filings.toolsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
95K characters. Original on sec.gov · Markdown
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
| --- | --- |
(dollars in thousands, except per share data)
Results of Operations for the Years Ended December 31, 2013, 2012 and 2011
Overview
Business
Our primary business is the construction and sale of single-family detached homes, townhomes and condominium buildings, all of which are primarily constructed on a pre-sold basis. To fully serve customers of our homebuilding operations, we also operate a mortgage banking and title services business. We primarily conduct our operations in mature markets. Additionally, we generally grow our business through market share gains in our existing markets and by expanding into markets contiguous to our current active markets. Our four homebuilding reportable segments consist of the following regions:
| Mid Atlantic: | Maryland, Virginia, West Virginia, Delaware and Washington, D.C. | |
| North East: | New Jersey and eastern Pennsylvania | |
| Mid East: | New York, Ohio, western Pennsylvania, Indiana and Illinois | |
| South East: | North Carolina, South Carolina, Tennessee and Florida |
Table of Contents
Our lot acquisition strategy is predicated upon avoiding the financial requirements and risks associated with direct land ownership and development. Historically, we generally have not engaged in land development to obtain finished lots for use in our homebuilding operations. Instead, we have acquired finished lots at market prices from various third party land developers pursuant to fixed price purchase agreements. These purchase agreements require deposits, typically ranging up to 10% of the aggregate purchase price of the finished lots, in the form of cash or letters of credit that may be forfeited if we fail to perform under the purchase agreement. This strategy has allowed us to maximize inventory turnover, which we believe enables us to minimize market risk and to operate with less capital, thereby enhancing rates of return on equity and total capital.
Our continued success is contingent upon our ability to control an adequate supply of finished lots on which to build and on our developers’ ability to deliver finished lots to meet the sales demands of our customers. However, during the past several years, the impact of economic conditions on the homebuilding industry has negatively impacted our developers’ ability to obtain acquisition and development financing and to raise equity investments to finance land development activity. As a result of the changing environment, in certain specific strategic circumstances we deviate from our historical lot acquisition strategy and engage in joint venture arrangements with land developers or directly acquire raw ground already zoned for its intended use for development. Once we acquire control of any raw ground, we determine whether to sell the raw parcel to a developer and enter into a fixed price purchase agreement with the developer to purchase the finished lots, or whether we will hire a developer to develop the land on our behalf. While joint venture arrangements and direct land development activity are not our preferred method of acquiring finished building lots, we may enter into additional transactions in the future on a limited basis where there exists a compelling strategic or prudent financial reason to do so. We expect, however, to continue to acquire substantially all of our finished lot inventory using fixed price purchase agreements with forfeitable deposits.
As of December 31, 2013, we controlled approximately 58,100 lots under purchase agreements with deposits in cash and letters of credit totaling approximately $296,600 and $2,500, respectively. In addition, we controlled approximately 6,000 lots through joint venture limited liability corporations with an aggregate investment of approximately $92,700. Further, as of December 31, 2013, we had approximately $41,300 in land under development, that once fully developed will result in approximately 650 lots for use in our homebuilding operations. Of the total finished lots expected to be developed, 125 lots are under contract to be sold to an unrelated party under lot purchase agreements. Included in the number of controlled lots are approximately 9,200 lots for which we have recorded a contract land deposit impairment reserve of approximately $59,800 as of December 31, 2013. See Notes 3, 4 and 5 to the consolidated financial statements included herein for additional information regarding fixed price purchase agreements, joint ventures and land under development, respectively.
In addition to constructing homes primarily on a pre-sold basis and utilizing what we believe is a conservative lot acquisition strategy, we focus on obtaining and maintaining a leading market position in each market we serve. This strategy allows us to gain valuable efficiencies and competitive advantages in our markets, which we believe contributes to minimizing the adverse effects of regional economic cycles and provides growth opportunities within these markets.
Current Business Environment and Key Financial Results
During 2013, sales trends in the first six months were stronger than the last six months of the year. During the first half of 2013, the homebuilding market continued to experience the favorable sales and pricing trends which began in 2012, driven by historically low mortgage interest rates and rising costs in the rental market which contributed to higher levels of housing affordability. Sales trends in the second half of 2013 were negatively impacted by increasing mortgage interest rates, higher home prices and buyer uncertainty. The housing market also continues to face challenges from tight mortgage underwriting standards. While we have benefited from generally improved market conditions, we continue to face gross margin pressure due to increasing land and construction costs.
Table of Contents
Our consolidated revenues for the year ended December 31, 2013 totaled $4,211,267, an increase of 32% from $3,184,650 in 2012. Net income for 2013 increased 48% from the prior year to $266,477. Diluted earnings per share in 2013 was $54.81, an increase of 56% from the prior year. New Orders for 2013 increased 8% from the prior year while our average new order sales price of $360.4 in 2013 was 10% higher than the prior year.
We believe that the continuation of the housing market recovery which began in 2012 is dependent upon a sustained overall economic recovery, driven by continued improvement in unemployment and consumer confidence levels. Due to the strength of our balance sheet, we believe that we are well positioned to take advantage of opportunities that may arise from future economic and homebuilding market volatility.
Homebuilding Operations
The following table summarizes the results of our consolidated homebuilding operations and certain operating activity for each of the last three years:
| Year Ended December 31, | ||||||||||||
| 2013 | 2012 | 2011 | ||||||||||
| Revenues | $ | 4,134,481 | $ | 3,121,244 | $ | 2,611,195 | ||||||
| Cost of sales | $ | 3,424,204 | $ | 2,575,639 | $ | 2,165,625 | ||||||
| Gross profit margin percentage | 17.2 | % | 17.5 | % | 17.1 | % | ||||||
| Selling, general and administrative expenses | $ | 313,029 | $ | 301,184 | $ | 264,266 | ||||||
| Settlements (units) | 11,834 | 9,843 | 8,487 | |||||||||
| Average settlement price | $ | 349.1 | $ | 317.1 | $ | 307.5 | ||||||
| New orders (units) | 11,800 | 10,954 | 9,247 | |||||||||
| Average new order price | $ | 360.4 | $ | 328.8 | $ | 304.1 | ||||||
| Backlog (units) | 4,945 | 4,979 | 3,676 | |||||||||
| Average backlog price | $ | 373.2 | $ | 346.2 | $ | 315.8 | ||||||
| New order cancellation rate | 14.9 | % | 14.5 | % | 13.6 | % |
Consolidated Homebuilding Revenues
Homebuilding revenues for 2013 increased 32% from 2012, as a result of a 20% increase in the number of homes settled and a 10% increase in the average settlement price year over year. The increase in the number of homes settled was primarily attributable to a 35% higher beginning backlog unit balance entering 2013 as compared to 2012, offset partially by a lower backlog turnover rate in 2013 compared to 2012. Average settlement prices in the current year were favorably impacted primarily by a 10% higher average price of homes in backlog entering 2013 compared to the average price of homes in backlog entering 2012 and a 10% higher average sales price of New Orders for the first six months of 2013 compared to 2012. The higher beginning backlog balance and average sales prices were driven by the favorable market conditions discussed in the Overview section above.
