UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
For the quarterly period ended June 30, 2004
OR
For the transition period from to
Commission File Number: 1-12378
NVR, Inc.
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
7601 Lewinsville Road, Suite 300
McLean, Virginia 22102
(703) 761-2000
(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)
(Not Applicable)
(Former name, former address, and former fiscal year if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act of 1934). Yes x No ¨
As of July 23, 2004 there were 6,388,188 total shares of common stock outstanding.
Form 10-Q
INDEX
PART I
Item 1.
Item 2.
Item 3.
Item 4.
PART II
Item 6.
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
(in thousands, except per share and share data)
June 30,
2004
December 31,
2003
Homebuilding:
Cash and cash equivalents
Receivables
Inventory:
Lots and housing units, covered under sales agreements with customers
Unsold lots and housing units
Manufacturing materials and other
Assets not owned, consolidated per FIN 46
Property, plant and equipment, net
Reorganization value in excess of amounts allocable to identifiable assets, net
Goodwill, net
Contract land deposits
Other assets
Mortgage Banking:
Mortgage loans held for sale, net
Mortgage servicing rights, net
Property and equipment, net
Total assets
(Continued)
See notes to condensed consolidated financial statements.
3
Condensed Consolidated Balance Sheets (Continued)
LIABILITIES AND SHAREHOLDERS’ EQUITY
Accounts payable
Accrued expenses and other liabilities
Liabilities related to assets not owned, consolidated per FIN 46
Obligations under incentive plans
Customer deposits
Other term debt
Senior notes
Accounts payable and other liabilities
Notes payable
Total liabilities
Commitments and contingencies
Shareholders’ equity:
Common stock, $0.01 par value; 60,000,000 shares authorized; 20,597,709 shares issued as of June 30, 2004 and December 31, 2003, respectively
Additional paid-in-capital
Deferred compensation trust – 492,118 and 510,118 shares as of June 30, 2004 and December 31, 2003, respectively, of NVR, Inc. common stock
Deferred compensation liability
Retained earnings
Less treasury stock at cost – 14,217,769 and 13,870,368 shares at June 30, 2004 and December 31, 2003, respectively
Total shareholders’ equity
Total liabilities and shareholders’ equity
4
Condensed Consolidated Statements of Income
(in thousands, except per share data)
(unaudited)
Three Months Ended
Six Months Ended
Revenues
Other income
Cost of sales
Selling, general and administrative
Operating income
Interest expense
Homebuilding income
Mortgage banking fees
Interest income
General and administrative
Mortgage banking income
Income before taxes
Income tax expense
Net income
Basic earnings per share
Diluted earnings per share
Basic average shares outstanding
Diluted average shares outstanding
5
Condensed Consolidated Statements of Cash Flows
(in thousands)
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
Mortgage loans closed
Proceeds from sales of mortgage loans
Gain on sale of mortgage servicing rights
Gain on sale of loans
Net change in assets and liabilities:
Increase in inventories
Increase in receivables
Increase in contract land deposits
Increase in accounts payable, customer deposits and accrued expenses
Decrease in obligations under incentive plans
Other, net
Net cash provided by operating activities
Cash flows from investing activities:
Purchase of property, plant and equipment
Principal payments on mortgage loans held for sale
Proceeds from sales of mortgage servicing rights, net
Net cash provided by investing activities
Cash flows from financing activities:
Purchase of NVR, Inc. common stock for funding of deferred compensation plan
Net borrowings (repayments) under notes payable and other term debt
Issuance of 5% senior notes due 2010
Purchase of treasury stock
Proceeds from exercise of stock options
Net cash (used) provided by financing activities
Net (decrease) increase in cash and cash equivalents
Cash and cash equivalents, beginning of the period
Cash and cash equivalents, end of period
Supplemental disclosures of cash flow information:
Interest paid during the period
Income taxes paid during the period, net of refunds
Supplemental disclosures of non-cash activities:
Net assets not owned, consolidated per FIN 46
6
Notes to Condensed Consolidated Financial Statements
(dollars in thousands except per share data)
1. Basis of Presentation
The accompanying unaudited, condensed consolidated financial statements include the accounts of NVR, Inc. (“NVR” or the “Company”) and its subsidiaries and certain other entities in which the Company is deemed to be the primary beneficiary (see Note 2). Intercompany accounts and transactions have been eliminated in consolidation. The statements have been prepared in conformity with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. Because the accompanying condensed consolidated financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America, they should be read in conjunction with the financial statements and notes thereto included in the Company’s 2003 Annual Report on Form 10-K. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the six-month period ended June 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
For the three and six month periods ended June 30, 2004 and 2003, comprehensive income equaled net income; therefore, a separate statement of comprehensive income is not included in the accompanying financial statements. Certain prior year balances have been reclassified to conform with the current year presentation.
