filings.toolsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
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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, 2010, 2009 and 2008
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 and Delaware
North East: New Jersey and eastern Pennsylvania
Mid East: Kentucky, New York, Ohio, western Pennsylvania and Indiana
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 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, current economic conditions and the continued downturn of the homebuilding industry have exerted pressure on 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 December 31, 2010, we controlled approximately 50,400 lots under purchase agreements with deposits in cash and letters of credit totaling approximately $174,300 and $6,600, respectively. In addition, we controlled approximately 1,100 lots through joint ventures. Included in the number of controlled lots are approximately 10,300 lots for which we have recorded a contract land deposit impairment reserve of approximately $73,500 as of December 31, 2010. See Note 3 to the consolidated financial statements included herein for additional information regarding contract land deposits. Further, as of December 31, 2010, we had approximately $78,000 in land under development, that once fully developed will result in approximately 890 lots.
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
The homebuilding environment in 2010 remained challenging as it continued to be impacted by the economic downturn that began several years prior. The market stabilization we had experienced toward the end of 2009 and into the first quarter of 2010 was negatively impacted by the April 30, 2010 expiration of the federal homebuyer tax credit. After April 30, 2010, new home sales experienced sharp declines, providing evidence that rather than increasing overall demand, the tax credit may have merely accelerated existing demand. The current home sales environment continues to be adversely impacted by high inventory levels, low consumer confidence driven by high unemployment rates, and a highly restrictive mortgage lending environment that has made it more difficult for our customers to obtain mortgage financing. Our new orders for 2010 remained flat with new orders in 2009, however, new housing demand declined in both the third and fourth quarters of 2010 from the higher new order results experienced in the first two quarters of 2010. In addition, cancellation rates increased to 18% in both the third and fourth quarters of 2010, compared to 14% and 15% in the third and fourth quarters of 2009, respectively, and 12% in the second quarter of 2010.
Consolidated revenues totaled $3,041,892 for 2010, an increase of 11% from $2,743,848 in 2009. The increase in revenues was driven by increased home settlements primarily resulting from the expiration of the federal homebuyer tax credit in the second quarter of 2010. Net income and diluted earnings per share in 2010 each increased 7% from 2009. Gross profit margins within our homebuilding business declined slightly to 18.2% in 2010 from 18.5% in 2009.
Although we believe we have once again begun to experience some pricing stabilization in several of our markets as we enter 2011, we believe that significant economic uncertainties remain which could result in continued sales and pricing pressure over the next several quarters. 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. Because these provisions are to be implemented through future rulemaking, the ultimate impact of such provisions on lending institutions, including our mortgage banking subsidiary, will depend on how the implementing rules are written.
Despite these ongoing economic uncertainties, we believe that we are well positioned to take advantage of opportunities that may arise due to the strength of our balance sheet and liquidity. As of December 31, 2010, our cash and cash equivalents balance totaled approximately $1,200,000. In addition, during 2010, we redeemed the remaining $133,370 of our outstanding senior notes upon their maturity and repurchased approximately $417,080 of our common stock.
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, | ||||||||||||
| 2010 | 2009 | 2008 | ||||||||||
| Revenues | $ | 2,980,758 | $ | 2,683,467 | $ | 3,638,702 | ||||||
| Cost of sales | $ | 2,438,292 | $ | 2,185,733 | $ | 3,181,010 | ||||||
| Gross profit margin percentage | 18.2 | % | 18.5 | % | 12.6 | % | ||||||
| Selling, general and administrative expenses | $ | 257,394 | $ | 233,152 | $ | 308,739 | ||||||
| Settlements (units) | 10,030 | 9,042 | 10,741 | |||||||||
| Average settlement price | $ | 297.1 | $ | 296.4 | $ | 338.4 | ||||||
| New orders (units) | 9,415 | 9,409 | 8,760 | |||||||||
| Average new order price | $ | 304.0 | $ | 292.7 | $ | 311.3 | ||||||
| Backlog (units) | 2,916 | 3,531 | 3,164 | |||||||||
| Average backlog price | $ | 328.6 | $ | 304.9 | $ | 316.9 | ||||||
| New order cancellation rate | 14 | % | 14 | % | 23 | % |
Consolidated Homebuilding Revenues
Homebuilding revenues for 2010 increased 11% from 2009, as a result of an 11%, or 988 unit, increase in the number of homes settled. The increase in the number of homes settled was primarily attributable to the impact of the federal homebuyer tax credit which resulted in strong first quarter sales and increased settlements through the second quarter of 2010 as compared to the same period in 2009. In addition, the increase in settlements was also favorably impacted by a 12% higher beginning backlog unit balance entering 2010 compared to the same period in 2009.
Homebuilding revenues for 2009 decreased 26% from 2008, as a result of a 16%, or 1,699 unit, decrease in the number of homes settled and a 12% decrease in the average settlement price. The decrease in the number of units settled was primarily attributable to our beginning backlog units being approximately 39%, or 1,981 units, lower entering 2009 compared to the backlog unit balance entering 2008, offset partially by a higher backlog turnover rate period over period. Average settlement prices were impacted primarily by a 15% lower
average price of homes in the beginning backlog entering 2009 compared to the same period in 2008, coupled with a 9% decline in the average sales price of new orders for the first six months of 2009 as compared to the same period in 2008.
Consolidated Homebuilding New Orders
New orders in 2010 remained flat with 2009 new orders, while the average sales price of new orders increased 4% year over year. New orders remained flat despite a strong first quarter in 2010, driven we believe by the federal homebuyer tax credit, and increased sales in the Indianapolis, IN, Orlando, FL and Raleigh, NC markets, each of which began operations in the second half of 2009. Since the first quarter of 2010, we experienced a consistent decline in the number of new orders across all of our markets in each of the second, third and fourth quarters of 2010 compared to the respective periods in 2009. The increase in the average price of new orders was attributable to a product mix shift away from our attached products to our detached product which generally sell at higher price points. We expect to continue to face selling pressure over the next several quarters due to continuing economic uncertainties, including low consumer confidence and high unemployment rates, as discussed in the Overview section above.
New orders in 2009 increased by 7% compared to 2008, while the average sales price of new orders decreased 6% year over year. The increase in new orders in 2009 was in part attributable to a 47% increase in new orders in the fourth quarter of 2009 compared to the same period in 2008, a period in which we experienced a significant drop-off in new orders due to a sharp decline in overall economic conditions. In addition, new orders in 2009 were favorably impacted by higher absorption rates, offsetting the 17% decrease in the average number of active communities year over year. We believe new orders in 2009 were also favorably impacted by the first-time homebuyer federal tax credit as well as by a decrease in the cancellation rate to 14% in 2009 from 23% in 2008. During 2009, to meet affordability issues in many of our markets, we altered our product offerings to provide smaller, lower priced products.
Consolidated Homebuilding Gross Profit
Gross profit margins in 2010 declined slightly to 18.2% from 18.5% in 2009. Gross profit margins in 2010 were negatively impacted by a contract land deposit impairment charge of approximately $4,300, or 14 basis points, while 2009 gross profit margins were favorably impacted by the recovery of approximately $6,500, or 24 basis points, of contract land deposits previously determined to be uncollectible. We expect to experience gross profit margin pressure over at least the next several quarters due to significant market uncertainties as discussed in the Overview section above.
Gross profit margins in 2009 improved to 18.5% compared to 12.6% in 2008 primarily due to a favorable variance in contract land deposit impairment charges year over year. In 2009 we recognized the recovery of approximately $6,500, or 24 basis points, of contract land deposits previously determined to be uncollectible. In 2008 we recognized a contract land deposit impairment charge of approximately $165,000, or 454 basis points. Gross profit margins in 2009 were also favorably impacted as a result of us exiting a significant number of poor performing communities in 2008 which were producing lower gross profit margins. In addition, gross profit margins in 2009 were favorably impacted by lower lumber and certain other commodity costs as well as by cost control measures implemented to reduce subcontractor and material costs in prior periods.
Consolidated Homebuilding Selling, General and Administrative (“SG&A”)
SG&A expenses in 2010 increased approximately $24,200 compared to 2009, but remained flat as a percentage of revenue year over year. The increase in SG&A expenses was attributable to an approximate $13,500 increase in stock-based compensation costs in 2010 compared to the same period in 2009, due to the grant of non-qualified stock options and restricted share units under the 2010 Equity Incentive Plan, offset partially by a reversal of approximately $6,600 in stock-based compensation expense previously recorded to SG&A expense as we adjusted our stock option forfeiture estimates to our actual forfeiture experience. SG&A expense was also higher due to an approximate $5,600 increase in management incentive costs as 2009 incentive
plans were limited to payouts of 50% of incentive earned, while no similar restrictions are imposed on 2010 incentive compensation. In addition, SG&A expenses were impacted by an approximate $7,600 increase in selling and marketing costs year over year due primarily to an approximate $5,700 increase in advertising and model home costs attributable in part to an increase in the average number of active communities to 371 communities in 2010 from 355 communities in 2009.
