Annual Report

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

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

For the fiscal year ended December 31, 2005

OR

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

For the Transition period from                      to                     

Commission file number 1-08951

Securities registered pursuant to Section 12(g) of the Act: None

      Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No o

      Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes o No þ

      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 þ No o

      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K . o

      Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer þ Accelerated filer o Non-accelerated filer o

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

      As of June 30, 2005, the aggregate market value of the Registrants’ common stock held by non-affiliates of the Registrants was $2.762 billion based on the closing sales price of $82.25 per share as reported on the New York Stock Exchange.

      As of January 31, 2006, the number of shares outstanding of Registrant’s common stock was 44,659,000.

DOCUMENTS INCORPORATED BY REFERENCE

Part III of this Form 10-K is incorporated by reference from the Registrant’s 2005 definitive proxy statement to be filed with the Securities and Exchange Commission no later than 120 days after the end of the Registrant’s fiscal year.

 

 

M.D.C. HOLDINGS, INC.

FORM 10-K

For the Year Ended December 31, 2005

Table of Contents

						Page
						No.
PART I
ITEM 1.				Business
				(a) General Development of Business			1
				(b) Available Information			2
				(c) Financial Information About Industry Segments			2
				(d) Narrative Description of Business			2
ITEM 1A.				Risk Factors Relating to our Business			11
ITEM 1B.				Unresolved Staff Comments			15
ITEM 2.				Properties			15
ITEM 3.				Legal Proceedings			15
ITEM 4.				Submission of Matters to a Vote of Security Holders			15
PART II
ITEM 5.				Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities			16
ITEM 6.				Selected Financial Data			17
ITEM 7.				Management’s Discussion and Analysis of Financial Condition and Results of Operations			20
ITEM 7A.				Quantitative and Qualitative Disclosures About Market Risk			40
ITEM 8.				Consolidated Financial Statements			F-1
ITEM 9.				Changes in and Disagreements With Accountants on Accounting and Financial Disclosure			41
ITEM 9A.				Controls and Procedures			41
ITEM 9B.				Other Information			43
PART III
ITEM 10.				Directors and Executive Officers of the Registrant			43
ITEM 11.				Executive Compensation			43
ITEM 12.				Security Ownership of Certain Beneficial Owners and Management			43
ITEM 13.				Certain Relationships and Related Transactions			44
ITEM 14.				Principal Accountant Fees and Services			44
PART IV
ITEM 15.				Exhibits and Financial Statement Schedules			45
SIGNATURES							51
Fifth Amendment to Third Amended and Restated Warehousing Credit Agreement
Rollover Amendment to 401(k) Savings Plan
Ratio of Earnings to Fixed Charges Schedule
Subsidiaries of the Company
Consent of Ernst & Young LLP
Certification of CEO Pursuant to Section 302
Certification of CFO Pursuant to Section 302
Certification of CEO Pursuant to Section 906
Certification of CFO Pursuant to Section 906

M.D.C. HOLDINGS, INC.

FORM 10-K

		* We ceased homebuilding operations in Florida and Texas in 1988 and 1990, respectively, and re-entered these markets in 2002 and 2003, respectively.

     (b)  Available Information

     Our website is located at www.richmondamerican.com . This Annual Report on Form 10-K and all other reports filed by the Company with the Securities and Exchange Commission (“SEC”) can be accessed, free of charge, through our website as soon as reasonably practicable after the report is filed electronically with the SEC, at http://www.investorrelations.richmondamerican.com/edgar.cfm .

     (c)  Financial Information About Industry Segments

     Note 3 to the Consolidated Financial Statements contains information regarding our business segments for each of the years ended December 31, 2005, 2004 and 2003.

     (d)  Narrative Description of Business

     Our business consists of two segments, homebuilding and financial services. In our homebuilding segment, our homebuilding subsidiaries build and sell primarily single-family detached homes, although we build some townhomes in certain markets. Our homes are designed and built to meet local customer preferences. We are the general contractor for all of our projects and retain subcontractors for site development and home construction. Our financial services segment consists of the operations of HomeAmerican and American Home Insurance. HomeAmerican is a full service mortgage lender with offices located in each of our markets and originates or brokers mortgage loans for approximately 70% of our homebuyers. As a result, HomeAmerican is an integral part of our business.

     The base prices for our homes primarily range from $150,000 to $650,000, although we also build homes with base prices above $1.6 million. The average sales price of our homes closed in 2005 and 2004 was $313,800 and $283,400, respectively. We maintain a variety of product offerings in each of our markets, targeting what we believe to be, based upon our experience within the homebuilding industry, the largest homebuyer segments within a given market, which generally are the first-time and first-time move-up buyer. As a result, more than 80% of our homebuyers fall into these two categories. Also, we build a limited number of homes for the second-time move-up and luxury buyer.

     When opening a new homebuilding project, we seek to maintain a two-year supply of lots to avoid overexposure to any single sub-market. When we acquire finished lots, we prefer using option contracts or paying in phases with cash. Also, we acquire entitled land for development into finished lots when we determine that the risk is justified. Our Asset Management Committees, which include members of MDC’s senior management, generally meet weekly to review all proposed land acquisitions and takedowns of lots under option. Additional information about our land acquisition practices may be found in the Homebuilding Segment, Land Acquisition and Development section.

           Economies of Scale. We are a large homebuilding company in the United States, as well as most of the markets in which we operate, in terms of number of homes closed in fiscal 2005 and consolidated revenues. Our economies of scale have contributed to improvements in homebuilding operating margins. We believe that our national, regional and local scale of operations have provided us with benefits such as:

	•		The ability to negotiate volume contracts with material suppliers and subcontractors;
	•		Earlier opportunities to contract for large land parcels;
	•		Availability of insurance coverage; and
	•		Greater access to and lower cost of capital.

           Operating Divisions. At December 31, 2005, we had 27 separate homebuilding operating divisions, some of which are in the same market area and some of which operate in more than one market area. Generally, each operating division consists of a division president; land procurement, sales, construction, customer service, finance, and purchasing personnel; and office staff. We believe that division presidents and their management teams, who are familiar with local market conditions, have better information on which to base decisions regarding local operations. Our division presidents receive performance bonuses based upon achieving targeted financial and operational results in their respective operating divisions.

           Regional and Corporate Management. We manage our homebuilding business through our regional offices. Some of our regional offices oversee operations in only one of our geographic markets, and others oversee operations in more than one geographic market. Generally, each regional office consists of a regional president, finance personnel, purchasing personnel and limited office support staff. Our regional presidents and their management teams are responsible for oversight of the operations of multiple homebuilding operating divisions. These responsibilities include:

	•		Review and approval of division business plans and budgets;
	•		Allocation of inventory investments within corporate guidelines;
	•		Oversight of land and home inventory levels; and
	•		Review of major personnel decisions.

          Our corporate executives and corporate and national departments generally are responsible for establishing and monitoring compliance with our policies and procedures. Among other things, the corporate office also has primary responsibility for:

	•		Asset management and capital allocation;
	•		Financial reporting;
	•		Legal;
	•		Information technology;
	•		Internal audit;
	•		Marketing;
	•		Merchandising;
	•		Training and development;
	•		Risk management; and
	•		Treasury.

           Housing. We build homes in a number of standardized series, each designed to appeal to a different segment of the homebuyer market. Within each series, we build several models, each with a different floor plan, elevation and standard and optional features. Differences in sales prices of similar models in any series depend primarily upon demand, location, optional features and design specifications. The series of homes offered at a particular location are based on perceived customer preference, lot size, the area’s demographics and, in certain cases, the requirements of major land sellers and local municipalities.

          We maintain limited levels of inventories of unsold homes in our markets. Unsold homes in various stages of completion allow us to meet the immediate and near-term demands of prospective homebuyers. In order to mitigate the risk of carrying excess inventory, we have strict procedures and limits on the number of our unsold homes under construction. At December 31, 2005, we had 1,131 unsold homes under construction.