2. Consolidation of Variable Interest Entities
In December 2003, the Financial Accounting Standards Board (“FASB”) issued Revised Interpretation No. 46 (“FIN 46R”), Consolidation of Variable Interest Entities, which was effective for NVR as of March 31, 2004. FIN 46R requires the primary beneficiary of a variable interest entity to consolidate that entity. The primary beneficiary of a variable interest entity is the party that absorbs a majority of the variable interest entity’s expected losses, receives a majority of the entity’s expected residual returns, or both, as a result of ownership, contractual, or other financial interests in the entity. Expected losses are the expected negative variability in the fair value of an entity’s net assets exclusive of its variable interests, and expected residual returns are the expected positive variability in the fair value of an entity’s net assets, exclusive of variable interests. As discussed below, NVR has determined that it must evaluate the provisions of FIN 46R as it relates to NVR’s finished lot acquisition strategy.
NVR does not engage in the land development business. Instead, the Company typically acquires finished building lots at market prices from various development entities under fixed price purchase agreements. The purchase agreements require deposits that may be forfeited if NVR fails 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 typically range up to 10% of the aggregate purchase price of the finished lots. As of June 30, 2004, the Company controlled approximately 74,000 lots with deposits in cash and letters of credit totaling approximately $321,900 and $14,200, respectively.
This lot acquisition strategy reduces the financial requirements and risks associated with direct land ownership and land development. NVR may, at its option, choose for any reason and at any time not to perform under these purchase agreements by delivering notice of its intent not to acquire the finished lots
7
under contract. NVR’s 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 liquidating damage provision contained within the purchase agreements. In other words, if NVR does not perform under a purchase agreement, NVR loses its deposit. NVR does not have any financial or specific performance guarantees, or completion obligations, under these purchase agreements. None of the creditors of any of the development entities with which NVR enters fixed price purchase agreements have recourse to the general credit of NVR. NVR also does not share in an allocation of either the profit earned or loss incurred by any of these entities with which NVR enters fixed price purchase agreements.
On a very limited basis, NVR also obtains finished lots using joint venture limited liability corporations (“LLC’s”). All LLC’s are structured such that NVR is a non-controlling limited partner and is at risk only for the amount invested. NVR is not a borrower, guarantor or obligor on any of the LLC’s debt. NVR enters into a standard fixed price purchase agreement to purchase lots from the LLC.
At June 30, 2004, NVR had an aggregate investment in twelve (12) separate LLC’s totaling approximately $13,400, which controlled approximately 1,000 lots. NVR recognizes its share of the earnings of the LLC’s as a reduction of the cost basis of the lots at the time that the lot and related home is settled with an external customer. During the quarter ended June 30, 2004, NVR reduced cost of sales by approximately $182, which represented NVR’s share of the earnings of the LLC’s.
Forward contracts, such as the fixed price purchase agreements utilized by NVR to acquire finished lot inventory, are deemed to be “variable interests” under FIN 46R. Therefore, the development entities with which NVR enters fixed price purchase agreements, including the LLC’s, are examined under FIN 46R for possible consolidation by NVR. NVR has developed a methodology to determine whether it or the owner of the applicable development entity is the primary beneficiary of a development entity. The methodology used to evaluate NVR’s primary beneficiary status requires substantial management judgment and estimation. These judgments and estimates involve assigning probabilities to various estimated cash flow possibilities relative to the development entity’s expected profits and losses and the cash flows associated with changes in the fair value of finished lots under contract. Because NVR does not have any contractual or ownership interests in the development entities with which it contracts to buy finished lots (other than the limited use of the LLC’s as discussed above), NVR does not have the ability to compel these development entities to provide financial or other data to assist NVR in the performance of the primary beneficiary evaluation. In many instances, these development entities provide little, if any, financial information. This lack of direct information from the development entities may result in NVR’s evaluation being conducted solely based on the aforementioned management judgments and estimates. Although management believes that its accounting policy is designed to properly assess NVR’s primary beneficiary status relative to its involvement with the development entities from which NVR acquires finished lots, changes to the probabilities and the cash flow possibilities used in NVR’s evaluation could produce widely different conclusions regarding NVR’s status or non-status as a development entity’s primary beneficiary.
