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.
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Results of Operations for the Years Ended December 31, 2015, 2014 and 2013
Overview
Business
Our primary business is the construction and sale of single-family detached homes, townhomes and condominium buildings, all of which are primarily constructed on a pre-sold basis. To fully serve customers of our homebuilding operations, we also operate a mortgage banking and title services business. We primarily conduct our operations in mature markets. Additionally, we generally grow our business through market share gains in our existing markets and by expanding into markets contiguous to our current active markets. Our four homebuilding reportable segments consist of the following regions:
| Mid Atlantic: | Maryland, Virginia, West Virginia, Delaware and Washington, D.C. | |
|---|---|---|
| North East: | New Jersey and Eastern Pennsylvania | |
| Mid East: | New York, Ohio, Western Pennsylvania, Indiana and Illinois | |
| South East: | North Carolina, South Carolina, Tennessee and Florida |
Our lot acquisition strategy is predicated upon avoiding the financial requirements and risks associated with direct land ownership and development. We generally do not engage in land development (see discussion below of our limited land development activities). Instead, we typically have acquired finished lots at market prices from various third party land developers pursuant to fixed price purchase agreements. These purchase agreements require deposits, typically ranging up to 10% of the aggregate purchase price of the finished lots, in the form of cash or letters of credit that may be forfeited if we fail to perform under the purchase agreement. This strategy has allowed us to maximize inventory turnover, which we believe enables us to minimize market risk and to operate with less capital, thereby enhancing rates of return on equity and total capital.
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. Our continued success is contingent upon our ability to control an adequate supply of finished lots on which to build.
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 to 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, 2015, we controlled approximately 68,800 lots under purchase agreements with deposits in cash and letters of credit totaling approximately $373,300 and $3,000, respectively. Included in the number of controlled lots are approximately 6,100 lots for which we have recorded a contract land deposit impairment reserve of approximately $42,200 as of December 31, 2015. In addition, we controlled approximately 8,000 lots through six JVs with an aggregate investment of approximately $60,500. Of the lots controlled by the JVs, approximately 3,300 were not under contract with us at December 31, 2015. Further, as of December 31, 2015, we directly owned four separate raw parcels of land, zoned for their intended use, with a current cost basis, including development costs, of approximately $60,600 that we intend to develop into approximately 980 finished lots. We have additional funding commitments under a joint development agreement related to our land under development of approximately $19,200, a portion of which we expect will be offset by development credits of approximately $9,600. We also had a $2,200 obligation under a letter of credit related to one of our land parcels. In February 2016, we acquired an additional raw parcel of land at a cost of approximately $150,000 which is expected to produce approximately 1,000 lots, of which approximately 160 lots are under contract with unrelated parties. See Notes 3, 4 and 5 to the consolidated financial statements included herein for additional information regarding fixed price purchase agreements, JVs and land under development, respectively.
In addition to the lots we currently control as discussed above, we have certain properties under contract with land owners that are expected to yield approximately 8,800 lots. Some of these properties may require rezoning or other approvals to achieve the expected yield. These properties are controlled with cash deposits and letters of credit totaling approximately $12,200 and $350, respectively, as of December 31, 2015, of which approximately $8,700 is refundable if we do not perform under the contract. Of the $12,200 in cash deposits, $5,000 relates to the raw parcel of land acquired in February 2016 discussed above. We generally expect to assign the raw land contracts to a land developer and simultaneously enter into a lot purchase agreement with the assignee if the project is determined to be feasible.
Current Business Environment and Key Financial Results
New home demand continued to improve throughout 2015. However, new home prices continued to be constrained by an increase in the number of new home communities in many markets. The housing market also continues to face challenges from tight mortgage underwriting standards.
Our consolidated revenues for the year ended December 31, 2015 totaled $5,159,008, an increase of 16% from $4,444,568 in 2014. Our net income for 2015 was $382,927, or $89.99 per diluted share, increases of 36% and 42% compared to 2014 net income and diluted earnings per share, respectively. Diluted earnings per share was favorably impacted by our ongoing share repurchase program. Our homebuilding gross profit margin percentage increased to18.7% in 2015 from 18.4% in 2014. New orders, net of cancellations (“New Orders”) during 2015 increased 14% from 2014 while our average New Order sales price increased 1% to $378.7 in 2015. Our backlog of homes sold but not yet settled with the customer as of December 31, 2015 increased on a unit basis by 14% to 6,229 units and increased on a dollar basis by 13% to $2,375,182 when compared to December 31, 2014.
We believe that a continuation of the housing market recovery is dependent upon a sustained overall economic recovery, driven by continued improvement in job and wage growth and household formation. We expect to continue to face gross profit margin and pricing pressures due to higher land and construction costs, as well as increased competition associated with the increase in the
number of new home communities in our markets. We believe that we are well positioned to take advantage of opportunities that may arise from future economic and homebuilding market volatility due to the strength of our balance sheet.
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, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | 2013 | ||||||||||
| Financial data: | ||||||||||||
| Revenues | $ | 5,065,200 | $ | 4,375,059 | $ | 4,134,481 | ||||||
| Cost of sales | $ | 4,118,782 | $ | 3,568,586 | $ | 3,424,204 | ||||||
| Gross profit margin percentage | 18.7 | % | 18.4 | % | 17.2 | % | ||||||
| Selling, general and administrative expenses | $ | 371,127 | $ | 358,851 | $ | 313,029 | ||||||
| Operating data: | ||||||||||||
| Settlements (units) | 13,326 | 11,859 | 11,834 | |||||||||
| Average settlement price | $ | 379.9 | $ | 368.5 | $ | 349.1 | ||||||
| New orders (units) | 14,080 | 12,389 | 11,800 | |||||||||
| Average new order price | $ | 378.7 | $ | 373.7 | $ | 360.4 | ||||||
| Backlog (units) | 6,229 | 5,475 | 4,945 | |||||||||
| Average backlog price | $ | 381.3 | $ | 384.6 | $ | 373.2 | ||||||
| New order cancellation rate | 14.5 | % | 14.6 | % | 14.9 | % |
Consolidated Homebuilding Revenues
Homebuilding revenues increased 16% in 2015 compared 2014, as a result of a 12% increase in the number of units settled and a 3% increase in the average settlement price year over year. Units settled and the average settlement prices were higher in each of our market segments year over year. The increases in the number of units settled and the average settlement price were attributable to an 11% higher backlog unit balance entering 2015 and a 3% higher average price of homes in backlog entering 2015 compared to backlog entering 2014. In addition, the unit and average settlement price increases were favorably impacted by a 15% increase in New Orders and a 2% increase in the average sales price of New Orders, respectively, for the first six months of 2015 compared to the same period in 2014.