           Land Acquisition and Development. We generally purchase finished lots using option contracts, in phases or in bulk for cash. We also acquire entitled land for development into finished lots when we believe that the risk is justified. In making land purchases, we consider a number of factors, including projected rates of return, sales prices of the homes to be built, population and employment growth patterns, proximity to developed areas, estimated costs of development and demographic trends. Generally, we acquire finished lots and land for development only in areas that will have, among other things, available building permits, utilities and suitable zoning. We attempt to maintain a supply of finished lots sufficient to enable us to start homes promptly after a contract for a home sale is executed. This approach is intended to minimize our investment in inventories and reduce the risk of shortages of labor and building materials. Increases in the cost of finished lots may reduce Home Gross Margins (as defined below) in the future to the extent that market conditions would not allow us to recover the higher cost of land through higher sales prices. We define “Home Gross Margins” to mean home sales revenue less home cost of sales (which primarily includes land and construction costs, capitalized interest, closing costs and a reserve for warranty expense) as a percent of home sales revenue. See “ Forward-Looking Statements ” above.

          We have the right to purchase a portion of the land we may acquire in the future utilizing option contracts, in some cases in phases for cash. Generally, in an option contract, we obtain the right to purchase lots in consideration for an option deposit. In the event we elect not to purchase the lots within a specified period of time, we forfeit the option deposit. Our option contracts generally do not contain provisions requiring our specific performance. At December 31, 2005, we had the right to acquire 18,819 lots under option agreements, with approximately $48.2 million and $23.1 million in non-refundable cash and letters of credit option deposits at risk, respectively, which had an aggregate purchase price of approximately $1.2 billion. Because of increased demand for finished lots in certain of our markets, our ability to acquire lots using rolling options has been reduced or has become significantly more expensive.

          We own or have the right under option contracts to acquire undeveloped parcels of real estate that we intend to develop into finished lots. We develop our land in phases (generally fewer than 100 lots at a time for each home series in a subdivision) in order to limit our risk in a particular project and to efficiently employ available funds. Building permits and utilities are available and zoning is suitable for the current intended use of substantially all of our undeveloped land. When developed, these lots generally will be used in our homebuilding activities. See “ Forward-Looking Statements ” above.

          The table below shows the carrying value of land and land under development, by market, at December 31, 2005, 2004 and 2003 (in thousands).

          The table below shows the number of lots owned and controlled under option (excluding lots in housing completed or under construction), by market, at December 31, 2005, 2004 and 2003 (dollars in thousands).

          At December 31, 2005, we owned a total of 23,445 lots, of which 10,619 lots were finished. In addition, 1,338 of these finished lots were subject to home sales contracts for which construction had not started. The remaining 12,826 lots were unfinished and in the process of being developed for future home sales. We believe we are well-positioned for future growth, consistent with our operating approach of seeking to maintain control of approximately a two-year supply of lots. See “ Forward-Looking Statements ” above.

           Labor and Raw Materials . For the most part, materials used in our homebuilding operations are standard items carried by major suppliers. We generally contract for our materials and labor at a fixed price for the anticipated construction period of our homes. This allows us to mitigate the risks associated with increases in building materials and labor costs between the time construction begins on a home and the time it is closed. Increases in the cost of building materials, particularly lumber, and subcontracted labor may reduce Home Gross Margins to the extent that

market conditions prevent the recovery of increased costs through higher sales prices. From time to time and to varying degrees, we may experience shortages in the availability of building materials and/or labor in each of our markets. These shortages and delays may result in delays in the delivery of homes under construction, reduced Home Gross Margins, or both. See “ Forward-Looking Statements ” above.

           Customer Service and Quality Control. Our operating divisions are responsible for pre-closing quality control inspections and responding to customers’ post-closing needs. Homebuyers are encouraged to become familiar with the details of their new home and to learn their care and maintenance responsibilities. They are afforded the opportunity to walk through their new home prior to closing to make sure it is ready for their occupancy. We believe that our pre-closing quality control inspections reduce post-closing repair costs and enhance our reputation for quality and service.

           Warranty . Our homes are sold with limited third-party warranties that generally provide for ten years of structural coverage (“structural warranty”), two years of coverage for plumbing, electrical and heating, ventilation and air conditioning systems, and one year of coverage for workmanship and materials. 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 substantially all of the work required to be performed during years three through ten of the warranties. As a consequence, warranty reserves are established as homes close on a house-by-house basis in an amount estimated to be adequate to cover expected costs of materials and outside labor during warranty periods. Reserves are determined based upon historical experience with respect to similar product types and geographical areas. Certain factors are given consideration in determining the per-house reserve amount, including: (1) the historical range of amounts paid per house; (2) the historical average amount paid per house; (3) any warranty expenditures included in (1) and (2) not considered to be normal and recurring; (4) improvements in quality control and construction techniques expected to impact future warranty expenditures; and (5) conditions that may affect certain projects and require higher per-house reserves for those specific projects.

           Seasonal Nature of Business . Our homebuilding business is seasonal in that some of our divisions, especially in the northernmost markets, are subject to weather-related slowdowns. Delays in development and construction activities resulting from adverse weather can increase our risk of buyer cancellations and contribute to higher costs for interest, materials and labor. See “ Forward-Looking Statements ” above.

           Backlog. At December 31, 2005 and 2004, homes under contract but not yet delivered (“Backlog”) totaled 6,532 and 6,505, respectively, with an estimated sales value of $2.44 billion and $1.92 billion, respectively. Our home order cancellation rates were 23.7% and 25.3% for the years ended December 31, 2005 and 2004, respectively. We define home order “Cancellation Rate” as total cancelled home order contracts during a specified period of time as a percent of total home orders received during such time period. Assuming our historical Cancellation Rates are indicative of future Cancellation Rates, and assuming no significant long-standing change in market conditions and mortgage interest rates, we anticipate that approximately 70% to 80% of our December 31, 2005 Backlog will close under existing sales contracts during 2006. The remaining 20% to 30% of the homes in Backlog are not expected to close under existing contracts due to cancellations. See “ Forward-Looking Statements ” above.

          The table below discloses, by market, our Backlog for the years ended December 31, 2005 and 2004 (dollars in thousands).

          Although units in Backlog remained relatively flat at the end of 2005, compared with 2004, the $78,300 increase in the average selling price for units in Backlog resulted in the estimated Backlog sales value increasing by 27% to $2.44 billion at December 31, 2005 from $1.92 billion at December 31, 2004. This increase, which was led by our Nevada, Arizona, Florida and Delaware Valley markets, was offset partially by lower Backlog sales value in Virginia and Colorado.

          Our 2005 year-end Backlog in Nevada increased 37% from December 31, 2004, primarily due to a 23% increase in average active subdivisions from 2004, as well as continued strong demand for new homes in this market. Combined Backlog in our newest markets of Delaware Valley and Illinois increased to 261 units at December 31, 2005, compared with 41 units at December 31, 2004, primarily due to an increase in the number of active subdivisions during 2005 resulting from our on-going efforts to grow in these markets. In Virginia, Backlog decreased, primarily due to an increase in our 2005 fourth quarter cancellations from the same period in 2004, as well as fewer home orders during 2005, compared with 2004, due to decrease in the average number of active subdivisions during 2005. Speculative buyers have recently begun exiting the new home market, resulting in what we believe to be a primary cause of this increase in cancellations, as well as a lower demand for new homes. As a result, the supply of homes available to be purchased by prospective buyers has increased in certain markets. Our Backlog in Colorado decreased as well, primarily due to fewer home orders in 2005 resulting from a more competitive environment for new homes in this market.