Homebuilding revenues for 2012 increased 20% from 2011, as a result of a 16% increase in the number of homes settled and a 3% increase in the average settlement price year over year. The increase in the number of homes settled was attributable to an 18% increase in New Orders during the first half of 2012 compared to the same period in 2011, coupled with a 26% higher beginning backlog unit balance entering 2012 as compared to 2011. These increases were offset partially by a lower backlog turnover rate in 2012 compared to 2011. Average settlement prices in 2012 were favorably impacted by a 7% higher average sales price of New Orders during the first six months of 2012 as compared to the same period in 2011, offset partially by a 4% lower average price of homes in backlog entering 2012 compared to the average price of homes in backlog entering 2011.
Table of Contents
Consolidated Homebuilding New Orders
New Orders and the average sales price of New Orders in 2013 increased 8% and 10%, respectively, when compared to 2012. New Orders and the average sales price were higher year over year in each of our market segments. The increase in New Orders was driven by a 12% increase in the number of active communities year over year, offset partially by a lower absorption rate in 2013. In addition, our December 2012 acquisition of Heartland Homes added 355 New Orders in 2013. The increase in active communities and pricing in 2013 was attributable to the favorable market conditions through the first half of 2013 as discussed in the Overview section above.
New Orders and the average sales price of New Orders in 2012 increased 18% and 8%, respectively, when compared to 2011. New Orders and the average sales price were higher year over year in each of our market segments. The increase in New Orders was driven by a 5% increase in the number of active communities year over year and by improved absorption rates in many of our markets. The increase in New Orders as well as in the average New Order sales price was attributable to improved market conditions in 2012.
Consolidated Homebuilding Gross Profit
Gross profit margins in 2013 decreased to 17.2% from 17.5% in 2012. Gross profit margins were negatively impacted in 2013 by two warranty accrual charges. The first charge of approximately $15,600 was recognized in the second quarter of 2013 related to remediation of primarily water infiltration issues in a single completed community. The water infiltration issues were the result of a design issue with several products developed for and built exclusively in that one community. The second charge of approximately $16,000 was recorded in the fourth quarter of 2013 to increase the warranty accrual for a non-recurring service issue unrelated to the second quarter service issue. Excluding these charges, gross profit margin was 17.9%, an increase of 46 basis points from the prior year. Gross profit margin was favorably impacted by higher settlement volume in the current year allowing us to better leverage our operating costs, partially offset by higher construction costs, including lumber and certain other commodity costs, year over year. We expect to continue to experience gross profit margin pressure over the next several quarters due to cost and pricing pressures.
Gross profit margins in 2012 increased to 17.5% from 17.1% in 2011. Margins were favorably impacted in 2012 by a $2,000 recovery of contract land deposits previously determined to be uncollectible compared to an $11,200 contract land deposit impairment charge in 2011. In addition, increased settlement volume and higher average settlement prices in 2012 allowed us to better leverage certain operating costs. However, this favorable impact was offset by higher construction, lumber and certain other commodity costs year over year.
Consolidated Homebuilding Selling, General and Administrative (“SG&A”)
SG&A expenses in 2013 increased approximately $11,800, or 4%, compared to 2012, but as a percentage of revenue decreased to 7.6% in 2013 from 9.7% in 2012. The increase in SG&A expense was attributable to increases of approximately $20,300 in personnel costs in 2013 due to an increase in headcount year over year. In addition, sales and marketing costs were approximately $14,400 higher in 2013 due to the increase in the number of active communities. These cost increases were partially offset by an approximate $28,700 reduction in equity-based compensation in 2013 compared to 2012. Equity-based compensation was favorably impacted as a result of the restricted share units (“RSUs”) issued in 2010 becoming fully vested as of December 31, 2012 and the reversal of approximately $7,100 in equity-based compensation expense previously recorded to SG&A expense as we adjusted our stock option forfeiture rates based on our actual forfeiture experience. These reductions were offset partially by equity-based compensation expense incurred in 2013 related to RSUs issued in May 2013. The decrease in SG&A costs as a percentage of revenue was driven by the 32% increase in revenue in 2013, allowing us to better leverage our overhead costs.
SG&A expenses in 2012 increased approximately $36,900, or 14%, compared to 2011, but as a percentage of revenue decreased to 9.7% in 2012 from 10.1% in the prior year. The increase in SG&A expense was attributable to an increase of approximately $19,700 in management incentive costs driven by improved
Table of Contents
financial results in 2012. In addition, personnel costs and sales and marketing costs were approximately $9,400 and $6,400 higher, respectively, in 2012 due primarily to the 5% increase in the number of active communities compared to 2011. SG&A expenses decreased as a percentage of revenue due to the 20% increase in revenues in 2012 compared to 2011.
Consolidated Homebuilding Backlog
Backlog units decreased approximately 1% to 4,945 as of December 31, 2013 compared to 4,979 as of December 31, 2012, while backlog dollars increased approximately 7% to $1,845,600 from $1,723,914 as of December 31, 2013 and December 31, 2012, respectively. Backlog dollars were higher primarily due to a 10% increase in the average price of New Orders for the six-month period ended December 31, 2013 compared to the same period in 2012.
Backlog, which represents homes sold but not yet settled with the customer, may be impacted by customer cancellations for various reasons that are beyond our control, such as failure to obtain mortgage financing, inability to sell an existing home, job loss, or a variety of other reasons. In any period, a portion of the cancellations that we experience are related to new sales that occurred during the same period, and a portion are related to sales that occurred in prior periods and therefore appeared in the opening backlog for the current period. Expressed as the total of all cancellations during the period as a percentage of gross sales during the period, our cancellation rate was approximately 15% in both 2013 and 2012, and 14% in 2011. During each of 2013, 2012 and 2011, approximately 6% of a reporting quarter’s opening backlog cancelled during the fiscal quarter. We can provide no assurance that our historical cancellation rates are indicative of the actual cancellation rate that may occur in future periods. Other than those units that are cancelled, we expect to settle substantially all of our December 31, 2013 backlog during 2014. See “Risk Factors” in Item 1A of this report.
The backlog turnover rate is impacted by various factors, including, but not limited to, changes in New Order activity, internal production capacity, external subcontractor capacity and other external factors over which we do not exercise control.
Backlog units and dollars increased approximately 35% to 4,979 and 49% to $1,723,914, respectively, as of December 31, 2012, compared to 3,676 and $1,160,879 as of December 31, 2011. The increase in backlog units was primarily attributable to New Orders being approximately 800 units higher for the six month period ended December 31, 2012 compared to the same period in 2011, coupled with a slower backlog turnover rate in 2012. In addition, our December 31, 2012 acquisition of Heartland Homes added approximately 200 units and $81,600 to the 2012 year-end backlog. The increase in backlog dollars is attributable to the increase in units and to a 9% higher average sales price for New Orders for the six month period ended December 31, 2012.
