Financial services operating profit for the third quarter and first nine months of 2003 increased, compared with the same periods in 2002, primarily due to higher gains on sales of mortgage loans and increased origination fee income, partially offset by higher general and administrative expenses resulting from HomeAmerican’s expanded loan origination activity. The principal amounts of originated and brokered loans were $528,271,000 and $1,348,540,000, respectively, in the third quarter and first nine months of 2003, compared with $385,272,000 and $1,028,706,000, respectively, for the same periods in 2002. These improvements primarily were due to increases in homes closed by the homebuilding segment. MDC home buyers were the source of approximately 99% of the principal amount of mortgage loans originated and brokered by HomeAmerican in the third quarter and first nine months of 2003. Mortgage loans originated by HomeAmerican for MDC home buyers as a percentage of total MDC home closings (“Capture Rate”) were 62% and 66%, respectively, for the quarter and nine months ended September 30, 2003, compared with 70% for the same periods in 2002. HomeAmerican also brokers mortgage loans originated by outside lending institutions for MDC home buyers. These brokered loans, for which HomeAmerican receives a fee, have been excluded from the computation of the Capture — 22 —
Rate. The Capture Rate including brokered loans was 80% for the third quarter and first nine months of 2003, compared with 80% and 81%, respectively, for the same periods in 2002. Forward Sales Commitments - HomeAmerican’s operations are affected by changes in mortgage interest rates. HomeAmerican utilizes forward mortgage securities contracts to manage price risk related to fluctuations in interest rates on its fixed-rate mortgage loans owned and rate-locked mortgage loans in the pipeline. Reported gains on sales of mortgage loans may vary significantly from period to period depending on the volatility in the interest rate market. Insurance Operations - American Home Insurance provides homeowners, auto and other types of casualty insurance in each of MDC’s markets. The results of its operations were not material for any of the periods presented. Other Operating Results Interest Expense - The Company capitalizes interest incurred on its corporate and homebuilding debt during the period of active development and through the completion of construction of its homebuilding inventories. Corporate and homebuilding interest incurred but not capitalized is reported as interest expense. Interest incurred by the financial services segment is charged to interest expense, which is deducted from interest income and reported as net interest income in Note F to the Company’s Condensed Consolidated Financial Statements. For a reconciliation of interest incurred, capitalized and expensed, see Note D to the Company’s Condensed Consolidated Financial Statements. Expenses Related to Debt Redemption —In May 2003, the Company redeemed $175,000,000 principal amount of its 8 3/8% Senior Notes due 2008 (the “8 3/8% Senior Notes”). The 8 3/8% Senior Notes were redeemed at 104.188% of their principal amount, or $182,329,000, plus accrued and unpaid interest through the date of redemption. Expenses for the quarter and six months ended June 30, 2003 related to this debt redemption of $9,315,000 include the above redemption premium of $7,329,000 and the related unamortized discount and debt issuance costs of $1,986,000. In compliance with the Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 145, the expenses related to this debt redemption are no longer treated as an extraordinary loss. Corporate General and Administrative Expenses - Corporate general and administrative expenses totaled $18,159,000 and $44,467,000, respectively, during the third quarter and first nine months of 2003, compared with $10,498,000 and $30,992,000, respectively, for the same periods of 2002. The increases in 2003 primarily were due to greater compensation-related costs principally resulting from the Company’s higher profitability, increased compensation and other expenses for information technology, as the Company is focusing on improving its systems in preparation for the growth of its homebuilding and financial services operations and a $2,000,000 charitable contribution to the M.D.C. Holdings, Inc. Charitable Foundation in the third quarter of 2003. Income Taxes - MDC’s overall effective income tax rate of 39.0% for the third quarter and first nine months of 2003, compared with 38.7% and 38.9%, respectively, for the same periods in 2002, differed from the federal statutory rate of 35%, primarily due to the impact of state income taxes. LIQUIDITY AND CAPITAL RESOURCES MDC uses its liquidity and capital resources to (1) support its operations, including its homebuilding inventories; (2) provide working capital; and (3) provide mortgage loans for its home buyers. Liquidity and capital resources are generated internally from operations and from external — 23 —