           Marketing and Sales . To communicate our brand as effectively as possible, we created an in-house advertising and marketing agency in March 2003, which helps us control quality and consistency in our execution. Our agency’s main objective is to direct qualified homebuyers to our sales offices, Home Galleries, Homebuyer Resource Centers and website. In addition, our in-house corporate communications team manages public relations and employee communication efforts and our interactive marketing team manages and maintains the MDC website and leads management activities.

          To complement our marketing efforts, the MDC brand also is reflected in our model homes and sales offices. Our in-house team of interior designers directs the merchandising plan for these homes, resulting in an exceptional overall presentation. Achieving brand consistency across all of these functions helps to enhance customer loyalty.

          We believe that all employees who serve our homebuyers should represent us professionally. Therefore, our on-site Sales Associates, Design Consultants and New Home Specialists undergo a region-specific 90-day training program in order to help meet customer needs.

      Home Gallery and Design Center. Another important part of our marketing presentation takes place in our design centers, which are located in most of MDC’s homebuilding markets. Homebuyers are able to customize certain features of their homes by selecting from a variety of options and upgrades. In 2004, we launched our new Home Gallery concept in certain markets. These Home Galleries combine sales support and offer thousands of options for personalizing new homes. This retail location also serves as a resource to homebuyers who are interested in purchasing a new Richmond American home. Prospective homebuyers can receive individualized attention from a trained team of new home specialists, resulting in a more focused, efficient home search.

      Title Operations . American Home Title provides title agency services to our homebuyers in Colorado, Delaware, Florida, Illinois, Texas, Maryland, Virginia and West Virginia.

      Insurance Operations. Allegiant Insurance Company, Inc., A Risk Retention Group (“Allegiant”), was organized as a risk retention group under the Federal Liability Risk Retention Act of 1981. Allegiant is licensed as a Class 3 stock insurance company by the Division of Insurance of the State of Hawaii and began operations in June 2004. Allegiant provides general liability coverage for products and completed operations to the Company and to subcontractors of homebuilding subsidiaries of MDC. In consideration of an annual re-insurance premium and pursuant to an agreement effective June 30, 2004, StarAmerican Insurance Ltd., a Hawaii corporation and a wholly owned subsidiary of MDC, agreed to re-insure all Allegiant claims in excess of $50,000 per occurrence.

      Competition . The homebuilding industry is fragmented and highly competitive. We compete with numerous homebuilders, including a number that are larger and have greater financial resources. Homebuilders compete for customers, desirable financing, land, building materials and subcontractor labor. Competition for home orders primarily is based upon price, style, financing provided to prospective purchasers, location of property, quality of homes built, customer service and general reputation in the community. We also compete with subdivision developers and land development companies when acquiring land. See “ Forward-Looking Statements ” above.

      Mortgage Interest Rates. Our homebuilding operations are dependent upon the availability and cost of mortgage financing. Increases in home mortgage interest rates may reduce the demand for homes and home mortgages which could negatively impact our business. We are unable to predict future changes in home mortgage interest rates or the impact such changes may have on our operating activities and results of operations. See “ Forward-Looking Statements ” above.

      Regulation . Our homebuilding operations are subject to continuing compliance requirements mandated by applicable federal, state and local statutes, ordinances, rules and regulations, including zoning and land use ordinances, building codes, contractors’ licensing laws, state insurance laws, federal and state human resources laws and regulations and health and safety regulations and laws (including, but not limited to, those of the Occupational Safety and Health Administration). Various localities in which we operate have imposed (or may impose in the future) fees on developers to fund schools, road improvements and low and moderate-income housing. See “ Forward-Looking Statements ” above.

     From time to time, various municipalities in which we operate restrict or place moratoriums on the availability of utilities, including water and sewer taps. Additionally, certain jurisdictions in which we operate have proposed or enacted growth initiatives that may restrict the number of building permits available in any given year. Although no assurances can be given as to future conditions or governmental actions, we believe that in general we have, or can obtain, water and sewer taps and building permits for our land inventory and land held for development. See “ Forward-Looking Statements ” above.

     Our homebuilding operations also are affected by environmental laws and regulations pertaining to availability of water, municipal sewage treatment capacity, land use, hazardous waste disposal, naturally occurring radioactive materials, building materials, population density and preservation of endangered species, natural terrain and vegetation. Due to these considerations, we generally obtain an environmental site assessment for parcels of land that we acquire. The particular environmental laws and regulations that apply to any given homebuilding project vary greatly according to the site’s location, the site’s environmental conditions and the present and former uses of the site. These environmental laws and regulations may result in project delays, causing us to incur substantial compliance and other costs, and/or prohibit or severely restrict homebuilding activity in certain environmentally sensitive regions or areas. See “ Forward-Looking Statements ” above.

      Bonds and Letters of Credit. In many cases, we are required to obtain bonds and letters of credit in support of our related obligations with respect to subdivision improvements, homeowners association dues and start-up expenses, warranty work, contractors’ license fees, earnest money deposits, etc. At December 31, 2005 and 2004, we had outstanding performance bonds totaling $392.4 million and $306.8 million, respectively, and letters of credit totaling $96.0 million and $94.7 million, respectively, including $24.6 million and $25.6 million, respectively, issued by HomeAmerican.

     In certain states, unless we take measures to release any state regulatory imposed restrictions on earnest money deposits (“Deposits”) received from a homebuyer in conjunction with a home sale, which may include posting blanket security bonds, we are restricted from using these Deposits for general purposes. Accordingly, at December 31, 2005 and 2004, we had $12.5 million outstanding in blanket security bonds to release restrictions on certain Deposits. Additionally, we had $6.7 million and $7.2 million in restricted cash related to Deposits at December 31, 2005 and 2004, respectively. We monitor, on a regular basis, the amount of Deposits we hold in certain states to confirm that our blanket security bonds exceed the amount of the earnest money deposits.

     In the event any such bonds or letters of credit issued by third parties are called, we would be obligated to reimburse the issuer of the bond or letter of credit. See “ Forward-Looking Statements ” above.

Financial Services Segment.

Mortgage Lending Operations.

      General . HomeAmerican is a full-service mortgage lender and is the principal originator of mortgage loans for our homebuyers. Through office locations in each of our markets and a centralized loan origination center, HomeAmerican originates mortgage loans primarily for our homebuyers. HomeAmerican also brokers mortgage loans for origination by outside lending institutions for our homebuyers.

     HomeAmerican is authorized to originate Federal Housing Administration-insured (“FHA”), Veterans Administration-guaranteed (“VA”), Federal National Mortgage Association (“FNMA”), Federal Home Loan Mortgage Corporation (“FHLMC”) and other private investor mortgage loans. HomeAmerican also is an authorized loan servicer for FNMA, FHLMC and the Government National Mortgage Association (“GNMA”) and, as such, is subject to the rules and regulations of these organizations.

     Substantially all of the mortgage loans originated by HomeAmerican are sold to third party purchasers within 45 days of origination. We use HomeAmerican’s secured warehouse line of credit, other borrowings and Company generated funds to finance these mortgage loans until they are sold. During the 2005 fourth quarter, we initiated an early purchase program, whereby we sell certain mortgage loans originated by HomeAmerican to a third party purchaser shortly after the close of a home. This program improves our overall available funds by enabling us to sell mortgage loans originated by HomeAmerican more quickly. Accordingly, for mortgage loans sold pursuant to this program, the number of days a loan is held in inventory has been reduced from the historical 45 days to less than five days.

     Historically, a substantial portion of our originated loans have been sold to one third party purchaser. It is likely that we will continue to depend on its ability and willingness to purchase a significant number of our loans originated. During the years ended December 31, 2005, 2004 and 2003, we sold approximately 68%, 37% and 16%, respectively, of our mortgage loans originated to this third party purchaser.