Table of Contents
Reportable Homebuilding Segments
Homebuilding profit before tax includes all revenues and income generated from the sale of homes, less the cost of homes sold, SG&A expenses, and a corporate capital allocation charge. The corporate capital allocation charge eliminates in consolidation, is based on the segment’s average net assets employed, and is charged using a consistent methodology in the years presented. The corporate capital allocation charged to the operating segment allows the Chief Operating Decision Maker to determine whether the operating segment’s results are providing the desired rate of return after covering our cost of capital. We record charges on contract land deposits when we determine that it is probable that recovery of the deposit is impaired. For segment reporting purposes, impairments on contract land deposits are generally charged to the operating segment upon the determination to terminate a finished lot purchase agreement with the developer or to restructure a lot purchase agreement resulting in the forfeiture of the deposit. We evaluate our entire net contract land deposit portfolio for impairment each quarter. For additional information regarding our contract land deposit impairment analysis, see the Critical Accounting Policies section within this Management Discussion and Analysis of Financial Condition and Results of Operations. For presentation purposes below, the contract land deposit reserve at December 31, 2013 and 2012 has been allocated to the reportable segments to show contract land deposits on a net basis. The net contract land deposit balances below also includes approximately $2,500 and $3,300 at December 31, 2013 and 2012, respectively, of letters of credit issued as deposits in lieu of cash. The following tables summarize certain homebuilding operating activity by reportable segment for each of the last three years:
Selected Segment Financial Data:
| Year Ended December 31, | ||||||||||||
| 2013 | 2012 | 2011 | ||||||||||
| Revenues: | ||||||||||||
| Mid Atlantic | $ | 2,439,387 | $ | 1,877,905 | $ | 1,582,826 | ||||||
| North East | 332,681 | 278,715 | 221,146 | |||||||||
| Mid East | 908,198 | 630,367 | 549,384 | |||||||||
| South East | 454,215 | 334,257 | 257,839 | |||||||||
| Gross profit margin: | ||||||||||||
| Mid Atlantic | $ | 461,481 | $ | 345,009 | $ | 286,266 | ||||||
| North East | 45,860 | 48,329 | 37,220 | |||||||||
| Mid East | 142,331 | 103,128 | 85,385 | |||||||||
| South East | 77,277 | 55,788 | 42,116 | |||||||||
| Segment profit: | ||||||||||||
| Mid Atlantic | $ | 276,399 | $ | 189,089 | $ | 148,373 | ||||||
| North East | 14,294 | 21,529 | 13,463 | |||||||||
| Mid East | 55,537 | 39,847 | 27,194 | |||||||||
| South East | 35,001 | 20,674 | 14,162 | |||||||||
| Gross profit margin percentage: | ||||||||||||
| Mid Atlantic | 18.9 | % | 18.4 | % | 18.1 | % | ||||||
| North East | 13.8 | % | 17.3 | % | 16.8 | % | ||||||
| Mid East | 15.7 | % | 16.4 | % | 15.5 | % | ||||||
| South East | 17.0 | % | 16.7 | % | 16.3 | % |
Segment Operating Activity:
| Year Ended December 31, | ||||||||||||||||||||||||
| 2013 | 2012 | 2011 | ||||||||||||||||||||||
| Average | Average | Average | ||||||||||||||||||||||
| Units | Price | Units | Price | Units | Price | |||||||||||||||||||
| Settlements: | ||||||||||||||||||||||||
| Mid Atlantic | 6,029 | $ | 404.0 | 5,047 | $ | 372.1 | 4,238 | $ | 373.4 | |||||||||||||||
| North East | 1,013 | $ | 328.4 | 889 | $ | 313.5 | 728 | $ | 303.6 | |||||||||||||||
| Mid East | 3,023 | $ | 300.4 | 2,472 | $ | 255.0 | 2,335 | $ | 235.1 | |||||||||||||||
| South East | 1,769 | $ | 256.7 | 1,435 | $ | 232.8 | 1,186 | $ | 217.1 | |||||||||||||||
| Total | 11,834 | $ | 349.1 | 9,843 | $ | 317.1 | 8,487 | $ | 307.5 | |||||||||||||||
Table of Contents
| Year Ended December 31, | ||||||||||||||||||||||||
| 2013 | 2012 | 2011 | ||||||||||||||||||||||
| Average | Average | Average | ||||||||||||||||||||||
| Units | Price | Units | Price | Units | Price | |||||||||||||||||||
| New orders, net of cancellations: | ||||||||||||||||||||||||
| Mid Atlantic | 6,056 | $ | 416.7 | 5,757 | $ | 382.9 | 4,616 | $ | 364.2 | |||||||||||||||
| North East | 1,075 | $ | 335.5 | 946 | $ | 325.3 | 872 | $ | 300.1 | |||||||||||||||
| Mid East | 2,903 | $ | 309.5 | 2,625 | $ | 264.2 | 2,412 | $ | 238.7 | |||||||||||||||
| South East | 1,766 | $ | 265.9 | 1,626 | $ | 243.7 | 1,347 | $ | 218.1 | |||||||||||||||
| Total | 11,800 | $ | 360.4 | 10,954 | $ | 328.8 | 9,247 | $ | 304.1 | |||||||||||||||
| Backlog: | ||||||||||||||||||||||||
| Mid Atlantic | 2,710 | $ | 422.7 | 2,683 | $ | 394.2 | 1,973 | $ | 370.3 | |||||||||||||||
| North East | 495 | $ | 345.5 | 433 | $ | 330.2 | 376 | $ | 303.0 | |||||||||||||||
| Mid East | 1,032 | $ | 323.0 | 1,152 | $ | 297.8 | 807 | $ | 245.6 | |||||||||||||||
| South East | 708 | $ | 276.5 | 711 | $ | 253.4 | 520 | $ | 227.0 | |||||||||||||||
| Total | 4,945 | $ | 373.2 | 4,979 | $ | 346.2 | 3,676 | $ | 315.8 | |||||||||||||||
Operating Data:
| Year Ended December 31, | ||||||||||||
| 2013 | 2012 | 2011 | ||||||||||
| New order cancellation rate: | ||||||||||||
| Mid Atlantic | 14.9 | % | 13.4 | % | 13.3 | % | ||||||
| North East | 15.0 | % | 16.8 | % | 13.1 | % | ||||||
| Mid East | 13.5 | % | 15.0 | % | 14.6 | % | ||||||
| South East | 16.8 | % | 16.0 | % | 13.0 | % | ||||||
| Average active communities: | ||||||||||||
| Mid Atlantic | 220 | 198 | 188 | |||||||||
| North East | 39 | 38 | 34 | |||||||||
| Mid East | 125 | 105 | 106 | |||||||||
| South East | 67 | 63 | 56 | |||||||||
| Total | 451 | 404 | 384 | |||||||||
Homebuilding Inventory:
| As of December 31, | ||||||||
| 2013 | 2012 | |||||||
| Sold inventory: | ||||||||
| Mid Atlantic | $ | 354,407 | $ | 319,958 | ||||
| North East | 57,541 | 41,447 | ||||||
| Mid East | 93,189 | 97,115 | ||||||
| South East | 57,631 | 49,305 | ||||||
| Total (1) | $ | 562,768 | $ | 507,825 | ||||
| Unsold lots and housing units inventory: | ||||||||
| Mid Atlantic | $ | 77,266 | $ | 46,007 | ||||
| North East | 3,881 | 3,645 | ||||||
| Mid East | 12,772 | 20,105 | ||||||
| South East | 8,834 | 8,985 | ||||||
| Total (1) | $ | 102,753 | $ | 78,742 | ||||
| (1) | The reconciling items between segment inventory and consolidated inventory include certain consolidation adjustments necessary to convert the reportable segments’ results, which are predominantly maintained on a cash basis, to a full accrual basis for external financial statement presentation purposes and are not allocated to our operating segments. |
|---|
Table of Contents
| Year Ended December 31, | ||||||||||||
| 2013 | 2012 | 2011 | ||||||||||
| Sold and unsold inventory impairments: | ||||||||||||
