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NVR > SEC Filings for NVR > Form 10-Q on 1-Aug-2014All Recent SEC Filings

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Form 10-Q for NVR INC


1-Aug-2014

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 Quarterly Report on 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. 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 may 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 Quarterly Report on Form 10-Q and Part I, Item 1A of NVR's Annual Report on Form 10-K for the fiscal year ended December 31, 2013.

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, 2014 and 2013

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, Florida and Tennessee

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


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to obtain finished lots for use in our homebuilding operations. Instead, we typically 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 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 negatively impacted our developers' ability to obtain acquisition and development financing or to raise equity investments to finance land development activity. As a result, in certain specific strategic circumstances we deviated from our historical lot acquisition strategy and engaged in joint venture arrangements with land developers or directly acquired 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 our finished lot inventory using fixed price purchase agreements with forfeitable deposits.

As of June 30, 2014, we controlled approximately 60,900 lots under purchase agreements with deposits in cash and letters of credit totaling approximately $306,200 and $2,400, respectively. Included in the number of controlled lots are approximately 8,000 lots for which we have recorded a contract land deposit impairment reserve of approximately $55,900 as of June 30, 2014. We also controlled approximately 5,600 lots through four joint venture limited liability corporations ("JVs") with an aggregate investment of approximately $85,500. Further, as of June 30, 2014, we directly owned six separate raw parcels of land, zoned for their intended use, with a current cost basis, including development costs, of approximately $63,800 that once fully developed will result in approximately 1,150 lots. 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 (see Notes 2, 3 and 4 to the condensed consolidated financial statements included herein for additional information regarding fixed price purchase agreements, JVs and land under development, respectively). In addition, NVR has certain properties under contract with land owners that are expected to yield approximately 4,900 lots, which are not included in our number of total lots controlled. Some of these properties may require rezoning or other approvals to achieve the expected yield. These properties are controlled with deposits and letters of credit totaling approximately $3,500 and $4,000, respectively as of June 30, 2014, of which approximately $7,300 is refundable if NVR does not perform under the contract. NVR generally expects to assign the raw land contracts to a land developer and simultaneously enter into a lot purchase agreement with the assignee if the project is determined to be feasible.

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

Through the first six months of 2014, the housing markets we serve have generally seen a flattening in the number of home sales and prices. Slow economic growth coupled with reduced affordability have been the primary drivers of the slowdown in the housing recovery. We have experienced a decline in traffic per community in the first six months of 2014 compared to the same period in 2013. In addition, new home


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competitors have been increasing the number of communities open for sale, which has resulted in a decline in sales per community. The housing market also continues to face challenges from tight mortgage underwriting standards.

Our consolidated revenues for the second quarter of 2014 totaled $1,102,100, a 9% increase from the second quarter of 2013. Our net income and diluted earnings per share in the current quarter were $68,178 and $15.17, respectively, increases of 34% and 50%, respectively, compared to the second quarter of 2013. Diluted earnings per share was favorably impacted by our ongoing share repurchase program, under which we repurchased 317,739 shares of our stock at an aggregate purchase price of $347,448 during the first six months of 2014. Our gross profit margin within our homebuilding business increased to 18.6% in the second quarter of 2014 compared to 15.9% in the second quarter of 2013. Gross profit margin in the second quarter of 2013 was negatively impacted by a previously disclosed service related accrual of approximately $15,600 which reduced gross profit margin by 157 basis points of revenue. Our new orders, net of cancellations ("New Orders") and the average sales price for New Orders increased 4% and 2%, respectively, compared to the second quarter of 2013.

While our gross profit margin improved from year ago levels, we continue to face gross margin pressure due to increasing land and construction costs. In addition, increased competition in the mortgage banking industry has resulted in reduced loan profitability. We believe that continued improvement in the housing market is dependent upon a sustained overall economic recovery, driven by continued improvement in job growth and consumer confidence levels as well as improvement in wage growth and household formation. 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 operations and other data for the
consolidated homebuilding operations:



                                            Three Months Ended                    Six Months Ended
                                                 June 30,                             June 30,
                                          2014              2013              2014               2013
Revenues                               $ 1,084,080        $ 992,210        $ 1,883,267        $ 1,743,078
Cost of sales                          $   882,778        $ 834,288        $ 1,537,930        $ 1,458,373
Gross profit margin percentage                18.6 %           15.9 %             18.3 %             16.3 %
Selling, general and
administrative expenses                $    93,583        $  82,120        $   184,215        $   160,533
Settlements (units)                          2,943            2,878              5,154              5,150
Average settlement price               $     368.2        $   344.7        $     365.3        $     338.4
New orders (units)                           3,415            3,278              6,740              6,788
Average new order price                $     368.0        $   361.1        $     368.0        $     351.8
Backlog (units)                                                                  6,531              6,617
Average backlog price                                                      $     374.1        $     358.6
New order cancellation rate                   13.2 %           13.8 %             12.4 %             13.5 %

