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NVR > SEC Filings for NVR > Form 10-Q on 30-Jul-2013All Recent SEC Filings

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Form 10-Q for NVR INC


30-Jul-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

(dollars in thousands)

Forward-Looking Statements

Some of the statements in this Form 10-Q, as well as statements made by us in periodic press releases or other public communications, constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Certain, but not necessarily all, of such forward-looking statements can be identified by the use of forward-looking terminology, such as "believes," "expects," "may," "will," "should," or "anticipates" or the negative thereof or other comparable terminology. All statements other than of historical facts are forward-looking statements. Forward-looking statements contained in this document include those regarding market trends, NVR's financial position, business strategy, the outcome of pending litigation, investigations or similar contingencies, projected plans and objectives of management for future operations. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results or performance of NVR to be materially different from future results, performance or achievements expressed or implied by the forward-looking statements. Such risk factors include, but are not limited to the following: general economic and business conditions (on both a national and regional level); interest rate changes; access to suitable financing by NVR and NVR's customers; increased regulation in the mortgage banking industry; the ability of our mortgage banking subsidiary to sell loans it originates into the secondary market; competition; the availability and cost of land and other raw materials used by NVR in its homebuilding operations; shortages of labor; weather related slow-downs; building moratoriums; governmental regulation; fluctuation and volatility of stock and other financial markets; mortgage financing availability; and other factors over which NVR has little or no control. NVR undertakes no obligation to update such forward-looking statements except as required by law. For additional information regarding risk factors, see Part II, Item 1A of this Form 10-Q and Part I, Item 1A of NVR's Form 10-K for the fiscal year ended December 31, 2012.

Unless the context otherwise requires, references to "NVR", "we", "us" or "our" include NVR and its consolidated subsidiaries.

Results of Operations for the Three and Six Months Ended June 30, 2013 and 2012

Overview

Business

Our primary business is the construction and sale of single-family detached homes, townhomes and condominium buildings, all of which are primarily constructed on a pre-sold basis. To fully serve customers of our homebuilding operations, we also operate a mortgage banking and title services business. We primarily conduct our operations in mature markets. Additionally, we generally grow our business through market share gains in our existing markets and by expanding into markets contiguous to our current active markets. Our four homebuilding reportable segments consist of the following regions:

 Mid Atlantic:   Maryland, Virginia, West Virginia, Delaware and Washington, D.C.
 North East:     New Jersey and eastern Pennsylvania
 Mid East:       New York, Ohio, western Pennsylvania, Indiana and Illinois
 South East:     North Carolina, South Carolina, Tennessee and Florida

Our lot acquisition strategy is predicated upon avoiding the financial requirements and risks associated with direct land ownership and development. Historically, we have not engaged in land development to obtain finished lots for use in our homebuilding operations. Instead, we have acquired finished lots at market prices from various third party land developers pursuant to fixed price purchase agreements. These purchase


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agreements require deposits, typically ranging up to 10% of the aggregate purchase price of the finished lots, in the form of cash or letters of credit that may be forfeited if we fail to perform under the purchase agreement. This strategy has allowed us to maximize inventory turnover, which we believe enables us to minimize market risk and to operate with less capital, thereby enhancing rates of return on equity and total capital.

Our continued success is contingent upon our ability to control an adequate supply of finished lots on which to build, and on our developers' ability to timely deliver finished lots to meet the sales demands of our customers. However, during the past several years, the impact of economic conditions on the homebuilding industry have negatively impacted our developers' ability to obtain acquisition and development financing or to raise equity investments to finance land development activity, potentially constraining our supply of finished lots. This pressure has necessitated that in certain specific strategic circumstances we deviate from our historical lot acquisition strategy and engage in joint venture arrangements with land developers or directly acquire raw ground already zoned for its intended use for development. Once we acquire control of any raw ground, we will determine whether to sell the raw parcel to a developer and enter into a fixed price purchase agreement with the developer to purchase the finished lots, or whether we will hire a developer to develop the land on our behalf. While joint venture arrangements and direct land development activity are not our preferred method of acquiring finished building lots, we may enter into additional transactions in the future on a limited basis where there exists a compelling strategic or prudent financial reason to do so. We expect, however, to continue to acquire substantially all of our finished lot inventory using fixed price purchase agreements with forfeitable deposits.