Homebuilding revenues increased 6% in 2014 compared to 2013 primarily as a result of a 6% increase in the average settlement price, while the number of units settled was flat year over year. The increase in the average settlement price was primarily attributable to the average price of homes in backlog being approximately 8% higher entering 2014 compared to 2013 and a 5% higher average sales price of New Orders for the first six months of 2014 compared to the same period in 2013. The higher average price of homes in backlog entering 2014 was attributable to favorable market conditions in 2013, leading to increasing prices during that year.
Consolidated Homebuilding New Orders
The number of New Orders and the average sales price of New Orders increased 14% and 1%, respectively, in 2015 compared to 2014. New Orders increased in 2015 despite a 3% decrease in the average number of active communities year over year, due to more favorable market conditions in 2015, which led to higher sales absorption in each of our market segments.
The number of New Orders and the average sales price of New Orders increased 5% and 4%, respectively, in 2014 compared to 2013. New Orders were higher due to the 8% increase in the average number of active communities year over year, offset partially by lower sales absorption rates in many of our markets. Average sales prices were higher in each of our market segments year over year as a result of favorable market conditions in 2013, which led to higher prices entering 2014.
Consolidated Homebuilding Gross Profit
Gross profit margin percentage in 2015 increased to 18.7% from 18.4% in 2014. Gross profit margin was favorably impacted in 2015 by an approximate $11,100, or 22 basis points of revenue, recovery of contract land deposits previously determined to be unrecoverable. Excluding the contract land deposit impairment recovery, gross profit margin was flat year over year as higher revenues were offset by higher lot and construction costs year over year. We expect continued gross margin pressure over the next several quarters due to weakness in sales pricing.
Gross profit margin percentage in 2014 increased to 18.4% compared to 17.2% in 2013. Gross profit margins were favorably impacted by our average settlement prices increasing at a higher rate than material and lot costs year over year, as well as by a relative shift in settlements to our Mid-Atlantic and North East segments which have higher average gross profit margins. Gross profit
margins in 2013 were negatively impacted by two service related accruals which reduced the 2013 gross profit margin by 76 basis points.
Consolidated Homebuilding Selling, General and Administrative (“SG&A”)
SG&A expenses in 2015 increased approximately $12,300, or 3%, compared to 2014. SG&A expenses increased primarily due to an approximate $14,900 increase in management incentive compensation attributable to the improved operating results in 2015. SG&A expenses decreased as a percentage of revenue to 7.3% in 2015 from 8.2% in 2014 due to improved leveraging of SG&A expenses.
SG&A expenses in 2014 increased approximately $45,800, or 15%, compared to 2013 and increased as a percentage of revenue to 8.2% from 7.6% year over year. The increase in SG&A expenses was attributable to an approximate $26,000 increase in equity-based compensation expense and an approximate $14,100 increase in sales and marketing expenses in 2014. Equity-based compensation expense increased primarily due to the grant of non-qualified stock options (“Options”) under the 2014 Equity Incentive Plan (the “2014 Plan”) following shareholder approval of the 2014 Plan in May 2014 and restricted share units (“RSUs”) in the second quarter of 2013. In addition, in 2013 we recorded a reversal of approximately $7,100 in equity-based compensation expense as a result of an adjustment to our stock option forfeiture rates based on our actual forfeiture experience. Sales and marketing expenses increased due primarily to an increase in model home expenditures attributable to the 8% increase in the number of active communities year over year.
Consolidated Homebuilding Backlog
Backlog units and dollars increased approximately 14% to 6,229 units and 13% to $2,375,182, respectively, as of December 31, 2015 compared to 5,475 units and $2,105,635, respectively, as of December 31, 2014. The increase in backlog units was primarily attributable to a 13% increase in New Orders for the six month period ended December 31, 2015 compared to the same period in 2014. Backlog dollars were favorably impacted by the increase in backlog units.
Backlog units and dollars increased approximately 11% to 5,475 units and 14% to $2,105,635, respectively, as of December 31, 2014 compared to 4,945 units and $1,845,600, respectively, as of December 31, 2013. Backlog units were higher primarily due to a 13% increase in New Orders for the six month period ended December 31, 2014 compared to the same period in 2013. Backlog dollars were favorably impacted by the 11% increase in the backlog unit balance and a 3% higher average price of homes in backlog year over year. The average price of homes in backlog was favorably impacted by a 2% increase in the average sales price of New Orders for the six month period ended December 31, 2014 compared to the same period in 2013.
Backlog, which represents homes sold but not yet settled with the customer, may be impacted by customer cancellations for various reasons that are beyond our control, such as failure to obtain mortgage financing, inability to sell an existing home, job loss, or a variety of other reasons. In any period, a portion of the cancellations that we experience are related to new sales that occurred during the same period, and a portion are related to sales that occurred in prior periods and therefore appeared in the beginning backlog for the current period. Expressed as the total of all cancellations during the period as a percentage of gross sales during the period, our cancellation rate was approximately 15% in each of 2015, 2014 and 2013. Additionally, during each of 2015, 2014 and 2013, 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 years. Other than those units that are cancelled, we expect to settle substantially all of our December 31, 2015 backlog during 2016. See “Risk Factors” in Item 1A of this Form 10-K.
The backlog turnover rate is impacted by various factors, including, but not limited to, changes in New Order activity, internal production capacity, external subcontractor capacity and other external factors over which we do not exercise control.
