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NVR > SEC Filings for NVR > Form 10-K on 20-Feb-2014All Recent SEC Filings

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Form 10-K for NVR INC


20-Feb-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

(dollars in thousands, except per share data)

Results of Operations for the Years Ended December 31, 2013, 2012 and 2011

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


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Our lot acquisition strategy is predicated upon avoiding the financial requirements and risks associated with direct land ownership and development. Historically, we generally 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 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 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 has negatively impacted our developers' ability to obtain acquisition and development financing and to raise equity investments to finance land development activity. As a result of the changing environment, 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 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 December 31, 2013, we controlled approximately 58,100 lots under purchase agreements with deposits in cash and letters of credit totaling approximately $296,600 and $2,500, respectively. In addition, we controlled approximately 6,000 lots through joint venture limited liability corporations with an aggregate investment of approximately $92,700. Further, as of December 31, 2013, we had approximately $41,300 in land under development, that once fully developed will result in approximately 650 lots for use in our homebuilding operations. Of the total finished lots expected to be developed, 125 lots are under contract to be sold to an unrelated party under lot purchase agreements. Included in the number of controlled lots are approximately 9,200 lots for which we have recorded a contract land deposit impairment reserve of approximately $59,800 as of December 31, 2013. See Notes 3, 4 and 5 to the consolidated financial statements included herein for additional information regarding fixed price purchase agreements, joint ventures 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.

Current Business Environment and Key Financial Results

During 2013, sales trends in the first six months were stronger than the last six months of the year. During the first half of 2013, the homebuilding market continued to experience the favorable sales and pricing trends which began in 2012, driven by historically low mortgage interest rates and rising costs in the rental market which contributed to higher levels of housing affordability. Sales trends in the second half of 2013 were negatively impacted by increasing mortgage interest rates, higher home prices and buyer uncertainty. The housing market also continues to face challenges from tight mortgage underwriting standards. While we have benefited from generally improved market conditions, we continue to face gross margin pressure due to increasing land and construction costs.


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Our consolidated revenues for the year ended December 31, 2013 totaled $4,211,267, an increase of 32% from $3,184,650 in 2012. Net income for 2013 increased 48% from the prior year to $266,477. Diluted earnings per share in 2013 was $54.81, an increase of 56% from the prior year. New Orders for 2013 increased 8% from the prior year while our average new order sales price of $360.4 in 2013 was 10% higher than the prior year.

We believe that the continuation of the housing market recovery which began in 2012 is dependent upon a sustained overall economic recovery, driven by continued improvement in unemployment and consumer confidence levels. Due to the strength of our balance sheet, we believe that we are well positioned to take advantage of opportunities that may arise from future economic and homebuilding market volatility.

Homebuilding Operations

The following table summarizes the results of our consolidated homebuilding
operations and certain operating activity for each of the last three years:



                                                              Year Ended December 31,
                                                    2013               2012               2011

Revenues                                         $ 4,134,481        $ 3,121,244        $ 2,611,195
Cost of sales                                    $ 3,424,204        $ 2,575,639        $ 2,165,625
Gross profit margin percentage                          17.2 %             17.5 %             17.1 %
Selling, general and administrative expenses     $   313,029        $   301,184        $   264,266
Settlements (units)                                   11,834              9,843              8,487
Average settlement price                         $     349.1        $     317.1        $     307.5
New orders (units)                                    11,800             10,954              9,247
Average new order price                          $     360.4        $     328.8        $     304.1
Backlog (units)                                        4,945              4,979              3,676
Average backlog price                            $     373.2        $     346.2        $     315.8
New order cancellation rate                             14.9 %             14.5 %             13.6 %

Consolidated Homebuilding Revenues

Homebuilding revenues for 2013 increased 32% from 2012, as a result of a 20% increase in the number of homes settled and a 10% increase in the average settlement price year over year. The increase in the number of homes settled was primarily attributable to a 35% higher beginning backlog unit balance entering 2013 as compared to 2012, offset partially by a lower backlog turnover rate in 2013 compared to 2012. Average settlement prices in the current year were favorably impacted primarily by a 10% higher average price of homes in backlog entering 2013 compared to the average price of homes in backlog entering 2012 and a 10% higher average sales price of New Orders for the first six months of 2013 compared to 2012. The higher beginning backlog balance and average sales prices were driven by the favorable market conditions discussed in the Overview section above.

Homebuilding revenues for 2012 increased 20% from 2011, as a result of a 16% increase in the number of homes settled and a 3% increase in the average settlement price year over year. The increase in the number of homes settled was attributable to an 18% increase in New Orders during the first half of 2012 compared to the same period in 2011, coupled with a 26% higher beginning backlog unit balance entering 2012 as compared to 2011. These increases were offset partially by a lower backlog turnover rate in 2012 compared to 2011. Average settlement prices in 2012 were favorably impacted by a 7% higher average sales price of New Orders during the first six months of 2012 as compared to the same period in 2011, offset partially by a 4% lower average price of homes in backlog entering 2012 compared to the average price of homes in backlog entering 2011.