As of June 30, 2013, we controlled approximately 55,500 lots under purchase agreements with deposits in cash and letters of credit totaling approximately $268,900 and $750, respectively. Included in the number of controlled lots are approximately 9,300 lots for which we have recorded a contract land deposit impairment reserve of approximately $61,200 as of June 30, 2013. In addition, we had an aggregate investment of approximately $90,800 in three joint venture limited liability corporations ("JVs"), expected to produce approximately 7,500 lots. Of the lots controlled by the JVs, approximately 2,700 were not under contract with us at June 30, 2013. Further, as of June 30, 2013, we directly owned four separate raw parcels of land, zoned for their intended use, with a current cost basis, including development costs, of approximately $87,600 that we intend to develop into approximately 950 finished lots for use in our homebuilding operations. See Notes 3 and 4 to the condensed consolidated financial statements included herein for additional information regarding JVs and land under development, respectively.

In addition to constructing homes primarily on a pre-sold basis and utilizing what we believe is a conservative lot acquisition strategy, we focus on obtaining and maintaining a leading market position in each market we serve. This strategy allows us to gain valuable efficiencies and competitive advantages in our markets, which we believe contributes to minimizing the adverse effects of regional economic cycles and provides growth opportunities within these markets.

Overview of Current Business Environment

Improved sales and pricing trends experienced over the last several quarters have continued into the second quarter of 2013. These favorable market conditions continue to be driven by strong affordability levels and low housing inventory levels. Despite these improvements, the housing market continues to face challenges from tight mortgage underwriting standards and a recent increase in mortgage interest rates. While we have benefited from improved market conditions, we continue to face gross margin pressure due to increasing land and construction costs.

As a result of the favorable market conditions in the second quarter of 2013, our new orders, net of cancellations ("new orders") and the average selling price for new orders increased 25% and 9%, respectively, compared to the second quarter of 2012. We experienced new order increases in each of our reportable segments quarter over quarter. Consolidated revenues for the second quarter of 2013 totaled $1,009,892, a 31% increase from the second quarter of 2012. Our net income and diluted earnings per share in the current


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quarter were $50,690 and $10.11, respectively, increases of 8% and 13%, respectively, compared to the second quarter of 2012. Net income in the second quarter of 2012 was favorably impacted by a reduction of $6,989 of income tax expense due to an adjustment to our provision for unrecognized tax benefits. As a result of the increased second quarter sales, our backlog of homes sold but not yet settled with customers at the end of the quarter was 31% higher on a unit basis and 42% higher on a dollar basis than the same period in 2012. Our gross profit margin within our homebuilding business decreased to 15.9% in the second quarter of 2013 compared to 17.3% in the second quarter of 2012 due primarily to a charge of approximately $15,600, or 157 basis points of revenue, to establish an accrual related to remediation of primarily water infiltration issues in a single community. The water infiltration issues were the result of a design issue with several products developed for and built exclusively in that one community. Build-out of that community has been completed. Excluding this charge, gross profit margin for the second quarter of 2013 was 17.5%.

We believe that the continuation of the housing market recovery which began in 2012 is dependent upon a sustained overall economic recovery. In addition, the Dodd-Frank Wall Street Reform and Consumer Protection Act, enacted on July 21, 2010, contains numerous provisions affecting residential mortgages and mortgage lending practices. The Consumer Financial Protection Bureau issued rules in January 2013, including "Ability to Repay" underwriting provisions, appraisal standards, servicing and escrow rules, and loan officer compensation requirements. Additional rulemaking is expected within the next several months. The ultimate impact of such provisions on lending institutions, including our mortgage banking subsidiary, will depend on the final interpretation and the banking industry's implementation of these new standards. Despite these ongoing economic uncertainties, because of the strength of our balance sheet, we believe that we are well positioned to take advantage of opportunities that may arise.