| Mid Atlantic | $ | 222 | $ | 349 | $ | 1,045 | ||||||
| North East | 47 | 19 | 246 | |||||||||
| Mid East | 923 | 72 | 554 | |||||||||
| South East | 82 | 102 | 228 | |||||||||
| Total | $ | 1,274 | $ | 542 | $ | 2,073 | ||||||
Lots Controlled and Land Deposits:
| As of December 31, | ||||||||
| 2013 | 2012 | |||||||
| Total lots controlled: | ||||||||
| Mid Atlantic | 32,646 | 30,969 | ||||||
| North East | 5,388 | 4,772 | ||||||
| Mid East | 16,420 | 15,409 | ||||||
| South East | 10,166 | 7,348 | ||||||
| Total | 64,620 | 58,498 | ||||||
| Lots included in impairment reserve: | ||||||||
| Mid Atlantic | 4,393 | 5,335 | ||||||
| North East | 876 | 549 | ||||||
| Mid East | 2,555 | 2,515 | ||||||
| South East | 1,345 | 1,771 | ||||||
| Total | 9,169 | 10,170 | ||||||
| Contract land deposits, net | ||||||||
| Mid Atlantic | $ | 156,570 | $ | 137,192 | ||||
| North East | 16,174 | 13,553 | ||||||
| Mid East | 39,907 | 29,094 | ||||||
| South East | 26,693 | 15,037 | ||||||
| Total | $ | 239,344 | $ | 194,876 | ||||
| Year Ended December 31, | ||||||||||||
| 2013 | 2012 | 2011 | ||||||||||
| Contract land deposit impairments (recoveries): | ||||||||||||
| Mid Atlantic | $ | (715 | ) | $ | 464 | $ | 6,741 | |||||
| North East | 803 | 1,588 | 818 | |||||||||
| Mid East | 173 | 1,075 | 493 | |||||||||
| South East | 119 | 203 | 311 | |||||||||
| Total | $ | 380 | $ | 3,330 | $ | 8,363 | ||||||
Table of Contents
Mid Atlantic
2013 versus 2012
The Mid Atlantic segment had an approximate $87,300, or 46%, increase in segment profit in 2013 compared to 2012. The increase in segment profit was driven by the increase of approximately $561,500, or 30%, in revenues year over year due to a 20% increase in the number of units settled and a 9% increase in the average settlement price. The increase in units settled was attributable to a 36% higher backlog unit balance entering 2013 compared to the backlog unit balance entering 2012, offset partially by a lower backlog turnover rate year over year. Settlements were also favorably impacted by a 14% increase in New Orders for the first six months of 2013 compared to the same period in 2012. Average settlement prices were higher due to a 6% higher average price of homes in backlog entering 2013 compared to the same period in 2012 and a 10% higher average sales price for New Orders during the first six months of 2013 compared to the same period in 2012. Gross profit margin in the current year was impacted by a charge of approximately $15,600, or 64 basis points of revenue, as discussed above in the Consolidated Homebuilding Gross Profit section, to establish an accrual related to remediation of primarily water infiltration issues in a single completed community. Excluding this charge, gross profit margin increased 119 basis points to 19.6% in the current year due to increased settlement volume, which allowed us to better leverage certain operating costs.
Segment New Orders and the average sales price increased 5% and 9%, respectively, in 2013 from 2012. New Orders increased due to an 11% increase in the number of active communities, partially offset by a lower absorption rate. The increase in the average sales price was attributable to a shift to higher priced communities in certain markets and favorable market conditions through the first half of 2013, which allowed us to increase prices in several markets within the Mid Atlantic segment.
2012 versus 2011
The Mid Atlantic segment had an approximate $40,700, or 27%, increase in segment profit in 2012 compared to 2011. The increase in segment profit was driven by the increase of approximately $295,100, or 19%, in revenues year over year due primarily to a 19% increase in the number of units settled. The increase in units settled was attributable to a 26% increase in New Orders during the first half of 2012 compared to the same period in 2011, coupled with a 24% higher backlog unit balance entering 2012 compared to the backlog unit balance entering 2011. These increases were partially offset by a slower backlog turnover rate in 2012 compared to 2011. The Mid Atlantic segment’s gross profit margin percentage increased to 18.4% in 2012 from 18.1% in 2011, primarily due to a 40 basis point decrease in contract land deposit impairment charges year over year. The favorable impact of the increased settlement volume in 2012, which allowed us to better leverage certain operating costs, was offset by higher construction, lumber and certain other commodity costs year over year.
Segment New Orders and the average sales price increased 25% and 5%, respectively, in 2012 compared to 2011. New Orders and the average sales price were higher in each of our markets within the Mid Atlantic segment. New Orders increased due to a 6% increase in the number of active communities and higher sales absorption driven by improved market conditions in 2012.
North East
2013 versus 2012
The North East segment had an approximate $7,200, or 34%, decrease in segment profit in 2013 compared to 2012. The decrease was attributable to a charge in the fourth quarter of 2013 to increase the warranty accrual for the non-recurring service issue discussed above in the Consolidated Homebuilding Gross Profit section. Excluding this charge to the segment of approximately $12,700, segment profit increased approximately $5,500, or 25% compared to 2012. Revenues in the segment increased approximately $54,000, or 19%, year over year due to a 14% increase in the number of units settled, coupled with a 5% increase in the
Table of Contents
average settlement price. The increase in units settled was attributable to a 15% higher backlog unit balance entering 2013 as compared to the backlog unit balance entering 2012, in addition to a 15% increase in New Orders for the first six months of 2013 compared to the same period in 2012. The average settlement price increased year over year due to a 9% higher average price of homes in backlog entering 2013 compared to the same period in 2012, and a 1% higher average sales price for New Orders during the first six months of 2013 compared to 2012. The North East segment’s gross profit margin percentage was down 356 basis points year over year. Excluding the warranty accrual charge discussed above of approximately $12,700, or 382 basis points of revenue, gross profit margin for the segment was 17.6%, an increase of 27 basis points compared to 2012.
Segment New Orders and the average sales price increased approximately 14% and 3%, respectively, in 2013 from 2012. New Orders were favorably impacted by higher sales absorption levels attributable to favorable market conditions through the first half of 2013 and a decrease in the cancellation rate year over year.