      Portfolio of Mortgage Loan Servicing . Mortgage loan servicing involves the collection of principal, interest, taxes and insurance premiums from the borrower and the remittance of such funds to the mortgage loan investor, local taxing authorities and insurance companies. The servicer is paid a fee to perform these services. HomeAmerican obtains the servicing rights related to the mortgage loans it originates. Certain mortgage loans are sold “servicing released” (the servicing rights are included with the sale of the corresponding mortgage loans). In 2005, 83% of the mortgage loans were sold “servicing released.” The servicing rights on the remainder of the mortgage loans generally are sold within two months of the sale of the mortgage loan. HomeAmerican intends to continue selling servicing rights on all mortgage loans originated in the future. See “ Forward-Looking Statements ” above.

     HomeAmerican’s portfolio of mortgage loan servicing at December 31, 2005 consisted of servicing rights with respect to 2,075 single-family loans, 99% of which were less than six months old. This includes 817 single-family loans for which the servicing rights had been sold but not transferred to the purchasers at December 31, 2005. HomeAmerican anticipates transferring these servicing rights in the first half of 2006. See “ Forward-Looking Statements ” above. These loans are secured by mortgages on properties in eleven states, with interest rates on the loans ranging from approximately 5.75% to 9.13% and averaging 6.46%. The underlying value of a servicing portfolio generally is determined based on the interest rates and the annual servicing fee rates, gross of guarantee fees, currently .44% for FHA/VA loans and .25% for conventional loans applicable to the loans comprising the portfolio.

      Pipeline. HomeAmerican’s mortgage loans in process that had not closed (the “Pipeline”) at December 31, 2005 had an aggregate principal balance of $1.6 billion. An estimated 70% to 80% of the Pipeline at December 31, 2005 is anticipated to close during 2006 under current homes sales contracts. If mortgage interest rates decline, a smaller percentage of these loans would be expected to close. Additionally, we had $245.7 million in mortgage loans committed for sale under forward sales contracts, of which $110.8 million were locked with an average interest rate of 6.64%. See “ Forward-Looking Statements ” above.

      Forward Sales Commitments. HomeAmerican is exposed to market risks related to fluctuations in interest rates on its mortgage loan inventory. 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. HomeAmerican utilizes the sales commitments to manage the price risk on fluctuations in interest rates on our mortgage loans owned and commitments to originate mortgage loans. Such contracts are the only significant financial derivative instruments utilized by us and are generally settled within 45 days of origination. Certain mortgage loans originated by HomeAmerican are able to be sold pursuant to the aforementioned early purchase program and generally are settled within five days of origination. Due to this hedging philosophy, the market risk associated with HomeAmerican’s mortgages is limited. See “ Forward-Looking Statements ” above.

      Competition. The mortgage industry is fragmented and highly competitive. In each of the locations in which it originates loans, HomeAmerican competes with numerous banks, thrifts and other mortgage bankers, many of which are larger and have greater financial resources. Competitive factors include pricing, loan terms, underwriting criteria and customer service.

Employees.

     At December 31, 2005, we employed approximately 4,000 employees. We consider our employee relations to be satisfactory.

Item 1A. Risk Factors Relating to our Business

An adverse change in economic conditions could reduce the demand for homes and, as a result, could reduce our earnings.

     Changes in national and regional economic conditions, as well as local economic conditions where our subsidiaries conduct operations and where prospective purchasers of our homebuilding subsidiaries’ homes live, can have a negative impact on our business. Adverse changes in employment levels, job growth, consumer confidence, housing demand, interest rates and population growth may reduce demand and depress prices for our homebuilding subsidiaries’ homes. This, in turn, can reduce our earnings. A material decline in the value of new residential housing could also result in a decreased value for the land, housing inventory and housing work-in-progress that we own. Any pronounced down cycle in the homebuilding industry, particularly in Nevada, California and Arizona, could cause demand for our homes and land that we own to weaken significantly.

If land is not available at reasonable prices, our sales and earnings could decrease.

     Our operations depend on our homebuilding subsidiaries’ ability to continue to obtain land for the development of our residential communities at reasonable prices. Changes in the general availability of land, competition for available land, availability of financing to acquire land, zoning, regulations that limit housing density and other market conditions may hurt our ability to obtain land for new residential communities. If the supply of land appropriate for development of our residential communities becomes more limited because of these factors, or for any

other reason, the cost of land could increase and/or the number of homes that our homebuilding subsidiaries build and sell could be reduced.

If our home prices continue to increase, our homes could become less affordable to the first-time and first-time move-up homebuyer.

     Home price increases may be caused by market conditions including inflation and increases in the cost of land, construction materials and labor. If our home prices become substantially less affordable to our first-time and first-time move-up homebuyers, we may experience a significant decline in home orders and/or an increase in our Cancellation Rate. In such circumstances, our home sales revenue and operating profits could be negatively impacted.

If the market value of our homes drops significantly, our profits could decrease.

     The market value of our land and housing inventories depends on market conditions. Our homebuilding subsidiaries acquire land for expansion into new markets and for replacement of land inventory and expansion within our current markets. If housing demand decreases below what we anticipated when we acquired our inventory, we may not be able to make profits similar to what we have made in the past, may experience less than anticipated profits and/or may not be able to recover our costs when our homebuilding subsidiaries build and sell homes. In the face of adverse market conditions, we may have substantial inventory carrying costs or our homebuilding subsidiaries may have to sell land or homes at a loss.

Interest rate increases or changes in federal lending programs could lower demand for our homes and our mortgage lending services.

     Our homebuilding and mortgage lending operations are impacted by the availability and cost of mortgage financing. Nearly all of our customers finance the purchase of their homes, and a significant number of these customers arrange their financing through our mortgage lending subsidiary, HomeAmerican. Increases in home mortgage interest rates may reduce the demand for homes and home mortgages. We are unable to predict the extent to which recent or future changes in home mortgage interest rates will affect our operating activities and results of operations.

     In addition, we believe that the availability of FNMA, FHLMC, FHA and VA mortgage financing is an important factor in our marketing strategy. Any changes, limitations or restrictions on the availability of these types of financing could reduce our subsidiaries’ home sales and mortgage lending volume.

Competition in the homebuilding industry could hurt our profits.

     The real estate industry is fragmented and highly competitive. Our homebuilding subsidiaries compete with numerous homebuilders, including a number that are substantially larger and have greater financial resources. Our homebuilding subsidiaries also compete with subdivision developers and land development companies, some of which are themselves homebuilders or affiliates of homebuilders. Homebuilders compete for customers, desirable financing, land, building materials and subcontractor labor. Competition for home orders primarily is based upon price, style, financing provided to prospective purchasers, location of property, quality of homes built, customer service and general reputation in the community. We, through our mortgage lending subsidiary, HomeAmerican, also compete with numerous banks, thrifts and other mortgage bankers, many of which are larger and have greater resources than we do. Increased competition could affect our ability to raise home prices and maintain lower levels of incentives, which could negatively impact our home sales revenue and operating profits.

Natural disasters could cause an increase in home construction costs, as well as delays, and could result in reduced profits.

     The climates and geology of many of the states in which we operate, including California and Florida, present increased risks of natural disasters. To the extent that hurricanes, severe storms, earthquakes, droughts, floods, heavy or prolonged precipitation, wildfires or other natural disasters or similar events occur, the homebuilding industry in general, and the operating profits of our business in particular, in such states may be negatively impacted. These, among other natural disasters, can affect an area in which we build, or one nearby, whereby there can be a diversion of

labor and materials in the area from new home construction to the rebuilding of the existing homes damaged or destroyed in the natural disaster. This can cause delays in construction and delivery of new homes and/or increase our construction costs.

Our business is subject to numerous environmental and other governmental regulations. These regulations could give rise to significant additional liabilities or expenditures, or restrictions on our business.