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Consolidated Homebuilding New Orders

New Orders and the average sales price of New Orders in 2013 increased 8% and 10%, respectively, when compared to 2012. New Orders and the average sales price 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, offset partially by a lower absorption rate in 2013. In addition, our December 2012 acquisition of Heartland Homes added 355 New Orders in 2013. The increase in active communities and pricing in 2013 was attributable to the favorable market conditions through the first half of 2013 as discussed in the Overview section above.

New Orders and the average sales price of New Orders in 2012 increased 18% and 8%, respectively, when compared to 2011. New Orders and the average sales price were higher year over year in each of our market segments. The increase in New Orders was driven by a 5% increase in the number of active communities year over year and by improved absorption rates in many of our markets. The increase in New Orders as well as in the average New Order sales price was attributable to improved market conditions in 2012.

Consolidated Homebuilding Gross Profit

Gross profit margins in 2013 decreased to 17.2% from 17.5% in 2012. Gross profit margins were negatively impacted in 2013 by two warranty accrual charges. The first charge of approximately $15,600 was recognized in the second quarter of 2013 related to remediation of primarily water infiltration issues in a single completed community. The water infiltration issues were the result of a design issue with several products developed for and built exclusively in that one community. The second charge of approximately $16,000 was recorded in the fourth quarter of 2013 to increase the warranty accrual for a non-recurring service issue unrelated to the second quarter service issue. Excluding these charges, gross profit margin was 17.9%, an increase of 46 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 and pricing pressures.

Gross profit margins in 2012 increased to 17.5% from 17.1% in 2011. Margins were favorably impacted in 2012 by a $2,000 recovery of contract land deposits previously determined to be uncollectible compared to an $11,200 contract land deposit impairment charge in 2011. In addition, increased settlement volume and higher average settlement prices in 2012 allowed us to better leverage certain operating costs. However, this favorable impact was offset by higher construction, lumber and certain other commodity costs year over year.

Consolidated Homebuilding Selling, General and Administrative ("SG&A")

SG&A expenses in 2013 increased approximately $11,800, or 4%, compared to 2012, but as a percentage of revenue decreased to 7.6% in 2013 from 9.7% in 2012. The increase in SG&A expense was attributable to increases of approximately $20,300 in personnel costs in 2013 due to an increase in headcount year over year. In addition, sales and marketing costs were approximately $14,400 higher in 2013 due to the increase in the number of active communities. These cost increases were partially offset by an approximate $28,700 reduction in equity-based compensation in 2013 compared to 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 and the reversal of approximately $7,100 in equity-based compensation expense previously recorded to SG&A expense as we adjusted our stock option forfeiture rates based on our actual forfeiture experience. These reductions were 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 the 32% increase in revenue in 2013, allowing us to better leverage our overhead costs.

SG&A expenses in 2012 increased approximately $36,900, or 14%, compared to 2011, but as a percentage of revenue decreased to 9.7% in 2012 from 10.1% in the prior year. The increase in SG&A expense was attributable to an increase of approximately $19,700 in management incentive costs driven by improved


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financial results in 2012. In addition, personnel costs and sales and marketing costs were approximately $9,400 and $6,400 higher, respectively, in 2012 due primarily to the 5% increase in the number of active communities compared to 2011. SG&A expenses decreased as a percentage of revenue due to the 20% increase in revenues in 2012 compared to 2011.

Consolidated Homebuilding Backlog

Backlog units decreased approximately 1% to 4,945 as of December 31, 2013 compared to 4,979 as of December 31, 2012, while backlog dollars increased approximately 7% to $1,845,600 from $1,723,914 as of December 31, 2013 and December 31, 2012, respectively. Backlog dollars were higher primarily due to a 10% increase in the average price of New Orders for the six-month period ended December 31, 2013 compared to the same period in 2012.

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 15% in both 2013 and 2012, and 14% in 2011. During each of 2013, 2012 and 2011, 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 future periods. Other than those units that are cancelled, we expect to settle substantially all of our December 31, 2013 backlog during 2014. See "Risk Factors" in Item 1A of this report.

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.

Backlog units and dollars increased approximately 35% to 4,979 and 49% to $1,723,914, respectively, as of December 31, 2012, compared to 3,676 and $1,160,879 as of December 31, 2011. The increase in backlog units was primarily attributable to New Orders being approximately 800 units higher for the six month period ended December 31, 2012 compared to the same period in 2011, coupled with a slower backlog turnover rate in 2012. In addition, our December 31, 2012 acquisition of Heartland Homes added approximately 200 units and $81,600 to the 2012 year-end backlog. The increase in backlog dollars is attributable to the increase in units and to a 9% higher average sales price for New Orders for the six month period ended December 31, 2012.