Homebuilding Operations

The following table summarizes the results of operations and other data for the
consolidated homebuilding operations:



                                            Three Months Ended                 Six Months Ended
                                                 June 30,                          June 30,
                                           2013            2012             2013              2012

Revenues                                 $ 992,210       $ 755,290       $ 1,743,078       $ 1,341,485
Cost of sales                            $ 834,288       $ 624,978       $ 1,458,373       $ 1,116,807
Gross profit margin percentage                15.9 %          17.3 %            16.3 %            16.8 %
Selling, general and administrative
expenses                                 $  82,120       $  73,754       $   160,533       $   145,930
Settlements (units)                          2,878           2,475             5,150             4,399
Average settlement price                 $   344.7       $   305.1       $     338.4       $     304.9
New orders (units)                           3,278           2,614             6,788             5,771
Average new order price                  $   361.1       $   330.5       $     351.8       $     321.1
Backlog (units)                                                                6,617             5,048
Average backlog price                                                    $     358.6       $     331.3
New order cancellation rate                   13.8 %          16.3 %            13.5 %            13.1 %

Consolidated Homebuilding - Three Months Ended June 30, 2013 and 2012

Homebuilding revenues increased 31% for the second quarter of 2013 from the same period in 2012 primarily as a result of a 16% increase in the number of units settled and a 13% increase in the average settlement price. The increase in the number of units settled was primarily attributable to our beginning backlog units being approximately 27% higher entering the second quarter of 2013 as compared to the same period in 2012, offset partially by a lower backlog turnover rate quarter over quarter. Average settlement


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prices were favorably impacted by a 10% higher average price of homes in beginning backlog period over period. In addition, both settlements and average settlement prices were favorably impacted by our December 31, 2012 acquisition of Heartland Homes.

Gross profit margin for the second quarter of 2013 decreased 134 basis points compared to the second quarter of 2012, primarily due to the aforementioned $15,600 charge, or 157 basis points of revenue, to establish an accrual related to remediation of primarily water infiltration issues at one of our completed communities. Excluding this charge, gross profit margin increased 24 basis points to 17.5% in the current year second quarter. Gross profit margin was favorably impacted by higher settlement volume in the current year quarter allowing us to better leverage our operating costs, partially offset by higher construction costs, including lumber and certain other commodity costs, quarter over quarter.

The number of new orders and the average selling price of new orders for the second quarter of 2013 increased 25% and 9%, respectively, when compared to the second quarter of 2012. New orders and average selling prices were higher quarter over quarter in each of our market segments. The increase in new orders was driven by a 12% increase in the number of active communities in the second quarter of 2013 compared to the prior year quarter, higher absorption rates and a decrease in the cancellation rate quarter over quarter. The Heartland Homes acquisition added approximately 90 new orders in the current year quarter.

Selling, general and administrative ("SG&A") expenses in the second quarter of 2013 increased approximately $8,400, or 11%, compared to the second quarter of 2012 but decreased as a percentage of revenue to 8.3% from 9.8% quarter over quarter. The increase in SG&A dollars was attributable primarily to an approximate $9,900 increase in personnel costs in the second quarter of 2013 due to an increase in headcount quarter over quarter. In addition, sales and marketing costs were approximately $2,900 higher in the current quarter due to the increase in the number of active communities quarter over quarter. These cost increases were partially offset by a $5,900 reduction in equity-based compensation in the second quarter of 2013 compared to the second quarter of 2012. Equity-based compensation was favorably impacted as a result of the restricted share units ("RSUs") issued in 2010 becoming fully vested as of December 31, 2012, offset partially by equity-based compensation expense incurred in 2013 related to RSUs issued in May 2013. The decrease in SG&A costs as a percentage of revenue was driven by increased revenue in the current quarter, allowing us to better leverage our overhead costs.

Consolidated Homebuilding - Six Months Ended June 30, 2013 and 2012

Homebuilding revenues increased 30% for the six months ended June 30, 2013 compared to the same period in 2012 as a result of a 17% increase in the number of units settled and an 11% increase in the average settlement price. The increase in the number of units settled was primarily attributable to our beginning backlog units being approximately 35% higher entering 2013 compared to the same period in 2012, offset partially by a lower backlog turnover rate year over year. Average settlement prices were favorably impacted by a 10% higher average price of homes in beginning backlog period over period. In addition, both settlements and average settlement prices were favorably impacted by the Heartland Homes acquisition.