Consolidated Homebuilding - Three Months Ended June 30, 2014 and 2013

Homebuilding revenue increased 9% in the second quarter of 2014 compared to the same period in 2013 primarily as a result of a 7% increase in the average settlement price and a 2% increase in the number of units settled quarter over quarter. The increase in the average settlement price was primarily attributable to the average price of homes in backlog being approximately 7% higher entering the second quarter of 2014


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compared to the same period in 2013. The higher average price of homes in backlog entering the second quarter of 2014 was attributable to the improved market conditions experienced in 2013 which led to increasing prices in 2013 and into the first quarter of 2014. In addition, beginning backlog was also favorably impacted by a shift in backlog units to our Mid Atlantic segment which is our highest priced segment.

Gross profit margin in the second quarter of 2014 increased 265 basis points to 18.6% compared to 15.9% the second quarter of 2013. Gross profit margin in the second quarter of 2013 was negatively impacted by the aforementioned service related accrual which reduced gross profit margin by 157 basis points. Additionally, second quarter 2014 gross profit margin was favorably impacted by our average settlement price increasing at a higher rate than material and lot costs quarter over quarter.

Selling, general and administrative ("SG&A") expense in the second quarter of 2014 increased approximately $11,500, or 14%, compared to the second quarter of 2013, and increased as a percentage of revenue to 8.6% from 8.3% quarter over quarter. SG&A expense increased primarily due to an increase in sales and marketing expenses and equity-based compensation expense. Sales and marketing costs increased approximately $5,300 quarter over quarter due to the 9% increase in the average number of active communities. Equity-based compensation expense increased approximately $4,900 due primarily to the granting of non-qualified stock options under the 2014 Equity Incentive Plan (the "2014 Plan"), which was approved by our shareholders at the May 2014 Annual Meeting (see Note 6 in the accompanying condensed consolidated financial statements for additional discussion of equity-based compensation and the 2014 Plan).

The number of New Orders and the average sales price of New Orders increased 4% and 2%, respectively, in second quarter of 2014 when compared to the second quarter of 2013. The increase in New Orders was driven by a 9% increase in the average number of active communities, offset partially by lower absorption rates quarter over quarter. Although the average sales price of New Orders increased slightly quarter over quarter, we have seen a leveling off of sales prices from the first quarter of 2014 through the second quarter.

Consolidated Homebuilding - Six Months Ended June 30, 2014 and 2013

Homebuilding revenue increased 8% for the six months ended June 30, 2014 compared to the same period in 2013 as a result of an 8% increase in the average settlement price. The increase in the average settlement price was primarily attributable to an 8% higher average price of homes in backlog entering 2014 compared to 2013. The higher average price of homes in backlog entering 2014 was attributable to the improved market conditions experienced in 2013.

Gross profit margin in the first six months of 2014 increased to 18.3% compared to 16.3% in the first six months of 2013. As noted previously, gross profit margin in the second quarter of 2013 was negatively impacted by a service related accrual which reduced the 2013 gross profit margin by 89 basis points. Additionally, 2014 gross profit margin was favorably impacted by our average settlement prices increasing at a higher rate than material and lot costs year over year.

SG&A expense in the first six months of 2014 increased approximately $23,700 compared to the first six months of 2013 and increased as a percentage of revenue to 9.8% from 9.2% year over year. The increase in SG&A expense was attributable to an approximate $9,100 increase in sales and marketing costs due to the increase in the average number of active communities, an approximate $7,700 increase in personnel costs due to an increase in headcount year over year, and an approximate $7,200 increase in equity-based compensation expense in 2014. Equity-based compensation expense increased due to the aforementioned non-qualified stock option grants in the second quarter of 2014 under the 2014 Plan and restricted share unit grants in the second quarter of 2013.

The number of New Orders was 1% lower for the first six months of 2014 compared to the first six months of 2013, while the average sales price of New Orders increased 5% year over year. New Orders were


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down despite a 10% increase in the average number of active communities year over year as sales absorption rates were lower in each of our market segments. Average sales prices were higher in each of our market segments year over year as a result of favorable market conditions in 2013, which led to increasing prices entering 2014. The average sales price of New Orders in the current year was also favorably impacted by a shift in New Orders to our Mid Atlantic and North East market segments, which have higher average sales prices.

Backlog units and dollars were 6,531 units and $2,443,238, respectively, as of June 30, 2014 compared to 6,617 units and $2,372,757, respectively, as of June 30, 2013. Backlog units were lower primarily due to our backlog units being approximately 1% lower entering 2014 compared to the same period in 2013. Backlog dollars were favorably impacted by a 5% higher average price of New Orders for the six month period ended June 30, 2014 compared to the six month period ended June 30, 2013.