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Reportable Homebuilding 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. 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 years 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 of Financial Condition and Results of Operations. For presentation purposes below, the contract land deposit reserve at December 31, 2013 and 2012 has been allocated to the reportable segments to show contract land deposits on a net basis. The net contract land deposit balances below also includes approximately $2,500 and $3,300 at December 31, 2013 and 2012, respectively, of letters of credit issued as deposits in lieu of cash. The following tables summarize certain homebuilding operating activity by reportable segment for each of the last three years:

Selected Segment Financial Data:



                                                  Year Ended December 31,
                                          2013             2012             2011
     Revenues:
     Mid Atlantic                      $ 2,439,387      $ 1,877,905      $ 1,582,826
     North East                            332,681          278,715          221,146
     Mid East                              908,198          630,367          549,384
     South East                            454,215          334,257          257,839

     Gross profit margin:
     Mid Atlantic                      $   461,481      $   345,009      $   286,266
     North East                             45,860           48,329           37,220
     Mid East                              142,331          103,128           85,385
     South East                             77,277           55,788           42,116

     Segment profit:
     Mid Atlantic                      $   276,399      $   189,089      $   148,373
     North East                             14,294           21,529           13,463
     Mid East                               55,537           39,847           27,194
     South East                             35,001           20,674           14,162

     Gross profit margin percentage:
     Mid Atlantic                             18.9 %           18.4 %           18.1 %
     North East                               13.8 %           17.3 %           16.8 %
     Mid East                                 15.7 %           16.4 %           15.5 %
     South East                               17.0 %           16.7 %           16.3 %

Segment Operating Activity:



                                              Year Ended December 31,
                              2013                      2012                      2011
                                   Average                   Average                  Average
                       Units        Price        Units        Price        Units       Price
       Settlements:
       Mid Atlantic      6,029     $  404.0        5,047     $  372.1       4,238     $  373.4
       North East        1,013     $  328.4          889     $  313.5         728     $  303.6
       Mid East          3,023     $  300.4        2,472     $  255.0       2,335     $  235.1
       South East        1,769     $  256.7        1,435     $  232.8       1,186     $  217.1

       Total            11,834     $  349.1        9,843     $  317.1       8,487     $  307.5


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                                              Year Ended December 31,
                              2013                      2012                      2011
                                   Average                   Average                  Average
                       Units        Price        Units        Price        Units       Price
       New orders, net of cancellations:
       Mid Atlantic      6,056     $  416.7        5,757     $  382.9       4,616     $  364.2
       North East        1,075     $  335.5          946     $  325.3         872     $  300.1
       Mid East          2,903     $  309.5        2,625     $  264.2       2,412     $  238.7
       South East        1,766     $  265.9        1,626     $  243.7       1,347     $  218.1

       Total            11,800     $  360.4       10,954     $  328.8       9,247     $  304.1


       Backlog:
       Mid Atlantic      2,710     $  422.7        2,683     $  394.2       1,973     $  370.3
       North East          495     $  345.5          433     $  330.2         376     $  303.0
       Mid East          1,032     $  323.0        1,152     $  297.8         807     $  245.6
       South East          708     $  276.5          711     $  253.4         520     $  227.0

       Total             4,945     $  373.2        4,979     $  346.2       3,676     $  315.8

Operating Data:



                                                Year Ended December 31,
                                              2013         2012        2011
             New order cancellation rate:
             Mid Atlantic                       14.9 %      13.4 %      13.3 %
             North East                         15.0 %      16.8 %      13.1 %
             Mid East                           13.5 %      15.0 %      14.6 %
             South East                         16.8 %      16.0 %      13.0 %

             Average active communities:
             Mid Atlantic                        220         198         188
             North East                           39          38          34
             Mid East                            125         105         106
             South East                           67          63          56

             Total                               451         404         384

Homebuilding Inventory:



                                                       As of December 31,
                                                       2013          2012
          Sold inventory:
          Mid Atlantic                               $ 354,407     $ 319,958
          North East                                    57,541        41,447
          Mid East                                      93,189        97,115
          South East                                    57,631        49,305

          Total (1)                                  $ 562,768     $ 507,825


          Unsold lots and housing units inventory:
          Mid Atlantic                               $  77,266     $  46,007
          North East                                     3,881         3,645
          Mid East                                      12,772        20,105
          South East                                     8,834         8,985

          Total (1)                                  $ 102,753     $  78,742

(1) The reconciling items between segment inventory and consolidated inventory include certain consolidation adjustments necessary to convert the reportable segments' results, which are predominantly maintained on a cash basis, to a full accrual basis for external financial statement presentation purposes and are not allocated to our operating segments.


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                                                     Year Ended December 31,
                                                   2013         2012       2011
        Sold and unsold inventory impairments:
        Mid Atlantic                             $     222      $ 349     $ 1,045
        North East                                      47         19         246
        Mid East                                       923         72         554
        South East                                      82        102         228

        Total                                    $   1,274      $ 542     $ 2,073

Lots Controlled and Land Deposits:



                                                     As of December 31,
                                                     2013          2012

            Total lots controlled:
            Mid Atlantic                              32,646        30,969
            North East                                 5,388         4,772
            Mid East                                  16,420        15,409
            South East                                10,166         7,348

            Total                                     64,620        58,498


            Lots included in impairment reserve:
. . .
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