Reportable 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 and is based on the segment’s average net assets employed. 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, 2015 and 2014 has been allocated to the reportable segments for the respective years to show contract land deposits on a net basis. The net contract land deposit balances below also include approximately $3,000 and $4,700 at December 31, 2015 and 2014, 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, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | 2013 | ||||||||||
| Revenues: | ||||||||||||
| Mid Atlantic | $ | 3,022,789 | $ | 2,617,108 | $ | 2,439,387 | ||||||
| North East | 432,145 | 376,862 | 332,681 | |||||||||
| Mid East | 1,014,920 | 892,513 | 908,198 | |||||||||
| South East | 595,346 | 488,576 | 454,215 |
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | 2013 | ||||||||||
| Gross profit margin: | ||||||||||||
| Mid Atlantic | $ | 563,299 | $ | 499,172 | $ | 461,481 | ||||||
| North East | 79,588 | 70,462 | 45,860 | |||||||||
| Mid East | 178,508 | 141,146 | 142,331 | |||||||||
| South East | 113,210 | 89,544 | 77,277 |
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | 2013 | ||||||||||
| Segment profit: | ||||||||||||
| Mid Atlantic | $ | 322,829 | $ | 271,965 | $ | 276,399 | ||||||
| North East | 37,914 | 33,390 | 14,294 | |||||||||
| Mid East | 86,336 | 47,538 | 55,537 | |||||||||
| South East | 57,384 | 37,525 | 35,001 |
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | 2013 | ||||||||||
| Gross profit margin percentage: | ||||||||||||
| Mid Atlantic | 18.6 | % | 19.1 | % | 18.9 | % | ||||||
| North East | 18.4 | % | 18.7 | % | 13.8 | % | ||||||
| Mid East | 17.6 | % | 15.8 | % | 15.7 | % | ||||||
| South East | 19.0 | % | 18.3 | % | 17.0 | % |
Segment Operating Activity:
| Year Ended December 31, | ||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | 2013 | ||||||||||||||||||||||
| Units | Average Price | Units | Average Price | Units | Average Price | |||||||||||||||||||
| Settlements: | ||||||||||||||||||||||||
| Mid Atlantic | 6,879 | $ | 439.2 | 6,129 | $ | 426.3 | 6,029 | $ | 404.0 | |||||||||||||||
| North East | 1,221 | $ | 353.9 | 1,089 | $ | 346.1 | 1,013 | $ | 328.4 | |||||||||||||||
| Mid East | 3,137 | $ | 323.5 | 2,845 | $ | 313.6 | 3,023 | $ | 300.4 | |||||||||||||||
| South East | 2,089 | $ | 284.9 | 1,796 | $ | 271.9 | 1,769 | $ | 256.7 | |||||||||||||||
| Total | 13,326 | $ | 379.9 | 11,859 | $ | 368.5 | 11,834 | $ | 349.1 |
| Year Ended December 31, | ||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | 2013 | ||||||||||||||||||||||
| Units | Average Price | Units | Average Price | Units | Average Price | |||||||||||||||||||
| New orders, net of cancellations: | ||||||||||||||||||||||||
| Mid Atlantic | 7,070 | $ | 439.5 | 6,365 | $ | 431.4 | 6,056 | $ | 416.7 | |||||||||||||||
| North East | 1,173 | $ | 365.9 | 1,182 | $ | 347.8 | 1,075 | $ | 335.5 | |||||||||||||||
| Mid East | 3,485 | $ | 321.4 | 2,963 | $ | 320.6 | 2,903 | $ | 309.5 | |||||||||||||||
| South East | 2,352 | $ | 287.3 | 1,879 | $ | 278.1 | 1,766 | $ | 265.9 | |||||||||||||||
| Total | 14,080 | $ | 378.7 | 12,389 | $ | 373.7 | 11,800 | $ | 360.4 |
| Year Ended December 31, | ||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | 2013 | ||||||||||||||||||||||
| Units | Average Price | Units | Average Price | Units | Average Price | |||||||||||||||||||
| Backlog: | ||||||||||||||||||||||||
| Mid Atlantic | 3,137 | $ | 435.3 | 2,946 | $ | 434.2 | 2,710 | $ | 422.7 | |||||||||||||||
| North East | 540 | $ | 374.7 | 588 | $ | 349.1 | 495 | $ | 345.5 | |||||||||||||||
| Mid East | 1,498 | $ | 331.7 | 1,150 | $ | 340.2 | 1,032 | $ | 323.0 | |||||||||||||||
| South East | 1,054 | $ | 294.6 | 791 | $ | 290.7 | 708 | $ | 276.5 | |||||||||||||||
| Total | 6,229 | $ | 381.3 | 5,475 | $ | 384.6 | 4,945 | $ | 373.2 |
Operating Data:
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | 2013 | ||||||||||
| New order cancellation rate: | ||||||||||||
| Mid Atlantic | 15.2 | % | 14.9 | % | 14.9 | % | ||||||
| North East | 14.3 | % | 14.8 | % | 15.0 | % | ||||||
| Mid East | 13.4 | % | 12.5 | % | 13.5 | % | ||||||
| South East | 14.2 | % | 16.6 | % | 16.8 | % |
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | 2013 | ||||||||||
| Average active communities: | ||||||||||||
| Mid Atlantic | 233 | 245 | 220 | |||||||||
| North East | 38 | 44 | 39 | |||||||||
| Mid East | 130 | 127 | 125 | |||||||||
| South East | 71 | 72 | 67 | |||||||||
| Total | 472 | 488 | 451 |
Homebuilding Inventory:
| As of December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | |||||||
| Sold inventory: | ||||||||
| Mid Atlantic | $ | 485,481 | $ | 435,833 | ||||
| North East | 72,481 | 61,233 | ||||||
| Mid East | 140,745 | 115,210 | ||||||
| South East | 90,794 | 73,223 | ||||||
| Total (1) | $ | 789,501 | $ | 685,499 |
| As of December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | |||||||
| Unsold lots and housing units inventory: | ||||||||
| Mid Atlantic | $ | 105,720 | $ | 103,685 | ||||
| North East | 19,674 | 5,528 | ||||||
| Mid East | 9,857 | 8,953 | ||||||
| South East | 11,726 | 12,051 | ||||||
| Total (1) | $ | 146,977 | $ | 130,217 |
| (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. |
|---|
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | 2013 | ||||||||||
| Sold and unsold inventory impairments: | ||||||||||||
| Mid Atlantic | $ | 321 | $ | 530 | $ | 222 | ||||||
| North East | 25 | 21 | 47 | |||||||||
| Mid East | 363 | 649 | 923 | |||||||||
| South East | — | - | 82 | |||||||||
| Total | $ | 709 | $ | 1,200 | $ | 1,274 |
Lots Controlled and Land Deposits:
| As of December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | |||||||
| Total lots controlled: | ||||||||
| Mid Atlantic | 35,200 | 32,800 | ||||||
| North East | 6,100 | 6,000 | ||||||
| Mid East | 18,500 | 17,400 | ||||||
| South East | 14,700 | 12,500 | ||||||
| Total | 74,500 | 68,700 |
| As of December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | |||||||
| Lots included in impairment reserve: | ||||||||
| Mid Atlantic | 2,800 | 3,700 | ||||||
| North East | 500 | 600 | ||||||
| Mid East | 2,400 | 2,500 | ||||||
| South East | 400 | 1,000 | ||||||
| Total | 6,100 | 7,800 |
| As of December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | |||||||
