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May 5, 2020, 4:06 p.m. EDT

10-Q: MDC HOLDINGS INC

(EDGAR Online via COMTEX) -- ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with, and is qualified in its entirety by, the Unaudited Consolidated Financial Statements and Notes thereto included elsewhere in this Quarterly Report on Form 10-Q. This item contains forward-looking statements that involve risks and uncertainties. The forward-looking statements are based upon management's experiences, observations, and analyses. Actual results may differ materially from those indicated in such forward-looking statements. Factors that may cause such a difference include, but are not limited to, those discussed in "Item 1A: Risk Factors" of our Annual Report on Form 10-K for the year ended December 31, 2019 and this Quarterly Report on Form 10-Q.

Specifically, as a result of the Coronavirus/COVID-19 pandemic, we experienced increasingly adverse business conditions, especially in the latter half of March 2020, which negatively impacted our operating results. These adverse business conditions have continued into the 2020 second quarter. It is unclear how long these adverse conditions will persist or how they will impact our results in future periods.







                                                                            Three Months Ended
                                                                                 March 31,
                                                                         2020                2019
                                                                     (Dollars in thousands, except per
        Homebuilding:                                                         share amounts)
        Home sale revenues                                           $     697,085       $     647,278
        Home cost of sales                                                (558,647 )          (524,552 )
        Inventory impairments                                                    -                (610 )
        Total cost of sales                                               (558,647 )          (525,162 )
        Gross profit                                                       138,438             122,116
        Gross margin                                                          19.9 %              18.9 %
        Selling, general and administrative expenses                       (89,321 )           (82,261 )
        Interest and other income                                            1,889               2,391
        Other expense                                                       (1,337 )            (1,191 )
        Homebuilding pretax income                                          49,669              41,055
        Financial Services:
        Revenues                                                            21,886              17,404
        Expenses                                                           (10,929 )            (8,957 )
        Other income (expense), net                                        (12,064 )             6,104
        Financial services pretax income (loss)                             (1,107 )            14,551
        Income before income taxes                                          48,562              55,606
        Provision for income taxes                                         (11,802 )           (15,056 )
        Net income                                                   $      36,760       $      40,550
        Earnings per share:
        Basic                                                        $        0.58       $        0.66
        Diluted                                                      $        0.56       $        0.64
        Weighted average common shares outstanding:
        Basic                                                           62,491,238          60,939,364
        Diluted                                                         64,931,225          62,708,334
        Dividends declared per share                                 $        0.33       $        0.30
        Cash provided by (used in):
        Operating Activities                                         $     (37,173 )     $      54,348
        Investing Activities                                         $      (7,018 )     $      (6,434 )
        Financing Activities                                         $      (5,396 )     $     (41,987 )
        


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Overview

Industry Conditions

During the first quarter of 2020, the new Coronavirus/COVID-19 pandemic emerged as a threat to global health and economic conditions. Starting in March 2020, the pandemic dramatically changed the everyday lives of individuals throughout much of the United States. For example, stay at home and shelter in place orders were issued by many state and local governments, including the required closure of non-essential businesses in many areas, which have had a significant impact on not only our industry, but the overall economy. Some state and local governments did not identify residential construction as an essential business, which has impacted our ability to physically construct homes, while others limited the operations of sales centers and model homes. While certain of these restrictions have started to lapse during the second quarter, the extent to which the pandemic will impact our financial results in the coming periods depends on future developments, which are highly uncertain and cannot be predicted at this time.

Our first priority with regard to the pandemic is to address the health and safety of our employees, customers, subcontractors and suppliers, as well as the communities in which we operate. We have implemented work-from-home arrangements for employees where practical, increased sanitization procedures in offices and subdivisions, imposed significant business travel restrictions and otherwise promoted social distancing measures. We have implemented virtual processes for key operational activities that have traditionally been done in-person, such as model home tours, Home Gallery appointments, and pre-closing walk-throughs. While we have continued to see some demand for new housing, overall we have experienced a significant decline in traffic and net home orders during the second half of March and continuing into the second quarter. The decline in activity to start the second quarter was evident in our net new orders for the month of April, which fell 53% year-over-year.

Three Months Ended March 31, 2020

For the three months ended March 31, 2020, our homebuilding operations generated pretax income of $49.7 million, which was a 21% increase compared to $41.1 million for the same period in the prior year. The increase was the result of an improvement in gross margin from home sales as well as an increase in home sale revenues year-over-year. Gross margin from home sales for the first quarter of 2020 rose 100 basis points to 19.9% compared to 18.9% in the prior year. Home sale revenues increased 8% from $647.3 million in the prior year period to $697.1 million in the first quarter of 2020.