sources. During the 2003 third quarter, the Company filed a registration statement, which has been declared effective, increasing its capacity to issue equity, debt or hybrid securities to $750,000,000 from $450,000,000. Capital Resources The Company’s capital structure is a combination of (1) permanent financing, represented by stockholders’ equity; (2) long-term financing, represented by its publicly traded 7% Senior Notes due 2012 (the “7% Senior Notes”), 5 ½% Senior Notes due 2013 (the “5 ½% Senior Notes”) and its homebuilding line of credit (the “Homebuilding Line”); and (3) current financing, primarily its mortgage lending line of credit (the “Mortgage Line”). Based upon its current capital resources and additional capacity available under existing credit agreements, the Company believes that its current financial condition is both balanced to fit its current operating structure and adequate to satisfy its current and near-term capital requirements, including the acquisition of land and expansion into new markets. The Company believes that it can meet its long-term capital needs (including meeting future debt payments and refinancing or paying off other long-term debt as it becomes due) from operations and external financing sources, assuming that no significant adverse changes in the Company’s business or capital and credit markets occur as a result of the various risk factors described elsewhere in this report. See “Forward-Looking Statements” below. Lines of Credit and Other Homebuilding - The Company’s Homebuilding Line is an unsecured revolving line of credit with a group of lenders for support of its homebuilding operations. Lender commitments under the Homebuilding Line total $600,000,000 with a maturity date of July 29, 2006. Pursuant to the terms of the Homebuilding Line, a term-out of this credit may commence prior to July 29, 2006 under certain circumstances. At September 30, 2003, $100,000,000 was borrowed and $25,742,000 in letters of credit were outstanding under the Homebuilding Line. Mortgage Lending - The Company’s Mortgage Line has a borrowing limit of $175,000,000 with terms that allow for increases of up to $50,000,000 in the borrowing limit to a maximum of $225,000,000, subject to concurrence by the participating banks. The terms of the Mortgage Line are set forth in the Third Amended and Restated Warehousing Credit Agreement dated as of October 23, 2003. Available borrowings under the Mortgage Line are collateralized by mortgage loans and mortgage-backed certificates and are limited to the value of eligible collateral as defined. At September 30, 2003, $86,132,000 was borrowed and an additional $24,105,000 was collateralized and available to be borrowed. The Mortgage Line is cancelable upon 120 days notice. General - - The agreements for the Company’s bank lines of credit and the indentures for the Company’s Senior Notes require compliance with certain representations, warranties and covenants. The Company believes that it is in compliance with these representations, warranties and covenants. The agreements for the bank lines of credit and the indentures for the Company’s Senior Notes are on file with the Securities and Exchange Commission and are listed in the Exhibit Table in Part IV of MDC’s Annual Report on Form 10-K for its fiscal year ended December 31, 2002. The financial covenants contained in the Homebuilding Line credit agreement include a leverage test and a consolidated tangible net worth test. Under the leverage test, generally, MDC’s consolidated indebtedness is not permitted to exceed 2.15 times (subject to downward adjustment in certain circumstances) MDC’s “adjusted consolidated tangible net worth,” as defined. Under the adjusted — 24 —
consolidated tangible net worth test, MDC’s “adjusted consolidated tangible net worth,” as defined, must not be less than the sum of (1) $491,382,000; (2) 50% of “consolidated net income,” as defined, of the “borrower,” as defined, and the “guarantors,” as defined, after December 31, 2001; and (3) 50% of the net proceeds or other consideration received for the issuance of capital stock. In addition, “adjusted consolidated tangible net worth,” as defined, must not be less than $307,114,000. The Company’s Senior Notes are not secured and the Senior Notes indentures do not contain financial covenants. The Company’s Senior Notes are fully and unconditionally guaranteed on an unsecured basis, jointly and severally, by most of the Company’s homebuilding segment subsidiaries. MDC Common Stock Repurchase Programs On March 24, 2003, the MDC board of directors authorized the repurchase of up to an additional 1,350,000 shares of MDC common stock, bringing the total authorization under the Company’s stock repurchase program to 4,350,000 shares. The Company repurchased a total of 727,100 shares of MDC common stock in the 2003 first quarter and no shares in the second and third quarters, bringing the total shares repurchased to 2,580,400 and leaving 1,769,600 shares available to be repurchased as of September 30, 2003 under this program. The per share prices, including commissions, for the 727,100 shares repurchased ranged from $35.96 to $39.03 with an average cost of $36.76. At September 30, 2003, the Company held 3,120,000 shares of treasury stock with an average purchase price of approximately $16.32 per share. Consolidated Cash Flow During the first nine months of 2003, the Company generated $22,462,000 of cash from its operating activities. Cash provided by net income before depreciation, amortization and expenses related to debt redemption and the sale of mortgage loans was offset partially by cash used to build net homebuilding assets in support of the Company’s expanding homebuilding activities. The Company utilized these operating cash flows to repurchase 727,100 shares of stock for $26,731,000 and for the payment of dividends. Also, during the second quarter of 2003, the Company issued the 5 ½% Senior Notes with a $150,000,000 principal amount at a discount of $2,721,000, and redeemed all $175,000,000 principal amount of its 8 3/8% Senior Notes. The Company paid a premium of $7,329,000 on the redemption. During the first nine months of 2002, the Company used $218,272,000 of cash in its operating activities. Cash provided by net income before depreciation and amortization and the sale of mortgage