| Contract land deposits, net: | ||||||||
| Mid Atlantic | $ | 223,147 | $ | 188,747 | ||||
| North East | 29,805 | 27,900 | ||||||
| Mid East | 39,996 | 40,061 | ||||||
| South East | 53,299 | 42,642 | ||||||
| Total | $ | 346,247 | $ | 299,350 |
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | 2013 | ||||||||||
| Contract land deposit impairments (recoveries), net: | ||||||||||||
| Mid Atlantic | $ | 1,840 | $ | 1,098 | $ | (715 | ) | |||||
| North East | 279 | 1,647 | 803 | |||||||||
| Mid East | 409 | 149 | 173 | |||||||||
| South East | 250 | 493 | 119 | |||||||||
| Total | $ | 2,778 | $ | 3,387 | $ | 380 |
Mid Atlantic
2015 versus 2014
The Mid Atlantic segment had an approximate $50,900, or 19%, increase in segment profit in 2015 compared to 2014, driven by an increase in revenues of approximately $405,700, or 16%, year over year. The increase in revenues is due primarily to a 12% increase in the number of units settled and a 3% increase in the average settlement price in 2015 compared to 2014. The number of units settled and the average settlement price were favorably impacted by a 9% higher backlog unit balance and a 3% higher average price of homes in backlog, respectively, entering 2015 compared to 2014. In addition, the unit and average settlement price increases were favorably impacted by a 13% increase in New Orders and a 3% increase in the average sales price of New Orders, respectively, for the first six months of 2015 compared to the same period in 2014. The Mid Atlantic segment’s gross profit margin percentage decreased to 18.6% in 2015 from 19.1% in 2014, due primarily to higher lot and construction costs year over year.
Segment New Orders and the average sales price for New Orders in 2015 increased 11% and 2%, respectively, compared to the same period in 2014. New Orders increased despite a 5% decrease in the average number of active communities year over year, due to higher sales absorption year over year. Community sales absorption was impacted by improved market conditions in 2015 compared to 2014.
2014 versus 2013
The Mid Atlantic segment had an approximate $4,400, or 2%, decrease in segment profit in 2014 compared to 2013. Segment profit was negatively impacted by higher SG&A expense attributable to an 11% increase in the average number of active communities year over year and an increase in the corporate capital allocation due primarily to higher inventory levels. Segment revenues increased approximately $177,700, or 7%, year over year due primarily to a 6% increase in the average settlement price in 2014 compared to 2013. The average settlement price was favorably impacted by a 7% higher average price of homes in backlog entering 2014 compared to the same period in 2013. The Mid Atlantic segment’s gross profit margin percentage was flat year over year; however, the gross profit margin in 2013 was negatively impacted by a service related accrual which reduced 2013 gross profit margin by 64 basis points. Excluding this charge, gross profit margin decreased 49 basis points to 19.1% in 2014. The decrease in gross profit margin was attributable to an increase in certain material costs.
Segment New Orders and the average sales price for New Orders in 2014 increased 5% and 4%, respectively, compared to 2013. New Orders were favorably impacted by an 11% increase in the average number of active communities in 2014 compared to 2013, offset partially by lower absorption rates attributable to lower traffic levels year over year. The increase in the average sales price of New Orders was attributable to the favorable market conditions in 2013, which led to higher average sales prices entering 2014.
North East
2015 versus 2014
The North East segment had an approximate $4,500, or 14%, increase in segment profit in 2015 compared to 2014. The increase in segment profit was primarily driven by an increase in revenues of approximately $55,300, or 15%, year over year due to a 12% increase in the number of units settled and a 2% increase in the average settlement price. The increase in units settled was attributable to a 19% higher backlog unit balance entering 2015 compared to the backlog unit balance entering 2014, offset partially by a slower backlog turnover rate year over year. The North East segment’s gross profit margin percentage decreased to 18.4% in 2015 from 18.7% in 2014 due to higher lot costs.
Segment New Orders in 2015 were flat compared to 2014, while the average sales price of New Orders increased approximately 5% year over year. Segment New Orders were negatively impacted by a 12% decrease in the average number of active communities year over year, offset by higher sales absorption. Community sales absorption was impacted by improved market conditions in 2015 compared to 2014. The increase in the average sales price of New Orders is primarily attributable to a shift in New Orders to our higher priced NVHomes product.
2014 versus 2013
The North East segment had an approximate $19,100, or 134%, increase in segment profit in 2014 compared to 2013. Segment profit in 2013 was negatively impacted by a charge of approximately $12,700 related to a service related accrual. Excluding that charge in 2013, segment profit increased approximately $6,400, or 24%, year over year. The increase in segment profit was driven by an increase of approximately $44,200, or 13%, in revenues year over year due to an 8% increase in the number of units settled, coupled with a 5% increase in the average settlement price. The increase in units settled was attributable to a 14% higher backlog unit balance entering 2014 compared to the backlog unit balance entering 2013. The increase in the average settlement price was driven by a 5% higher average price of homes in backlog entering 2014 compared to the same period in 2013 and a shift in settlements to higher priced markets. The North East segment’s gross profit margin increased to 18.7% in 2014 from 13.8% in 2013. Excluding the previously discussed service accrual which reduced gross profit margin in 2013 by 382 basis points, gross profit margin increased 109 basis points year over year. Gross profit margin was favorably impacted by a shift in settlements to higher priced markets with higher gross margins and by increased settlement volume, which allowed us to better leverage certain operating costs in 2014.
