Toll Brothers, Inc. quarterly report, Q2 FY2019

Toll Brothers, Inc. — Form 10-Q Summary

Reporting period: Fiscal quarter and six months ended April 30, 2019. Toll Brothers is a luxury homebuilder operating through Traditional Home Building and City Living, with geographic operations across the North, Mid-Atlantic, South, West, and California markets. The filing was signed June 6, 2019.

Financial performance and position

Metric	Three months ended April 30, 2019	Six months ended April 30, 2019	Comparable change
Total revenue	$1.716 billion	$3.079 billion	Up 7% and 11%, respectively
Net income	$129.3 million	$241.4 million	Up 16%; down 1%, respectively
Diluted EPS	$0.87	$1.63	Up from $0.72 and $1.55
Income from operations	$160.5 million	$284.9 million	Up 19% and 31%, respectively
Operating margin	Approximately 9.4%	Approximately 9.3%	Improved from approximately 8.4% and 7.9%
Net margin	Approximately 7.5%	Approximately 7.8%	Improved quarterly; approximately flat for six months

Home sales revenue was $1.712 billion in the quarter and $3.031 billion year to date. Deliveries increased 1% to 1,911 homes in the quarter and 4% to 3,441 homes for the six months; average delivered prices increased 6% and 5%, respectively.
Home sales cost of revenues declined to 80.3% of home sales revenue in the quarter and 79.7% for the six months, versus 81.2% and 80.5% in the prior periods. Management cited product and geographic mix, lower interest expense, and a $6.5 million state reimbursement of previously expensed environmental cleanup costs.
SG&A increased 7% in the quarter and 5% for the six months, principally due to compensation, sales and marketing, design studio costs, and implementation of enterprise information technology systems.
Inventory impairment charges and write-offs were $19.4 million in the quarter and $27.0 million for the six months, compared with $13.8 million and $17.7 million, respectively.
Income from unconsolidated entities declined to $10.6 million for the six months from $41.4 million, primarily because the prior-year period included a $30.8 million gain from a joint-venture asset sale. Other income increased to $32.1 million from $24.8 million, including a $12.2 million gain on the sale of a golf club property and an $8.4 million gain on land contributed to a rental-property joint venture.
Cash and cash equivalents were $924.4 million at April 30, 2019, down from $1.182 billion at October 31, 2018. Inventory was $7.791 billion, up from $7.598 billion.
Operating activities used $85.7 million of cash, compared with $326.3 million used in the prior-year period. Investing activities provided $28.2 million, while financing activities used $200.5 million.
Total debt consisted of approximately $1.027 billion of loans payable, $2.512 billion of senior notes, and $110.0 million of mortgage-company borrowings. Estimated fair value of debt was $3.713 billion.
The company had no borrowings under its $1.295 billion revolving credit facility, approximately $179.3 million of outstanding letters of credit, and approximately $1.12 billion of remaining availability. Its leverage ratio was approximately 0.56 to 1.00 versus a maximum permitted 1.75 to 1.00.

Material changes versus the prior comparable period

Six-month net contracts signed declined 22% in value and 15% in units to $3.17 billion and 3,803 homes. Second-quarter contracts declined 16% in value and 9% in units to $2.00 billion and 2,424 homes.
Backlog at April 30, 2019 declined 11% in value and 8% in units to $5.66 billion and 6,467 homes. California backlog value declined 23% year over year; City Living backlog declined 26%.
Management attributed weaker orders to an industry-wide slowdown associated with rising interest rates, higher home prices, and reduced buyer sentiment. Demand improved late in the second quarter, but the filing does not provide formal full-year earnings or delivery guidance.
Traditional Home Building revenue increased 12% for the six months, led by California, the South, and the West. City Living revenue declined 26%, while City Living six-month pretax income declined 13%.
The company adopted ASC 606 on November 1, 2018 using the modified retrospective method. The adoption did not materially affect reported operations, but it changed presentation of land sales and retained customer deposits and reduced opening retained earnings by approximately $18.0 million, net of tax.
In May 2019, after the reporting date, the company acquired substantially all assets and operations of Sharp Residential for approximately $93.2 million in cash. The acquisition added approximately 950 owned or controlled home sites, 125 contracted homes, and 10 selling communities.

Outlook, risks, contingencies, and unusual items

Management believes desirable locations, difficult-to-replace communities, and market approvals provide embedded value, but cautions that economic and housing-market conditions may affect demand, pricing, sales pace, cancellations, margins, and inventory values.
The company owned or controlled approximately 54,600 home sites at April 30, 2019, including approximately 33,500 owned sites and 21,100 optioned sites. Land purchase commitments totaled $2.45 billion, requiring approximately $2.22 billion of additional cash if all parcels are acquired.
Investments in unconsolidated entities totaled $390.1 million, with additional funding commitments of $30.9 million. Guarantees related to unconsolidated entities represented estimated maximum exposure of $271.1 million for currently borrowed debt and $310.6 million if specified commitments were fully drawn, before collateral recoveries or partner reimbursements.
Water-intrusion claims in Pennsylvania and Delaware remain subject to significant estimation uncertainty. Recorded aggregate estimated repair costs were $324.4 million, expected recoveries were approximately $152.6 million, and remaining estimated repair costs and recoveries were approximately $148.1 million and $104.1 million, respectively. Resolution is expected to take several years, and actual costs or recoveries could differ materially.
The Pennsylvania Attorney General is reviewing construction of stucco homes built after January 1, 2005; the company responded to a subpoena during the quarter. Management cannot predict the scope or outcome.
Outstanding surety bonds totaled $909.6 million, including $734.2 million primarily supporting community improvements, and letters of credit totaled $179.3 million. Management did not believe it was probable that these instruments would be drawn.
Variable-rate debt totaled approximately $920.6 million. Holding balances constant, a 1% increase in interest rates would increase annual interest expense by approximately $9.2 million.
The company repurchased approximately 788,000 shares for $25.2 million during the six months and approximately 2.5 million additional shares through June 5, 2019. It declared and paid dividends of $0.22 per share during the six months.

Investor verification items

Verify whether the late-quarter improvement in demand continued and whether orders, cancellations, pricing, and backlog stabilized after April 30, particularly in California and City Living.
Assess the sustainability of improved margins given higher material and labor costs, inventory impairments, sales incentives, and potential housing-market weakness.
Review cash conversion, inventory growth, land commitments, and the funding required for the Sharp Residential acquisition and apartment developments.
Monitor debt maturities, refinancing needs, interest-rate exposure, covenant headroom, and available revolving-credit capacity.
Track water-intrusion claims, insurance recoveries, the Pennsylvania Attorney General review, joint-venture guarantees, and other litigation contingencies.
Adjust year-over-year comparisons for ASC 606 presentation changes and the nonrecurring prior-year tax benefit and joint-venture asset-sale gain.