SG&A expenses in 2009 decreased approximately $75,600 compared to 2008, but increased slightly as a percentage of revenue to 8.7% in 2009 from 8.5% in 2008. The decrease in SG&A expenses was primarily attributable to a $36,300 decrease in selling and marketing costs in 2009 compared to 2008 due to a 17% decrease in the average number of active communities year over year to 355 in 2009 from 427 in 2008. In addition, personnel costs were down approximately $26,900 due primarily to 24% decrease in average staffing levels year over year.
Consolidated Homebuilding Backlog
Backlog units and dollars decreased approximately 17% to 2,916 and 11% to $958,287, respectively, as of December 31, 2010 compared to 3,531 and $1,076,437 as of December 31, 2009. The decrease in backlog units was primarily attributable to the increased settlement activity in 2010 as discussed above. Backlog dollars were negatively impacted by the decrease in backlog units.
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 14% in both 2010 and 2009, and 23% in 2008. During 2010, 2009 and 2008, approximately 6%, 7% and 10% of a reporting quarter’s opening backlog cancelled during the fiscal quarter, respectively. We can provide no assurance that our historical cancellation rates are indicative of the actual cancellation rate that may occur in future periods. See “Risk Factors” in Item 1A of this Report.
Backlog units and dollars were 3,531 and $1,076,437, respectively, as of December 31, 2009 compared to 3,164 and $1,002,795 as of December 31, 2008. Net new order and settlement activity during 2009 resulted in the increase in backlog units year over year. The 7% increase in backlog dollars was primarily attributable to the 12% increase in backlog units offset partially by a 4% decrease in the average price of homes in ending backlog.
Consolidated Homebuilding — Other Charges
We reassessed our goodwill and intangible asset balances for impairment in the fourth quarter of 2008, as a result of the continuing declines in new orders and backlog in 2008, and the continuing deterioration of the homebuilding environment in each of our markets spurred further in 2008 by the credit crisis in the latter part of 2008. As a result of that assessment, we determined that the goodwill and intangible assets related to our Rymarc Homes and Fox Ridge Homes operations were fully impaired and we wrote-off a total of $11,686 related to such assets in 2008. We completed the annual assessment of the intangible asset balance in 2010 and 2009 and determined that there was no impairment. See Note 1 in the accompanying consolidated financial statements included herein for further discussion of intangible assets.
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 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 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. For presentation purposes below, the contract land deposit reserve at December 31, 2010, 2009 and 2008, respectively, 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 $6,600, $4,900 and $5,400 at December 31, 2010, 2009 and 2008, 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, | ||||||||||||
| 2010 | 2009 | 2008 | ||||||||||
| Revenues: | ||||||||||||
| Mid Atlantic | $ | 1,780,521 | $ | 1,661,244 | $ | 2,161,764 | ||||||
| North East | 287,561 | 254,654 | 347,142 | |||||||||
| Mid East | 632,377 | 505,431 | 659,649 | |||||||||
| South East | 280,299 | 262,138 | 470,147 | |||||||||
| Total | $ | 2,980,758 | $ | 2,683,467 | $ | 3,638,702 | ||||||
| Gross profit margin: | ||||||||||||
| Mid Atlantic | $ | 338,586 | $ | 307,525 | $ | 294,699 | ||||||
| North East | 48,528 | 42,282 | 46,607 | |||||||||
| Mid East | 109,579 | 85,931 | 104,761 | |||||||||
| South East | 41,074 | 36,490 | 60,173 | |||||||||
| Total | $ | 537,767 | $ | 472,228 | $ | 506,240 | ||||||
| Segment profit: | ||||||||||||
| Mid Atlantic | $ | 209,496 | $ | 185,861 | $ | 103,690 | ||||||
| North East | 25,091 | 19,572 | 13,182 | |||||||||
| Mid East | 56,882 | 38,012 | 39,643 | |||||||||
| South East | 10,870 | 7,384 | 7,904 | |||||||||
| Total | $ | 302,339 | $ | 250,829 | $ | 164,419 | ||||||
| Gross profit margin percentage: | ||||||||||||
| Mid Atlantic | 19.0 | % | 18.5 | % | 13.6 | % | ||||||
| North East | 16.9 | % | 16.6 | % | 13.4 | % | ||||||
| Mid East | 17.3 | % | 17.0 | % | 15.9 | % | ||||||
| South East | 14.7 | % | 13.9 | % | 12.8 | % |
Segment Operating Activity:
| Year Ended December 31, | ||||||||||||||||||||||||
| 2010 | 2009 | 2008 | ||||||||||||||||||||||
| Average | Average | Average | ||||||||||||||||||||||
| Units | Price | Units | Price | Units | Price | |||||||||||||||||||
| Settlements: | ||||||||||||||||||||||||
| Mid Atlantic | 5,043 | $ | 353.0 | 4,722 | $ | 351.8 | 5,240 | $ | 412.5 | |||||||||||||||
| North East | 920 | $ | 312.5 | 882 | $ | 288.7 | 1,086 | $ | 319.7 | |||||||||||||||
| Mid East | 2,886 | $ | 219.0 | 2,323 | $ | 216.3 | 2,762 | $ | 237.4 | |||||||||||||||
| South East | 1,181 | $ | 237.2 | 1,115 | $ | 235.1 | 1,653 | $ | 284.4 | |||||||||||||||
| Total | 10,030 | $ | 297.1 | 9,042 | $ | 296.4 | 10,741 | $ | 338.4 | |||||||||||||||
| New orders, net of cancellations: | ||||||||||||||||||||||||
| Mid Atlantic | 4,775 | $ | 365.1 | 4,809 | $ | 347.4 | 4,290 | $ | 373.4 | |||||||||||||||
| North East | 827 | $ | 317.3 | 904 | $ | 293.5 | 884 | $ | 298.5 | |||||||||||||||
| Mid East | 2,656 | $ | 221.3 | 2,552 | $ | 217.3 | 2,380 | $ | 229.5 | |||||||||||||||
| South East | 1,157 | $ | 231.9 | 1,144 | $ | 230.2 | 1,206 | $ | 261.2 | |||||||||||||||
| Total | 9,415 | $ | 304.0 | 9,409 | $ | 292.7 | 8,760 | $ | 311.3 | |||||||||||||||
| Backlog: | ||||||||||||||||||||||||
| Mid Atlantic | 1,595 | $ | 396.2 | 1,863 | $ | 359.0 | 1,776 | $ | 371.3 | |||||||||||||||
| North East | 232 | $ | 315.9 | 325 | $ | 302.8 | 303 | $ | 288.8 | |||||||||||||||
| Mid East | 730 | $ | 234.7 | 960 | $ | 224.7 | 731 | $ | 223.9 | |||||||||||||||
| South East | 359 | $ | 227.6 | 383 | $ | 244.1 | 354 | $ | 260.5 | |||||||||||||||
| Total | 2,916 | $ | 328.6 | 3,531 | $ | 304.9 | 3,164 | $ | 316.9 | |||||||||||||||
Operating Data:
| Year Ended December 31, | ||||||||||||
| 2010 | 2009 | 2008 | ||||||||||
| New order cancellation rate: | ||||||||||||
| Mid Atlantic | 11.3 | % | 14.4 | % | 24.4 | % | ||||||
| North East | 16.4 | % | 14.5 | % | 19.7 | % | ||||||
| Mid East | 15.0 | % | 13.9 | % | 17.7 | % | ||||||
| South East | 18.9 | % | 14.8 | % | 28.9 | % | ||||||
| Average active communities: | ||||||||||||
| Mid Atlantic | 171 | 168 | 205 | |||||||||
| North East | 33 | 37 | 39 | |||||||||
| Mid East | 108 | 100 | 118 | |||||||||
| South East | 59 | 50 | 65 | |||||||||
| Total | 371 | 355 | 427 | |||||||||
Homebuilding Inventory:
| As of December 31, | ||||||||||||
| 2010 | 2009 | 2008 | ||||||||||
| Sold inventory: | ||||||||||||
| Mid Atlantic | $ | 182,128 | $ | 219,885 | $ | 215,587 | ||||||
| North East | 20,703 | 36,315 | 31,321 | |||||||||
| Mid East | 43,506 | 60,107 | 41,751 | |||||||||
| South East | 23,711 | 21,521 | 29,781 | |||||||||
| Total | $ | 270,048 | $ | 337,828 | $ | 318,440 | ||||||
| Unsold lots and housing units inventory: | ||||||||||||
| Mid Atlantic | $ | 42,682 | $ | 47,120 | $ | 30,370 | ||||||
| North East | 3,687 | 4,152 | 4,195 | |||||||||
| Mid East | 11,089 | 16,353 | 14,549 | |||||||||
| South East | 8,967 | 4,783 | 5,878 | |||||||||
| Total | $ | 66,425 | $ | 72,408 | $ | 54,992 | ||||||
| Year Ended December 31, | ||||||||||||
| 2010 | 2009 | 2008 | ||||||||||
| Unsold inventory impairments: | ||||||||||||
| Mid Atlantic | $ | 1,520 | $ | 1,286 | $ | 1,163 | ||||||
| North East | 420 | 598 | 573 | |||||||||
| Mid East | 434 | 592 | 69 | |||||||||
| South East | 820 | 268 | 129 | |||||||||
| Total | $ | 3,194 | $ | 2,744 | $ | 1,934 | ||||||
Lots Controlled and Land Deposits:
| As of December 31, | ||||||||||||
| 2010 | 2009 | 2008 | ||||||||||
| Total lots controlled: | ||||||||||||
| Mid Atlantic | 30,201 | 26,938 | 23,711 | |||||||||
| North East | 4,025 | 3,898 | 3,619 | |||||||||
| Mid East | 11,061 | 10,163 | 11,027 | |||||||||
| South East | 7,023 | 5,338 | 6,626 | |||||||||