loans was more than offset by cash used to build net homebuilding assets in support of the Company’s expanding homebuilding activities. The Company financed these operating cash requirements primarily through borrowings on its bank lines of credit. IMPACT OF INFLATION, CHANGING PRICES AND ECONOMIC CONDITIONS Real estate and residential housing prices are affected by inflation, which can cause increases in the price of land, raw materials and subcontracted labor. Unless these increased costs are recovered through higher sales prices, Home Gross Margins would decrease. If interest rates increase, construction and financing costs, as well as the cost of borrowings, also would increase, which can result in lower Home Gross Margins. Increases in home mortgage interest rates make it more difficult for MDC’s customers to qualify for home mortgage loans, potentially decreasing home sales revenue. Increases in interest rates also may affect adversely the volume of mortgage loan originations. — 25 —
The volatility of interest rates could have an adverse effect on MDC’s future operations and liquidity. Reported gains on sales of mortgage loans may vary significantly from period to period depending on the volatility in the interest rate market. Derivative instruments utilized in the normal course of business by HomeAmerican include forward sales securities commitments, private investor sales commitments and commitments to originate mortgage loans. The Company utilizes these commitments to manage the price risk on fluctuations in interest rates on its mortgage loans held in inventory and commitments to originate mortgage loans. Such contracts are the only significant financial derivative instruments utilized by MDC. An increase in interest rates may affect adversely the demand for housing and the availability of mortgage financing and may reduce the credit facilities offered to MDC by banks, investment bankers and mortgage bankers. See “Forward-Looking Statements” below. MDC’s business also is affected significantly by general economic conditions and, particularly, the demand for new homes in the markets in which it builds. CRITICAL ACCOUNTING POLICIES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Due to uncertainties in the estimation process, it is at least reasonably possible that actual results could differ from those estimates. The Company has determined that its critical accounting policies, or those policies that require significant use of judgment and estimates in their application, are those related to (1) homebuilding inventory valuation; (2) estimates to complete land development and home construction; (3) warranty costs; and (4) litigation reserves. The Company’s critical accounting policies have not changed from those reported in Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s 2002 Annual Report on Form 10-K. RECENT ACCOUNTING PROUNCEMENTS In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150 establishes standards for classifying and measuring as liabilities certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity. The application of SFAS No. 150 has been deferred indefinitely for noncontrolling interests in limited-life subsidiaries. The Company does not expect the adoption of SFAS No. 150 to have a material effect on the Company’s financial position or results of operations. In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS No. 149 provides for more consistent reporting of contracts as either freestanding derivative instruments subject to SFAS No. 133 in its entirety, or as hybrid instruments with debt host contracts and embedded derivative features. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, and hedging relationships designated after — 26 —
June 30, 2003. The adoption of SFAS No. 149 did not have a material effect on the Company’s financial position or results of operations. In January 2003, the FASB issued its Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”). A variable interest entity (“VIE”) is an entity that has (1) an insufficient amount of equity to absorb the entity’s expected losses; or (2) equity owners as a group that are not able to make decisions about the entity’s activities, do not have the obligation to absorb the entity’s expected losses or do not have the right to receive the entity’s expected residual returns. FIN 46 requires the consolidation of a VIE by the Company when the Company will absorb a majority of the VIE’s expected losses, receive a majority of the VIE’s expected residual returns, or both. FIN 46 applies immediately to VIE’s created after January 31, 2003, and applies to all VIE’s created prior to February 1, 2003 for reporting periods ending after December 15, 2003. In the normal course of business, MDC enters into lot option purchase contracts to acquire land. Option contracts generally require the payment of cash for the right to acquire land during a specified period of time at a specified price. The Company’s liability with respect to option contracts generally is limited to forfeiture of the related non-refundable deposits and letters of credit, which aggregated approximately $18,487,000 at September 30, 2003. Under the regulations of FIN 46, certain of these contracts create a variable interest for the Company, with the land seller being the VIE. The Company has evaluated its lot option purchase contracts created after January 31, 2003, which represent over 50% of the lots controlled by the Company under option purchase contracts as of September 30, 2003. Based on this evaluation, MDC has determined that its interests in these VIE’s do not result in significant variable interests or require consolidation as the Company’s interests do