     Our operations are subject to continuing compliance requirements mandated by applicable federal, state and local statutes, ordinances, rules and regulations, including zoning and land use ordinances, building, plumbing and electrical codes, contractors’ licensing laws, state insurance laws, federal and state human resources laws and regulations and health and safety regulations and laws (including, but not limited to, those of the Occupational Safety & Health Administration). Various localities in which we operate have imposed (or may impose in the future) fees on developers to fund schools, road improvements and low and moderate income housing.

     From time to time, various municipalities in which our homebuilding subsidiaries operate restrict or place moratoriums on the availability of utilities, including water and sewer taps. Additionally, certain jurisdictions in which our homebuilding subsidiaries operate have proposed or enacted “slow growth” or “no growth” initiatives and other ballot measures that may restrict the number of building permits available in any given year. These initiatives or other slow or no growth measures could reduce our ability to open new home communities and build and sell homes in the affected markets and may create additional costs and administration requirements, which in turn could negatively impact our future home sales and operating profits. Although future conditions or governmental actions may impact our ability to obtain necessary permits or water and sewer taps, we currently believe that we have, or can obtain, water and sewer taps and building permits for our homebuilding subsidiaries’ land inventory and land held for development.

     Our homebuilding operations also are affected by environmental laws and regulations pertaining to availability of water, municipal sewage treatment capacity, stormwater discharges, land use, hazardous waste disposal, naturally occurring radioactive materials, building materials, population density and preservation of endangered species, natural terrain and vegetation. Due to these considerations, our homebuilding subsidiaries generally obtain an environmental site assessment for parcels of land that they acquire. The particular environmental laws and regulations that apply to any given homebuilding project vary greatly according to a particular site’s location, the site’s environmental conditions and the present and former uses. These environmental laws may result in project delays, cause us to incur substantial compliance and other costs and/or prohibit or severely restrict homebuilding activity in certain environmentally sensitive regions or areas.

Product liability litigation and warranty claims that arise in the ordinary course of business may be costly.

     As a homebuilder, we are subject to construction defect and home warranty claims, including moisture intrusion and related mold claims, arising in the ordinary course of business. These claims are common to the homebuilding industry and can be costly. In addition, the costs of insuring against construction defect and product liability claims are high and the amount of coverage offered by insurance companies is currently limited. This coverage may be further restricted and become more costly. If we are not able to obtain adequate insurance against these claims, we may experience losses that could hurt our business.

The interests of certain control persons may be adverse to investors.

     Larry A. Mizel, David D. Mandarich and other of our affiliates own, directly or indirectly, in the aggregate, almost 25% of our outstanding common stock. To the extent they and their affiliates vote their shares in the same manner, their combined stock ownership may effectively give them the power to elect our entire board of directors and control our management, operations and affairs. Circumstances may occur in which the interest of the controlling shareholders could be in conflict with your interests. The large percentage of stock held by these persons could also delay or prevent a change of control.

We depend on certain markets, and reduced demand for homes in these markets could reduce home sales revenue and earnings.

     Although we have increased our geographic diversification in recent years, we still conduct a significant portion of our business in the California, Nevada and Arizona markets and generate a disproportionate amount of our revenues and profits in these states. Demand for new homes, and in some instances home prices, have declined from time to time in some of our markets. If we experience a slowdown in our operations within one or more of these markets, our earnings and financial position would likely be negatively impacted.

Labor and material shortages could cause delays in the construction of our homes.

     The residential construction industry experiences serious labor and material shortages from time to time, including: work stoppages; labor disputes and shortages in qualified trades people, insulation, drywall, concrete (as recently experienced in several of our markets), steel and lumber; lack of availability of adequate utility infrastructure and services; our need to rely on local subcontractors who may not be adequately capitalized or insured; and shortages, or delays in availability, or fluctuations in prices, of building materials. These labor and material shortages can be more severe during periods of strong demand for housing or during periods where the markets in which we operate experience natural disasters that have a significant impact on existing residential and commercial structures. Any of these circumstances could give rise to delays in the start or completion, or increase the cost, of developing one or more of our residential communities. Increases in the costs of subcontracted labor, finished lots, building materials, and other resources, to the extent that market conditions prevent the recovery of increased costs through higher selling prices, could negatively affect our operating results.

Because of the seasonal nature of our business, our quarterly operating results fluctuate.

     We experience seasonal variations in our quarterly operating results and capital requirements. Typically, we do not commence significant construction on a home before a sales contract has been signed with a homebuyer. A significant percentage of our sales contracts are made during our first and second fiscal quarters. Accordingly, we generally have more homes under construction, close more homes and have greater revenues and operating income in the third and fourth quarters of our fiscal year. Additionally, our financial position at the end of the third and fourth fiscal quarters is not necessarily representative of our financial position at the end of the first and second fiscal quarters.

We are reliant on a small number of third party purchasers of mortgage loans originated by HomeAmerican which could impact our results of operations.

     Historically, a substantial portion of our originated loans have been sold to one third party purchaser. It is likely that we will continue to depend on its ability and willingness to purchase a significant number of our loans originated. Should this purchaser discontinue or reduce the number of loans it is willing to purchase from us, our ability to timely sell HomeAmerican originated loans could be significantly impacted, which could result in lower revenue and earnings in a given reporting period for our financial services and homebuilding segments.

If our potential homebuyers are not able to obtain suitable financing, our business may decline.

     Our business and earnings depend on interest rates and the ability of our homebuyers to obtain affordable mortgages for the purchase of our homes. Increases in the cost of mortgage financing could prevent homebuyers from purchasing our homes. In addition, if our homebuyers must sell an existing home in order to buy a home from us, increases in mortgage costs could interfere with such a sale and result in our homebuyers’ inability to buy a home from us.

     Additionally, the increased use of adjustable-rate mortgage products, including interest-only mortgages, could affect the ability of existing homeowners to obtain suitable financing for their homes at the end of their adjustable-rate term. This potentially could lead to an increase in home foreclosures, thereby creating additional competition from higher unsold home inventory levels. These risks could negatively impact our home sales revenue and earnings.

Item 1B. Unresolved Staff Comments.

     None

PART II

Item 6. Selected Financial and Other Data.

     The data in this table should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Company’s Consolidated Financial Statements (in thousands, except per share and unit amounts).

Seasonality and Variability in Quarterly Results

     We have experienced, and expect to continue to experience, significant seasonality and quarter-to-quarter variability in homebuilding activity levels. In general, homes closed have increased substantially in our third and fourth fiscal quarters, compared with our first and second fiscal quarters. We believe that this seasonality reflects the tendency of homebuyers to shop for a new home in the spring with the goal of closing in the fall or winter, as well as the scheduling of construction to accommodate seasonal weather conditions. Also, we have experienced, and expect to continue to experience, seasonality in our financial services operations because loan originations correspond with the closing of homes in our homebuilding operations. The following table reflects our unaudited summarized quarterly consolidated financial and operational information for the two years ended December 31, 2005 (in thousands, except per share amounts). See “ Forward-Looking Statements ” above.

Item 7. 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 Consolidated Financial Statements and Notes thereto included elsewhere in this Annual Report on Form 10-K . This item contains forward-looking statements that involve risks and uncertainties. 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 Relating to our Business.”