The Company has evaluated all of its fixed price purchase agreements and LLC arrangements and has determined that it is the primary beneficiary of seventeen (17) of those development entities with which the agreements and arrangements are held. As a result, at June 30, 2004, NVR has consolidated such development entities in the accompanying condensed consolidated balance sheet. Where NVR deemed itself to be the primary beneficiary of a development entity created after December 31, 2003 and the development entity refused to provide financial statements, NVR utilized estimation techniques to perform the consolidation. The effect of the consolidation at June 30, 2004 was the inclusion on the balance sheet of $65,232 as Assets not owned, consolidated per FIN 46 with a corresponding inclusion of $41,353 as Liabilities related to inventory not owned, consolidated per FIN 46, after elimination of intercompany items. Inclusive in these totals were assets of $12,675 and liabilities of $9,225 estimated for two (2) development entities created after December 31, 2003 that did not provide financial statements.
8
Following are the consolidating schedules at June 30, 2004:
andSubsidiaries
ASSETS
Homebuilding inventory
Reorganization value in excess of amount allocable to identifiable assets, net
Mortgage banking assets:
FIN 46R Entities:
Land under development
Accounts payable, accrued expenses and other liabilities
Mortgage banking liabilities:
Debt
Advances from NVR, Inc.
Minority interest
Equity
9
Under FIN 46R, an enterprise with an interest in a variable interest entity or potential variable interest entity created before December 31, 2003, is not required to apply FIN 46R to that entity if the enterprise, after making an “exhaustive effort”, is unable to obtain the information necessary to perform the accounting required to consolidate the variable interest entity for which it is determined to be the primary beneficiary. NVR was unable to obtain the information necessary to perform the accounting required to consolidate twenty-one (21) separate development entities created before December 31, 2003 for which NVR determined it was the primary beneficiary. NVR has made, or has committed to make, aggregate deposits, totaling $21,430 to these twenty-one (21) separate development entities, with a total aggregate purchase price for the finished lots of approximately $151,000. The aggregate deposit made or committed to being made is NVR’s maximum exposure to loss. As noted above, because NVR does not have any contractual or ownership interests in the development entities with which it contracts to buy finished lots (other than the limited use of the LLC’s as discussed above), NVR does not have the ability to compel these development entities to provide financial or other data. Because NVR has no ownership rights in any of these twenty-one (21) development entities, the consolidation of such entities would have had no impact on NVR’s net income or earnings per share for the three or six months ended June 30, 2004. Aggregate activity with respect to the twenty-one (21) development entities is included in the following table:
Finished lots purchased - dollars
Finished lots purchased - units
3. Stock-Based Compensation
At June 30, 2004, the Company had seven active stock-based employee compensation plans. As permitted under Statement of Financial Accounting Standard (“FAS”) No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, an amendment of FASB Statement No. 123, NVR has elected to continue to follow the intrinsic value method in accounting for its stock-based employee compensation arrangements as defined by Accounting Principles Board Opinion (“APB”) No. 25, Accounting for Stock Issued to Employees, and related interpretations including Financial Accounting Standards Board Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB No. 25. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FAS 123 to stock-based employee compensation.
Net income, as reported
Deduct: Total stock-based employee compensation expense determined under fair value-based method for all awards, net of related tax effects
Pro forma net income
Earnings per share:
Basic—as reported
Basic—pro forma
Diluted—as reported
Diluted—pro forma
10
4. Earnings per Share
The following weighted average shares and share equivalents are used to calculate basic and diluted EPS for the three and six months ended June 30, 2004 and 2003:
Basic weighted average number of shares outstanding
Shares issuable upon exercise of dilutive options and deferred compensation payable in shares of NVR common stock
Diluted average number of shares outstanding
Options issued under equity plans to purchase 168,019 and 120,935 shares of common stock during the three and six months ended June 30, 2004, respectively, and 1,500 and 41,500 during the three and six months ended June 30, 2003, respectively, were outstanding but were not included in the computation of diluted earnings per share because the effect would have been anti-dilutive.