not qualify it as the primary beneficiary of residual returns or losses. The Company is in the process of reviewing its lot option purchase contracts created prior to February 1, 2003, but does not believe that the application of the requirements of FIN 46 to these contracts will result in a material impact on its financial position or results of operations. OTHERForward-Looking Statements Certain statements in this Quarterly Report on Form 10-Q, the Company’s Annual Report on Form 10-K for its fiscal year ended December 31, 2002, as well as statements made by the Company in periodic press releases, oral statements made by the Company’s officials to analysts and shareowners in the course of presentations about the Company and conference calls following quarterly earnings releases, constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking 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 any future results, performance or achievements expressed or implied by the forward-looking statements. Such factors include, among other things, (1) general economic and business conditions; (2) interest rate changes; (3) the relative stability of debt and equity markets; (4) competition; (5) the availability and cost of land and other raw materials used by the Company in its homebuilding operations; (6) the availability and cost of performance bonds and insurance covering risks associated with our business; (7) shortages and the cost of labor; (8) weather related slowdowns; (9) slow growth initiatives; (10) building moratoria; (11) governmental regulation, including the interpretation of tax, labor and environmental laws; (12) changes in consumer confidence and preferences; (13) required accounting changes; (14) terrorist acts and other acts of war; and (15) other factors over which the Company has little or no control. — 27 —
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. There have been no material changes from the 2002 Annual Report on Form 10-K related to the Company’s exposure to market risk from interest rates. ITEM 4. CONTROLS AND PROCEDURES. (a) Evaluation of disclosure controls and procedures — Management of MDC recognizes its responsibility for maintaining effective and efficient internal controls, disclosure controls and procedures. The Company has a group of officers which is responsible for reviewing all quarterly and annual SEC reports. This group consists mostly of MDC’s senior management, including its chief financial officer, general counsel, treasurer, and homebuilding and mortgage lending presidents and vice presidents of finance. An evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures was performed under the supervision, and with the participation, of the Company’s management, including the chief executive officer and the chief financial officer. Based on that evaluation, the Company’s management, including the chief executive officer and chief financial officer, concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2003. (b) Changes in internal control over financial reporting — The evaluation did not identify any change in the Company’s internal control over financial reporting that occurred during the quarter ended September 30, 2003 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. — 28 —
M.D.C. HOLDINGS, INC.
FORM 10-QPART IIITEM 1. LEGAL PROCEEDINGS The Company and certain of its subsidiaries and affiliates have been named as defendants in various claims, complaints and other legal actions arising in the normal course of business, including moisture intrusion and related mold claims. In the opinion of management, the outcome of these matters will not have a material adverse effect upon the financial condition, results of operations or cash flows of the Company. The Company previously purchased 63 lots within the former Lowry Air Force Base, in an area known as the Northwest Neighborhood, in Denver, Colorado. The Company constructed homes on 46 of these lots, which have been sold. Asbestos, believed to have resulted from historic activities of the United States Air Force, has been discovered in this area. In August 2003 the Colorado Department of Public Health and Environment issued a Final Response Plan imposing requirements to remediate the asbestos. To date, the Company has expended approximately $1,800,000 in sampling and remediation costs. The Company currently projects the total costs of these efforts to be approximately $3,400,000. The Company has notified the Air Force and United States Department of Defense of their responsibility to reimburse the Company for all costs associated with the asbestos. Those agencies currently dispute their responsibility to reimburse the Company and the other land owners. The Company is evaluating available legal remedies to recover costs associated with the asbestos. Because of the nature of the homebuilding business, and in the ordinary course of its operations, the Company from time to time may be subject to product liability claims. The Company is not aware of any litigation, matter or pending claim against the Company that would result in material contingent liabilities related to environmental hazards or asbestos. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREOWNERS No matters were submitted to shareowners during the third quarter of 2003. ITEM 5. OTHER INFORMATION On October 20 2003, the Company’s board of directors declared a dividend of $0.125 per share for the quarter ended September 30, 2003, payable November 19, 2003, to shareowners of record on November 5, 2003. Future dividend payments are subject to the discretion of the Company’s board of directors. — 29 —
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibit: |