| Total | 52,310 | 46,337 | 44,983 | |||||||||
| Lots included in impairment reserve: | ||||||||||||
| Mid Atlantic | 5,973 | 6,575 | 7,565 | |||||||||
| North East | 594 | 846 | 1,879 | |||||||||
| Mid East | 2,055 | 2,022 | 3,553 | |||||||||
| South East | 1,678 | 1,363 | 3,738 | |||||||||
| Total | 10,300 | 10,806 | 16,735 | |||||||||
| Contract land deposits, net | ||||||||||||
| Mid Atlantic | $ | 82,165 | $ | 38,729 | $ | 17,953 | ||||||
| North East | 8,525 | 3,513 | 1,233 | |||||||||
| Mid East | 11,876 | 5,242 | 6,788 | |||||||||
| South East | 4,830 | 3,161 | 1,332 | |||||||||
| Total | $ | 107,396 | $ | 50,645 | $ | 27,306 | ||||||
| Year Ended December 31, | ||||||||||||
| 2010 | 2009 | 2008 | ||||||||||
| Contract land deposit impairments: | ||||||||||||
| Mid Atlantic | $ | 9,150 | $ | 18,425 | $ | 81,834 | ||||||
| North East | 4,898 | 2,489 | 11,190 | |||||||||
| Mid East | 1,686 | 7,244 | 10,393 | |||||||||
| South East | 4,618 | 5,236 | 20,081 | |||||||||
| Total | $ | 20,352 | $ | 33,394 | $ | 123,498 | ||||||
Mid Atlantic
2010 versus 2009
The Mid Atlantic segment had an approximate $23,600, or 13%, increase in segment profit in 2010 compared to 2009. Revenues increased approximately $119,300, or 7%, in 2010 from 2009 on a 7% increase in the number of units settled. The increase in units settled was attributable to the impact of the federal homebuyer tax credit which we believe resulted in higher first quarter sales and increased settlements through the second quarter of 2010 as compared to the same period in 2009. In addition, 2010 settlements were also favorably impacted by a 5% higher beginning backlog unit balance entering 2010 as compared to 2009. The segment’s
gross profit margin percentage increased to 19.0% in 2010 from 18.5% in 2009. Segment profit and gross profit margins were favorably impacted by lower contract land deposit impairment charges in 2010 of $9,150, or 51 basis points, compared to $18,425, or 111 basis points in 2009.
Segment new orders in 2010 declined approximately 1%, while the average sales price of new orders in 2010 increased approximately 5%, as compared to new orders and the average sales price in 2009. The increase in the average price of new orders was attributable to a product mix shift away from our attached products to our detached product which generally sell at higher price points.
2009 versus 2008
The Mid Atlantic segment had an approximate $82,200, or 79%, increase in segment profit in 2009 compared to 2008. Revenues for the Mid Atlantic segment, which represents approximately 62% of total homebuilding revenues for the year, decreased approximately $500,500, or 23%, in 2009 compared to 2008. Revenues declined due to a 10%, or 518 unit, decrease in units settled and a 15% decrease in the average settlement price of homes in 2009 compared to 2008. The decrease in units settled is attributable to a 35%, or 950 unit, lower backlog balance at the beginning of 2009 compared to the same period in 2008, offset partially by a higher backlog turnover rate year over year. The decrease in the average settlement price was primarily attributable to a 17% lower average price of homes in the beginning backlog year over year, coupled with a 9% decline in the average sales price of new orders for the first six months of 2009 as compared to the same period in 2008. The segment’s gross profit margin percentage increased to 18.5% in 2009 from 13.6% in 2008. Gross profit margins were favorably impacted by lower contract land deposit impairment charges in 2009 of $18,425, or 111 basis points, compared to $81,834, or 379 basis points, in 2008. Gross profit margins in 2009 were also favorably impacted as a result of us exiting poor performing communities in 2008 which were producing lower gross profit margins. In addition, 2009 gross profit margins as well as segment profit were favorably impacted by lower lumber and certain other commodity costs as well as by cost control measures taken in prior quarters, reducing material and personnel costs.
Segment new orders in 2009 increased 12% from 2008, while the segment’s average sales price of new orders decreased 7% year over year. New orders were favorably impacted in part by a 43% increase in the number of new orders in the fourth quarter of 2009 compared to the same period in 2008, as a result of the significant impact of the fourth quarter 2008 credit crisis on the homebuilding market. New orders were also favorably impacted in 2009 by a decrease in the cancellation rate in 2009 to 14% from 24% during 2008. In addition, we believe that the federal tax credit for first-time homebuyers had a favorable impact on new orders in 2009, as first-time homebuyers made up a higher percentage of our total sales in the segment year over year.
North East
2010 versus 2009
The North East segment had an approximate $5,500, or 28% increase in segment profit in 2010 compared to 2009. Revenues increased approximately $32,900, or 13%, in 2010 from 2009. Revenues increased due to a 4% increase in the number of units settled and an 8% increase in the average settlement price year over year. The increase in units settled was primarily attributable to the impact of the federal homebuyer tax credit which we believe resulted in higher first quarter sales and increased settlements through the second quarter of 2010 as compared to the same period in 2009. The increase in the average settlement price resulted from a product mix shift away from our attached products to our detached product, which generally sells at higher price points. Gross profit margins remained relatively flat period over period, as the higher contract land deposit impairment charges in 2010 of $4,898, or 170 basis points, compared to 2009 of $2,489, or 98 basis points, were offset by improved leveraging of fixed operating costs due to higher settlement volume year over year.
Segment new orders in 2010 decreased 9% compared to 2009, while the average sales price of new orders increased 8% year over year. Subsequent to the April 30, 2010 expiration of the federal homebuyer tax credit, we experienced a decline in new orders in each quarter of 2010 as compared to the respective quarters of
- The average sales price of new orders has been favorably impacted by a product mix shift away from our attached products to our detached product, which generally sells at higher price points.
2009 versus 2008
The North East segment had an approximate $6,400, or 49%, increase in segment profit in 2009 compared to 2008, despite a decrease in revenues of approximately $92,500, or 27%, year over year. The decline in revenues was due to a 19%, or 204 unit, decrease in the number of units settled and a 10% decrease in the average settlement price year over year. The decrease in the number of units settled and the average settlement price was primarily attributable to a 40%, or 202 unit, lower beginning backlog balance entering 2009 compared to 2008 and 15% lower average price of homes in beginning backlog year over year. Gross profit margins increased to 16.6% in 2009 from 13.4% in 2008. The increase in gross margins was attributable primarily to lower contract land deposit impairment charges in 2009 of $2,489, or 98 basis points, compared to 2008 of $11,190, or 322 basis points. In addition, 2009 gross profit margins as well as segment profit were favorably impacted by lower lumber and certain other commodity costs as well as by cost control measures taken in prior quarters, reducing material and personnel costs.
Segment new orders in 2009 increased 2% from 2008, while the segment’s average sales price for new orders decreased 2% year over year. New orders were favorably impacted in part by a 26% increase in the number of new orders in the fourth quarter of 2009 compared to the same period in 2008, as a result of the significant impact of the fourth quarter 2008 credit crisis on the homebuilding market. We believe new orders were also favorably impacted in 2009 by the federal tax credit for first-time homebuyers and by a decrease in the cancellation rate to 15% in 2009 from 20% in 2008.