2012 versus 2011
The North East segment had an approximate $8,100, or 60%, increase in segment profit in 2012 compared to 2011. The increase in segment profit was primarily driven by an increase of approximately $57,600, or 26%, in revenues year over year due to a 22% increase in the number of units settled and a 3% increase in the average settlement price. The increase in units settled was attributable to a 62% higher backlog unit balance entering 2012 compared to the backlog unit balance entering 2011, coupled with an 8% increase in New Orders during the first half of 2012 compared to the same period in 2011. These increases were partially offset by a slower backlog turnover rate in 2012 compared to 2011. The increase in the average settlement price in 2012 was primarily attributable to a 9% increase in the average New Order sales price for the first six months of 2012 compared to the same period in 2011 due to a product mix shift from our attached products to our detached products which generally sell at higher price points. This increase was partially offset by a 4% lower average price of homes in backlog entering 2012 compared to the average price of homes in backlog entering 2011. The North East segment’s gross profit margin percentage increased approximately 50 basis points in 2012 compared to 2011. Segment profit and gross profit margins were favorably impacted by the previously mentioned higher average settlement price year over year. In addition, gross profit margins were favorably impacted by the higher settlement volumes, allowing us to better leverage certain operating costs in 2012. These favorable variances were partially offset by higher construction, lumber and certain other commodity costs year over year.
Segment New Orders and the average sales price each increased approximately 8% in 2012 compared to 2011. New Orders were favorably impacted by the improved market conditions in 2012 and by a 12% increase in the number of active communities in 2012 compared to 2011. This favorable impact was partially offset by an increase in the cancellation rate in the North East segment to 16.8% in 2012 from 13.1% in the prior year. The increase in the average sales price is attributable to a product mix shift away from our attached products to our detached products which generally sell at higher price points.
Mid East
2013 versus 2012
The Mid East segment had an approximate $15,700, or 39%, increase in segment profit in 2013 compared to 2012. The increase in segment profit was driven by an increase in revenues of approximately $277,800, or 44%, year over year due to a 22% increase in the number of units settled and an 18% increase in the average settlement price. The increase in settlements was primarily attributable to a 43% higher backlog unit balance entering 2013 compared to the same period in 2012, coupled with a 21% increase in New Orders during the first half of 2013 compared to the same period in 2012. The higher backlog balance entering 2013 was in part attributable to our Heartland Homes acquisition, which added approximately 200 units and $81,600 to backlog at December 31, 2012. Average settlement prices were higher due to a 21% higher average price of homes in backlog entering 2013 compared to 2012 resulting from a shift in mix to higher priced communities as well as to the higher average price of homes in the backlog acquired from Heartland Homes. In addition, the average settlement price was favorably impacted by a 17% increase in the average New Order sales price during the first
Table of Contents
half of 2013 compared to the same period in 2012. Gross profit margin decreased to 15.7% in 2013 from 16.4% in 2012, due to the lower average gross profit margin associated with the Heartland Homes backlog acquired, and higher construction costs, including lumber and certain other commodity costs. These cost increases were partially offset by the favorable impact of increased settlement volume which allowed us to better leverage certain operating costs.
Segment New Orders and the average sales price for New Orders increased 11% and 17%, respectively, during 2013 compared to 2012. New Orders increased due to 355 New Orders from Heartland Homes. The increase in the average New Order sales price was attributable to a shift in mix to higher priced communities in certain markets, including higher average sales prices associated with the Heartland Homes New Orders, coupled with favorable market conditions through the first half of 2013 which allowed us to increase prices in certain markets.
2012 versus 2011
The Mid East segment had an approximate $12,700, or 47%, increase in segment profit in 2012 compared to 2011 due primarily to an increase in revenues of approximately $81,000, or 15%, year over year. Revenues increased due to a 6% increase in the number of units settled and a 9% increase in the average price of settlements in 2012 compared to 2011. The increase in units settled was attributable to an 11% higher backlog unit balance entering 2012 compared to the backlog unit balance entering 2011, coupled with a 7% increase in New Orders during the first half of 2012 compared to the same period in 2011. These increases were partially offset by a slower backlog turnover rate in 2012 compared to 2011. Average settlement prices were favorably impacted by an 11% increase in the average New Order sales price for the first six months of 2012 compared to the same period in 2011 due to a shift in mix to higher priced communities in certain markets. Gross profit margins increased approximately 80 basis points in 2012 from 2011 primarily as a result of the increase in the average settlement price, as well as from the increase in the number of settlements, allowing us to better leverage certain operating costs in 2012. These favorable variances were partially offset by higher construction, lumber and certain other commodity costs year over year.
Segment New Orders and the average sales price for New Orders increased 9% and 11%, respectively, in 2012 compared to 2011. New Orders were favorably impacted by the improved market conditions in 2012 which contributed in part to higher sales absorption levels. The increase in the average sales price was attributable to a shift in mix to higher priced communities in certain markets.
The increases to the Mid East segment’s 2012 backlog, sold and unsold inventory, lots controlled and contract land deposit balances were all in part driven by the Heartland Homes acquisition on December 31, 2012. The acquisition did not impact sales or settlement results in 2012.
South East
2013 versus 2012
The South East segment had an approximate $14,300, or 69%, increase in segment profit in 2013 compared to 2012, primarily due to an increase in revenues of approximately $120,000, or 36%, year over year. Segment revenues were higher due to a 23% increase in the number of units settled and a 10% increase in the average settlement price. The increase in settlements was attributable to a 37% higher backlog unit balance entering 2013 compared to 2012 and a 29% increase in New Orders for the first six months of 2013 compared to the same period in 2012. These increases were partially offset by a lower backlog turnover rate year over year. The average settlement price was favorably impacted by a 12% higher average price of homes in backlog entering 2013 compared to the same period in 2012, as well as by a 9% increase in the average sales price of homes in the first six months of 2013 compared to the same period in 2012. The South East segment’s gross profit margin increased 32 basis points in 2013 from 2012 primarily due to the favorable impact of increased settlement volume, which allowed us to better leverage certain operating costs.
Table of Contents
Segment New Orders and the average sales price for New Orders each increased approximately 9% in 2013 from 2012. New Orders increased due to a 7% increase in the number of active communities and higher sales absorption levels driven by favorable market conditions through the first half of 2013. The increase in the average sales price for New Orders was attributable to a shift in mix of New Orders to higher priced communities in certain markets.
2012 versus 2011
The South East segment had an approximate $6,500, or 46%, increase in segment profit in 2012 compared to 2011, primarily due to an increase in revenues of approximately $76,400, or 30%, year over year. Segment revenues were higher primarily due to a 21% increase in the number of homes settled and a 7% increase in the average settlement price year over year. The increase in settlements was attributable to a 45% higher backlog unit balance entering 2012 compared to 2011, coupled with a 23% increase in New Orders during the first half of 2012 compared to the same period in 2011. These increases were partially offset by a slower backlog turnover rate in 2012 compared to 2011. Average settlement prices were favorably impacted by a 12% increase in the average New Order sales price for the first six months of 2012 compared to the same period in 2011 attributable to a shift in mix to higher priced markets and higher priced communities in certain markets. The South East segment’s gross profit margins in 2012 increased approximately 40 basis points from 2011 primarily due to the higher average settlement prices and improved operating leverage attributable to higher settlement volume year over year. These favorable variances were partially offset by higher construction, lumber and certain other commodity costs year over year.
Segment New Orders and the average sales price for New Orders increased approximately 21% and 12%, respectively, in 2012 compared to 2011. New Orders were favorably impacted in 2012 by a 12% increase in the number of active communities and by the improved market conditions in 2012 which contributed in part to higher sales absorption levels. The increase in the average sales price for New Orders was attributable to a shift in mix to higher priced markets and higher priced communities in certain markets.