5. Shareholders’ Equity
A summary of changes in shareholders’ equity is presented below:
Balance, December 31, 2003
Deferred compensation activity, net
Purchase of common stock for treasury
Stock option activity
Tax benefit from stock-based compensation activity
Treasury shares issued upon option exercise
Balance, June 30, 2004
Approximately 204,000 options to purchase shares of the Company’s common stock were exercised during the first six months of 2004. The Company settles option exercises by issuing shares of treasury stock to option holders. Shares are relieved from the treasury account based on the weighted average cost basis of treasury shares acquired. The Company repurchased approximately 552,000 shares of its common stock at an aggregate purchase price of $245,857 during the six months ended June 30, 2004.
11
6. Segment Disclosures
NVR operates in two business segments: homebuilding and mortgage banking. Corporate general and administrative expenses are fully allocated to the homebuilding and mortgage banking segments in the information presented below.
For the Six Months Ended June 30, 2004
Revenues from external customers
Segment income
Segment assets
Add: Excess reorganization value and goodwill
Total consolidated assets
For the Three Months Ended June 30, 2004
For the Six Months Ended June 30, 2003
For the Three Months Ended June 30, 2003
12
7. Recent Accounting Pronouncement
In March 2004, the Securities and Exchange Commission staff issued Staff Accounting Bulletin 105 (“SAB 105”). Existing accounting guidance requires an entity to record on its balance sheet the fair value of any issued and outstanding mortgage loan commitments. SAB 105 requires that the fair value measurement of outstanding mortgage loan commitments include only differences between the guaranteed interest rate in the loan commitment and a market interest rate, excluding any future cash flows related to (i) expected fees to be received when the loan commitment becomes a loan, (ii) gains from selling the loan, or (iii) the servicing value created from the loan. NVR adopted the guidance in SAB 105 for its mortgage loan commitments effective April 1, 2004. The adoption of SAB 105 did not have a material effect on NVR’s financial condition or results of operations.
8. Excess Reorganization Value and Goodwill
Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, requires goodwill and reorganization value in excess of amounts allocable to identifiable assets (“excess reorganization value”) to be tested for impairment on an annual basis subsequent to the year of adoption. The Company continually evaluates whether events and circumstances have occurred that indicate that the remaining value of goodwill and excess reorganization value may not be recoverable. The Company completed the annual assessment of impairment during the first quarter of 2004, and as of June 30, 2004, management believes that goodwill and excess reorganization value were not impaired.
9. Product Warranties
The Company establishes warranty and product liability reserves to provide for estimated future expenses as a result of construction and product defects, product recalls and litigation incidental to NVR’s homebuilding business. Liability estimates are determined based on management’s 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 discussions with our General Counsel and other outside counsel retained to handle specific product liability cases. The following table reflects the changes in the Company’s warranty reserve during the three and six months ended June 30, 2004 and 2003:
Warranty reserve, beginning of period
Provision
Payments
Warranty reserve, end of period
13
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
(dollars in thousands)
Forward-Looking Statements
Some of the statements in this Form 10-Q, as well as statements made by NVR, Inc. (“NVR”) in periodic press releases and other public communications, constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934. Certain, but not necessarily all, of such forward-looking statements can be identified by the use of forward-looking terminology, such as “believes,” “expects,” “may,” “will,” “should,” or “anticipates” or the negative thereof or other variations thereof or comparable terminology, or by discussion of strategies, each of which involves risks and uncertainties. All statements other than those of historical facts included herein, including those regarding market trends, NVR’s financial position, business strategy, projected plans and objectives of management for future operations, are forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results or performance of NVR to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. Such risk factors include, but are not limited to, general economic and business conditions (on both a national and regional level), interest rate changes, access to suitable financing, competition, the availability and cost of land and other raw materials used by NVR in its homebuilding operations, shortages of labor, weather related slow downs, building moratoria, governmental regulation, the ability of NVR to integrate any acquired business, fluctuation and volatility of stock and other financial markets and other factors over which NVR has little or no control. NVR has no obligation to update such forward-looking statements.
Results of Operations for the Three and Six Months Ended June 30, 2004 and 2003
Overview
NVR’s primary business is the construction and sale of single-family detached homes, townhomes and condominium buildings. To fully serve our homebuilding customers, we also operate a mortgage banking and title services business. NVR operates in the following markets:
We believe we operate our business with a conservative operating strategy. We do not engage in land development and primarily construct homes on a pre-sold basis. This strategy allows us to maximize inventory turnover, which enables us to minimize market risk and to operate with less capital, thereby enhancing rates of return on equity and total capital. In addition, 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 management believes contributes to minimizing the adverse effects of regional economic cycles and provides growth opportunities within these markets.