Mid East
2010 versus 2009
The Mid East segment had an approximate $18,900, or 50%, increase in segment profit in 2010 compared to 2009. The increase in segment profit was driven by an increase in revenues of approximately $126,900, or 25%, in 2010 compared to 2009 primarily due to a 24% increase in the number of units settled year over year. The increase in units settled was attributable to the impact of the federal homebuyer tax credit which we believe resulted in higher first quarter sales and increased settlements through the second quarter of 2010 as compared to the same period in 2009. In addition, settlements were favorably impacted by a 31% higher beginning backlog entering 2010 compared to the same period in 2009. Gross profit margins remained relatively flat year over year, at 17.3% in 2010 compared to 17.0% in 2009.
Segment new orders and the average new order selling price in 2010 increased 4% and 2%, respectively compared to 2009. New orders were favorably impacted primarily by the 178 new orders in the current year in Indianapolis, IN, market which began operations in the fourth quarter of 2009. This increase was offset partially by an increase in the cancellation rate in both the third and fourth quarters of 2010 to 21% in each quarter as compared to 15% and 13% in the third and fourth quarters of 2009, respectively.
2009 versus 2008
The Mid East segment had an approximate $1,600, or 4%, decrease in segment profit and an approximate $154,200, or 23%, decrease in revenues in 2009 compared to 2008. Revenues decreased due to a 16%, or 439 unit, decrease in the number of units settled and a 9% decrease in the average settlement price period over period. The decreases in the number of units settled and the average settlement price were primarily attributable to a 34%, or 382 unit, lower beginning backlog balance and 9% lower average price of homes in beginning backlog year over year, respectively. In addition, average settlement prices were negatively impacted by a 10% decline in the average sales price of new orders for the first six months of 2009 as compared to the same period in 2008. Gross profit margins increased year over year, as cost reduction measures initiated in prior periods offset the decrease in the average settlement price in 2009 compared to 2008. Gross profit margins in 2009 were also favorably impacted as a result of us exiting poor performing communities in 2008 which were producing lower gross profit margins.
Segment new orders in 2009 increased 7% from 2008, while the segment’s average sales price for new orders decreased 5% year over year. New orders were favorably impacted in part by a 51% increase in the number of new orders in the fourth quarter of 2009 compared to the same period in 2008, as a result of the significant impact of the fourth quarter 2008 credit crisis on the homebuilding market. We believe new orders in 2009 were also favorably impacted by the federal tax credit for first-time homebuyers, and a decrease in the cancellation rate to 14% in 2009 from 18% in 2008, despite a reduction in the average number of active communities year over year. New order average sale prices continued to be negatively impacted by market conditions, which required us to alter our product offerings and reduce prices in each market within this segment.
South East
2010 versus 2009
The South East segment had an approximate $3,500 increase in segment profit in 2010 compared to 2009. The increase in segment profit was driven by an increase of approximately $18,200, or 7%, in revenues in 2010 from 2009 due primarily to a 6% increase in the number of units settled. The increase in units settled was primarily attributable to the impact of the federal homebuyer tax credit which we believe resulted in higher first quarter sales and increased settlements through the second quarter of 2010 as compared to the same period in 2009. In addition, settlements were favorably impacted by an 8% higher beginning backlog entering 2010 compared to the same period in 2009. Gross profit margins increased to 14.7% in 2010 from 13.9% in 2009 due in part to lower contract land deposit impairment charges in 2010 of $4,618, or 165 basis points, compared to $5,236, or 200 basis points in 2009, coupled with improved leveraging of fixed operating costs due to higher settlement volume year over year.
Segment new orders and the average sales price of new orders for 2010 remained relatively flat with 2009. New orders were favorably impacted by an 18% increase in the average number of active communities year over year, and by the increase of approximately 80 new orders in 2010 in the Orlando, FL and Raleigh, NC markets, in which we began operations in the third quarter of 2009. These favorable variances were offset by higher cancellations rates in the segment in both the third and fourth quarters of 2010 of 32% and 19% respectively, compared to 14% and 18% for the respective quarters of 2009 and lower absorption rates year over year. Market conditions continued to deteriorate in this segment throughout 2010. The challenging market conditions, coupled with the expiration of the federal homebuyer tax credit in April of 2010, attributed to the segment’s higher cancellation rates and fewer new orders in each the second, third and fourth quarters of 2010 as compared to the respective quarters in 2009. We believe we will continue to face significant new order and sales pricing pressure in many of our markets in the South East segment over the next several quarters due to continuing difficult market conditions.
2009 versus 2008
The South East segment had an approximate $500, or 7% decrease in segment profit and an approximate $208,000, or 44%, decrease in revenues in 2009 compared to 2008. Revenues decreased primarily due to a 33%, or 538 unit, decrease in the number of units settled and a 17% decrease in the average settlement price year over year. The decrease in units settled was attributable to a 56%, or 447 unit, lower beginning backlog balance entering 2009 compared to the same period in 2008 coupled with a 25%, or 203 unit, decrease in new orders during the first six months of 2009 as compared to the first six months of 2008. The decrease in the average settlement price was primarily attributable to a 16% lower average price of units in backlog entering 2009 compared to the same period in 2008, coupled with a 16% decline in the average sales price of new orders for the first six months of 2009 as compared to the same period in 2008. Gross profit margins increased to 13.9% in 2009 from 12.8% in 2008. Gross profit margins were favorably impacted by lower contract land deposit impairment charges in 2009 of $5,236, or 200 basis points, compared to $20,081, or 427 basis points, in 2008. This favorable impact on gross profit margins year over year was partially offset by a 12% decline in average new order sales prices in 2009 from 2008, as the South East segment market conditions were more challenging than those seen in our other market segments.
Segment new orders and the average new order sales price decreased 5% and 12%, respectively, in 2009 compared to 2008. New orders have been negatively impacted by a 23% decrease in the average number of active communities year over year. In addition, the challenging market conditions in the South East segment had continued to negatively impact both new orders and new order sales prices. We believe new orders were favorably impacted in 2009 by the federal tax credit for first-time homebuyers and by a decrease in cancellation rates to 15% in 2009 from 29% in 2008.
Homebuilding Segment Reconciliations to Consolidated Homebuilding Operations
In addition to the corporate capital allocation and contract land deposit impairments discussed above, the other reconciling items between homebuilding segment profit and homebuilding consolidated profit before tax include unallocated corporate overhead (which includes all management incentive compensation), stock option compensation expense, goodwill and intangible asset impairment charges, consolidation adjustments and external corporate interest expense. Our overhead functions, such as accounting, treasury, human resources, etc., are centrally performed and the costs are not allocated to our operating segments. Consolidation adjustments consist of such items 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. Likewise, stock option compensation expense and goodwill and intangible asset impairment charges are not charged to the operating segments. External corporate interest expense is primarily comprised of interest charges on our senior notes, and is not charged to the operating segments because the charges are included in the corporate capital allocation discussed above.