Segment New Orders and the average sales price of New Orders increased approximately 10% and 4%, respectively, in 2014 compared to 2013. The increase in New Orders was driven by an 11% increase in the average number of active communities. The increase in the average sales price of New Orders was attributable to a shift in sales to higher priced markets and to higher priced communities in certain markets.
Mid East
2015 versus 2014
The Mid East segment had an approximate $38,800, or 82%, increase in segment profit in 2015 compared to 2014. The increase in segment profit was driven by an increase in revenues of approximately $122,400, or 14%, year over year due primarily to a 10% increase in the number of units settled and a 3% increase in the average settlement price. The number of units settled and the average settlement price were favorably impacted by a 11% higher backlog unit balance and a 5% higher average price of homes in backlog, respectively, entering 2015 compared to 2014. In addition, the unit and average settlement price increases were favorably impacted by a 14% increase in New Orders and a 2% increase in the average sales price of New Orders, respectively, for the first six months of 2015 compared to the same period in 2014. The segment’s gross profit margin percentage increased to 17.6% in 2015 from 15.8% in 2014, due primarily to increased settlement activity, which allowed us to better leverage certain operating costs in 2015, offset partially by higher lot costs year over year.
Segment New Orders increased 18%, while the average sales price of New Orders was flat in 2015 compared to 2014. New Orders were favorably impacted by a 2% increase in the average number of active communities year over year and by higher sales absorption in 2015 compared to 2014 due to improved market conditions.
2014 versus 2013
The Mid East segment had an approximate $8,000, or 14%, decrease in segment profit in 2014 compared to 2013. The decrease in segment profit was driven by a decrease in revenues of approximately $15,700, or 2%, year over year due primarily to a 6% decrease in the number of units settled, offset partially by a 4% increase in the average settlement price. The decrease in settlements was primarily attributable to a 10% lower backlog unit balance entering 2014 compared to the backlog unit balance entering 2013. The average settlement price was favorably impacted by an 8% higher average price of homes in backlog entering 2014 compared to the same period in 2013 and a 3% higher average sales price for New Orders during the first six months of 2014 compared to the same period in 2013. The segment’s gross profit margin in 2014 of 15.8% was flat with 2013 as higher average settlement prices were offset by increases in certain material costs year over year. Segment New Orders and the average sales price of New Orders increased 2% and 4%, respectively, in 2014 compared to 2013.
South East
2015 versus 2014
The South East segment had an approximate $19,900, or 53%, increase in segment profit in 2015 compared to 2014. The increase in segment profit was driven by an increase in revenues of approximately $106,800, or 22%, year over year due to a 16% increase in the number of units settled and a 5% increase in the average settlement price. The number of units settled and the average settlement price were favorably impacted by a 12% higher backlog unit balance and a 5% higher average price of homes in backlog, respectively, entering 2015 compared to 2014. In addition, the unit and average settlement price increases were favorably impacted by a 26% increase in New Orders and a 3% increase in the average sales price of New Orders, respectively, for the first six months of 2015 compared to the same period in 2014. The South East segment’s gross profit margin percentage increased to 19.0% in 2015 from 18.3% in 2014, due to the increased settlement activity, which allowed us to better leverage certain operating costs in 2015. Segment gross profit margin was also favorably impacted by a market mix shift in settlements to markets with higher average gross profit margins. These favorable gross profit margin impacts were partially offset by higher lot costs year over year.
Segment New Orders and the average sales price of New Orders increased 25% and 3%, respectively, in 2015 compared to 2014. New Orders increased despite a 2% decrease in the average number of active communities year over year, due to higher sales absorption year over year. Community sales absorption was favorably impacted by improved market conditions in 2015 compared to 2014.
2014 versus 2013
The South East segment had an approximate $2,500, or 7%, increase in segment profit in 2014 compared to 2013. Segment revenues increased approximately $34,400, or 8%, year over year due to a 2% increase in the number of units settled and a 6% increase in the average settlement price. The average settlement price in 2014 was favorably impacted by a 9% higher average price of homes in backlog entering 2014 compared to the same period in 2013. The South East segment’s gross profit margin increased to 18.3% in 2014 from 17.0% in 2013, due primarily to our average settlement prices increasing at a higher rate than lot and certain material costs year over year.
Segment New Orders and the average sales price for New Orders increased 6% and 5%, respectively, in 2014 compared to 2013. New Orders were favorably impacted by an 8% increase in the number of active communities in 2014 compared to 2013, offset partially by lower absorption levels attributable to lower traffic levels year over year. The increase in the average sales price for New Orders in 2014 was attributable to the introduction of our NVHomes product line in the Raleigh market in 2014, which sells at a higher price point, and to a shift in mix in New Orders to higher priced 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. 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.