Because we are not active in the land development business, 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 timely meet the sales demands of our customers. We acquire finished building lots at market prices from various development entities under fixed price purchase agreements (“purchase agreements”). These purchase agreements require deposits in the form of cash or letters of credit that may be forfeited if we fail to perform under the purchase agreement. However, this lot acquisition strategy reduces the financial requirements and risks associated with direct land ownership and development.
14
As of June 30, 2004, we controlled approximately 74,000 lots with deposits in cash and letters of credit totaling approximately $321,900 and $14,200, respectively. We also controlled approximately 1,000 lots through investments in joint venture limited liability corporations.
Consolidated revenues and net income for the six-months ended June 30, 2004 increased 18%, respectively, from the same period in 2003. The increase in net income coupled with our continuing share repurchase program resulted in a 30% increase in diluted earnings per share for the year to date period ended June 30, 2004 from the same period in 2003.
Homebuilding Segment
The following table summarizes homebuilding settlements, new orders and backlog activity by region for the quarter and six-month period ended June 30, 2004 and 2003:
Washington
Baltimore
North
South
Total
Average settlement price
New Orders (units):
Average new order price
Backlog (units):
Average backlog price
The following table summarizes the results of operations for the homebuilding segment:
Gross profit margin percentage
15
Three Months Ended June 30, 2004 and 2003
Homebuilding revenues increased 19% for the quarter ended June 30, 2004 from the same period in 2003 primarily due to a 13% increase in the average selling price per home closed and a 6% increase in the number of homes settled. Average settlement prices increased throughout each of our regions quarter over quarter as a result of strong housing demand in prior quarters within each region. The increase in total settlements is attributable to the 11% higher overall unit backlog at the beginning of the second quarter of 2004 as compared to the same period in 2003. Development delays have impacted the 2004 quarter’s settlements on a regional basis in varying degrees, particularly in the Washington region.
The 2004 quarter over quarter reduction in new orders is due a deceleration in the level of sales traffic visiting NVR’s sales models and, to a lesser extent, development delays. The total number of average communities open for sales activity remained flat at 437 quarter over quarter.
The increase in gross profit margins in the second quarter of 2004 as compared to the second quarter of 2003 is primarily attributable to our ability in prior quarters to increase sales prices due to strong housing demand, partially offset by lot, lumber and other commodity price increases.
Selling, general and administrative (“SG&A”) expenses increased approximately $3,900. The increase was primarily caused by increased selling and marketing expenses, which are related to our continued growth objectives.
Six Months Ended June 30, 2004 and 2003
Homebuilding year to date revenues for 2004 exceeded prior year revenues by 19% primarily due to a 12% increase in the average price of homes settled and a 7% increase in the number of homes settled. The increase in average settlement prices in each of our regions is attributable to strong housing demand resulting from favorable market conditions. The increase in the number of homes settled is primarily the result of the beginning unit backlog in 2004 being 8% higher than the beginning unit backlog in 2003. Settlements in the Washington region continue to lag prior year settlements primarily due to development delays.
Overall, new orders increased 4% in the first six months of 2004 as compared to the same period in 2003, which was all attributable to the first quarter of 2004. As discussed above, the second quarter new orders were impacted by a deceleration of sales traffic, and, to a lesser extent, development delays.
The increase in gross profit margins in the 2004 period as compared to the 2003 period is primarily attributable to our ability in prior quarters to increase sales prices due to strong housing demand. However, lot, lumber and other commodity prices remain higher in 2004 compared to 2003. Gross margins in future periods may be negatively impacted by the trend of higher lot, lumber and other commodity prices if we are unable to maintain the current level of sales prices.
Selling, general and administrative (“SG&A”) expenses increased approximately $11,400. The increase was primarily attributable to a $4,300 increase in selling and marketing costs and a $4,100 increase in personnel costs, both of which are related to our continued growth objectives.