     M.D.C. Holdings, Inc. is a Delaware Corporation. We refer to M.D.C. Holdings, Inc. as the “Company,” “MDC,” “we” or “our” in this Form 10-K, and these designations include our subsidiaries unless we state otherwise. Our primary business is owning and managing subsidiary companies that build and sell homes under the name “Richmond American Homes.” Richmond American Homes maintains operations in certain markets within the United States, including Arizona, California, Colorado, Delaware Valley (which includes Pennsylvania, Delaware and New Jersey), Florida, Illinois, Maryland, Nevada, Texas (although we recently reported our intention not to contract for the acquisition of additional land in our Texas markets), Utah and Virginia. Our financial services segment consists of HomeAmerican Mortgage Corporation (“HomeAmerican”), which originates mortgage loans primarily for our homebuyers, and American Home Insurance Agency, Inc. (“American Home Insurance”), which offers third party insurance products to our homebuyers. In addition, we provide title agency services through American Home Title and Escrow Company (“American Home Title”) to our homebuyers in Colorado, Delaware, Florida, Illinois, Maryland, Texas, Virginia, and West Virginia.

EXECUTIVE SUMMARY

     As a residential homebuilder, we are focused on maximizing risk-adjusted returns. While we will complete some level of development work on lots when the returns justify the risk, generally, we do not develop master-planned communities. Based upon our experience within the homebuilding industry, we focus on what we believe are the largest demand segments within a given market, which generally are the first-time and first-time move-up buyers. As a result, more than 80% of our homebuyers fall into these two categories. Also, we build a limited number of homes for second-time move-up and luxury buyers. Our objective is to achieve a major market share in each of the markets in which we operate. We have selected our markets, among other reasons, for their potential population and employment growth.

     We have operated our business consistent with the objective of investing capital in homebuilding projects that generate solid risk-adjusted returns. This strategy resulted in new Company highs during 2005 for home closings, revenue, average selling prices and net income. Our net income and revenue increased $114.6 million, or 29%, and $875.1 million, or 22%, respectively, during 2005, compared with 2004. Additionally, our home closings increased to 15,307 during 2005, compared with 13,876 homes closed during 2004.

     In the fourth quarter of 2005, we began to experience slower orders for homes, reduced home price increases and higher Cancellation Rates (as defined below) in several markets in which we operate. Speculative buyers have recently begun exiting the new home market, resulting in what we believe to be a primary cause of this increase in cancellations, as well as a lower demand for new homes. As a result, the supply of homes available to be purchased by prospective buyers has increased in certain markets. We believe events which occurred in late 2004 and through 2005, including a number of natural disasters; increases in incentives offered by our competitors; higher interest rates; increases in the cost of living, particularly associated with higher energy costs; and an overall reduction in consumer confidence, may have contributed to a slowing demand for new homes in a number of our markets. Because home sale price increases slowed in several of our markets and existing homes have taken longer to sell, prospective homebuyers appear to have become more selective or hesitant in making home buying decisions. Despite these challenges, we remain cautiously optimistic about the future growth of our business. We continue to focus on our sales strategy and, in certain markets, we have increased incentives as a means of generating homebuyer interest and home orders. A continued slowdown could have a greater negative impact on our Home Gross Margins (as defined below) during 2006. See “ Forward-Looking Statements ” above.

     During 2005, we continued to focus on quality growth, as evidenced by our 21% increase in active subdivisions at December 31, 2005, compared with 2004. This subdivision growth was most notable in markets such as Arizona, Illinois, California, Nevada and the Delaware Valley. When opening a new subdivision, we try to acquire no more than a two-year supply of lots to avoid overexposure to any single sub-market. We prefer to acquire finished lots using rolling options or in phases for cash. However, we will acquire entitled land for development into finished lots when we determine that the risk is justified. Our Asset Management Committees, which include members of our senior management, generally meet weekly to review all proposed land acquisitions and takedowns of lots under option. During periods in which we experience extraordinary demand, as well as lower than normal demand, for new homes, our two-year

supply of lots may be affected, resulting in us maintaining significantly more or less than a two-year supply of lots. We continue to closely monitor the number of lots we control to confirm that our supply of lots is relatively consistent with our two-year supply objective given the then current market conditions. See “ Forward-Looking Statements ” above.

     Our financial position continued to strengthen during 2005. Total stockholders’ equity at December 31, 2005 increased to $2.0 billion, compared with $1.4 billion at December 31, 2004. This growth primarily was the result of our 2005 net income, offset by $33.5 million in cash dividends paid during 2005. In July 2005, we completed a public offering of $250 million principal amount of 5 ³ / 8 % medium-term senior notes due in July 2015, the proceeds being used primarily for the purchase of homebuilding inventories. Additionally, in December 2005, we updated our effective shelf registration by raising its capacity back to $1.0 billion, with $500 million earmarked for our medium-term senior note program.

     Consistent with our commitment to allocate capital to opportunities that are expected to create long-term value for our shareowners, we do not anticipate allocating additional capital and resources to our Texas markets. We will continue to build on or sell the lots we control in Texas. However, we currently have no plans to enter into new contracts for the acquisition of additional land in our Texas markets. See “ Forward-Looking Statements ” above.

CRITICAL ACCOUNTING ESTIMATES AND POLICIES

     The preparation of financial statements in conformity with accounting policies generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Management evaluates such estimates and judgments on an on-going basis and makes adjustments as deemed necessary. Actual results could differ from these estimates using different estimates and assumptions, or if conditions are significantly different in the future. See “ Forward-Looking Statements ” above.

     Listed below are those estimates and policies that we believe are critical and require the use of complex judgment in their application. Our critical accounting estimates and policies are as follows and should be read in conjunction with the Notes to our Consolidated Financial Statements.

      Homebuilding Inventory Valuation. Homebuilding inventories, which include housing completed or under construction and land and land under development, are carried at cost unless events and circumstances indicate that the carrying value of the underlying projects may not be recoverable. In making this determination, we review, among other things, actual and trending Gross Profit, which is defined as home sales revenue less home cost of sales and all direct incremental costs associated with the home closing, for homes closed, forecasted Gross Profit for homes in Backlog (as defined below) and known or current expectations that the carrying value may not be recoverable. In accordance with the Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”), if the carrying value of long-lived assets are determined to not be recoverable, the assets are reviewed for impairment by comparing the estimated future cash flows (undiscounted and without interest charges) from an individual project to its carrying value. If such cash flows are less than the project’s carrying value, the carrying value of the project is written down to its estimated fair value. Homebuilding inventories held for sale are carried at the lower of cost or fair value, less selling costs, and are evaluated on a project basis. Fair value is determined by management estimate and incorporates anticipated future revenues and costs. Due to uncertainties in the estimation process, actual results could differ from those estimates. We continue to evaluate the carrying value of our inventory and, based on historical results, we believe that the existing estimation process is accurate and do not anticipate any material change in the process. We recorded no homebuilding asset impairment charges in 2005, 2004 or 2003.

      Estimates to Complete Land Development and Home Construction. Upon closing a home, we record an estimated accrual associated with certain construction and land development costs incurred but not yet paid at the time of a home closing (“Estimates-to-Complete”). Generally, these accruals are established based upon contracted work which has yet to be paid, open work orders not paid at the time of home closing, punch list items identified during the course of the homebuyer’s final walkthrough of the home, as well as land completion costs more likely than not to be incurred, and represent estimates believed to be adequate to cover the expected remaining home construction and land development costs. We monitor the adequacy of these accruals on a house-by-house basis, in aggregate for each of our markets, as well as on a

consolidated basis. At December 31, 2005 and 2004, we had Estimates-to-Complete accruals of $75.0 million and $54.7 million, respectively. Actual results could differ from such estimates.

      Warranty Costs. Our homes are sold with limited third-party warranties. Warranty reserves are established as homes close on a house-by-house basis in an amount estimated to be adequate to cover expected costs of materials and outside labor during warranty periods. Reserves are determined based upon historical experience with respect to similar product types and geographical areas. Certain factors are given consideration in determining the per-house reserve amount, including (1) the historical range of amounts paid per house; (2) the historical average amount paid per house; (3) any warranty expenditures included in (1) and (2) not considered to be normal and recurring; (4) improvements in quality control and construction techniques expected to impact future warranty expenditures; and (5) conditions that may affect certain projects and require higher per-house reserves for those specific projects.