| Year Ended December 31, | ||||||||||||
| 2010 | 2009 | 2008 | ||||||||||
| Homebuilding Consolidated Gross Profit: | ||||||||||||
| Homebuilding Mid Atlantic | $ | 338,586 | $ | 307,525 | $ | 294,699 | ||||||
| Homebuilding North East | 48,528 | 42,282 | 46,607 | |||||||||
| Homebuilding Mid East | 109,579 | 85,931 | 104,761 | |||||||||
| Homebuilding South East | 41,074 | 36,490 | 60,173 | |||||||||
| Consolidation adjustments and other (1) | 4,699 | 25,506 | (48,548 | ) | ||||||||
| Consolidated homebuilding gross profit | $ | 542,466 | $ | 497,734 | $ | 457,692 | ||||||
| Year Ended December 31, | ||||||||||||
| 2010 | 2009 | 2008 | ||||||||||
| Homebuilding Consolidated Profit Before Tax: | ||||||||||||
| Homebuilding Mid Atlantic | $ | 209,496 | $ | 185,861 | $ | 103,690 | ||||||
| Homebuilding North East | 25,090 | 19,572 | 13,182 | |||||||||
| Homebuilding Mid East | 56,882 | 38,012 | 39,643 | |||||||||
| Homebuilding South East | 10,870 | 7,384 | 7,904 | |||||||||
| Reconciling items: | ||||||||||||
| Contract land deposit impairment reserve (2) | 16,206 | 42,939 | (41,134 | ) | ||||||||
| Equity-based compensation expense (3) | (50,357 | ) | (43,495 | ) | (38,681 | ) | ||||||
| Corporate capital allocation (4) | 65,971 | 61,753 | 108,509 | |||||||||
| Unallocated corporate overhead (5) | (55,992 | ) | (44,103 | ) | (52,696 | ) | ||||||
| Consolidation adjustments and other | 15,848 | 4,970 | 24,437 | |||||||||
| Impairment of goodwill and intangible assets (6) | — | — | (11,686 | ) | ||||||||
| Corporate interest expense | (4,546 | ) | (9,810 | ) | (12,417 | ) | ||||||
| Reconciling items sub-total | (12,870 | ) | 12,254 | (23,668 | ) | |||||||
| Homebuilding consolidated profit before taxes | $ | 289,468 | $ | 263,083 | $ | 140,751 | ||||||
| (1) | The year over year variances in consolidation adjustments and other relates primarily to changes to the contract land deposit impairment reserve, which are not allocated to the reportable segments. | |
| (2) | This item represents changes to the contract land deposit impairment reserve, which are not allocated to the reportable segments. During both 2010 and 2009, unallocated reserves decreased from the respective prior years primarily as a result of charging previously reserved land impairments to the operating segments and certain recoveries of deposits previously determined to be impaired. | |
| (3) | The increase in equity-based compensation expense in 2010 compared to the prior year was primarily due to the granting of non-qualified stock options and restricted share units from the 2010 Equity Incentive Plan in the current year. The current year increase in stock based compensation expense was partially offset by an approximate $7,000 pre-tax reversal of stock-based compensation expense attributable to an adjustment of our option forfeiture estimates based on our actual forfeiture experience. | |
| (4) | This item represents the elimination of the corporate capital allocation charge included in the respective homebuilding reportable segments. The corporate capital allocation charge is based on the segment’s monthly average asset balance, and is as follows for the years presented: |
| Year Ended December 31, | ||||||||||||
| 2010 | 2009 | 2008 | ||||||||||
| Homebuilding Mid Atlantic | $ | 44,758 | $ | 40,765 | $ | 73,042 | ||||||
| Homebuilding North East | 5,926 | 6,473 | 10,081 | |||||||||
| Homebuilding Mid East | 9,657 | 8,863 | 12,902 | |||||||||
| Homebuilding South East | 5,630 | 5,652 | 12,484 | |||||||||
| Total | $ | 65,971 | $ | 61,753 | $ | 108,509 | ||||||
| (5) | The increases in unallocated corporate overhead in 2010 from 2009 is attributable to increased personnel levels year over year and to higher management incentive costs as the 2009 incentive plan was limited to a payout of 50% of the maximum bonus opportunity. The decrease in 2009 from 2008 was primarily driven by a reduction in personnel and other overhead costs as part of our focus to size our organization to meet current activity levels. | |
| (6) | The 2008 impairment charge relates to the write-off of goodwill and indefinite life intangible assets related to the Company’s 2005 acquisition of Rymarc Homes and the goodwill related to the 1997 acquisition of Fox Ridge Homes. |
Mortgage Banking Segment
We conduct our mortgage banking activity through NVR Mortgage Finance, Inc. (“NVRM”), a wholly owned subsidiary. NVRM focuses almost exclusively on serving the homebuilding segment’s customer base. Following is a table of financial and statistical data for the years ended December 31, 2010, 2009 and 2008:
| 2010 | 2009 | 2008 | ||||||||||
| Loan closing volume: | ||||||||||||
| Total principal | $ | 2,219,946 | $ | 2,060,376 | $ | 2,351,341 | ||||||
| Loan volume mix: | ||||||||||||
| Adjustable rate mortgages | 4 | % | 1 | % | 5 | % | ||||||
| Fixed-rate mortgages | 96 | % | 99 | % | 95 | % | ||||||
| Operating Profit: | ||||||||||||
| Segment Profit | $ | 35,704 | $ | 38,138 | $ | 29,227 | ||||||
| Equity-based compensation expense | (2,779 | ) | (2,807 | ) | (2,523 | ) | ||||||
| Mortgage banking income before tax | $ | 32,925 | $ | 35,331 | $ | 26,704 | ||||||
| Capture rate: | 90 | % | 91 | % | 85 | % | ||||||
| Mortgage Banking Fees: | ||||||||||||
| Net gain on sale of loans | $ | 46,225 | $ | 46,960 | $ | 38,921 | ||||||
| Title services | 14,108 | 12,787 | 14,581 | |||||||||
| Servicing fees | 801 | 634 | 835 | |||||||||
| $ | 61,134 | $ | 60,381 | $ | 54,337 | |||||||
2010 versus 2009
Loan closing volume for the year ended December 31, 2010 increased 8% from 2009. The 2010 increase was primarily attributable to a 7% increase in the number of units closed and a 1% increase in the average loan amount year over year. The increases in the number of units closed and the average loan amount are attributable to the aforementioned increase in the homebuilding segment’s number of units settled and the increase in the average settlement prices in 2010 as compared to 2009.
Segment profit for the year ended December 31, 2010 decreased approximately $2,400 from 2009. The decrease in segment profit was primarily attributable to an approximately $5,800 increase in general and administrative expenses. The increase in general and administrative expenses was primarily the result of a $6,000 increase in the provision for loan loss compared to 2009. The $5,800 increase in general and administrative expenses was partially offset by an approximate $2,500 increase in interest income primarily as a result of the change in our loan sale distribution channels (refer to Mortgage Banking-Other section below for additional information).
2009 versus 2008
Loan closing volume for the year ended December 31, 2009 decreased 12% from 2008. The 2009 decrease was primarily attributable to a 7% decrease in the number of units closed and a 6% decrease in the average loan amount year over year. These decreases are attributable to the aforementioned decrease in the homebuilding segment’s number of units settled and the decrease in the average settlement prices in 2009 as compared to 2008. The aforementioned decrease in builder settlements in 2009 compared to 2008, was partially offset by a 6 percentage point increase in the number of loans closed by NVRM for our homebuyers who obtain a mortgage to purchase the home (“Capture Rate”), which increased to 91% for the period ended December 31, 2009, compared to 85% for the same period in 2008.
Segment profit for the year ended December 31, 2009 increased approximately $8,900 from 2008. The increase was partially attributable to an approximate $6,000 increase in mortgage banking fees, which was primarily the result of a decrease in incentives. The increase was partially offset by a decrease in fees attributable to the aforementioned decrease in closed loan volume. The increase in mortgage banking fees for the year ended December 31, 2009 was also partially attributable to an approximate $440 increase in unrealized income from the fair value measurement of our locked loan commitments, forward mortgage-backed securities sales, and closed loans held for sale, which is included in mortgage banking fees. The fair value calculations are classified as Level 2 observable inputs as defined by GAAP (refer to Note 11, in the accompanying consolidated financial statements for additional information). The aforementioned fair value measurements will be impacted in the future by the change in the value of the servicing rights and the change in volume and product mix of our closed loans and locked loan commitments.
The increase in segment profit for the year ended December 31, 2009 was also partially attributable to an approximate $4,400 decrease in general and administrative expenses compared to the same period for 2008. The decrease in general and administrative expenses was primarily the result of a decrease in salary and other personnel costs primarily as the result of an approximate 24% decrease in staffing compared to the same period for 2008.
Mortgage Banking — Other
We sell all of the loans we originate into the secondary mortgage market. Insofar as we underwrite our originated loans to the standards and specifications of the ultimate investor, we have no further financial obligations from the issuance of loans, except in certain limited instances where early payment default occurs. Those underwriting standards are typically equal to or more stringent than the underwriting standards required by FNMA, VA and FHA. NVRM has always maintained an allowance for losses on mortgage loans originated that reflects our judgment of the present loss exposure in the loans that we have originated and sold. The allowance is calculated based on an analysis of historical experience and anticipated losses on mortgages held for investment, real estate owned, and specific expected loan repurchases or indemnifications. For the period January 1, 2005 to December 31, 2010, we have originated approximately $17,200,000 of mortgage loans and have cumulative actual charges incurred related to mortgage indemnifications and repurchases of approximately $5,400 during that period. It has been reported that investors have become increasingly aggressive in looking for any type of underwriting deficiency incurred on loans that have gone into default to force the seller or the originator of the loans to assume any losses incurred on the defaulted loans. We have not experienced an abnormal increase in the number of loans that we have been requested to either repurchase or provide indemnification for losses. Because we sell all of our loans and do not service them, there is often a substantial delay between the time that a loan goes into default and the time that the servicer requests us to reimburse them for losses incurred because of the default. We believe that all of the loans that we originate are underwritten to the standards and specifications of the ultimate investor to whom we sell our originated loans. We employ a quality control department to ensure that our underwriting controls are effective, and further assess the underwriting function as part of our assessment of internal controls over financial reporting. At December 31, 2010, we had an allowance for loan losses of approximately $8,200. Although we consider the allowance for loan losses reflected on the December 31, 2010 balance sheet to be adequate, there can be no assurance that this allowance will prove to be adequate to cover losses on loans previously originated.