Backlog units and dollars increased 6% and 20%, respectively, to 8,490 and $3,064,726, respectively, at June 30, 2004 compared to 8,017 and $2,556,321, respectively, at June 30, 2003. The number of units in backlog is higher at June 30, 2004 compared to June 30, 2003 because of the higher beginning number of units in backlog for the 2004 period compared to the 2003 period. The increase in backlog dollars was also impacted by a 16% increase in the average selling price for the six-month period ended June 30, 2004 as compared to the same period ending June 30, 2003.
16
Mortgage Banking Segment
Three and Six Months Ended June 30, 2004 and 2003
NVR conducts its mortgage banking activity through NVR Mortgage Finance, Inc. (“NVRM”), a wholly owned subsidiary. NVRM focuses almost exclusively on serving the homebuilding segment’s customer base.
Loan closing volume:
Total principal
Capture Rate:
Segment income:
Mortgage Banking Fees:
Net gain on sale of loans
Title services
Servicing
Gain on sale of servicing
Loan closing volume for the three months ended June 30, 2004 increased 8% over the same period for 2003. The 2004 increase is attributable to an 11% increase in the average loan amount, offset by a quarter over quarter 3% reduction in the number of units closed. Loan closing volume for the six months ended June 30, 2004 increased 5% over the 2003 six-month period. The 2004 increase is attributable to a 10% increase in the average loan amount, offset by a period over period 4% reduction in the number of units closed. The increases in the average loan amount for the three and six-month periods reflect the aforementioned increase in the homebuilding segment’s average selling prices. The unit decreases for the three and six-month 2004 periods primarily reflect declines in the percentage of the number of loans closed for NVR’s homebuyers who obtain a mortgage to purchase the home (“Capture Rate”). The Capture Rate declines are a result of increased competition caused by the industry-wide fall-off in refinance activity.
Segment income for the three and six-month periods ended June 30, 2004 decreased approximately $3,000 and $5,600, respectively, over the comparable 2003 periods. The decreases are primarily due to a product mix shift during 2004 from fixed rate mortgages to adjustable rate mortgages and brokered mortgages, both of which are generally less profitable products than fixed rate mortgages. The decreases are also due to higher costs incurred of approximately $600 and $1,200 for the three and six months ended June 30, 2004, respectively, related to the contractual repayment of loan sale income to investors for paid in full loans. General and administrative expenses have also increased during the three and six-month 2004 periods compared to the prior year 2003 periods by approximately $1,400 and $2,200, respectively, which is largely due to a 13% increase in the total number of NVRM employees in 2004 versus 2003. The increased staffing level is to position NVRM for future growth and to increase the Capture Rate.
17
Liquidity and Capital Resources
On May 27, 2004, NVR filed a Shelf Registration statement (“New Shelf”) with the Securities and Exchange Commission (“SEC”) to register up to $1,000,000 for future offer and sale of debt securities, common shares, preferred shares, depositary shares representing preferred shares and warrants. The SEC declared the New Shelf effective on June 15, 2004. The proceeds received from future offerings issued under the New Shelf are expected to be used for general corporate purposes. In addition, NVR has $55,000 available for issuance under an existing shelf registration statement filed with the SEC on January 20, 1998. The existing shelf registration statement, as declared effective on February 27, 1998, provides that securities may be offered from time to time in one or more series and in the form of senior or subordinated debt. This discussion of NVR’s shelf registration capacity does not constitute an offer of any securities for sale.
NVR’s homebuilding segment generally provides for its working capital cash requirements using cash generated from operations and a short-term unsecured working capital revolving credit facility (the “Facility”). The Facility provides for borrowings of up to $150,000, subject to certain borrowing base limitations, and expires in August 2007. Up to approximately $50,000 of the Facility is currently available for issuance in the form of letters of credit, of which $22,694 was outstanding at June 30, 2004. There were no direct borrowings outstanding under the Facility as of June 30, 2004. At June 30, 2004, there were no borrowing base limitations reducing the amount available to NVR for borrowings.
NVR’s mortgage banking segment provides for its mortgage origination and other operating activities using cash generated from operations as well as a short-term credit facility. NVR’s mortgage banking segment utilizes an annually renewable mortgage warehouse facility with an aggregate available borrowing limit of $175,000 to fund its mortgage origination activities. The mortgage warehouse facility expires in August 2004. Management believes that the mortgage warehouse facility will be renewed with terms materially consistent with the current warehouse facility prior to its expiration. There was $91,573 outstanding under this facility at June 30, 2004. At June 30, 2004, borrowing base limitations reduced the amount available to NVR for borrowings to approximately $104,000. NVR’s mortgage banking segment also currently has available an aggregate of $50,000 of borrowing capacity in an uncommitted gestation and repurchase agreement. There were no amounts outstanding under the gestation and repurchase agreement at June 30, 2004.