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), equity-based compensation expense, consolidation adjustments and external corporate interest expense. Our overhead functions, such as accounting, treasury and human resources, 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, equity-based compensation expense is not charged to the operating segments. External corporate interest expense is primarily comprised of interest charges on our 3.95% Senior Notes due 2022 (the “Senior Notes”), and is not charged to the operating segments because the charges are included in the corporate capital allocation discussed above.
Table of Contents
| Year Ended December 31, | ||||||||||||
| 2013 | 2012 | 2011 | ||||||||||
| Homebuilding Consolidated Gross Profit: | ||||||||||||
| Homebuilding Mid Atlantic | $ | 461,481 | $ | 345,009 | $ | 286,266 | ||||||
| Homebuilding North East | 45,860 | 48,329 | 37,220 | |||||||||
| Homebuilding Mid East | 142,331 | 103,128 | 85,385 | |||||||||
| Homebuilding South East | 77,277 | 55,788 | 42,116 | |||||||||
| Consolidation adjustments and other | (16,672 | ) | (6,649 | ) | (5,417 | ) | ||||||
| Consolidated homebuilding gross profit | $ | 710,277 | $ | 545,605 | $ | 445,570 | ||||||
| Homebuilding Consolidated Profit Before Tax: | ||||||||||||
| Homebuilding Mid Atlantic | $ | 276,399 | $ | 189,089 | $ | 148,373 | ||||||
| Homebuilding North East | 14,294 | 21,529 | 13,463 | |||||||||
| Homebuilding Mid East | 55,537 | 39,847 | 27,194 | |||||||||
| Homebuilding South East | 35,001 | 20,674 | 14,162 | |||||||||
| Reconciling items: | ||||||||||||
| Contract land deposit impairment reserve (1) | 5,313 | 5,333 | (2,878 | ) | ||||||||
| Equity-based compensation expense (2) | (31,547 | ) | (60,859 | ) | (61,359 | ) | ||||||
| Corporate capital allocation (3) | 116,457 | 91,507 | 71,226 | |||||||||
| Unallocated corporate overhead (4) | (72,703 | ) | (70,258 | ) | (45,355 | ) | ||||||
| Consolidation adjustments and other | 2,362 | 10,858 | 20,477 | |||||||||
| Corporate interest expense (5) | (21,743 | ) | (6,796 | ) | (715 | ) | ||||||
| Reconciling items sub-total | (1,861 | ) | (30,215 | ) | (18,604 | ) | ||||||
| Homebuilding consolidated profit before taxes | $ | 379,370 | $ | 240,924 | $ | 184,588 | ||||||
| (1) | This item represents changes to the contract land deposit impairment reserve, which are not allocated to the reportable segments. |
|---|
| (2) | Equity-based compensation expense was lower in 2013 due to RSUs issued in 2010 under the 2010 Equity Incentive Plan becoming fully vested effective December 31, 2012 and an approximate $7,450 pre-tax compensation expense reversal attributable to an adjustment of our option forfeiture rates based on our actual forfeiture experience. These reductions were partially offset by equity-based compensation expense incurred in 2013 related to RSUs issued in May 2013 under the 2010 Equity Incentive Plan. |
|---|
| (3) | 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, | ||||||||||||
| 2013 | 2012 | 2011 | ||||||||||
| Homebuilding Mid Atlantic | $ | 72,271 | $ | 59,144 | $ | 48,697 | ||||||
| Homebuilding North East | 9,461 | 8,187 | 5,763 | |||||||||
| Homebuilding Mid East | 22,580 | 15,039 | 11,074 | |||||||||
| Homebuilding South East | 12,145 | 9,137 | 5,692 | |||||||||
| Total | $ | 116,457 | $ | 91,507 | $ | 71,226 | ||||||
| (4) | The increase in unallocated corporate overhead in 2012 from 2011 was attributable to increased management incentive costs year over year. |
|---|
| (5) | Corporate interest expense is attributable primarily to interest on our Senior Notes which were issued in the third quarter of 2012. |
|---|
Table of Contents
Mortgage Banking Segment
We conduct our mortgage banking activity through 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, 2013, 2012 and 2011:
| 2013 | 2012 | 2011 | ||||||||||
| Loan closing volume: | ||||||||||||
| Total principal | $ | 2,538,072 | $ | 2,206,092 | $ | 1,868,472 | ||||||
| Loan volume mix: | ||||||||||||
| Adjustable rate mortgages | 6 | % | 5 | % | 9 | % | ||||||
| Fixed-rate mortgages | 94 | % | 95 | % | 91 | % | ||||||
| Operating profit: | ||||||||||||
| Segment profit | $ | 42,075 | $ | 38,135 | $ | 26,102 | ||||||
| Equity-based compensation expense | (2,749 | ) | (3,982 | ) | (3,114 | ) | ||||||
| Mortgage banking income before tax | $ | 39,326 | $ | 34,153 | $ | 22,988 | ||||||
| Capture rate: | 81 | % | 87 | % | 88 | % | ||||||
| Mortgage banking fees: | ||||||||||||
| Net gain on sale of loans | $ | 56,528 | $ | 47,019 | $ | 34,632 | ||||||
| Title services | 19,862 | 15,977 | 12,769 | |||||||||
| Servicing fees | 396 | 410 | 553 | |||||||||
| $ | 76,786 | $ | 63,406 | $ | 47,954 | |||||||
2013 versus 2012
Loan closing volume for the year ended December 31, 2013 increased 15% from 2012. The increase was primarily attributable to a 7% increase in the number of units closed and an 8% increase in the average loan amount year over year. The increase in the number of units closed and the increase in the average loan amount are primarily attributable to the aforementioned increase in the homebuilding segment’s number of units settled and the increase in the average settlement prices in 2013 as compared to 2012, partially offset by a decrease in the number of loans closed by NVRM for our homebuyers who obtain a mortgage to purchase a home (“Capture Rate”). The Capture Rate decreased from 87% in 2012 to 81% in 2013 primarily due to a more competitive market for mortgage loans as other lenders’ refinancing activity slowed.
Segment profit for the year ended December 31, 2013 increased approximately $3,900 from 2012. The increase in segment profit was primarily attributable to an approximate $13,400 increase in mortgage banking fees, partially offset by an approximate $10,000 increase in general and administrative expenses. The increase in mortgage banking fees was primarily attributable to the aforementioned 15% increase in closed loan volume and an increase in secondary marketing fees. The increase in general and administrative expenses is primarily attributable to an increase in compensation costs as a result of a 43% increase in headcount compared to 2012.
Table of Contents
2012 versus 2011
Loan closing volume for the year ended December 31, 2012 increased 18% from 2011. The 2012 increase was primarily attributable to a 14% increase in the number of units closed and a 3% increase in the average loan amount year over year. The increase in the number of units closed and the increase in the average loan amount are primarily attributable to the aforementioned increase in the homebuilding segment’s number of units settled and the increase in the average settlement prices in 2012 as compared to 2011.