Our financial services business incurred a pretax loss of $1.1 million for the three months ended March 31, 2020 compared to pretax income of $14.6 million for the same period in the prior year. This decrease was the result of unrealized losses on equity securities during the first quarter of 2020 totaling $13.9 million as compared to unrealized gains of $4.6 million during the first quarter of 2019. These equity securities form part of the investment portfolio held by our Insurance Entities and the holding period of these investments is intended to align with the longer-term nature of the underlying insurance reserves held by these entities.

For the three months ended March 31, 2020, we reported net income of $36.8 million, or $0.56 per diluted share, a 9% decrease compared to net income of $40.6 million, or $0.64 per diluted share, for the same period in the prior year. This decrease was the result of the losses incurred on the investment portfolio discussed above, which were partially offset by the growth in homebuilding pretax income as well as tax benefits recognized during the first quarter of 2020 related to vested share-based awards and energy tax credits.

Outlook for MDC*

We remain confident in our ability to manage through the uncertainty created by the pandemic, even though the extent to which it will impact our financial results in the coming periods depends on future developments, which are highly uncertain and cannot be predicted at this time (see discussion above and in Risk Factors below). Our financial position to end the 2020 first quarter remained strong, with cash and investment balances exceeding $450 million and available borrowing capacity on our Revolving Credit Facility exceeding $950 million, resulting in total liquidity of more than $1.4 billion. We ended the quarter with $2.2 billion dollars of homes in backlog, which was 31% higher than at the end of the 2019 first quarter. However, our ability to convert that backlog into closings has been negatively impacted by a higher rate of cancellations and some limitations that have temporarily been placed on construction and closing activity. We have taken steps to improve cash flow and reduce costs to diminish the future impacts of the pandemic on our business. We have been successful in extending the closing date of some of our planned land purchases and have re-evaluated planned development activities to decrease cash expenditures. Our experienced senior leadership team continues to monitor the impact of the pandemic on a daily basis adjusting day-to-day business operations and our ongoing operating strategy as necessary to adapt to our current environment.

* See "Forward-Looking Statements" below.

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        Homebuilding
        Pretax Income:
                                             Three Months Ended
                                                  March 31,                 Change
                                             2020          2019        Amount       %
                                                      (Dollars in thousands)
        West                               $  36,576     $  33,200     $ 3,376       10 %
        Mountain                              21,512        21,714        (202 )    (1) %
        East                                     900         1,473        (573 )   (39) %
        Corporate                             (9,319 )     (15,332 )     6,013       39 %
        Total Homebuilding pretax income   $  49,669     $  41,055     $ 8,614       21 %
        


As noted above, we generated homebuilding pretax income for the quarter of $49.7 million, an increase of $8.6 million from $41.1 million for the same period in the prior year. The increase was due to a 100 basis point improvement in our gross margin from home sales and an 8% increase in home sale revenues.

Our West segment experienced a $3.4 million year-over-year increase in pretax income, due to an improved gross margin from home sales and a 10% increase in home sales revenue, which was slightly offset by a $3.4 million increase in general and administrative expenses resulting from a change in our Corporate cost allocation discussed below. Our Mountain segment experienced a $0.2 million decrease in pretax income from the prior year, as a result of a $1.6 million increase in general and administrative expenses due to a change in our Corporate cost allocation, which was mostly offset by a 7% increase in home sales revenue. Our East segment experienced a $0.6 million decrease in pretax income from the prior year, due primarily to a $0.7 million increase in general and administrative expenses resulting from a change in our Corporate cost allocation. Our Corporate segment experienced a $6.0 million increase in pretax income, due mostly to the impact of the change in our Corporate cost allocation.

On a periodic basis, we assess our Corporate cost allocation estimates. Our most recent assessment resulted in increases in Corporate cost allocations to both our homebuilding and financial services segments beginning January 1, 2020, to reflect the use of centralized administrative functions. Applying the most recent cost allocation estimate to the three months ended March 31, 2019 would have resulted in decreased pretax income for our homebuilding and financial services segments of approximately $2.7 million and $0.4 million, respectively, with corresponding increases in our Corporate segment pretax income. Additionally, beginning January 1, 2020, we have reflected the expense associated with all homebuilding employee bonuses in the respective homebuilding segment to which the employee reports, consistent with how the CODM is now evaluating homebuilding division performance and making operating decisions. Had these bonuses been reflected in a similar manner during the three months ended March 31, 2019, pretax income for our homebuilding segments would have decreased by an additional $3.0 million with a corresponding increase in our Corporate segment pretax income.