NVRM continues to manage its interest rate risk by entering into optional or mandatory delivery forward sale contracts to sell whole loans and mortgage-backed securities to broker/dealers to mitigate the effect of the interest rate risk inherent in providing rate lock commitments to our borrowers. However, in April 2010, NVRM changed the method by which we deliver loans into our sale distribution channels in order to increase our profitability. While loans are still typically sold to investors within 30 days of settlement, the change has resulted in loans remaining in inventory for a longer period of time than under our previous loan sale channels. This change has resulted in an increase in the mortgages held for sale balance included in the consolidated balance sheet for December 31, 2010 compared to previous years and in the related interest income.
NVRM is dependent on our homebuilding segment’s customers for business. As new orders and selling prices of the homebuilding segment decline, NVRM’s operations will also be adversely affected. In addition, the mortgage segment’s operating results may be adversely affected in future periods due to the continued tightening and volatility of the credit markets as well as increased regulation of mortgage lending practices.
Seasonality
Overall, we do not experience material seasonal fluctuations in sales, settlements or loan closings.
Effective Tax Rate
Our consolidated effective tax rate in 2010, 2009 and 2008 was 36.1%, 35.6% and 39.75%, respectively. The lower effective tax rates in 2010 and 2009 as compared to 2008 were due to the expiration of certain tax reserves previously established, the amendment of certain prior year federal and state income tax returns that we believe will result in tax refunds, and changes under Internal Revenue Code Section 199, domestic manufacturing deduction, that provides us the ability to obtain a larger tax benefit. In addition, the 2009 effective tax rate was favorably impacted by Mr. Schar relinquishing his Executive Officer role with us in 2009, generating a tax benefit related to compensation expense recorded for certain outstanding option grants held by Mr. Schar that were previously considered to be a permanent non-deductible tax difference.
Recent Accounting Pronouncements Pending Adoption
There have not been any pronouncements issued but not yet implemented that we believe will have a material impact on our financial statements. See Note 1 in the accompanying consolidated financial statements for discussion of pronouncements adopted in 2010.
Liquidity and Capital Resources
Lines of Credit and Notes Payable
Our homebuilding segment has generally provided for its working capital cash requirements using cash generated from operations, a short-term unsecured working capital revolving credit facility and the public debt and equity markets. Effective October 27, 2010, we voluntarily terminated our $300,000 unsecured working capital revolving credit facility which was set to expire on December 6, 2010. We currently do not intend to enter into a new credit facility; however, effective October 27, 2010, we entered into an uncommitted collateralized letter of credit facility to issue letters of credit in our ordinary course of business. See Note 10 in the accompanying consolidated financial statements for further discussion of letters of credit.
Our mortgage subsidiary, NVRM, provides for its mortgage origination and other operating activities using cash generated from operations as well as a revolving mortgage repurchase facility, which is non-recourse to NVR. On July 30, 2010, we renewed and amended our Master Repurchase Agreement dated August 5, 2008 with U.S. Bank National Association, as Agent and representative of itself as a Buyer, and the other Buyers thereto (the “Master Repurchase Agreement”) pursuant to a Second Amendment to Master Repurchase Agreement with U.S. Bank National Association, as Agent and representative of itself as Buyer (“Agent”), and the other Buyers thereto (together with the Master Repurchase Agreement, the “Repurchase Agreement”). The purpose of the Repurchase Agreement is to finance the origination of mortgage loans by NVRM. The Repurchase Agreement provides for loan purchases up to $100,000, subject to certain sub limits. In addition, the Repurchase Agreement provides for an accordion feature under which NVRM may request that the aggregate commitments under the Repurchase Agreement be increased to an amount up to $125,000. The Repurchase Agreement expires on August 2, 2011.
Advances under the Repurchase Agreement carry a Pricing Rate based on the LIBOR Rate plus the LIBOR Margin, or the Default Pricing Rate, as determined under the Repurchase Agreement, provided that the Pricing Rate shall not be less than 4.5%. Prior to the July 30, 2010 renewal date, the Pricing Rate was based on LIBOR plus LIBOR Margin, or at NVRM’s option, the Balance Funded Rate, which included credit for
compensating balances. Under the Repurchase Agreement, we may enter into separate agreements with the Buyers party to the Repurchase Agreement, adjusting the Pricing Rate in effect. These separate agreements do not effect the maximum aggregate commitment available under the Repurchase Agreement. There are several restrictions on purchased loans, including that they cannot be sold to others, they cannot be pledged to anyone other than the agent, and they cannot support any other borrowing or repurchase agreement. The average Pricing Rate on outstanding balances at December 31, 2010 was 4.1%. The average Pricing Rate for amounts outstanding under the previous Repurchase Agreement at December 31, 2009 was 4.1%.
At December 31, 2010, there was $90,338 outstanding under the Repurchase Agreement, which is included in the mortgage banking segment’s “Note payable” in the accompanying consolidated balance sheet. Amounts outstanding under the Repurchase Agreement are collateralized by the our mortgage loans held for sale, which are included in assets in the December 31, 2010 balance sheet in the accompanying consolidated financial statements. There were no borrowing base limitations at December 31, 2010.
The Repurchase Agreement contains various affirmative and negative covenants with which NVRM must comply. The negative covenants include among others, certain limitations on transactions involving acquisitions, mergers, the incurrence of debt, sale of assets and creation of liens upon any of its Mortgage Notes. Additional covenants include (i) a tangible net worth requirement, (ii) a minimum liquidity requirement, (iii) a minimum tangible net worth ratio, (iv) a minimum net income requirement, and (v) a maximum leverage ratio requirement. We were in compliance with all covenants under the Repurchase Agreement at December 31, 2010.
On June 17, 2003, we completed an offering, at par, for $200,000 of 5% Senior Notes due 2010 (the “Senior Notes”) under a shelf registration statement filed in 1998 with the Securities and Exchange Commission (the “SEC”). The Senior Notes bore interest at 5%, payable semi-annually in arrears on June 15 and December 15. Upon their maturity on June 15, 2010, we redeemed the remaining $133,370 in outstanding Senior Notes upon maturity at par.
On September 8, 2008, we filed a shelf registration statement (the “2008 Shelf Registration”) with the SEC to register for future offer and sale an unlimited amount of debt securities, common shares, preferred shares, depositary shares representing preferred shares and warrants. We expect to use the proceeds received from future offerings, if any, issued under the 2008 Shelf Registration for general corporate purposes. This discussion of NVR’s shelf registration capacity does not constitute an offer of any securities for sale.
Equity Repurchases
In addition to funding growth in our homebuilding and mortgage banking operations, we historically have used a substantial portion of our excess liquidity to repurchase outstanding shares of our common stock in open market and privately negotiated transactions. This ongoing repurchase activity is conducted pursuant to publicly announced Board authorizations, and is typically executed in accordance with the safe-harbor provisions of Rule 10b-18 promulgated under the Securities and Exchange Act of 1934, as amended. In addition, the Board resolutions authorizing us to repurchase shares of our common stock specifically prohibit us from purchasing shares from our officers, directors, Profit Sharing/401K Plan Trust or Employee Stock Ownership Plan Trust. The repurchase program assists us in accomplishing our primary objective, creating increases in shareholder value. See Part II, Item 5 of this Form 10-K for disclosure of amounts repurchased during the fourth quarter of 2010. For the year ended December 31, 2010, we repurchased 644,562 shares of our common stock at an aggregate purchase price of $417,079. As of December 31, 2010, we had $109,200 available under a $300,000 board approved repurchase authorization.
Cash Flows
For the year ended December 31, 2010, cash and cash equivalents decreased by $56,400. Net cash provided by operating activities was $55,388. Cash was provided primarily by homebuilding operations and was used to fund increases to contract land deposits. The presentation of operating cash flows was reduced by $63,558, which is the amount of the excess tax benefit realized from the exercise of stock options and deferred
compensation during 2010 and credited directly to additional paid in capital. Investing activities provided net cash of $212,440, primarily due to the net redemption of $219,535 in marketable securities at maturity during the year. Net cash used by financing activities was $324,228. During 2010, we repurchased 644,562 shares of our common stock at an aggregate purchase price of $417,079 under our ongoing common stock repurchase program as discussed above. In addition, we redeemed the remaining outstanding 5% Senior Notes due 2010, totaling $133,370, upon their maturity on June 15, 2010. Stock option exercise activity during 2010 provided $77,492 in exercise proceeds and we realized $63,558 in excess income tax benefits from the exercise of stock options and deferred compensation plan distributions. We also increased net borrowings under the mortgage warehouse facility by $77,579 due to a change in the distribution channel for the sale of mortgage loans closed, as discussed previously in the Mortgage Banking Segment discussion.