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | 2013 | ||||||||||
| Homebuilding consolidated gross profit: | ||||||||||||
| Mid Atlantic | $ | 563,299 | $ | 499,172 | $ | 461,481 | ||||||
| North East | 79,588 | 70,462 | 45,860 | |||||||||
| Mid East | 178,508 | 141,146 | 142,331 | |||||||||
| South East | 113,210 | 89,544 | 77,277 | |||||||||
| Consolidation adjustments and other | 11,813 | 6,149 | (16,672 | ) | ||||||||
| Homebuilding consolidated gross profit | $ | 946,418 | $ | 806,473 | $ | 710,277 |
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | 2013 | ||||||||||
| Homebuilding consolidated profit before taxes: | ||||||||||||
| Mid Atlantic | $ | 322,829 | $ | 271,965 | $ | 276,399 | ||||||
| North East | 37,914 | 33,390 | 14,294 | |||||||||
| Mid East | 86,336 | 47,538 | 55,537 | |||||||||
| South East | 57,384 | 37,525 | 35,001 | |||||||||
| Reconciling items: | ||||||||||||
| Contract land deposit impairment reserve (1) | 13,805 | 3,612 | 5,313 | |||||||||
| Equity-based compensation expense (2) | (50,738 | ) | (58,501 | ) | (31,547 | ) | ||||||
| Corporate capital allocation (3) | 171,170 | 152,140 | 116,458 | |||||||||
| Unallocated corporate overhead | (83,124 | ) | (61,108 | ) | (72,703 | ) | ||||||
| Consolidation adjustments and other | 22,622 | 23,867 | 2,361 | |||||||||
| Corporate interest expense | (22,869 | ) | (22,544 | ) | (21,743 | ) | ||||||
| Reconciling items sub-total | 50,866 | 37,466 | (1,861 | ) | ||||||||
| Homebuilding consolidated profit before taxes | $ | 555,329 | $ | 427,884 | $ | 379,370 |
| (1) | This item represents changes to the contract land deposit impairment reserve, which are not allocated to the reportable segments. |
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| (2) | The increase in equity-based compensation in 2014 from 2013 is primarily attributable to the issuance of stock options under the 2014 Plan in May 2014 and RSUs issued in the second quarter of 2013. Equity-based compensation expense was also lower in 2013 due to an approximate $7,450 pre-tax compensation expense reversal attributable to an adjustment of our option forfeiture rates based on our actual forfeiture experience. |
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| (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: |
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| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | 2013 | ||||||||||
| Corporate capital allocation charge: | ||||||||||||
| Mid Atlantic | $ | 107,705 | $ | 96,328 | $ | 72,272 | ||||||
| North East | 16,987 | 12,107 | 9,461 | |||||||||
| Mid East | 27,263 | 26,299 | 22,580 | |||||||||
| South East | 19,215 | 17,406 | 12,145 | |||||||||
| Total corporate capital allocation charge | $ | 171,170 | $ | 152,140 | $ | 116,458 |
Mortgage Banking Segment
We conduct our mortgage banking activity through NVRM, a wholly owned subsidiary. NVRM focuses almost exclusively on serving the homebuilding segment customer base. The following table summarizes the results of our mortgage banking operations and certain statistical data for each of the last three years:
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | 2013 | ||||||||||
| Loan closing volume: | ||||||||||||
| Total principal | $ | 3,492,342 | $ | 2,833,612 | $ | 2,538,072 | ||||||
| Loan volume mix: | ||||||||||||
| Adjustable rate mortgages | 14 | % | 17 | % | 6 | % | ||||||
| Fixed-rate mortgages | 86 | % | 83 | % | 94 | % | ||||||
| Operating profit: | ||||||||||||
| Segment profit | $ | 51,236 | $ | 30,388 | $ | 42,075 | ||||||
| Equity-based compensation expense | (3,353 | ) | (4,726 | ) | (2,749 | ) | ||||||
| Mortgage banking income before tax | $ | 47,883 | $ | 25,662 | $ | 39,326 | ||||||
| Capture rate: | 88 | % | 84 | % | 81 | % | ||||||
| Mortgage banking fees: | ||||||||||||
| Net gain on sale of loans | $ | 67,891 | $ | 47,791 | $ | 56,528 | ||||||
| Title services | 25,427 | 21,292 | 19,862 | |||||||||
| Servicing fees | 490 | 426 | 396 | |||||||||
| $ | 93,808 | $ | 69,509 | $ | 76,786 |
2015 versus 2014
Loan closing volume in 2015 increased by approximately $658,700, or 23%, from 2014. The increase was primarily attributable to a 20% increase in the number of loans closed and a 3% increase in the average loan amount year over year. The increase in the number of loans closed was primarily attributable to the aforementioned increase in the homebuilding segment’s number of settlements in 2015 as compared to 2014 and an increase in the number of loans closed by NVRM for our homebuyers who obtain a mortgage to purchase the home (the “Capture Rate”). The Capture Rate increased from 84% in 2014 to 88% in 2015. The increase in the average loan amount is consistent with the homebuilding segment’s increase in average settlement price.
Segment profit in 2015 increased by approximately $20,800, or 69%, from 2014. The increase in segment profit was primarily attributable to an increase in mortgage banking fees, partially offset by an increase in general and administrative expenses. Mortgage banking fees increased by approximately $24,300, resulting from the aforementioned increase in loan closing volume and higher rate lock commitments. General and administrative expenses increased by approximately $5,200, resulting primarily from an increase in management incentive compensation attributable to the improved operating results in the current year.
2014 versus 2013
Loan closing volume in 2014 increased 12% from 2013. The increase was primarily attributable to a 6% increase in the number of units closed and a 5% increase in the average loan amount year over year. The increase in the number of units closed is attributable to an increase in the Capture Rate from 81% in 2013 to 84% in 2014. The increase in the average loan amount is primarily attributable to the increase in the homebuilding segment’s average settlement prices in 2014 as compared to 2013.
Segment profit in 2014 decreased approximately $11,700 from 2013. The decrease in segment profit was primarily attributable to an approximate $7,300 decrease in mortgage banking fees and an approximate $4,400 increase in general and administrative expenses. The decrease in mortgage banking fees was primarily attributable to a decrease in secondary marketing fees due to a product mix shift out of fixed rate government product due to increased consumer costs on FHA mortgage loans, and an increase in adjustable rate loans which generally are less profitable than fixed rate products. The relative product mix shift from fixed rate to adjustable rate products is attributable to interest rate volatility in 2014. The increase in general and administrative expenses was primarily attributable to an increase in compensation costs as a result of a 12% increase in average headcount in 2014 compared to 2013.
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.
We maintain 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, 2015, we had an allowance for loan losses of approximately $12,300. Although we consider the allowance for loan losses reflected on the December 31, 2015 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 operation’s customers for business. If new orders and selling prices of the homebuilding segment decline, NVRM’s operations will also be adversely affected. In addition, NVRM’s operating results may be adversely affected in future periods due to tightening and volatility of the credit markets, changes in investor funding times, increased regulation of mortgage lending practices and increased competition in the mortgage market.