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 beginning 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 12.4% and 13.5% in the first six months of 2014 and 2013, respectively. During the most recent four quarters, approximately 6% of a reporting quarter's beginning backlog cancelled during the fiscal quarter. We can provide no assurance that our historical cancellation rates are indicative of the actual cancellation rates that may occur during the remainder of 2014 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, 2014 and 2013 has been allocated to each reportable segment for the respective years to show contract land deposits on a net basis. The net contract land deposit balances below also include approximately $6,400 and $2,400 at June 30, 2014 and 2013, respectively, of letters of credit issued as deposits in lieu of cash. The following tables summarize certain homebuilding operating activity by reportable segment for the three months ended June 30, 2014 and 2013:


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Selected Segment Financial Data:



                                     Three Months Ended               Six Months Ended
                                          June 30,                        June 30,
                                    2014           2013            2014             2013
Revenues:
Mid Atlantic                      $ 657,825      $ 594,902      $ 1,122,855      $ 1,026,770
North East                           92,438         82,260          171,230          144,871
Mid East                            221,088        213,463          371,736          384,219
South East                          112,729        101,585          217,446          187,218

Gross profit margin:
Mid Atlantic                      $ 123,097      $  94,825      $   212,383      $   172,105
North East                           17,677         14,176           31,985           24,556
Mid East                             34,784         31,101           55,634           52,155
South East                           20,389         15,666           39,336           28,679

Segment profit:
Mid Atlantic                      $  67,347      $  48,727      $   108,358      $    85,266
North East                            8,398          6,397           14,705           10,083
Mid East                             11,116          9,412           10,867           11,235
South East                            7,895          5,101           15,941            8,748

Gross profit margin percentage:
Mid Atlantic                           18.7 %         15.9 %           18.9 %           16.8 %
North East                             19.1 %         17.2 %           18.7 %           17.0 %
Mid East                               15.7 %         14.6 %           15.0 %           13.6 %
South East                             18.1 %         15.4 %           18.1 %           15.3 %

Operating Activity:



                                             Three Months Ended June 30,                      Six Months Ended June 30,
                                      2014        2013        2014        2013        2014        2013        2014        2013
                                            Units               Average Price               Units               Average Price
Settlements:
Mid Atlantic                           1,547       1,493     $ 425.1     $ 398.4       2,671       2,631     $ 420.3     $ 390.2
North East                               271         259     $ 341.1     $ 317.6         504         450     $ 339.7     $ 321.9
Mid East                                 707         722     $ 312.5     $ 295.6       1,185       1,315     $ 313.6     $ 292.1
South East                               418         404     $ 269.6     $ 251.4         794         754     $ 273.7     $ 248.3

Total                                  2,943       2,878     $ 368.2     $ 344.7       5,154       5,150     $ 365.3     $ 338.4

New orders, net of cancellations:
Mid Atlantic                           1,751       1,671     $ 427.4     $ 421.0       3,426       3,387     $ 428.1     $ 409.9
North East                               288         274     $ 337.9     $ 338.4         586         567     $ 342.1     $ 330.0
Mid East                                 825         833     $ 314.3     $ 304.2       1,716       1,782     $ 313.1     $ 302.6
South East                               551         500     $ 275.4     $ 268.2       1,012       1,052     $ 272.8     $ 259.4

Total                                  3,415       3,278     $ 368.0     $ 361.1       6,740       6,788     $ 368.0     $ 351.8


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                                               As of June 30,
                                  2014        2013        2014        2013
                                        Units               Average Price
                  Backlog:
                  Mid Atlantic     3,465       3,439     $ 430.0     $ 412.8
                  North East         577         550     $ 347.0     $ 336.8
                  Mid East         1,563       1,619     $ 319.1     $ 310.2
                  South East         926       1,009     $ 274.7     $ 263.4

                  Total            6,531       6,617     $ 374.1     $ 358.6

                                       Three Months Ended           Six Months Ended
                                            June 30,                    June 30,
                                       2014            2013         2014          2013
      New order cancellation rate:
      Mid Atlantic                        13.6 %        12.2 %        12.3 %       13.2 %
      North East                          13.5 %        17.7 %        13.4 %       14.7 %
      Mid East                            12.4 %        14.1 %        11.0 %       12.7 %
      South East                          13.1 %        16.0 %        14.4 %       14.7 %
      Average active communities:
      Mid Atlantic                         246           218           244          211
      North East                            45            38            44           38
      Mid East                             128           129           126          129
      South East                            75            67            73           66

      Total                                494           452           487          444

Homebuilding Inventory:



                                                         As of June 30,
                                                       2014          2013
          Sold inventory:
          Mid Atlantic                               $ 502,787     $ 473,220
. . .
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