In 2009, cash and cash equivalents increased by approximately $102,500. Operating activities provided cash of $241,642. Cash was provided primarily by homebuilding operations and by an approximate $32,400 decrease in mortgage loans held for sale. The presentation of operating cash flows was reduced by approximately $66,400, which is the amount of the excess tax benefit realized from the exercise of stock options and deferred compensation during the period and credited directly to additional paid in capital. Net cash used for investing activities during 2009 was $221,617 for the year ended December 31, 2009, which primarily resulted from the net purchase of marketable securities during 2009. The marketable securities, which were debt securities issued by the U.S. Treasury and other U.S. government corporations and agencies, were classified as held-to-maturity securities and matured within one year. Net cash provided by financing activities during 2009 was $82,482. Financing cash flow was favorably impacted by approximately $78,500 of proceeds from the exercise of stock options and deferred compensation and the realization of approximately $66,400 in excess income tax benefits from the exercise of stock options. Cash was used by financing activities to reduce net borrowings under the mortgage warehouse facility by approximately $32,200 and we repurchased $29,950 of our 5% Senior Notes due 2010, at par during 2009.
In 2008, cash and cash equivalents increased by approximately $483,000. Operating activities provided cash of $462,361. Cash was provided primarily by homebuilding operations and a reduction in our homebuilding inventories of approximately $288,000 due to a reduction in the number of homes under construction at the end of 2008 as compared to the same period in 2007. Operating cash flow was reduced by a decrease in our customer deposits of approximately $66,000. The presentation of operating cash flows was also reduced by approximately $50,000, which is the amount of the excess tax benefit realized from the exercise of stock options during the period and credited directly to additional paid in capital. Cash used for investing activities of $5,498 in 2008, was used primarily for property and equipment purchases. Financing activities in 2008 provided $26,571 due primarily to proceeds from the exercise of stock options of approximately $52,000 and the realization of approximately $50,000 in excess income tax benefits from the exercise of stock options. Cash was used in financing activities to reduce net borrowings under the mortgage warehouse facility by approximately $39,000 and to repurchase $36,680 of our 5% Senior Notes due 2010 at a cost of approximately $36,400.
At December 31, 2010, 2009 and 2008, the homebuilding segment had restricted cash of approximately $22,889, $4,600 and $4,500, respectively. The increase in restricted cash in 2010 is primarily attributable to holding requirements related to outstanding letters of credit issued under our letter of credit agreement as discussed further in Note 10 in the accompanying consolidated financial statements. In addition, restricted cash relates to customer deposits for certain home sales.
We believe that our current cash holdings, cash generated from operations and borrowings available under our mortgage repurchase agreement and the public debt and equity markets will be sufficient to satisfy near and long term cash requirements for working capital and debt service in both our homebuilding and mortgage banking operations.
Off Balance Sheet Arrangements
Lot Acquisition Strategy
We generally do not engage in land development. Instead, we typically acquire finished building lots at market prices from various land developers under fixed price purchase agreements that require deposits that may be forfeited if we fail to perform under the agreement. The deposits required under the purchase agreements are in the form of cash or letters of credit in varying amounts and represent a percentage, typically ranging up to 10%, of the aggregate purchase price of the finished lots.
We believe that our lot acquisition strategy reduces the financial requirements and risks associated with direct land ownership and land development. We may, at our option, choose for any reason and at any time not to perform under these purchase agreements by delivering notice of our intent not to acquire the finished lots under contract. Our sole legal obligation and economic loss for failure to perform under these purchase agreements is limited to the amount of the deposit pursuant to the liquidated damage provision contained within the purchase agreements. We do not have any financial guarantees or completion obligations and we typically do not guarantee lot purchases on a specific performance basis under these purchase agreements.
At December 31, 2010, we controlled approximately 50,400 lots with an aggregate purchase price of approximately $4,600,000, by making or committing to make deposits of approximately $180,900 in the form of cash and letters of credit. Our entire risk of loss pertaining to the aggregate purchase price contractual commitment resulting from our non-performance under the contracts is limited to the $180,900 deposit. Of the $180,900 deposit total, approximately $174,300 is in cash and approximately $6,600 is in letters of credit which have been issued as of December 31, 2010. Subsequent to December 31, 2010, we will pay approximately $43,200 in additional deposits assuming that contractual development milestones are met by the developers (see Contractual Obligations section below). As of December 31, 2010, we had recorded an impairment valuation allowance of approximately $73,500 related to the cash deposits currently outstanding. Please refer to Note 1 in the accompanying consolidated financial statements for a further discussion of the contract land deposits and Note 3 in the accompanying consolidated financial statements for a description of our lot acquisition strategy in relation to our accounting related to the consolidation of variable interest entities_._
Bonds and Letters of Credit
We enter into bond or letter of credit arrangements with local municipalities, government agencies, or land developers to collateralize our obligations under various contracts. We had approximately $38,300 of contingent obligations under such agreements as of December 31, 2010 (inclusive of the $6,600 of lot acquisition deposits in the form of letters of credit discussed above). We believe we will fulfill our obligations under the related contracts and do not anticipate any material losses under these bonds or letters of credit.
Mortgage Commitments and Forward Sales
In the normal course of business, our mortgage banking segment enters into contractual commitments to extend credit to buyers of single-family homes with fixed expiration dates. The commitments become effective when the borrowers “lock-in” a specified interest rate within time frames established by us. All mortgagors are evaluated for credit worthiness prior to the extension of the commitment. Market risk arises if interest rates move adversely between the time of the “lock-in” of rates by the borrower and the sale date of the loan to a broker/dealer. To mitigate the effect of the interest rate risk inherent in providing rate lock commitments to borrowers, we enter into optional or mandatory delivery forward sale contracts to sell whole loans and mortgage-backed securities to broker/dealers. The forward sale contracts lock in an interest rate and price for the sale of loans similar to the specific rate lock commitments. We do not engage in speculative or trading derivative activities. Both the rate lock commitments to borrowers and the forward sale contracts to broker/dealers are undesignated derivatives, and, accordingly, are marked to fair value through earnings. At December 31, 2010, there were contractual commitments to extend credit to borrowers aggregating $96,265 and open forward delivery contracts aggregating $262,839. Please refer to Note 11 in the accompanying consolidated financial statements for a description of our fair value accounting.
Contractual Obligations
Our fixed, non-cancelable obligations as of December 31, 2010, were as follows:
| Payments due by period | ||||||||||||||||||||
| Less than | 1-3 | 3-5 | More than | |||||||||||||||||
| Total | 1 year | years | years | 5 years | ||||||||||||||||
| Debt (a) | $ | 90,338 | $ | 90,338 | $ | — | $ | — | $ | — | ||||||||||
| Capital leases (b) | 2,359 | 346 | 1,288 | 725 | — | |||||||||||||||
| Operating leases (c) | 74,408 | 19,014 | 24,020 | 14,448 | 16,926 | |||||||||||||||
| Purchase obligations (d) | 43,178 | * | * | * | * | |||||||||||||||
| Executive Officer employment contracts (e) | 9,323 | 1,863 | 3,730 | 3,730 | — | |||||||||||||||
| Other long-term liabilities (f) | $ | 28,963 | 28,377 | 586 | — | — | ||||||||||||||
| Total | $ | 248,569 | $ | 139,938 | $ | 29,624 | $ | 18,903 | $ | 16,926 | ||||||||||
| (a) | See Note 6 in the accompanying consolidated financial statements for additional information regarding debt and related matters. | |
| (b) | The present value of these obligations is included on the Consolidated Balance Sheets. See Note 6 in the accompanying consolidated financial statements for additional information regarding capital lease obligations. | |
| (c) | See Note 10 in the accompanying consolidated financial statements for additional information regarding operating leases. | |
| (d)(*) | Amounts represent required payments of forfeitable deposits with land developers under existing, fixed price purchase agreements, assuming that contractual development milestones are met by the developers. We expect to make all payments of these deposits within the next three years, but due to the nature of the contractual development milestones that must be met, we are unable to accurately estimate the portion of the deposit obligation that will be made within one year and that portion that will be made within one to three years. | |
| (e) | We have entered into employment agreements with four of our executive officers. Each of the agreements expires on January 1, 2016 and provides for payment of a minimum base salary, which may be increased at the discretion of the Compensation Committee of NVR’s Board of Directors (the “Compensation Committee”), and annual incentive compensation of up to 100% of base salary upon achievement of annual performance objectives established by the Compensation Committee. The agreements also provide for payment of severance benefits upon termination of employment, in amounts ranging from $0 to two times the executive officer’s then annual base salary, depending on the reason for termination, plus up to $100 in outplacement assistance. Accordingly, total payments under these agreements will vary based on length of service, any future increases to base salaries, annual incentive payments earned, and the reason for termination. The agreements have been reflected in the above table assuming the continued employment of the executive officers for the full term of the respective agreements, and at the executive officers’ current base salaries. The above balances do not include any potential annual incentive compensation. The actual amounts paid could differ from that presented. | |
| (f) | Amounts represent payments due under incentive compensation plans and are included on the Consolidated Balance Sheet, approximately $2,900 of which is recorded in the Mortgage Banking accounts payable and other liabilities line item. |
Critical Accounting Policies
General
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires us to make estimates and assumptions that affect the reported
amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. We continually evaluate the estimates we use to prepare the consolidated financial statements and update those estimates as necessary. In general, our estimates are based on historical experience, on information from third party professionals, and other various assumptions that are believed to be reasonable under the facts and circumstances. Actual results could differ materially from those estimates made by management.