Seasonality
We generally have higher New Order activity in the first half of the year and higher home settlements, revenues and net income in the second half of the year.
Effective Tax Rate
Our consolidated effective tax rate in 2015, 2014 and 2013 was 36.52%, 37.90% and 36.36%, respectively. During 2014, we recognized income tax expense of approximately $7,000 due to the reversal of certain previously recognized tax deductions.
Recent Accounting Pronouncements Pending Adoption
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The standard will replace most existing revenue recognition guidance in GAAP when it becomes effective. In July 2015, the FASB delayed the standard’s effective date for one year. The standard is effective for us as of January 1, 2018. Early adoption is permitted for the annual period beginning January 1, 2017. The standard
permits the use of either the retrospective or cumulative effect transition method. We have not yet selected a transition method and are currently evaluating the effect that the standard will have on our consolidated financial statements and related disclosures.
In August 2014, FASB issued ASU 2014-15, Presentation of Financial Statements – Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. The standard requires an entity’s management to evaluate at each annual and interim reporting period whether there are conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date the financial statements are issued and to provide related footnote disclosures. The standard is effective for the first annual period ending after December 15, 2016, and interim periods thereafter. We do not believe that the adoption of this standard will have a material effect on our consolidated financial statements and related disclosures.
In February 2015, FASB issued ASU 2015-02, Consolidation (Topic 810) – Amendments to the Consolidation Analysis. The standard changes the manner in which reporting entities evaluate consolidation requirements of certain legal entities. The standard is effective for us as of January 1, 2016. We do not believe that the adoption of this standard will have a material effect on our consolidated financial statements and related disclosures.
In April 2015, FASB issued ASU 2015-03, Interest – Imputation of Interest (Subtopic 835-30) – Simplifying the Presentation of Debt Issuance Costs. The standard requires that debt issuance costs related to a recognized debt liability be presented on the balance sheet as a direct deduction from the debt liability, rather than as an asset. The standard is effective for us for the first annual period beginning after December 15, 2015, and must be applied retrospectively to all prior periods presented in the financial statements. Early adoption is permitted. We do not believe that the adoption of this standard will have a material effect on our consolidated financial statements and related disclosures.
In April 2015, FASB issued ASU 2015-05, Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40). The standard adds guidance to Subtopic 350-40 to help entities evaluate the accounting for fees paid by a customer in a cloud computing arrangement. The standard provides a basis for evaluating whether a cloud computing arrangement includes a software license or whether the arrangement should be accounted for as a service contract. The standard is effective for us as of January 1, 2016. We do not believe that the adoption of this standard will have a material effect on our consolidated financial statements and related disclosures.
In July 2015, FASB issued ASU 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory. The standard simplifies the subsequent measurement of inventory by requiring inventory to be measured at the lower of cost or net realizable value. The amendments in the standard do not apply to inventory that is measured using last-in, first-out (LIFO) or the retail inventory method. The standard is effective for us for the first annual period beginning after December 15, 2016. The amendments in the standard are to be applied prospectively with early adoption permitted. We do not believe that the adoption of this standard will have a material effect on our consolidated financial statements and related disclosures.
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 10, 2012, we completed an offering for $600,000 aggregate principal amount of 3.95% Senior Notes due 2022 under a Shelf Registration Statement filed on September 5, 2012 with the SEC. 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 Senior Notes mature on September 15, 2022 and bear interest at 3.95%, payable semi-annually in arrears on March 15 and September 15. 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.
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 January 18, 2016, NVRM entered into the Seventh Amendment (the “Amendment”) to its Amended and Restated Master Repurchase Agreement dated August 2, 2011 with U.S. Bank National Association (as amended by the Amendment and six earlier amendments, the “Repurchase Agreement”). The Repurchase Agreement provides borrowing capacity up to $150,000 (as compared to $25,000 prior to the Amendment), subject to certain sub-limits, and provides for an incremental commitment pursuant to which we may from time to time request increases in the total commitment available under the Repurchase Agreement by up to $50,000 in the aggregate. The purpose of the Repurchase Agreement is to finance the origination of mortgage loans by NVRM. The Repurchase
Agreement expires on July 27, 2016. Advances under the Repurchase Agreement carry a Pricing Rate based on the LIBOR Rate plus the LIBOR Margin, as determined under the Repurchase Agreement, provided that the Pricing Rate shall not be less than 2.25%. 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, 2015. At December 31, 2015, there was no debt outstanding under the Repurchase Agreement and there were no borrowing base limitations.
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 Plan Trust or Employee Stock Ownership Plan Trust. The repurchase program assists us in accomplishing our primary objective, creating increases in shareholder value. See “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” in Item 5 of this Form 10-K for disclosure of amounts repurchased during the fourth quarter of 2015. For the year ended December 31, 2015, we repurchased 289,687 shares of our common stock at an aggregate purchase price of $431,367. As of December 31, 2015, we had approximately $339,200 available under Board approved repurchase authorizations.
Cash Flows
For the year ended December 31, 2015, cash and cash equivalents decreased by $120,103. Net cash provided by operating activities was $203,391. Cash provided by earnings in 2015 was used to fund the increase in homebuilding inventory of $134,803, as a result of an increase in units under construction at December 31, 2015 compared to December 31, 2014, and the increase of $37,561in contract land deposits. Cash was favorably impacted by an increase of $55,404 in accounts payable and accrued expenses associated with the increase in homebuilding inventory. Net cash used in investing activities in 2015 of $1,022 included cash used for purchases of property, plant and equipment of $18,277 and investments in our unconsolidated JVs totaling $1,917. These were partially offset by the receipt of capital distributions from our unconsolidated JVs totaling $18,489. Net cash used in financing activities was $322,472, due primarily to our repurchase of 289,687 shares of our common stock for an aggregate purchase price of $431,367 under our ongoing common stock repurchase program as discussed above. Stock option exercise activity during 2015 provided $85,948 in proceeds, and we realized $23,311 in excess income tax benefits from equity-based compensation plan activity.