Segment profit for the year ended December 31, 2012 increased approximately $12,000 from 2011. The increase in segment profit was primarily attributable to an approximate $15,500 increase in mortgage banking fees, partially offset by an approximate $2,700 increase in general and administrative expenses. The increase in mortgage banking fees was partially attributable to the aforementioned 18% increase in closed loan volume and an increase in secondary marketing fees. The increase in general and administrative expenses was primarily attributable to an increase in compensation costs as a result of a 33% increase in headcount compared to 2011. The increase in compensation costs was partially offset by an approximate $3,700 decrease in the provision for loan loss as compared to 2011.
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. 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 investor 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.
NVRM maintains an allowance for losses on mortgage loans originated that reflects our judgment of the present loss exposure from the loans that we have originated and sold. The allowance is calculated based on an analysis of historical experience and exposure. At December 31, 2013, we had an allowance for loan losses of approximately $8,200. Although we consider the allowance for loan losses reflected on the December 31, 2013 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 is dependent on our homebuilding segment’s customers for business. If New Orders and sales 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, changes in investor funding times, as well as increased regulation of mortgage lending practices. The Dodd-Frank Wall Street Reform and Consumer Protection Act, enacted on July 21, 2010, contains numerous provisions affecting residential mortgages and mortgage lending practices. The CFPB issued rules in January 2013, including “Ability to Repay” underwriting provisions, definition and parameters of “Qualified Mortgages” and the establishment of certain protections from liability under “Ability to Repay” provisions for “Qualified Mortgages”. The CFPB’s rulemaking also included limitations on certain fees and loan officer compensation requirements. These rules were effective January 2014. Although we do not expect these new requirements to significantly impact our mortgage business, fee restrictions may impact our ability to provide a comprehensive package of mortgage services to our homebuyers.
Seasonality
Overall, we do not experience material seasonal fluctuations in sales, settlements or loan closings.
Table of Contents
Effective Tax Rate
Our consolidated effective tax rate in 2013, 2012 and 2011 was 36.36%, 34.35% and 37.65%, respectively. During 2012, we reduced our provision for unrecognized tax benefits by $9,154, which reduced the 2012 effective tax rate. The reduction resulted from settlements with and an audit by certain taxing authorities during 2012 which led us to update our evaluation of the administrative practice in other states for similar uncertain tax positions to determine whether the positions taken in those states were effectively settled. See Note 11 in the accompanying consolidated financial statements herein for further discussion of income taxes.
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.
Liquidity and Capital Resources
Lines of Credit and Notes Payable
Our homebuilding business segment funds its operations from cash flows provided by operating activities and the public debt and equity markets. On September 5, 2012, we filed a Shelf Registration Statement (the “Shelf”) 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. On September 10, 2012, we issued $600,000 aggregate principal amount of 3.95% Senior Notes due 2022 under the Shelf. The Senior Notes were issued at a discount to yield 3.97% and have been reflected net of the unamortized discount in the accompanying consolidated balance sheet. The offering of the Senior Notes resulted in aggregate net proceeds of approximately $593,900, after deducting offering expenses. The Senior Notes mature on September 15, 2022 and bear interest at 3.95%, payable semi-annually in arrears on March 15 and September 15, which commenced on March 15, 2013. The Senior Notes are senior unsecured obligations and rank equally in right of payment with any of our existing and future unsecured senior indebtedness, will rank senior in right of payment to any of our future indebtedness that is by its terms expressly subordinated to the Senior Notes and will be effectively subordinated to any of our existing and future secured indebtedness to the extent of the value of the collateral securing such indebtedness. The indenture governing the Senior Notes does not contain any financial covenants, however, it does contain, among other items, and subject to certain exceptions, covenants that restrict our ability to create, incur, assume or guarantee secured debt, enter into sale and leaseback transactions and conditions related to mergers and/or the sale of assets. The proceeds from the Senior Notes issuance were used for general corporate purposes, which includes repurchases of our common shares.
Our mortgage subsidiary, NVRM, provides for its mortgage origination and other operating activities using cash generated from operations, borrowings from its parent company, NVR, as well as a revolving mortgage repurchase facility, which is non-recourse to NVR. On July 31, 2013, NVRM renewed and amended its repurchase agreement with U.S. Bank National Association which provides for loan purchases up to $25,000, subject to certain sub-limits (the “Repurchase Agreement”). The purpose of the Repurchase Agreement is to finance the origination of mortgage loans by NVRM. The Repurchase Agreement expires on July 30, 2014.
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 3.00%. 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 Repurchase Agreement contains various affirmative and negative covenants. 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 net income requirement, and (iv) a maximum leverage ratio requirement. We were in compliance with all covenants under the Repurchase Agreement at December 31, 2013. At December 31, 2013, there was no debt outstanding under the Repurchase Agreement and there were no borrowing base limitations.
Table of Contents
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 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 2013. For the year ended December 31, 2013, we repurchased 581,387 shares of our common stock at an aggregate purchase price of $554,491. As of December 31, 2013, we had approximately $438,100 available under two Board approved repurchase authorizations.
Cash Flows
For the year ended December 31, 2013, cash and cash equivalents decreased by $287,254. Net cash provided by operating activities was $270,222. Cash was provided by homebuilding operations and by an increase of $114,456 in accounts payable, accrued expenses and customer deposits in 2013 compared to 2012. Accounts payables were higher due primarily to an increase in our inventory levels, while accrued expenses were higher due to the aforementioned increased warranty reserves and income taxes payable attributable to our increased earnings. Cash was used to fund the increase to homebuilding inventory of $52,861, due to increased units under construction at the end of 2013 compared to 2012. In addition, cash was used to fund the $40,034 increase in contract land deposits year over year. Investing activities during 2013 used net cash of $34,477, primarily as a result of investments in unconsolidated joint ventures totaling $22,850 (see Note 4 to the accompanying consolidated financial statements included herein for additional discussion of joint ventures). Cash was also used for the purchase of property, plant and equipment totaling $19,016 during 2013. These uses of cash from investing activities were partially offset by capital distributions of $6,782 received from our unconsolidated joint ventures. Net cash used in financing activities was $522,999, due primarily to our purchase of treasury stock. During 2013, we repurchased 581,387 shares of our common stock for an aggregate purchase price of $554,491 under our ongoing common stock repurchase program as discussed above. This use of cash from financing activities was partially offset by $13,957 in proceeds from stock option exercises and the realization of $20,636 in excess income tax benefits from equity-based compensation plan activity and deferred compensation plan distributions.
For the year ended December 31, 2012, cash and cash equivalents increased by $672,713. Net cash provided by operating activities was $264,384. Cash was provided by homebuilding operations and by an approximate $63,400 decrease in mortgage loans held for sale. In addition, cash was provided by an increase of $110,396 in accounts payable, accrued expenses and customer deposits in 2012 compared to 2011. Payables were higher due primarily to an increase in our inventory levels. The increase in accrued expenses and customer deposits were attributable to increased management incentive accruals associated with our improved financial results and an increase in customer deposits associated with increased sales volume. Cash provided by homebuilding operations was used to fund the increase to homebuilding inventory of $97,750, as a result of an increase in the units under construction at the end of 2012 compared to 2011. In addition, cash was used to fund the $53,942 increase in contract land deposits year over year. Investing activities during 2012 used net cash of $22,611, primarily as a result of the acquisition of substantially all of the assets of Heartland Homes on December 31, 2012 (see Note 16 to the accompanying consolidated financial statements included herein for additional discussion of the acquisition). In addition, cash was used for the purchase of property, plant and equipment totaling $12,365 during 2012. These uses of cash from investing activities were partially offset by capital distributions received from our unconsolidated joint ventures. Net cash provided by financing activities was $430,940, due primarily to the receipt of $593,866 in net proceeds from the issuance of the Senior Notes and $73,211 in proceeds from stock option exercises. During 2012, we spent $227,281 to repurchase 285,495 shares of our common stock. In addition, cash was used in the repayment of $21,910 of loans assumed in the acquisition of Heartland Homes.