Gross profit margin in the first six months of 2013 decreased 41 basis points compared to the first six months of 2012. Excluding the charge in the second quarter of 2013 of approximately $15,600, or 89 basis points of revenue, for service repairs noted above, gross profit margin was 17.2%, an increase of 48 basis points from the prior year. Gross profit margin was favorably impacted by higher settlement volume in the current year allowing us to better leverage our operating costs, partially offset by higher construction costs, including lumber and certain other commodity costs, year over year. We expect to continue to experience gross profit margin pressure over the next several quarters, due to cost pressures.

The number of new orders and the average selling price of new orders for the first six months of 2013 increased 18% and 10%, respectively, when compared to the first six months of 2012. New orders and average new order selling prices were higher year over year in each of our market segments. The increase in new orders was driven by a 12% increase in the number of active communities year over year and improved sales


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absorption in many of our markets. The Heartland Homes acquisition added approximately 240 new orders in the current year. The favorable market conditions discussed in the Overview section above have allowed us to increase our number of active communities and our pricing in many of our markets.

Selling, general and administrative ("SG&A") expenses in the first six months of 2013 increased approximately $14,600 compared to the first six months of 2012 but decreased as a percentage of revenue to 9.2% from 10.9% year over year. The increase in SG&A dollars was attributable primarily to an approximate $20,100 increase in personnel costs in 2013 due to an increase in headcount year over year. In addition, sales and marketing costs were approximately $5,000 higher in 2013 due to the increase in the number of active communities. These cost increases were partially offset by an approximate $13,800 reduction in equity-based compensation in 2013 compared to 2012. Equity-based compensation was favorably impacted as a result of the restricted share units issued in 2010 becoming fully vested as of December 31, 2012, offset partially by equity-based compensation expense incurred in 2013 related to RSUs issued in May 2013. The decrease in SG&A costs as a percentage of revenue was driven by increased revenue in the current quarter, allowing us to better leverage our overhead costs.

Backlog units and dollars were 6,617 and $2,372,757, respectively, as of June 30, 2013 compared to 5,048 and $1,672,622, respectively, as of June 30, 2012. Backlog units were higher primarily due to our beginning backlog units being approximately 35% higher entering 2013 compared to the same period in 2012, coupled with the increase in new orders and a lower backlog turnover rate in 2013. Backlog dollars were favorably impacted by the increase in backlog units and the 10% higher average new order selling price year over year.

Backlog, which represents homes sold but not yet settled with the customer, may be impacted by customer cancellations for various reasons that are beyond our control, such as failure to obtain mortgage financing, inability to sell an existing home, job loss, or a variety of other reasons. In any period, a portion of the cancellations that we experience are related to new sales that occurred during the same period, and a portion are related to sales that occurred in prior periods and therefore appeared in the opening backlog for the current period. Expressed as the total of all cancellations during the period as a percentage of gross sales during the period, our cancellation rate was approximately 13.5% and 13.1% in the first six months of 2013 and 2012, respectively. During the most recent four quarters, approximately 6% of a reporting quarter's opening backlog cancelled during the fiscal quarter. We can provide no assurance that our historical cancellation rates are indicative of the actual cancellation rate that may occur in 2013 or future years.

The backlog turnover rate is impacted by various factors, including, but not limited to, changes in new order activity, internal production capacity, external subcontractor capacity and other external factors over which we do not exercise control.

Reportable Segments

Homebuilding profit before tax includes all revenues and income generated from the sale of homes, less the cost of homes sold, SG&A expenses, and a corporate capital allocation charge determined at the corporate headquarters. The corporate capital allocation charge eliminates in consolidation, is based on the segment's average net assets employed, and is charged using a consistent methodology in the periods presented. The corporate capital allocation charged to the operating segment allows the Chief Operating Decision Maker to determine whether the operating segment's results are providing the desired rate of return after covering our cost of capital. We record charges on contract land deposits when we determine that it is probable that recovery of the deposit is impaired. For segment reporting purposes, impairments on contract land deposits are generally charged to the operating segment upon the determination to terminate a finished lot purchase agreement with the developer or to restructure a lot purchase agreement resulting in the forfeiture of the deposit. We evaluate our entire net contract land deposit portfolio for impairment each quarter. For additional information regarding our contract land deposit impairment analysis, see the Critical Accounting Policies section within this Management Discussion and Analysis. For presentation purposes below, the contract land deposit reserve at June 30, 2013 and 2012 has been allocated to the respective year's reportable segments to show contract land deposits on a net basis. The net contract land deposit balances below also