Homebuilding Inventory
The carrying value of inventory is stated at the lower of cost or market value. Cost of lots and completed and uncompleted housing units represent the accumulated actual cost of the units. Field construction supervisors’ salaries and related direct overhead expenses are included in inventory costs. Interest costs are not capitalized into inventory, with the exception of land under development. Upon settlement, the cost of the unit is expensed on a specific identification basis. Cost of manufacturing materials is determined on a first-in, first-out basis.
Sold inventory is evaluated for impairment based on the contractual selling price compared to the total estimated cost to construct. Unsold inventory is evaluated for impairment by analyzing recent comparable sales prices within the applicable community compared to the costs incurred to date plus the expected costs to complete. Any calculated impairments are recorded immediately.
Land Under Development and Contract Land Deposits
Land Under Development
On a very limited basis, we directly acquire raw parcels of land already zoned for its intended use to develop into finished lots. Land under development includes the land acquisition costs, direct improvement costs, capitalized interest, where applicable, and real estate taxes.
Land under development, including the land under development held by our unconsolidated joint ventures and the related joint venture investments, is reviewed for potential write-downs when impairment indicators are present. In addition to considering market and economic conditions, we assess land under development impairments on a community-by-community basis, analyzing, as applicable, current sales absorption levels, recent sales’ gross profit, and the dollar differential between the projected fully-developed cost of the lots and the current market price for lots. If indicators of impairment are present for a community, we perform an analysis to determine if the undiscounted cash flows estimated to be generated by those assets are less than their carrying amounts, and if so, impairment charges are required to be recorded if the fair value of such assets is less than their carrying amounts. For those assets deemed to be impaired, the impairment to be recognized is measured as the amount by which the carrying amount of the asset exceeds the fair value of the assets. Our determination of fair value is primarily based on discounting the estimated future cash flows at a rate commensurate with the inherent risks associated with the asset and related estimated cash flow streams. We do not believe that any of the land under development, all of which was acquired during 2010, is impaired at this time. However, there can be no assurance that we will not incur impairment charges in the future due to unanticipated adverse changes in the economy or other events adversely affecting specific markets or the homebuilding industry.
Contract Land Deposits
We purchase finished lots under fixed price purchase agreements that require deposits that may be forfeited if we fail to perform under the contract. The deposits are in the form of cash or letters of credit in varying amounts and represent a percentage of the aggregate purchase price of the finished lots.
We maintain an allowance for losses on contract land deposits that reflects our judgment of the present loss exposure in the existing contract land deposit portfolio at the end of the reporting period. To analyze contract land deposit impairments, we utilize a loss contingency analysis that is conducted each quarter. In
addition to considering market and economic conditions, we assess contract land deposit impairments on a community-by-community basis pursuant to the purchase contract terms, analyzing, as applicable, current sales absorption levels, recent sales’ gross profit, the dollar differential between the contractual purchase price and the current market price for lots, a developer’s financial stability, a developer’s financial ability or willingness to reduce lot prices to current market prices, and the contract’s default status by either us or the developer along with an analysis of the expected outcome of any such default.
Our analysis is focused on whether we can sell houses profitably in a particular community in the current market with which we are faced. Because we don’t own the finished lots on which we had placed a contract land deposit, if the above analysis leads to a determination that we can’t sell homes profitably at the current contractual lot price, we then determine whether we will elect to default under the contract, forfeit our deposit and terminate the contract, or whether we will attempt to restructure the lot purchase contract, which may require us to forfeit the deposit to obtain contract concessions from a developer. We also assess whether an impairment is present due to collectability issues resulting from a developer’s non-performance because of financial or other conditions.
Although we consider the allowance for losses on contract land deposits reflected on the December 31, 2010 balance sheet to be adequate (see Note 1 to the accompanying consolidated financial statements included herein), there can be no assurance that this allowance will prove to be adequate over time to cover losses due to unanticipated adverse changes in the economy or other events adversely affecting specific markets or the homebuilding industry.
Intangible Assets
Reorganization value in excess of identifiable assets (“excess reorganization value”) is an indefinite life intangible asset that was created upon our emergence from bankruptcy on September 30, 1993. Based on the allocation of our reorganization value, the portion of our reorganization value which was not attributed to specific tangible or intangible assets has been reported as excess reorganization value, which is treated similarly to goodwill. Excess reorganization value is not subject to amortization. Rather, excess reorganization value is subject to an impairment assessment on an annual basis or more frequently if changes in events or circumstances indicate that impairment may have occurred. Because excess reorganization value was based on the reorganization value of our entire enterprise upon bankruptcy emergence, the impairment assessment is conducted on an enterprise basis based on the comparison of our total equity compared to the market value of our outstanding publicly-traded common stock. We do not believe that excess reorganization value is impaired at this time. However, changes in strategy or continued adverse changes in market conditions could impact this judgment and require an impairment loss to be recognized if our book value, including excess reorganization value, exceeds the fair value.
Warranty/Product Liability Accruals
Warranty and product liability accruals are established to provide for estimated future costs as a result of construction and product defects, product recalls and litigation incidental to our business. Liability estimates are determined based on our judgment considering such factors as historical experience, the likely current cost of corrective action, manufacturers’ and subcontractors’ participation in sharing the cost of corrective action, consultations with third party experts such as engineers, and evaluations by our General Counsel and outside counsel retained to handle specific product liability cases. Although we consider the warranty and product liability accrual reflected on the December 31, 2010 balance sheet to be adequate (see Note 10 to the accompanying consolidated financial statements included herein), there can be no assurance that this accrual will prove to be adequate over time to cover losses due to increased costs for material and labor, the inability or refusal of manufacturers or subcontractors to financially participate in corrective action, unanticipated adverse legal settlements, or other unanticipated changes to the assumptions used to estimate the warranty and product liability accrual.
Stock-Based Compensation Expense
Compensation costs related to our stock based compensation plans are recognized within our income statement. The costs recognized are based on the grant date fair value. Compensation cost for share-based grants is recognized on a straight-line basis over the requisite service period for the entire award (from the date of grant through the period of the last separately vesting portion of the grant).
We calculate the fair value of our non-publicly traded, employee stock options using the Black-Scholes option-pricing model. While the Black-Scholes model is a widely accepted method to calculate the fair value of options, its results are dependent on input variables, two of which, expected term and expected volatility, are significantly dependent on management’s judgment. We have concluded that our historical exercise experience is the best estimate of future exercise patterns to determine an option’s expected term. To estimate expected volatility, we analyze the historical volatility of our common stock over a period equal to the option’s expected term. Changes in management’s judgment of the expected term and the expected volatility could have a material effect on the grant-date fair value calculated and expensed within the income statement. In addition, we are required to estimate future grant forfeitures when considering the amount of stock-based compensation costs to record. We have concluded that our historical forfeiture rate is the best measure to base our estimate of future forfeitures of equity-based compensation grants. However, there can be no assurance that our future forfeiture rate will not be materially higher or lower than our historical forfeiture rate, which would affect the aggregate cumulative compensation expense recognized.
Mortgage Loan Loss Allowance
We originate several different loan products to our customers to finance the purchase of their home. We sell all of the loans we originate into the secondary mortgage market generally within 30 days from origination. All of the loans that we originate are underwritten to the standards and specifications of the ultimate investor. Those underwriting standards are typically equal to or more stringent than the underwriting standards required by FNMA, VA and FHA. Insofar as we underwrite our originated loans to those standards, we bear no increased concentration of credit risk from the issuance of loans, except in certain limited instances where early payment default occurs. We employ a quality control department to ensure that our underwriting controls are effectively operating, and further assess the underwriting function as part of our assessment of internal controls over financial reporting. We maintain an allowance for losses on mortgage loans originated that reflects our judgment of the present loss exposure in the loans that we have originated and sold. The allowance is calculated based on an analysis of historical experience and anticipated losses on mortgages held for investment, real estate owned, and specific expected loan repurchases or indemnifications. Although we consider the allowance for loan losses reflected on the December 31, 2010 balance sheet to be adequate (see Note 12 to the accompanying consolidated financial statements included herein), there can be no assurance that this allowance will prove to be adequate over time to cover losses due to unanticipated changes to the assumptions used to estimate the mortgage loan loss allowance.
Impact of Inflation, Changing Prices and Economic Conditions
See Risk Factors included in Item 1A herein. See also the discussion above under Overview of Current Business Environment.
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