In addition to funding growth in its homebuilding and mortgage banking operations, NVR historically has used a substantial portion of its excess liquidity to repurchase outstanding shares of its common stock in the open market and in 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 10(b)-18 of the 1933 Securities Act. The repurchase program assists NVR in accomplishing one of its primary objectives, which is to create increases in shareholder value. See Part II, Item 2 of this Form 10-Q for disclosure of amounts repurchased during the second quarter of 2004. NVR expects to continue to repurchase its common stock from time to time subject to market conditions and available excess liquidity.
Management believes that internally generated cash and borrowings available under credit facilities will be sufficient to satisfy near and long term cash requirements for working capital in both its homebuilding and mortgage banking operations.
18
Critical Accounting Policies
General
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management 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. NVR continually evaluates the estimates it uses to prepare the consolidated financial statements, and updates those estimates as necessary. In general, management’s 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.
Variable Interest Entities
In December 2003, the Financial Accounting Standards Board (“FASB”) issued Revised Interpretation No. 46 (“FIN 46R”), Consolidation of Variable Interest Entities, which was effective for NVR as of March 31, 2004. FIN 46R requires the primary beneficiary of a variable interest entity to consolidate that entity. The primary beneficiary of a variable interest entity is the party that absorbs a majority of the variable interest entity’s expected losses, receives a majority of the entity’s expected residual returns, or both, as a result of ownership, contractual, or other financial interests in the entity. Expected losses are the expected negative variability in the fair value of an entity’s net assets exclusive of its variable interests, and expected residual returns are the expected positive variability in the fair value of an entity’s net assets, exclusive of variable interests.
Forward contracts, such as the fixed price purchase agreements utilized by NVR to acquire finished lot inventory, are deemed to be “variable interests” under FIN 46R. Therefore, the development entities with which NVR enters fixed price purchase agreements are examined under FIN 46R for possible consolidation by NVR, including the joint venture limited liability corporations (“LLC’s”) utilized by NVR on a limited basis. NVR has developed a methodology to determine whether it or the owner of the applicable development entity is the primary beneficiary of a development entity. The methodology used to evaluate NVR’s primary beneficiary status requires substantial management judgment and estimation. These judgments and estimates involve assigning probabilities to various estimated cash flow possibilities relative to the development entity’s expected profits and losses and the cash flows associated with changes in the fair value of finished lots under contract. Because NVR does not have any contractual or ownership interests in the development entities with which it contracts to buy finished lots (other than the limited use of the LLC’s), NVR does not have the ability to compel these development entities to provide financial or other data to assist NVR in the performance of the primary beneficiary evaluation. In many instances, these development entities provide little, if any, financial information. This lack of direct information from the development entities may result in NVR’s evaluation being conducted solely based on the aforementioned management judgments and estimates. Further, where NVR deems itself to be the primary beneficiary of a development entity created after December 31, 2003 and that development entity refuses to provide financial statements, NVR utilizes estimation techniques to perform the consolidation. While management believes that its estimation techniques provide a reasonable basis of providing the financial condition of a development entity that refuses to provide financial statements, the actual financial condition of the development entity could differ from that reported. Although management believes that its accounting policy is designed to properly assess NVR’s primary beneficiary status relative to its involvement with the development entities from which NVR acquires finished lots, changes to the probabilities and the cash flow possibilities used in NVR’s evaluation could produce widely different conclusions regarding NVR’s status or non-status as a development entity’s primary beneficiary.
19
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 thereof. Field construction supervisors’ salaries and related direct overhead expenses are included in inventory costs. Interest costs are not capitalized into inventory. Upon settlement, the cost of the units is expensed on a specific identification basis. Cost of manufacturing materials is determined on a first-in, first-out basis. Recoverability and impairment, if any, is primarily evaluated by analyzing sales of comparable assets. Management believes that its accounting policy is designed to properly assess the carrying value of homebuilding inventory.
