fair Value

   

Carrying
Amount

   

Fair Value

 
   

(Dollars in thousands)

 

5⅝% Senior Notes due February 2020, net

  $ 247,144     $ 264,208     $ 246,915     $ 265,611  

5½% Senior Notes due January 2024, net

    248,439       257,325       248,391       258,800  

6% Senior Notes due January 2043, net

    346,354       309,563       346,340       297,087  

Total

  $ 841,937     $ 831,096     $ 841,646     $ 821,498  

 

7.

Inventories

 

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

 

   

March 31,

   

December 31,

 
   

2017

   

2016

 
   

(Dollars in thousands)

 

Housing Completed or Under Construction:

               

West

  $ 454,262     $ 470,503  

Mountain

    299,449       277,922  

East

    137,172       125,774  

Subtotal

    890,883       874,199  

Land and Land Under Development:

               

West

    470,522       499,186  

Mountain

    289,323       271,252  

East

    95,363       114,177  

Subtotal

    855,208       884,615  

Total Inventories

  $ 1,746,091     $ 1,758,814  

 

Our inventories are primarily associated with communities where we intend to construct and sell homes, including models and unsold 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 Topic 360, Property, Plant, and Equipment (“ASC 360”), homebuilding inventories, excluding those classified as held for sale, 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 incremental costs associated directly with the subdivision, including sales commissions and marketing costs);

 

estimated future undiscounted cash flows and Operating Margin;

 

forecasted Operating Margin for homes in backlog;

 

actual and trending net home orders;

 

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.

 

 
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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

 

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 (including capitalized interest) 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, which are Level 3 inputs that are commensurate with the risk of the subdivision under evaluation. The evaluation for the recoverability of the carrying value of the assets for each individual subdivision can be impacted significantly by our estimates of future home sale revenues, home construction costs, and development costs per home, all of which are Level 3 inputs.

 

If land is classified as held for sale, in accordance with ASC 360, we measure it at the lower of the carrying value or fair value less estimated costs to sell. In determining fair value, we primarily rely upon the most recent negotiated price which is a Level 2 input. If a negotiated price is not available, we will consider several factors including, but not limited to, current market conditions, recent comparable sales transactions and market analysis studies. If the fair value less estimated costs to sell is lower than the current carrying value, the land is impaired down to its estimated fair value less costs to sell.

 

Impairments of homebuilding inventory by segment for the three months ended March 31, 2017 are shown in the table below. No such impairments were recorded during the same period in 2016.

 

   

Three Months Ended

 
   

March 31,

 
   

2017

   

2016

 
   

(Dollars in thousands)

 

West

  $ 4,100     $ -  

Mountain

    -       -  

East

    750       -  

Total Inventory Impairments

  $ 4,850     $ -  

 

The table below provides quantitative data, for the periods presented, used in determining the fair value of the impaired inventory.

 

   

Impairment Data

   

Quantitative Data

Three Months Ended

 

Total
Subdivisions
Tested

   

Inventory
Impairments

   

 

Fair Value of
Inventory

After

Impairments

   

Number of
Subdivisions
Impaired

   

Discount Rate

   

(Dollars in thousands)

         

March 31, 2017

    33     $ 4,850     $ 19,952       2      12% to 18%

March 31, 2016

    14     $ -     $ -       -       N/A  

 

 
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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 during the period that related units or lots are delivered. To the extent our homebuilding debt exceeds our qualified assets as defined in ASC 835, we expense a portion of the 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. For all periods presented below, our qualified assets exceeded our homebuilding debt and as such, all interest incurred has been capitalized. 

 

   

Three Months Ended

 
   

March 31,

 
   

2017

   

2016

 
   

(Dollars in thousands)

 

Homebuilding interest incurred

  $ 13,188     $ 13,218  

Less: Interest capitalized

    (13,188 )     (13,218 )

Homebuilding interest expensed

  $ -     $ -  
                 

Interest capitalized, beginning of period

  $ 68,085     $ 77,541  

Plus: Interest capitalized during period

    13,188       13,218  

Less: Previously capitalized interest included in home and land cost of sales

    (15,197 )     (10,976 )

Interest capitalized, end of period

  $ 66,076     $ 79,783  

 

 

9.