     Warranty payments are tracked on a house-by-house basis and are charged against the warranty reserve established for the house. Payments incurred after the close of a home are monitored to determine their nature and, to the extent they are warranty-related payments, they are recorded against the warranty reserve. To the extent this evaluation determines the payments made are related to completion of a home or land development, the payments are then recorded against the Estimates-to-Complete reserve. Additional reserves are established for known, unusual warranty-related expenditures not covered by the general warranty reserves. General warranty reserves not utilized for a particular house are evaluated for reasonableness on an aggregate basis for the entire Company. If warranty payments for an individual house exceed the related reserve, then payments in excess of the reserve are evaluated in the aggregate to determine if an adjustment to home cost of sales should be recorded.

     Generally warranty reserves are reviewed monthly, using historical data and other relevant information, to determine the reasonableness and adequacy of both the aggregate reserve and the per unit reserve amount originally included in cost of sales, as well as the timing of any reversals of the original reserve. We continue to evaluate the adequacy of the warranty reserves and, based on historical results, believe that our existing estimation process is accurate and do not anticipate the process to change materially in the future. Due to uncertainties in the estimation process, it is at least reasonably possible that actual results could differ from those estimates. Warranty reserves were $82.2 million and $64.4 million at December 31, 2005 and 2004, respectively. A positive or negative change of 10% in the per-house reserve rate would have resulted in approximately a $6 million increase or decrease in the warranty expense during 2005.

      Revenue Recognition. We recognize revenue from home closings in accordance with SFAS No. 66, “Accounting for Sales of Real Estate” (“SFAS 66”). Accordingly, revenue is recognized when the home closing has occurred, title has passed, adequate initial and continuing investment from the homebuyer is received, possession and other attributes of ownership have been transferred to the buyer and we are not obligated to perform significant additional activities after closing and delivery. We evaluate the initial investment provided under Federal Housing Administration-insured and Veterans Administration-guaranteed loans in accordance with Emerging Issues Task Force No. 87-9, “Profit Recognition on Sales of Real Estate with Insured Mortgages or Surety Bonds” and all other loans, in accordance with SFAS 66. Revenue from homes that close with the buyer providing a sufficient initial and continuing investment, assuming all other revenue recognition criteria have been met, is recognized using the full accrual method as provided in SFAS 66 on the date of closing. For a home closing in which HomeAmerican originates the mortgage loan and the homebuyer does not provide a sufficient initial and continuing investment, we utilize the installment method of accounting in accordance with SFAS 66. Accordingly, the corresponding Gross Profit is deferred and subsequently recognized on the date that HomeAmerican sells the homebuyer’s loan to a third party purchaser. In accordance with SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“SFAS 140”), sale of a homebuyer loan has occurred when the following criteria have been met; (1) the payment from the third party purchaser is not subject to future subordination; (2) we have transferred all the usual risks and rewards of ownership that is in substance a sale; and (3) we do not have a substantial continuing involvement with the loan. Factors that we consider in assessing whether a sale of a loan has occurred in accordance with SFAS 140 include, among other things, (1) the amount of recourse, if any, to HomeAmerican for credit and interest rate risk; (2) the right or obligation, if any, of HomeAmerican to repurchase the loan; and (3) the amount of control HomeAmerican retains, or is perceived to retain, over the administration of the assets post closing.

     Income with respect to loan origination fees, net of certain direct loan origination costs incurred, and loan commitment fees are deferred and amortized over the life of the loan. Loan servicing fees are recorded as revenue when the mortgage loan payments are received. Revenues from the sale of mortgage loan servicing are recognized upon the exchange of consideration for the mortgage loans and related servicing rights between us and the third party purchaser in accordance with the provisions of SFAS 140. Based upon the current terms of our contracts, exchange of consideration is deemed effective when we receive the proceeds from the third party purchaser and when the collateral data records are delivered, either electronically or manually to the third party purchaser.

      Land Options. In the normal course of business, we enter into lot option purchase contracts, generally through a deposit of cash or letter of credit, for the right to purchase land or lots at a future point in time with predetermined terms. We account for these transactions in accordance with FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” as amended (“FIN 46”). Our obligation with respect to option contracts generally is limited to forfeiture of the related non-refundable cash deposits and/or letters of credit. Under FIN 46, certain of these contracts create a variable interest, with the land seller being the variable interest entity (“VIE”) and, as such, may require us to consolidate the assets and liabilities of the VIE. We have evaluated all lot option purchase contracts outstanding at December 31, 2005 pursuant to FIN 46, and considered (1) what investments were at risk; (2) contractual obligations to perform; (3) expected changes in market prices of land over a given period; and (4) annual risk free interest rates. Based on this evaluation, we have determined that our interests in these VIEs do not result in significant variable interests or require us to consolidate the VIEs. Due to significant assumptions used in our evaluation process, it is at least reasonably possible that our evaluation of lot option contracts in the future could result in MDC being identified as the primary beneficiary which could result in our consolidation of a VIE.

     Since we own no equity interest in any of the unaffiliated VIEs that we must evaluate pursuant to FIN 46, certain assumptions about the assets and liabilities of such entities are required. In most cases, the fair value of the assets of the evaluated VIEs have been assumed to be the remaining contractual purchase price of the land or lots we are purchasing.

     We periodically enter into lot option arrangements with third parties that will purchase or have purchased property at our direction which we may later acquire. We evaluate these transactions in accordance with FIN 46 as well as SFAS No. 49, “Accounting for Product Financing Arrangements” (“SFAS 49”) to determine if we should record an asset and liability at the time we enter into the lot option contract. Factors considered include (1) amount of deposit at risk; (2) loss of anticipated future operating income associated with selling homes; (3) unreimbursed commitments to incur costs associated with lots; and (4) the uniqueness or location of the lots. Based upon this evaluation of lot option purchase contracts outstanding at December 31, 2005, we have determined that no asset or liability was required to be recorded prior to the date of purchase.

     At December 31, 2005, we had approximately $1.2 billion in land available to be purchased under lot option purchase contracts which have been evaluated in accordance with FIN 46 and SFAS 49.

RESULTS OF OPERATIONS

      2005 Compared With 2004 . Revenues in 2005 increased by 22% from 2004 levels, primarily due to a 10% rise in homes closed and a $30,400 increase in the average selling price of homes closed in 2005.

     Income before income taxes rose $171.8 million in 2005. This growth primarily resulted from increases of $183.4 million and $6.2 million in homebuilding and financial services segment operating profits, respectively, partially offset by an increase in net corporate expenses of $17.8 million. Homebuilding operating profits increased primarily due to the higher number of homes closed and an increase of $30,400 in our average selling prices, as well as a 70 basis point increase in Home Gross Margins (as defined below). The increase in financial service segment operating profits primarily resulted from a $7.7 million increase in loan origination fees. Net corporate expenses increased $17.8 million primarily due to an increase in compensation-related costs associated with our expanding homebuilding operations.

      2004 Compared With 2003 . The 37% growth in revenues primarily resulted from a 24% increase in the number of homes closed to 13,876, as well as an increase of $29,100 in our average home selling price.

     Income before income taxes increased $288.7 million in 2004. The increase primarily was due to a $325.3 million increase in homebuilding segment operating profit, partially offset by a $9.8 million decrease in financial services segment operating profit and a $26.8 million increase in net corporate expenses. The homebuilding segment profit increase principally was the result of the increases in home closings and average selling prices described above and a 360 basis point increase in Home Gross Margins. The financial services segment profit decrease primarily was due to a $6.0 million decrease in gains on sales of mortgage loans and a $6.2 million increase in general and administrative expenses resulting from HomeAmerican’s expanded loan origination activity.