Table of Contents
For the year ended December 31, 2011, cash and cash equivalents decreased by $712,956. Net cash provided by operating activities was $1,463. Cash provided by homebuilding operations was used to fund the increase to homebuilding inventory of $99,527, as a result of an increase in the units under construction at the end of 2011 compared to 2010. In addition, cash was used to fund the $42,385 increase in contract land deposits. The presentation of operating cash flows was reduced by $22,835, which is the amount of the excess tax benefit realized from stock option exercises and deferred compensation plan distributions during 2011 and credited directly to additional paid in capital. Investing activities during 2011 used net cash of $61,866, primarily as a result of our investment in a joint venture with Morgan Stanley Real Estate Investing of $61,250. In addition, cash was used to purchase $11,444 in property, plant and equipment during 2011. These uses of cash from investing activities were partially offset by capital distributions received from our unconsolidated joint ventures. Net cash used by financing activities was $652,553. During 2011, we spent approximately $689,300 to repurchase 1,017,588 shares of our common stock under our ongoing common stock repurchase program as discussed above. In addition, cash was used in the repayment of approximately $90,000 of the outstanding NVRM repurchase facility due to our decision to substantially reduce the available credit capacity under the Repurchase Agreement. These uses of cash from financing activities were offset partially by equity-based activity which provided stock option exercise proceeds of $106,999 and the realization of $22,835 in excess income tax benefits from equity-based compensation plan activity.
At December 31, 2013 and 2012, the homebuilding segment had restricted cash of $20,563 and $19,661, respectively, which is included in “Other assets” on the accompanying consolidated balance sheets. The restricted cash balances relate primarily to holding requirements for outstanding letters of credit issued under our letter of credit agreement and customer deposits for certain home sales.
We believe that our current cash holdings, cash generated from operations 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 in 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, 2013, we controlled approximately 64,600 lots through lot purchase agreements, joint ventures and land under development, with an aggregate purchase price of approximately $5,800,000. These lots are controlled by making or committing to make deposits of approximately $372,400 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 our $299,100 deposit paid, plus the additional $73,300 referred to below. Of the $299,100 deposit total, approximately $296,600 was in cash and approximately $2,500 was in letters of credit which had been issued as of December 31, 2013. The remaining
Table of Contents
balance of approximately $73,300 relates to deposits to be paid subsequent to December 31, 2013 assuming that contractual development milestones are met by the developers (see Contractual Obligations section below). As of December 31, 2013, we had recorded an impairment valuation allowance of approximately $59,800 related to certain 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 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 $54,500 of contingent obligations under such agreements as of December 31, 2013, inclusive of the $2,500 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, 2013, there were contractual commitments to extend credit to borrowers aggregating $243,084 and open forward delivery contracts aggregating $430,859. Please refer to Note 14 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, 2013, were as follows:
| Payments due by period | ||||||||||||||||||||
| Total | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | ||||||||||||||||
| Debt (1) | $ | 600,000 | $ | — | $ | — | $ | — | $ | 600,000 | ||||||||||
| Interest on debt (1) | 213,234 | 23,700 | 47,400 | 47,400 | 94,734 | |||||||||||||||
| Capital lease (2) | 117 | 117 | — | — | — | |||||||||||||||
| Operating leases (3) | 110,206 | 21,998 | 30,069 | 22,302 | 35,837 | |||||||||||||||
| Purchase obligations (4) | 74,999 | * | * | * | * | |||||||||||||||
| Executive Officer employment contracts (5) | 4,300 | 2,150 | 2,150 | — | — | |||||||||||||||
| Other long-term liabilities (6) | 42,861 | 42,171 | 690 | — | — | |||||||||||||||
| Uncertain tax positions (7) | 28,467 | * | * | * | * | |||||||||||||||
| Total | $ | 1,074,184 | $ | 90,136 | $ | 80,309 | $ | 69,702 | $ | 730,571 | ||||||||||
| (1) | See Note 9 in the accompanying consolidated financial statements for additional information regarding the Senior Notes. |
|---|
Table of Contents
| (2) | The present value of this obligation is included on the consolidated balance sheets. See Note 9 in the accompanying consolidated financial statements for additional information regarding capital lease obligations. |
|---|
| (3) | See Note 13 in the accompanying consolidated financial statements for additional information regarding operating leases. |
|---|
| (4) | Amount represents required payments of forfeitable deposits with land developers under existing fixed price purchase agreements, assuming that contractual development milestones are met by the developers, and specific performance guarantees. 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. |
|---|
| (5) | We have entered into employment agreements with our four 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 our 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. |
|---|
| (6) | Amounts represent payments due under incentive compensation plans and are included on the accompanying consolidated balance sheets, approximately $1,532 of which is recorded in the Mortgage Banking “Accounts payable and other liabilities” line item, and the remainder in the Homebuilding “Accrued expenses and other liabilities” line item. |
|---|
| (7) | Due to the nature of the uncertain tax positions, we are unable to make a reasonable estimate as to the period of settlement with the respective taxing authorities. |
|---|
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 production 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 sale prices within the applicable community compared to the costs incurred to date plus the expected costs to complete. Any calculated impairments are recorded immediately.
Table of Contents
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 they are, impairment charges are required to be recorded in an amount by which the carrying amount of the assets 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 assets and related estimated cash flow streams.
At December 31, 2013, we had approximately $41,300 in land under development in five separate communities. In addition, at December 31, 2013, we had an aggregate investment totaling approximately $92,700 in four separate joint ventures that controlled land under development. None of the communities classified as land under development nor any of the undeveloped land held by the joint ventures had any indicators of impairment at December 31, 2013. As such, we do not believe that any of the land under development 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 do not own the finished lots on which we had placed a contract land deposit, if the above analysis leads to a determination that we cannot 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.
Table of Contents
Although we consider the allowance for losses on contract land deposits reflected on the December 31, 2013 consolidated 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.
Excess Reorganization Value
Reorganization value in excess of identifiable assets (“excess reorganization value”) is an indefinite-lived 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 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, 2013 consolidated balance sheet to be adequate (see Note 13 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.
Equity-Based Compensation Expense
Compensation costs related to our equity-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
Table of Contents
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. 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. Those underwriting standards are typically equal to or more stringent than the underwriting standards required by FNMA, VA and FHA. 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 exposure. Although we consider the allowance for loan losses reflected on the December 31, 2013 consolidated balance sheet to be adequate (see Note 15 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 for a description of the impact of inflation, changing prices and economic conditions on our business and our financial results. See also the discussion of the current business environment in the Overview section above.
Previous: Item 6. Selected Financial Data. · Next: Item 7A. Quantitative and Qualitative Disclosure About Market Risk.