Homebuilding Prepaid and Other Assets

 

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

 

   

March 31,

   

December 31,

 
   

2017

   

2016

 
   

(Dollars in thousands)

 

Deferred marketing costs

  $ 35,952     $ 35,313  

Land option deposits

    11,532       8,683  

Goodwill

    6,008       6,008  

Prepaid expenses

    4,478       4,735  

Deferred debt issuance costs on revolving credit facility, net

    4,063       4,340  

Other

    1,386       1,384  

Total

  $ 63,419     $ 60,463  

 

10.

Homebuilding Accrued Liabilities and Financial Services Accounts Payable and Accrued Liabilities

 

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

 

   

March 31,

   

December 31,

 
   

2017

   

2016

 
   

(Dollars in thousands)

 

Customer and escrow deposits

  $ 34,598     $ 27,183  

Warranty accrual

    20,770       20,678  

Accrued compensation and related expenses

    16,570       27,830  

Accrued interest

    11,031       23,234  

Land development and home construction accruals

    7,824       8,695  

Other accrued liabilities

    50,914       36,946  

Total accrued liabilities

  $ 141,707     $ 144,566  

 

 
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Table of Contents
 

 

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

 

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

 

   

March 31,

   

December 31,

 
   

2017

   

2016

 
   

(Dollars in thousands)

 

Insurance reserves

  $ 43,359     $ 42,204  

Accounts payable and other accrued liabilities

    8,042       8,530  

Total accounts payable and accrued liabilities

  $ 51,401     $ 50,734  

 

11.

Warranty Accrual

 

Our homes are sold with limited third-party warranties and, under our agreement with the issuer of the third-party warranties, we are responsible for performing all of the work for the first two years of the warranty coverage and paying for substantially all of the work required to be performed during years three through ten of the warranties. We record accruals for general and structural warranty claims, as well as accruals for known, unusual warranty-related expenditures. Our warranty accrual is 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 accrual 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 accrual is included in accrued liabilities in the homebuilding section of our consolidated balance sheets and adjustments to our warranty accrual are recorded as an increase or reduction to home cost of sales in the homebuilding section of our consolidated statements of operations and comprehensive income.

 

The table set forth below summarizes accrual, adjustment and payment activity related to our warranty accrual for the three months ended March 31, 2017 and 2016. For the three months ended March 31, 2017 and 2016, we recorded adjustments to increase our warranty accrual of $0.1 million and $3.0 million, respectively. The adjustment made during the 2016 first quarter was due to higher than expected recent warranty related expenditures.

 

   

Three Months Ended

 
   

March 31,

 
   

2017

   

2016

 
   

(Dollars in thousands)

 

Balance at beginning of period

  $ 20,678     $ 15,328  

Expense provisions

    2,407       1,452  

Cash payments

    (2,365 )     (2,915 )

Adjustments

    50       2,987  

Balance at end of period

  $ 20,770     $ 16,852  

 

12.

Insurance and Construction Defect Claim 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 actuarial 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. It is possible that changes in the insurance payment experience used in estimating our ultimate insurance losses could have a material impact on our insurance reserves.

 

The establishment of reserves for estimated losses to be incurred by our homebuilding subsidiaries associated with (1) the self-insured retention (“SIR”) portion of construction defect claims that are expected to be covered under insurance policies with Allegiant and (2) the entire cost of any construction defect claims that are not expected to be covered by insurance policies with Allegiant are based on actuarial studies that include known facts similar to those established for our insurance reserves. It is possible that changes in the payment experience used in estimating our ultimate losses for construction defect claims could have a material impact on our reserves.

 

 
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Table of Contents
 

 

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

 

The table set forth below summarizes our insurance and defect claim reserves activity for the three months ended March 31, 2017 and 2016. These reserves are included as a component of accrued liabilities in either the financial services or homebuilding sections of the consolidated balance sheets.

 

   

Three Months Ended

 
   

March 31,

 
   

2017

   

2016

 
   

(Dollars in thousands)

 

Balance at beginning of period

  $ 50,954     $ 47,061  

Expense provisions

    2,116       1,388  

Cash payments, net of recoveries

    (1,219 )     (820 )

Balance at end of period

  $ 51,851     $ 47,629  

 

In the ordinary course of business, we make payments from our insurance and construction defect claim 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, 2017 and 2016 are not necessarily indicative of what future cash payments will be for subsequent periods.

