Toll Brothers, Inc. 2020 Q3 Form 10-Q Summary
Business context and reporting period
Toll Brothers is a luxury residential homebuilder operating through Traditional Home Building and City Living, with ancillary mortgage, title, apartment, golf and other businesses. This report covers the three and nine months ended July 31, 2020, compared with the corresponding 2019 periods. Fiscal 2020 results were materially affected by the COVID-19 pandemic, particularly in the second quarter and, to a lesser extent, the third quarter.
Key financial metrics
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Total revenue | $1.651 billion | $1.766 billion | $4.532 billion | $4.845 billion |
| Home sales revenue | $1.628 billion | $1.757 billion | $4.441 billion | $4.788 billion |
| Income from operations | $149.6 million | $171.0 million | $289.7 million | $455.9 million |
| Net income | $114.8 million | $146.3 million | $247.3 million | $387.7 million |
| Diluted EPS | $0.90 | $1.00 | $1.87 | $2.63 |
| Operating margin | 9.1% | 9.7% | 6.4% | 9.4% |
| Home sales cost as % of home sales revenue | 81.0% | 79.8% | 81.7% | 79.7% |
| Deliveries | 2,022 homes | 1,994 homes | 5,556 homes | 5,435 homes |
| Net contracts signed | 2,833 homes/$2.214 billion | 2,241 homes/$1.869 billion | 6,525 homes/$5.256 billion | 6,044 homes/$5.035 billion |
At July 31, 2020, cash and cash equivalents were $559.3 million, compared with $1.286 billion at October 31, 2019. Inventory was $8.035 billion, total liabilities were $5.811 billion and total equity was $4.726 billion. Backlog was $6.085 billion covering 7,239 homes, compared with $5.844 billion and 6,839 homes at July 31, 2019.
Operating activities provided $141.6 million of cash in the first nine months, compared with $22.5 million in the prior-year period. Investing activities used $123.5 million, including $75.0 million for property and equipment, $60.3 million for the Thrive Residential acquisition and $47.3 million for unconsolidated investments. Financing activities used $751.6 million, principally due to $633.9 million of share repurchases and $42.7 million of dividends.
Debt consisted of $1.082 billion of loans payable, $2.661 billion of senior notes and $122.2 million drawn under the mortgage company loan facility. The $1.905 billion revolving credit facility had no borrowings and approximately $1.78 billion of availability, subject to $129.3 million of letters of credit. The $800.0 million term loan facility was outstanding at a 1.47% interest rate. The debt-to-total-capitalization ratio was 0.45 to 1.00.
Material changes versus the prior comparable period
- Nine-month revenue declined 6%, operating income declined 36% and net income declined 36%; Q3 revenue declined 6% and net income declined 22%.
- Deliveries increased modestly, but average delivered price declined 9% in both the quarter and nine-month period, reflecting geographic and product mix shifts toward more affordable markets and quick-delivery homes.
- Home sales cost as a percentage of revenue increased, reflecting higher land, labor and material costs, lower-margin mix and purchase-accounting effects from the Sharp and Sabal acquisitions.
- SG&A declined 14% in Q3 due to lower sales and marketing spending and cost-reduction initiatives, but increased 1% for the nine-month period because of compensation, $7.5 million of severance and ERP implementation costs.
- Demand rebounded sharply after pandemic-related restrictions eased. Q3 net contracts increased 26% in units and 18% in value, while backlog increased 6% in units and 4% in value year over year.
- Pacific and City Living weakened significantly: Q3 revenue declined 29% and 63%, respectively. Mountain revenue increased 45% and South revenue increased 13%.
- The company repurchased 15.948 million shares for $633.9 million during the first nine months, materially exceeding the $167.5 million repurchased in the prior-year period.
- Inventory impairments totaled $21.9 million for the first nine months, compared with $31.6 million in 2019, including $15.4 million in the Mid-Atlantic region and $4.8 million in City Living.
Guidance, outlook, commentary, risks and unusual items
The filing does not provide a clear quantitative fiscal 2020 earnings or delivery guidance. Management reported that demand remained strong into the first month of fiscal fourth quarter, supported by low interest rates, housing undersupply and increased consumer focus on the home. Management nevertheless remained cautious because the duration and economic effects of COVID-19, unemployment, mortgage availability, consumer confidence and possible subsequent outbreaks remained uncertain.
Unusual or non-recurring items included a $7.8 million tax benefit from the retroactive extension of the federal energy-efficient home credit, a $10.7 million gain on the sale of a rental-property joint venture interest, $13.0 million of gains from golf club property sales, a $3.0 million impairment of a homebuilding joint venture, and an $8.0 million reversal of an accrued discretionary benefit-plan contribution.
Material contingencies include approximately $2.641 billion of land purchase commitments, $58.2 million of remaining funding commitments to unconsolidated entities, and estimated maximum exposure of $161.4 million under repayment and carry-cost guarantees for currently borrowed joint-venture debt. The company also had $795.0 million of surety bonds and $129.3 million of letters of credit outstanding.
Water-intrusion and construction-defect claims remain subject to significant estimation and insurance-recovery uncertainty. Recorded remaining estimated repair costs were approximately $81.4 million, with expected recoveries of approximately $69.1 million at July 31, 2020. Arbitration with certain insurers was ongoing. The Pennsylvania Attorney General continued reviewing stucco-home construction, and management could not predict the outcome.
Additional risks include housing-market and interest-rate volatility, rising labor and material costs, land availability, financing access, joint-venture losses and guarantees, cyberattacks, ERP implementation risk and the continuing COVID-19 pandemic. A 1% increase in variable interest rates would increase annual interest expense by approximately $9.4 million, assuming debt balances remained constant.
Most important facts for investors to verify
- Whether the strong Q3 and early Q4 contract pace can continue as pandemic restrictions, employment conditions and mortgage availability evolve.
- Whether lower average selling prices and higher construction costs continue to pressure gross and operating margins.
- Cash generation relative to the $8.0 billion inventory balance, $2.64 billion of land commitments and ongoing joint-venture funding needs.
- The company’s ability to maintain liquidity after substantial share repurchases and the decline in cash from October 2019.
- Potential additional inventory impairments, particularly in the Mid-Atlantic, Pacific and City Living operations.
- The ultimate cost and insurance recovery associated with water-intrusion claims and the Pennsylvania stucco review.
- Exposure from unconsolidated-entity guarantees, joint-venture debt and apartment or hotel projects affected by COVID-19.
- Execution of the ERP implementation and protection against cyberattacks or data-security breaches.