Contract Land Deposits
NVR purchases finished lots under fixed price purchase agreements that require deposits that may be forfeited if NVR fails to perform under the purchase agreement. 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. NVR maintains an allowance for losses on contract land deposits that it believes is sufficient to provide for losses in the existing contract land deposit portfolio. The allowance reflects management’s judgment of the present loss exposure at the end of the reporting period, considering market and economic conditions, sales absorption and profitability within specific communities and terms of the various contracts. Although NVR considers the allowance for losses on contract land deposits reflected on the June 30, 2004 balance sheet to be adequate, there can be no assurance that this allowance will prove to be adequate over time to cover losses due to unanticipated adverse changes in the economy or other events adversely affecting specific markets or the homebuilding industry.
Intangible Assets
Reorganization value in excess of identifiable assets (“excess reorganization value”) and goodwill are no longer subject to amortization upon the adoption of Statement of Financial Accounting Standards No 142, “Goodwill and Other Intangible Assets (“FAS 142”). Rather, excess reorganization value and goodwill are subject to at least an annual assessment for impairment by applying a fair-value based test. NVR continually evaluates whether events and circumstances have occurred that indicate that the remaining value of excess reorganization value and goodwill may not be recoverable. NVR completed the annual assessment of impairment during the first quarter of 2004, and as of June 30, 2004, management believes that excess reorganization value and goodwill were not impaired. This conclusion is based on management’s judgment, considering such factors as NVR’s history of operating success, NVR’s well recognized brand names and the significant positions held in the markets in which NVR operates. However, changes in strategy or adverse changes in market conditions could impact this judgment and require an impairment loss to be recognized for the amount that the carrying value of excess reorganization value and/or goodwill exceeds their fair value.
Warranty/Product Liability Accruals
Warranty and product liability accruals are established to provide for estimated future expenses as a result of construction and product defects, product recalls and litigation incidental to NVR’s business. Liability estimates are determined based on management’s 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 discussions with our General Counsel and other outside counsel retained to handle specific product liability cases. Although NVR considers the warranty and product liability accrual reflected on the June 30, 2004 condensed consolidated balance sheet (see note 9 to the condensed consolidated financial statements) to be adequate, 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.
20
Item 3. Quantitative and Qualitative Disclosure About Market Risk
There have been no material changes in our market risks during the six months ended June 30, 2004. For additional information regarding market risk, see our Annual Report on Form 10-K for the year ended December 31, 2003.
Item 4. Controls and Procedures
As of the end of the period covered by this report, an evaluation was performed under the supervision and with the participation of NVR’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of NVR’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the design and operation of these disclosure controls and procedures were effective. There have been no changes in NVR’s internal controls over financial reporting identified in connection with the evaluation referred to above that have materially affected, or are reasonably likely to materially affect, NVR’s internal controls over financial reporting.
PART II. OTHER INFORMATION
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
(Dollars in thousands, except per share data)
NVR had two repurchase authorizations outstanding during the quarter ended June 30, 2004. On each of December 17, 2003 (“December Authorization”) and May 3, 2004 (“May Authorization”), NVR publicly announced the Board of Director’s approval for NVR to repurchase up to an aggregate of $200,000 (in each authorization) of its common stock in one or more open market and/or privately negotiated transactions. The December and May Authorizations do not have an expiration date. During the quarter ended June 30, 2004, NVR fully utilized the December Authorization. NVR repurchased the following shares of its common stock during the second quarter of 2004:
Period
April 1-30, 2004 (1)
May 1-31, 2004 (2)
June 1-30, 2004 (3)
21
Item 4. Submission of Matters to a Vote of Security Holders
NVR held its Annual Meeting of Shareholders on May 3, 2004. There were 6,684,610 shares of NVR, Inc. common stock eligible to vote at the 2004 Annual Meeting. The following are the matters voted upon at the Annual Meeting and the results of the votes on such matters:
J. Carter Bacot, C. Scott Bartlett, Jr., Robert C. Butler, William A. Moran, Dwight C. Schar and George E. Slye continued as directors after the Annual Meeting.
Votes
For
Ratification of appointment
of KPMG LLP as independent
auditors for NVR for 2004
22
Item 6. Exhibits and Reports on Form 8-K
NVR furnished a Form 8-K on April 19, 2004 reporting the issuance of a press release announcing the financial results for the quarter ended March 31, 2004.
Exhibit Index
Exhibit
Number
Description
23
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
July 28, 2004
/s/ Paul C. Saville
Paul C. Saville
Executive Vice President, Chief Financial
Officer and Treasurer
24