 

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. Our overall effective income tax rates were 38.8% and 33.0% for the three months ended March 31, 2017 and 2016, respectively, resulting in income tax expense of $14.1 million and $4.7 million for the same periods, respectively. The year-over-year increase in our effective tax rate was primarily the result of (1) our 2016 first quarter estimate of our full year effective tax rate including an estimate for energy credits whereas our estimate for the 2017 full year includes no such estimate as the credit for 2017 has not been approved by the U.S. Congress and (2) establishment of a valuation allowance against certain state net operating loss carryforwards where realization is more uncertain at this time.

 

At March 31, 2017 and December 31, 2016 we had deferred tax assets, net of valuation allowances and deferred tax liabilities, of $70.5 million and $74.9 million, respectively. The valuation allowances were related to: (1) various state net operating loss carryforwards where realization is more uncertain at this time due to the limited carryforward periods that exist in certain states; and (2) the portion of the amount by which the carrying value of our Metro Bonds for tax purposes exceeds our carrying value for book purposes, as we believe realization of that portion is more uncertain at this time.

 

 

14.

Senior Notes

 

The carrying value of our senior notes as of March 31, 2017 and December 31, 2016, net of any unamortized debt issuance costs or discount, were as follows:

 

   

March 31,

   

December 31,

 
   

2017

   

2016

 
   

(Dollars in thousands)

 

5⅝% Senior Notes due February 2020, net

  $ 247,144     $ 246,915  

5½% Senior Notes due January 2024, net

    248,439       248,391  

6% Senior Notes due January 2043, net

    346,354       346,340  

Total

  $ 841,937     $ 841,646  

 

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

 

 
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Table of Contents
 

 

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

 

15.

Stock Based Compensation

 

We account for share-based awards in accordance with ASC 718, which requires the fair value of stock-based compensation awards to be amortized as an expense over the vesting period. Stock-based compensation awards are valued at fair value on the date of grant. The following table sets forth share-based award expense activity for the three months ended March 31, 2017 and 2016:

 

   

Three Months Ended

 
   

March 31,

 
   

2017

   

2016

 
   

(Dollars in thousands)

 

Stock option grant expense

  $ 276     $ 2,650  

Restricted stock awards expense

    319       337  

Total stock based compensation

  $ 595     $ 2,987  

 

On May 18, 2015, the Company granted a non-qualified stock option to each of the Chief Executive Officer and the Chief Operating Officer for 1,050,000 shares of common stock under the Company’s 2011 Equity Incentive Plan. The terms of each option provide that, over a five year period, one third of the option shares will vest as of each of the third, fourth, and fifth anniversary dates of the grant of the option; provided that all unvested option shares will vest immediately in the event the closing price of the Company’s stock, as reported by the New York Stock Exchange, in any 20 out of 30 consecutive trading days closes at a price equal to or greater than 120% of the closing price on the date of grant (the “market-based condition”). The option exercise price is equal to the closing price of the Company’s common stock on the date of grant, which was $27.10 and the expiration date of each option is May 18, 2025. In accordance with ASC 718, the market-based awards were assigned a fair value of $5.35 per share (total value of $11.2 million) on the date of grant using a Monte Carlo simulation model and, as calculated under that model, all expense was recorded on a straight-line basis through the end of the 2016 second quarter. Included in the stock-based compensation expense for the three months ended March 31, 2017 and 2016, shown in the table above, was $0 and $2.5 million, respectively, of stock option grant expense related to these market-based option grants.

 

On July 25, 2016, the Company granted long term performance stock unit awards (“PSUs”) to each of the Chief Executive Officer, the Chief Operating Officer, and the Chief Financial Officer under the Company’s 2011 Equity Incentive Plan. The PSUs will be earned based upon the Company’s performance, over a three year period commencing July 1, 2016 and ending June 30, 2019 (the “Performance Period”), measured by increasing home sale revenues over the Base Period. The “Base Period” for the awards is July 1, 2015 to June 30, 2016. The awards are conditioned upon the Company achieving an average gross margin from home sales percentage (excluding impairments) of at least fifteen percent (15%) over the Performance Period. Target goals of 105,000 shares for each of the Chief Executive Officer and the Chief Operating Officer and 26,250 shares for the Chief Financial Officer (the “Target Goals”) will be earned if the Company’s three year average home sale revenues over the Performance Period (“Performance Revenues”) exceed the $1.975 billion in home sale revenues over the Base Period (“Base Revenues”) by at least 10% but less than 20%. If Performance Revenues exceed the Base Revenues by at least 5% but less than 10%, 50% of the Target Goals will be earned. If Performance Revenues exceed the Base Revenues by at least 20%, 200% of the Target Goals will be earned.