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include $750 and $3,700 at June 30, 2013 and 2012, respectively, of letters of credit issued as deposits in lieu of cash. The following tables summarize certain homebuilding operating activity by segment for the three and six months ended June 30, 2013 and 2012:

Selected Segment Financial Data:



                                      Three Months Ended              Six Months Ended
                                           June 30,                       June 30,
                                     2013           2012            2013            2012
 Revenues:
 Mid Atlantic                      $ 594,902      $ 454,504      $ 1,026,770      $ 815,315
 North East                           82,260         71,201          144,871        123,401
 Mid East                            213,463        152,021          384,219        258,303
 South East                          101,585         77,564          187,218        144,466

 Gross profit margin:
 Mid Atlantic                      $  94,825      $  83,246      $   172,105      $ 147,008
 North East                           14,176         12,308           24,556         20,859
 Mid East                             31,101         25,589           52,155         39,987
 South East                           15,666         13,043           28,679         24,094

 Segment profit:
 Mid Atlantic                      $  48,727      $  44,579      $    85,266      $  73,665
 North East                            6,397          5,632           10,083          8,093
 Mid East                              9,412          9,644           11,235         10,604
 South East                            5,101          4,379            8,748          8,284

 Gross profit margin percentage:
 Mid Atlantic                           15.9 %         18.3 %           16.8 %         18.0 %
 North East                             17.2 %         17.3 %           17.0 %         16.9 %
 Mid East                               14.6 %         16.8 %           13.6 %         15.5 %
 South East                             15.4 %         16.8 %           15.3 %         16.7 %

Segment Operating Activity:



                         Three Months Ended June 30,                      Six Months Ended June 30,
                  2013        2012        2013        2012        2013        2012        2013        2012
                        Units               Average Price               Units               Average Price
  Settlements:
  Mid Atlantic     1,493       1,275     $ 398.4     $ 356.4       2,631       2,281     $ 390.2     $ 357.4
  North East         259         247     $ 317.6     $ 288.3         450         416     $ 321.9     $ 296.6
  Mid East           722         609     $ 295.6     $ 249.6       1,315       1,057     $ 292.1     $ 244.3
  South East         404         344     $ 251.4     $ 225.1         754         645     $ 248.3     $ 223.7

  Total            2,878       2,475     $ 344.7     $ 305.1       5,150       4,399     $ 338.4     $ 304.9


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Three Months Ended June 30, Six Months Ended June 30, 2013 2012 2013 2012 2013 2012 2013 2012 Units Average Price Units Average Price

New orders, net of cancellations:

Mid Atlantic                           1,671       1,321     $ 421.0     $ 388.2       3,387       2,984     $ 409.9     $ 373.7
North East                               274         236     $ 338.4     $ 329.6         567         495     $ 330.0     $ 327.7
Mid East                                 833         677     $ 304.2     $ 267.0       1,782       1,475     $ 302.6     $ 258.6
South East                               500         380     $ 268.2     $ 243.6       1,052         817     $ 259.4     $ 237.5

Total                                  3,278       2,614     $ 361.1     $ 330.5       6,788       5,771     $ 351.8     $ 321.1

                                               As of June 30,
                                  2013        2012        2013        2012
                                        Units               Average Price

                  Backlog:
                  Mid Atlantic     3,439       2,676     $ 412.8     $ 385.1
                  North East         550         455     $ 336.8     $ 335.7
                  Mid East         1,619       1,225     $ 310.2     $ 262.4
                  South East       1,009         692     $ 263.4     $ 242.5

                  Total            6,617       5,048     $ 358.6     $ 331.3

. . .

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