        Assets:
                                     March 31,       December 31,            Change
                                       2020              2019           Amount         %
                                                    (Dollars in thousands)
        West                        $ 1,559,410     $    1,461,645     $  97,765         7 %
        Mountain                        907,727            869,665        38,062         4 %
        East                            216,063            194,592        21,471        11 %
        Corporate                       466,192            505,507       (39,315 )     (8) %
        Total homebuilding assets   $ 3,149,392     $    3,031,409     $ 117,983         4 %
        


Total homebuilding assets increased 4% from December 31, 2019 to March 31, 2020. Homebuilding assets increased in each of our operating segments largely due to a greater number of homes completed or under construction as of March 31, 2020. However, the funds for the construction activity came from our Corporate segment, causing a decline in our Corporate segment's assets.

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New Home Deliveries & Home Sale Revenues:

Changes in home sale revenues are impacted by changes in the number of new homes delivered and the average selling price of those delivered homes. Commentary for each of our segments on significant changes in these two metrics is provided below. Our backlog conversion rate has been negatively impacted by the pandemic due to a higher rate of cancellations and some limitations that have temporarily been placed on construction activity.







                                                                           Three Months Ended March 31,
                                            2020                                     2019                                     % Change
                                         Home Sale      Average                   Home Sale      Average                     Home Sale        Average
                             Homes       Revenues        Price        Homes       Revenues        Price        Homes         Revenues          Price
                                                                              (Dollars in thousands)
        West                    871     $   405,498     $  465.6         752     $   369,558     $  491.4           16 %              10 %         (5) %
        Mountain                435         222,858        512.3         409         209,192        511.5            6 %               7 %           0 %
        East                    241          68,729        285.2         197          68,528        347.9           22 %               0 %        (18) %
        Total                 1,547     $   697,085     $  450.6       1,358     $   647,278     $  476.6           14 %               8 %         (5) %
        


West Segment Commentary

For the three months ended March 31, 2020, the increase in new home deliveries was the result of a 33% increase in the number of homes in backlog to begin the period. This increase was partially offset by a decrease in backlog conversion rates in most of our markets within this segment. This decrease was driven by a lower percentage of homes both sold and delivered in the first quarter of 2020 as compared to the 2019 first quarter. The average selling price of homes-delivered decreased as a result of a decline in the percentage of deliveries coming from our higher priced communities in Southern California. In addition, a greater percentage of closings within nearly all of our Western markets during the current period were from our more affordable product offerings.

Mountain Segment Commentary

For the three months ended March 31, 2020, the increase in new home deliveries was the result of a 16% increase in the number homes in backlog to begin the period. This increase was partially offset by a decrease in backlog conversion rates in our Colorado markets due to a lower percentage of homes in backlog to start the 2020 first quarter that were under construction at that time.

East Segment Commentary

For the three months ended March 31, 2020, the increase in new home deliveries was the result of a 53% increase in the number of homes in backlog to begin the period. This increase was partially offset by a decrease in backlog conversion rates in most of our markets within this segment due to (1) a lower percentage of homes in backlog to start the 2020 first quarter that were under construction at that time and (2) a lower percentage of homes both sold and delivered in the first quarter of 2020 as compared to the 2019 first quarter. The decrease in the average selling price of homes delivered in our East segment was due to a change in mix resulting from (1) a higher percentage of deliveries in this segment coming from communities that offer more affordable home plans and (2) a higher percentage of our deliveries coming from our Florida markets, which have a lower average selling price than our mid-Atlantic market.

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Gross Margin from Home Sales:

Our gross margin from home sales for the three months ended March 31, 2020, increased 100 basis points year-over-year from 18.9% to 19.9%. During the three months ended March 31, 2019 we recorded inventory impairments of $0.6 million and warranty adjustments of $0.9 million, which negatively impacted gross margin by 20 basis points in the prior year. Gross margins increased in the first quarter of 2020 on both build-to-order and speculative home deliveries driven by price increases implemented across the majority of our communities over the past nine-months. Gross margins were also positively impacted as a result of a lower percentage of speculative home deliveries in the quarter, which typically have a lower gross margin than our build-to-order deliveries.







        Inventory Impairments:
        Impairments of homebuilding inventory by segment for the three months ended
        March 31, 2020 and 2019 are shown in the table below:
                                          Three Months Ended March 31,
                                        2020                    2019
                                             (Dollars in thousands)
        West                          $       -           $              -
        Mountain                              -                        400
        East                                  -                        210
        Total inventory impairments   $       -           $            610
        


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







                                                                      Impairment Data                          Quantitative Data
                                                                       Fair Value of         Number of
                                                     Inventory        Inventory After       Subdivisions
        Three Months Ended                          Impairments         Impairments           Impaired           Discount Rate
        March 31, 2019                             $         610     $          10,476                  2                     N/A
        