 

In accordance with ASC 718, the PSUs were valued at the fair value on the date of grant. The grant date fair value of these awards was $22.93 per share and the maximum potential expense that would be recognized by the Company if the maximum of the performance targets were met would be approximately $10.8 million. ASC 718 does not permit recognition of expense associated with performance based stock awards until achievement of the performance targets are probable of occurring. As of March 31, 2017, the Company concluded that achievement of any of the performance targets had not met the level of probability required to record compensation expense at that time and, as such, no compensation expense was recognized related to the grant of these awards during the 2017 first quarter.

 

16.

Commitments and Contingencies

 

Surety Bonds and Letters of Credit. We are required to obtain surety bonds and letters of credit in support of our obligations for land development and subdivision improvements, homeowner association dues, warranty work, contractor license fees and earnest money deposits. At March 31, 2017, we had outstanding surety bonds and letters of credit totaling $173.3 million and $52.9 million, respectively, including $27.8 million in letters of credit issued by HomeAmerican. The estimated cost to complete obligations related to these bonds and letters of credit were approximately $43.4 million and $20.0 million, respectively. All letters of credit as of March 31, 2017, excluding those issued by HomeAmerican, were issued under our unsecured revolving credit facility (see Note 18 for further discussion of the revolving credit facility). We expect that the obligations secured by these performance bonds and letters of credit generally will be performed in the ordinary course of business and in accordance with the applicable contractual terms. To the extent that the obligations are performed, the related performance bonds and letters of credit should be released and we should not have any continuing obligations. However, in the event any such performance bonds or letters of credit are called, our indemnity obligations could require us to reimburse the issuer of the performance bond or letter of credit.

 

 
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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

 

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

 

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

 

Lot Option Contracts. In the ordinary course of business, we enter into lot option purchase contracts (“Option Contracts”), generally through a deposit of cash or a letter of credit, for the right to purchase land or lots at a future point in time with predetermined terms. The use of such land option and other contracts generally allow us to reduce the risks associated with direct land ownership and development, reduces our capital and financial commitments, and minimizes the amount of land inventories on our consolidated balance sheets. Our obligation with respect to Option Contracts is generally limited to forfeiture of the related deposits. At March 31, 2017, we had cash deposits and letters of credit totaling $8.0 million and $2.1 million, respectively, at risk associated with the option to purchase 3,032 lots.

 

17.

Derivative Financial Instruments

 

The derivative instruments we utilize in the normal course of business are interest rate lock commitments and forward sales of mortgage-backed securities, both of which typically are short-term in nature. Forward sales of mortgage-backed securities are utilized to hedge changes in fair value of our interest rate lock commitments as well as mortgage loans held-for-sale not under commitments to sell. For forward sales of mortgage-backed securities, as well as interest rate lock commitments that are still outstanding at the end of a reporting period, we record the changes in fair value of the derivatives in revenues in the financial services section of our consolidated statements of operations and comprehensive income with an offset to other assets or accounts payable and accrued liabilities in the financial services section of our consolidated balance sheets, depending on the nature of the change.

 

At March 31, 2017, we had interest rate lock commitments with an aggregate principal balance of $122.8 million. Additionally, we had $28.6 million of mortgage loans held-for-sale at March 31, 2017 that had not yet been committed to a mortgage purchaser. In order to hedge the changes in fair value of our interest rate lock commitments and mortgage loans held-for-sale that had not yet been committed to a mortgage purchaser, we had forward sales of securities totaling $104.5 million at March 31, 2017.

 

For the three months ended March 31, 2017 and 2016, we recorded a net loss of $0.3 million and a net gain $0.6 million, respectively, on our derivatives.

 

18.