      Home Sales Revenue. Home sales revenue in 2005 increased 22% over 2004 primarily as a result of an 11% increase in average selling price and a 10% increase in the number of homes closed, as discussed below.

      Homes Closed. Home closings were 10% higher during the year ended December 31, 2005, compared with 2004. Our Arizona, Florida and Utah operations closed 5,658 homes during 2005, compared with 4,323 homes closed during 2004, a 31% increase. This aggregate increase resulted partially from higher year-over-year Backlog (as defined below) at the beginning of the 2005 period, compared with the start of the prior year, resulting from the strong demand for new homes in these markets. In addition, home closings in Florida were higher in 2005, primarily as a result of our September 2004 acquisition of certain assets of Watson Home Builders, Inc. Home closings increased in Nevada by 10% in 2005, aided by a 23% increase in the average number of active subdivisions during 2005, compared with 2004. These increases partially were offset by fewer homes closed in California, Colorado and Virginia, primarily due to lower Backlog at the beginning of 2005, compared with the beginning of 2004, and lower home orders received in each of these markets during the first six months of 2005, compared with the same period in 2004.

      Average Selling Price Per Home Closed. The average selling price per home closed increased $30,400 to $313,800 in 2005 from $283,400 in 2004. This increase primarily was attributable to higher average selling prices in most of our markets, particularly in Virginia, Maryland, Nevada and California, where the average selling prices increased in excess of $50,000 per home. Additionally, approximately 25% of our homes closed during 2005 and 2004 were in Arizona, where we experienced a $30,400 increase in average selling price in 2005. These increases partially were offset by closing a higher percentage of homes in our Florida market, whose average selling prices were below the Company average. Although the substantial rate of home price increases experienced in Nevada and Arizona over the past two years have moderated to more normalized levels, we believe these markets provide a favorable environment for continued strength in the demand for new homes. Therefore, we have allocated significant capital for growth in these markets in 2006. See “ Forward-Looking Statements ” above.

      Home Gross Margins. We define “Home Gross Margins” to mean home sales revenues less home cost of sales (which primarily includes land and construction costs, capitalized interest, closing costs and a reserve for warranty expense) as a percent of home sales revenues. Home Gross Margins increased 70 basis points to 28.4% in 2005 from 27.7% in 2004. We experienced particularly strong year-over-year improvements in Home Gross Margins in Virginia, Maryland and Arizona, primarily as a result of increases in the average selling prices during 2005, compared with 2004, in each of these markets. In addition, we were able to moderate the impact of labor and material cost increases through national purchasing programs, limiting the impact on Home Gross Margins across the Company. These increases partially were offset by decreases in Home Gross Margins in our Nevada market, primarily resulting from increases in the cost of land and construction materials used in building new homes. Despite year-over-year improvements in Home Gross Margins in Utah and Florida, the 70 basis point improvement in Home Gross Margin partially was offset by the impact of closing a greater number of homes in these markets, where Home Gross Margins were lower than the Company average. Additionally, Home Gross Margins were lower in Colorado, primarily due to a more competitive environment for new homes in this market.

     Future Home Gross Margins may be impacted by, among other things: (1) increased competition, which could affect our ability to raise home prices and maintain lower levels of incentives; (2) increases in the costs of subcontracted labor, finished lots, building materials, and other resources, to the extent that market conditions prevent the recovery of increased costs through higher selling prices; (3) adverse weather; (4) shortages of subcontractor labor, finished lots and other resources, which can result in delays in the delivery of homes under construction and increases in related cost of sales; (5) the impact of changes in demand for housing in our markets, particularly Nevada, California and Arizona; and (6) other general risk factors. See “ Forward-Looking Statements ” above.

      Orders for Homes. Orders for homes, net of cancellations, increased 8% in 2005 from 2004, with growth in our Nevada and Florida markets providing the most significant increases. The 27% increase in Nevada primarily was due to a 23% increase in average active subdivisions from 2004, as well as continued strong demand for new homes. The increase in Florida primarily resulted from an increase in active subdivisions due to the purchase of certain homebuilding assets from Watson Home Builders, Inc. in September 2004. We received 339 net home orders during 2005 from our newer markets in Delaware Valley and Illinois, compared with 43 during 2004, primarily due to an increase in the number of active subdivisions during 2005 resulting from our on-going efforts to grow in these markets. In addition, we received an increase of 200 net home orders in Utah, despite an 18% temporary decline in active subdivisions, due to the continued strong demand for new homes in this market. These increases partially were offset by lower net home orders in our Arizona, Colorado and Virginia markets. In Arizona, the decline reflected a sharp reduction in the number of net home orders per active subdivision from the unsustainably high levels experienced in this market during 2004, to a level more consistent with previous years. The decline in Colorado resulted from a more competitive environment for new homes in this market. We received fewer net home orders in Virginia in 2005, primarily due to a decline in the number of active subdivisions, as well as an increase in our 2005 fourth quarter cancellations from the same period in 2004. See “ Forward-Looking Statements ” above.

      Backlog. We define “Backlog” as homes under contract but not yet delivered. At December 31, 2005 and 2004, we had 6,532 homes and 6,505 homes in our Backlog. Because our Backlog equals total home orders less home order cancellations and homes closed, refer to the aforementioned discussion on “Homes Closed” and “Orders for Homes” for an explanation of the change in the number of homes in Backlog. Although homes in Backlog remained relatively flat at the end of 2005, compared with 2004, increases in the average selling prices for homes in Backlog resulted in the estimated Backlog sales value increasing by 27% to $2.44 billion at December 31, 2005 from $1.92 billion at December 31, 2004. These increases, which were led by our Nevada, Arizona, Florida and Delaware Valley markets, primarily resulted from increases in the average price of our homes in Backlog. These increases partially were offset by lower Backlog sales values in Virginia and Colorado.

     We define home order “Cancellation Rate” as total cancelled home order contracts during a specified period of time as a percent of total home orders received during such time period. Our Cancellation Rates were 23.7% and 25.3% for the years ended December 31, 2005 and 2004, respectively. Assuming our historical Cancellation Rates are indicative of future Cancellation Rates and assuming no significant long-standing change in market conditions and mortgage interest rates, we anticipate that approximately 70% to 80% of our December 31, 2005 Backlog will close under existing sales contracts during 2006. The remaining 20% to 30% of the homes in Backlog are not expected to close under existing contracts due to cancellations. See “ Forward-Looking Statements ” above.

      Marketing and Commissions . Marketing expenses (which include advertising, amortization of deferred marketing costs, model home expenses and other costs) totaled $106.0 million and $92.6 million in 2005 and 2004, respectively. The $13.4 million rise in 2005 primarily was due to increases of (1) $5.3 million in amortization of deferred marketing costs resulting from our higher home closings; (2) $3.7 million in salaries and benefits attributable to our expanding homebuilding operations in new and existing markets; and (3) $2.7 million in product advertising in connection with our increased number of active subdivisions. Commission expenses (which include direct incremental commissions paid for closed homes) increased by 23% to $130.3 million in 2005 from $106.0 million in 2004. This increase in 2005 was attributable to the 22% rise in home sales revenues resulting from higher average selling prices and homes closed.

      General and Administrative. General and administrative expenses totaled $239.0 million and $181.6 million for the years ended December 31, 2005 and 2004, respectively. The increase of $57.4 million primarily resulted from an increase of approximately $30.6 million in compensation and other employee benefit-related costs associated with the expanded operations in many of our markets, most notably California, Nevada, Arizona, Florida and Virginia. Supervisory expenses (see Note 3 to our Consolidated Financial Statements) increased approximately $13.1 million and other general and administrative expenses increased approximately $8.0 million primarily due to our continued growth in the homebuilding segment. Also impacting the increase in general and administrative expense was a $5.4 million increase in building rent and office-related expenses.