For the year ended December 31, 2014, cash and cash equivalents decreased by $320,834. Net cash provided by operating activities was $184,549. Cash was provided by homebuilding operations and net proceeds of $55,830 from mortgage loan activity. Cash was used to fund the increase in homebuilding inventory of $127,729, as a result of an increase in the number of units under construction at December 31, 2014 compared to December 31, 2013. Cash was also used to fund the $57,566 increase in contract land deposits year over year. Investing activities in 2014 used net cash of $19,082 due primarily to the addition of $31,672 in property, plant and equipment, offset partially by the receipt of $11,569 of capital distributions from unconsolidated joint ventures. Net cash used in financing activities was $486,301, due primarily to our repurchase of 507,648 shares of our common stock for an aggregate purchase price of $567,544. This use of cash in financing activities was partially offset by $76,153 in proceeds from stock option exercises.
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 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. 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. This use of cash in 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.
At December 31, 2015 and 2014, the homebuilding segment had restricted cash of $23,440 and $24,106, 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, 2015, we controlled approximately 74,500 lots through lot purchase agreements, joint ventures and land under development, with an aggregate purchase price of approximately $6,900,000. These lots are controlled by making or committing to make deposits of approximately $472,600 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 $378,400 in deposits paid, plus approximately $94,200 related to deposits to be paid subsequent to December 31, 2015 assuming that contractual development milestones are met by the developers and we exercise our option, and approximately $1,500 in specific performance obligations (see Contractual Obligations section below). Of the $378,400 deposit total, approximately $373,300 was in cash and approximately $5,100 was in letters of credit which had been issued as of December 31, 2015. As of December 31, 2015, we had recorded an impairment valuation allowance of approximately $42,200 related to certain cash deposits currently outstanding. Additionally, as of December 31, 2015, we had funding commitments totaling $11,500 to three of our joint ventures and approximately $19,200 under a joint development agreement related to our land under development, a portion of which we expect will be offset by development credits of approximately $9,600.
In addition, we have certain properties under contract with land owners that are expected to yield approximately 8,800 lots, which are not included in our number of total lots controlled above. Some of these properties may require rezoning or other approvals to achieve the expected yield. These properties are controlled with cash deposits and letters of credit totaling approximately $12,200 and $350, respectively, as of December 31, 2015, of which approximately $8,700 is refundable if we do not perform under the contract and the remainder is at risk of loss. We generally expect to assign the raw land contracts to a land developer and simultaneously enter into a lot purchase agreement with the assignee if the project is determined to be feasible. In February 2016, we acquired one of these properties at a cost of approximately $150,000 which is expected to produce approximately 1,000 lots, of which approximately 160 lots are under contract with unrelated parties. Of the total $12,200 in cash deposits noted above, $5,000 relates to this property. 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 for 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 $58,300 of contingent obligations under such agreements as of December 31, 2015, inclusive of the $5,500 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, NVRM 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, 2015, we had contractual commitments to extend credit to borrowers aggregating $462,329 and open forward delivery contracts aggregating $737,052, which hedge both the rate lock loan commitments and closed loans held for sale (see 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, 2015, were as follows:
| Payments due by year | ||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Total | 2016 | 2017 to 2018 | 2019 to 2020 | 2021 and Later | ||||||||||||||||
| Debt (1) | $ | 600,000 | $ | — | $ | — | $ | — | $ | 600,000 | ||||||||||
| Interest on debt (1) | 165,834 | 23,700 | 47,400 | 47,400 | 47,334 | |||||||||||||||
| Operating leases (2) | 99,399 | 24,032 | 31,871 | 21,082 | 22,414 | |||||||||||||||
| Purchase obligations (3) | 114,850 | * | * | * | * | |||||||||||||||
| Uncertain tax positions (4) | 30,284 | * | * | * | * | |||||||||||||||
| Total | $ | 1,010,367 | $ | 47,732 | $ | 79,271 | $ | 68,482 | $ | 669,748 |
| (1) | See Note 9 in the accompanying consolidated financial statements for additional information regarding the Senior Notes. |
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| (2) | See Note 13 in the accompanying consolidated financial statements for additional information regarding operating leases. |
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| (3) | Amount represents expected payments of forfeitable deposits with land developers under existing fixed price purchase agreements assuming that contractual development milestones are met by the developers and we exercise our option, specific performance guarantees and estimated contractual obligations for land development agreements. We expect to make the majority of payments of the deposits with land developers 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. |
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| (4) | 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. |
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Critical Accounting Policies
General
The preparation of financial statements in conformity with 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 building 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, plus a reasonable profit margin. 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 and a reasonable profit margin. Any calculated impairments are recorded immediately.
Land Under Development and Contract Land Deposits
Land Under Development
On a 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, 2015, we had approximately $60,600 in land under development in four separate communities. In addition, at December 31, 2015, we had an aggregate investment totaling approximately $60,500 in six 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, 2015. 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.
Although we consider the allowance for losses on contract land deposits reflected on the December 31, 2015 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.
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, 2015 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 equity-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). For the recognition of equity-based compensation expense, the Options which are subject to a performance condition are treated as a separate award from the “service-only” Options, and compensation expense is recognized when it becomes probable that the stated performance target will be achieved.
We calculate the fair value of our non-publicly traded, employee 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.
In addition, when recognizing stock based compensation cost related to “performance condition” Option grants, we are required to make a determination as to whether the performance conditions will be met prior to the completion of the actual performance period. The performance metric is based on our return on capital performance during a specified three year period based on the date of Option grant, with the initial performance period being 2014 through 2016. While we currently believe that this performance condition will be satisfied at the target level and are recognizing compensation expense related to such Options accordingly, our future expected activity levels could cause us to make a different determination, resulting in a change to the compensation expense to be recognized related to performance condition option grants that would otherwise have been recognized to date. Although we believe that the compensation costs recognized in 2015 are representative of the cumulative ratable amortization of the grant-date fair value of unvested options outstanding and expected to be exercised, changes to the estimated input values such as expected term and expected volatility and changes to the determination of whether performance condition grants will vest, could produce widely different fair values.
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, 2015 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 of this Form 10-K 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.
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