Lines of Credit

 

Revolving Credit Facility. We have an unsecured revolving credit agreement (“Revolving Credit Facility”) with a group of lenders which may be used for general corporate purposes. This agreement has an aggregate commitment of $550 million (the “Commitment”) and was amended on December 18, 2015 to extend the maturity to December 18, 2020. Each lender may issue letters of credit in an amount up to 50% of its commitment. The facility permits an increase in the maximum Commitment amount to $1.0 billion upon our request, subject to receipt of additional commitments from existing or additional lenders and the consent of the designated agent and the co-administrative agent. As defined in the Revolving Credit Facility agreement, interest rates on outstanding borrowings are equal to the highest of (1) 0.0% or (2) a specified eurocurrency rate, federal funds effective rate or prime rate, plus a margin that is determined based on our credit ratings and leverage ratio. At any time at which our leverage ratio, as of the last day of the most recent calendar quarter, exceeds 55%, the aggregate principal amount of all consolidated senior debt borrowings outstanding may not exceed the borrowing base. There is no borrowing base requirement if our leverage ratio, as of the last day of the most recent calendar quarter, is 55% or less.

 

The Revolving Credit Facility is fully and unconditionally guaranteed, jointly and severally, by most of our homebuilding segment subsidiaries. The facility contains various representations, warranties and covenants that we believe are customary for agreements of this type. The financial covenants include a consolidated tangible net worth test and a leverage test, along with a consolidated tangible net worth covenant, all as defined in the facility agreement. A failure to satisfy the foregoing tests does not constitute an event of default, but can trigger a “term-out” of the facility. A breach of the consolidated tangible net worth covenant (but not the consolidated tangible net worth test) or a violation of anti-corruption or sanctions laws would result in an event of default.

 

 
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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

 

The Revolving Credit Facility is subject to acceleration upon certain specified events of default, including breach of the consolidated tangible net worth covenant, a violation of anti-corruption or sanctions laws, failure to make timely payments, breaches of certain representations or covenants, failure to pay other material indebtedness, or another person becoming beneficial owner of 50% or more of our outstanding common stock. We believe we were in compliance with the representations, warranties and covenants included in the Revolving Credit Facility as of March 31, 2017.

 

We incur costs associated with unused commitment fees pursuant to the terms of the Revolving Credit Facility. At March 31, 2017 and December 31, 2016, there were $25.1 million and $23.0 million, respectively, in letters of credit outstanding, which reduced the amounts available to be borrowed under the Revolving Credit Facility. At both March 31, 2017 and December 31, 2016, we had $15.0 million outstanding under the Revolving Credit Facility. As of March 31, 2017, availability under the Revolving Credit Facility was approximately $509.9 million.

 

Mortgage Repurchase Facility. HomeAmerican entered into an Amended and Restated Master Repurchase Agreement (the “Mortgage Repurchase Facility”) with U.S. Bank National Association (“USBNA”), effective September 16, 2016. The Mortgage Repurchase Facility amends and restates the prior Master Repurchase Agreement with USBNA dated as of November 12, 2008, as amended, which contained similar terms. The Mortgage Repurchase Facility increases the facility amount from $50 million to $75 million, extends the expiration date to September 15, 2017, adjusts the facility’s sublimits, expands the types of eligible loans, and reduces the facility fee. The Mortgage Repurchase Facility provides liquidity to HomeAmerican by providing for the sale of eligible mortgage loans to USBNA with an agreement by HomeAmerican to repurchase the mortgage loans at a future date. Until such mortgage loans are transferred back to HomeAmerican, the documents relating to such loans are held by USBNA, as custodian, pursuant to the Custody Agreement (“Custody Agreement”), dated as of November 12, 2008, by and between HomeAmerican and USBNA. In the event that an eligible mortgage loan becomes ineligible, as defined under the Mortgage Repurchase Facility, HomeAmerican may be required to repurchase the ineligible mortgage loan immediately. The maximum aggregate commitment of the Mortgage Repurchase Facility was temporarily increased on March 29, 2017 from $75 million to $100 million and was effective through April 27, 2017. The Mortgage Repurchase Facility also had a temporary increase in the maximum aggregate commitment from $75 million to $125 million from December 27, 2016 through January 25, 2017. At March 31, 2017 and December 31, 2016, HomeAmerican had $70.5 million and $114.5 million, respectively, of mortgage loans that HomeAmerican was obligated to repurchase under the Mortgage Repurchase Facility. Mortgage loans that HomeAmerican is obligated to repurchase under the Mortgage Repurchase Facility are accounted for as a debt financing arrangement and are reported as mortgage repurchase facility in the consolidated balance sheets. Advances under the Mortgage Repurchase Facility carry a price range that is LIBOR-based. The Mortgage Repurchase Facility contains various representations, warranties and affirmative and negative covenants that we believe are customary for agreements of this type. The negative covenants include, among others, (i) a minimum Adjusted Tangible Net Worth requirement, (ii) a maximum Adjusted Tangible Net Worth ratio, (iii) a minimum adjusted net income requirement, and (iv) a minimum Liquidity requirement. The foregoing capitalized terms are defined in the Mortgage Repurchase Facility. We believe HomeAmerican was in compliance with the representations, warranties and covenants included in the Mortgage Repurchase Facility as of March 31, 2017.