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        Selling, General and Administrative Expenses:
                                                                   Three Months Ended March 31,
                                                                2020            2019          Change
                                                                      (Dollars in thousands)
        General and administrative expenses                  $   45,089       $  42,572     $    2,517
        General and administrative expenses as a
        percentage of home sale revenues                           6.5%            6.6%       (10) bps
        Marketing expenses                                   $   21,446       $  18,296     $    3,150
        Marketing expenses as a percentage of home sale
        revenues                                                   3.1%            2.8%         30 bps
        Commissions expenses                                 $   22,786       $  21,393     $    1,393
        Commissions expenses as a percentage of home sale
        revenues                                                   3.3%            3.3%          0 bps
        Total selling, general and administrative expenses   $   89,321       $  82,261     $    7,060
        Total selling, general and administrative expenses
        as a percentage of home sale revenues                     12.8%           12.7%         10 bps
        


For the three months ended March 31, 2020, the increase in our marketing expenses was driven by (1) increased sales office expense and product advertising resulting from an increased number of average active subdivisions and (2) increased compensation expense due to a higher average headcount during the quarter.

General and administrative expenses increased for the three months ended March 31, 2020 due to increased compensation-related expenses driven by higher average headcount during the quarter.

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Other Homebuilding Operating Data

Net New Orders and Active Subdivisions:

Changes in the dollar value of net new orders are impacted by changes in the number of net new orders and the average selling price of those homes. Commentary for each of our segments on significant changes in these two metrics is provided below. Our monthly absorption rate has been negatively impacted by the pandemic due to a higher rate of cancellations and a decrease in customer traffic resulting from stay at home and shelter in place orders. The negative impact is shown in net new home orders for the month of March, which decreased 27% year-over-year to 611. Furthermore, to start the 2020 second quarter, April net new orders decreased 53% year-over-year to 357.







                                                                                      Three Months Ended March 31,
                                                   2020                                         2019                                         % Change
                                                                  Monthly                                     Monthly                                          Monthly
                                          Dollar      Average    Absorption            Dollar     Average    Absorption             Dollar      Average       Absorption
                                Homes      Value       Price       Rate *     Homes     Value      Price       Rate *     Homes     Value        Price           Rate
                                                                                         (Dollars in thousands)
        West                    1,382   $   655,892   $  474.6         5.13     965   $ 433,307   $  449.0         3.82      43 %       51 %            6 %           34 %
        Mountain                  693       339,132      489.4         3.54     719     336,932      468.6         3.52     (4) %        1 %            4 %            1 %
        East                      324        97,723      301.6         3.66     272      81,179      298.5         4.17      19 %       20 %            1 %         (12) %
        Total                   2,399   $ 1,092,747   $  455.5         4.33   1,956   $ 851,418   $  435.3         3.75      23 %       28 %            5 %           16 %
        


*Calculated as total net new orders in period � average active communities during period � number of months in period







                                                     Average Active Subdivisions
                      Active Subdivisions                Three Months Ended
                     March 31,          %             March 31,                %
                   2020      2019     Change      2020         2019         Change
        West        92        88           5 %     90           84                 7 %
        Mountain    64        64           0 %     65           69                (6 )%
        East        29        26          12 %     30           22                36 %
        Total       185      178           4 %    185          175                 6 %
        


West Segment Commentary

For the three months ended March 31, 2020, the increase in net new orders was driven by increases in both the monthly sales absorption rate and average active subdivisions. Nearly all markets experienced an improvement in their sales pace year-over-year, with our Nevada, Phoenix and California markets all experiencing a sales pace in excess of five net new orders per community per month. The increase in average selling price was due to price increases implemented over the past nine-months within the majority of our communities as well as a shift in mix of homes sold from Nevada to more expensive Southern California markets.

Mountain Segment Commentary

For the three months ended March 31, 2020, the decrease in net new orders was the result of (1) a slight decrease in the number of average active subdivisions in Colorado and (2) an increased cancellation rate (see further discussion below). The increase in average selling price was the result of price increases implemented across the majority of our communities over the past nine-months.

East Segment Commentary

For the three months ended March 31, 2020, the increase in net new orders was driven by an increase in the number of average active subdivisions in each of our Florida and mid-Atlantic markets. This increase was partially offset by a decrease in the monthly sales absorption rate due to (1) a decrease in close out communities in our mid-Atlantic market and (2) an increased cancellation rate (see further discussion below).

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        Cancellation Rate:
                       Cancellations as a Percentage of Homes in
                                   Beginning Backlog
                        Three Months
                       Ended March 31,                Change in
                     2020           2019             Percentage
        West             15 %           14 %                       1 %
        Mountain         22 %           14 %                       8 %
        . . .
        


May 05, 2020

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