 

19.

Related Party Transactions

 

We contributed $1.5 million and $1.0 million in cash to the MDC/Richmond American Homes Foundation (the “Foundation”) during the three months ended March 31, 2017 and 2016, respectively. The Foundation is a Delaware non-profit corporation that was incorporated on September 30, 1999.

 

The Foundation is a non-profit organization operated exclusively for charitable, educational and other purposes beneficial to social welfare within the meaning of Section 501(c)(3) of the Internal Revenue Code. The following Directors and/or officers of the Company served as directors of the Foundation at March 31, 2017, all of whom serve without compensation:

 

Name

 

MDC Title

 

Larry A. Mizel

 

Chairman and Chief Executive Officer

 

David D. Mandarich

 

President

 

 

Three other individuals, who are independent of the Company, also serve as directors of the Foundation. All directors of the Foundation serve without compensation.

 

See footnote 6 for related party information regarding the Metro District.

 

 
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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

 

20.

Supplemental Guarantor Information

 

Our senior notes are fully and unconditionally guaranteed on an unsecured basis, jointly and severally, by the following subsidiaries (collectively, the "Guarantor Subsidiaries"), which are 100%-owned subsidiaries of the Company.

 

 

M.D.C. Land Corporation

 

RAH of Florida, Inc.

 

Richmond American Construction, Inc.

 

Richmond American Homes of Arizona, Inc.

 

Richmond American Homes of Colorado, Inc.

 

Richmond American Homes of Delaware, Inc.

 

Richmond American Homes of Florida, LP

 

Richmond American Homes of Illinois, Inc.

 

Richmond American Homes of Maryland, Inc.

 

Richmond American Homes of Nevada, Inc.

 

Richmond American Homes of New Jersey, Inc.

 

Richmond American Homes of Pennsylvania, Inc.

 

Richmond American Homes of Utah, Inc.

 

Richmond American Homes of Virginia, Inc.

 

Richmond American Homes of Washington, Inc.

 

The senior note indentures do not provide for a suspension of the guarantees, but do provide that any Guarantor may be released from its guarantee so long as (1) no default or event of default exists or would result from release of such guarantee, (2) the Guarantor being released has consolidated net worth of less than 5% of the Company’s consolidated net worth as of the end of the most recent fiscal quarter, (3) the Guarantors released from their guarantees in any year-end period comprise in the aggregate less than 10% (or 15% if and to the extent necessary to permit the cure of a default) of the Company’s consolidated net worth as of the end of the most recent fiscal quarter, (4) such release would not have a material adverse effect on the homebuilding business of the Company and its subsidiaries and (5) the Guarantor is released from its guarantee(s) under all Specified Indebtedness (other than by reason of payment under its guarantee of Specified Indebtedness). Upon delivery of an officers’ certificate and an opinion of counsel stating that all conditions precedent provided for in the indenture relating to such transactions have been complied with and the release is authorized, the guarantee will be automatically and unconditionally released. “Specified Indebtedness” means indebtedness under the senior notes, the Company’s Indenture dated as of December 3, 2002, the Revolving Credit Facility, and any refinancing, extension, renewal or replacement of any of the foregoing.

 

We have determined that separate, full financial statements of the Guarantor Subsidiaries would not be material to investors and, accordingly, supplemental financial information for the Guarantor and Non-Guarantor Subsidiaries is presented below.

 

 
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M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

 

Supplemental Condensed Combining Balance Sheet

 

   

March 31, 2017

 
                   

Non-

                 
           

Guarantor

   

Guarantor

   

Eliminating

   

Consolidated

 
   

MDC

   

Subsidiaries

   

Subsidiaries

   

Entries

   

MDC

 

ASSETS

 

(Dollars in thousands)

 

Homebuilding: