Toll Brothers, Inc. quarterly report, Q2 FY2020

Toll Brothers, Inc. 10-Q Summary

Business context and reporting period

Toll Brothers is a U.S. luxury homebuilder operating through Traditional Home Building and City Living segments, with ancillary mortgage, title, apartment, land development and other businesses. This unaudited report covers the three and six months ended April 30, 2020, the second quarter of fiscal 2020, compared primarily with the corresponding 2019 periods.

Results were materially affected by the COVID-19 pandemic, including stay-at-home orders, business closures, construction restrictions and reduced customer activity beginning in mid-March 2020.

Financial and operating metrics

Metric	Three months ended April 30, 2020	Year-over-year change	Six months ended April 30, 2020	Year-over-year change
Total revenue	$1.549 billion	Down 10%	$2.881 billion	Down 6%
Home sales revenue	$1.516 billion	Down 11%	$2.814 billion	Down 7%
Income from operations	$92.5 million	Down 42%	$140.0 million	Down 51%
Net income	$75.7 million	Down 41%	$132.5 million	Down 45%
Diluted EPS	$0.59	Down from $0.87	$0.99	Down from $1.63
Homes delivered	1,923	Up 1%	3,534	Up 3%
Net contracts signed	1,886	Down 22%	3,692	Down 3%

Approximate consolidated operating margin was 6.0% in the quarter and 4.9% for the six-month period, compared with approximately 9.4% and 9.3%, respectively, in the prior-year periods. Approximate net margin was 4.9% in the quarter and 4.6% year to date, compared with 7.5% and 7.8% in the prior-year periods.

Home sales cost of revenues increased to 82.5% of home sales revenue in the quarter and 82.1% year to date, from 80.3% and 79.7%, respectively.
SG&A was $179.4 million in the quarter and $371.2 million year to date. SG&A as a percentage of home sales revenue rose to 11.8% and 13.2%, respectively.
Cash used in operating activities was $191.1 million for the six months, compared with $85.7 million used in the prior-year period. Inventory increased to $8.196 billion from $7.873 billion at October 31, 2019.
Cash and cash equivalents were $741.2 million at April 30, 2020, compared with $1.286 billion at October 31, 2019. Cash, cash equivalents and restricted cash totaled $779.2 million.
Cash used in investing activities was $69.7 million, including $60.3 million for the acquisition of Thrive Residential and $50.8 million for property and equipment, partially offset by investment returns and golf-club sale proceeds.
Cash used in financing activities was $279.6 million, including $633.6 million of share repurchases and $28.8 million of dividends, partially offset by $378.4 million of net borrowings.

Debt and liquidity

Total debt, including loans payable, senior notes and the mortgage company loan facility, was approximately $4.335 billion at April 30, 2020, compared with $3.934 billion at October 31, 2019.
Debt to total capitalization was 0.49 to 1.00. The company reported a leverage ratio of approximately 0.75 to 1.00 versus a maximum covenant ratio of 1.75 to 1.00.
The $1.905 billion unsecured revolving credit facility had $450.0 million drawn and approximately $164.8 million of outstanding letters of credit. Approximately $1.29 billion was available; the company repaid $100.0 million after April 30, 2020.
The company also had an $800.0 million senior unsecured term loan and approximately $2.67 billion of senior notes outstanding.
Each 1% increase in variable interest rates, assuming debt balances remain constant, would increase annual interest expense by approximately $13.7 million.

Material changes versus the prior comparable period

COVID-19 caused a sharp deterioration in demand and operating activity late in the quarter. Contracts signed increased 43% through March 15, 2020, but declined 64% from March 16 through April 30 versus the comparable 2019 period.
Quarterly net contract value declined 22% to $1.553 billion, while backlog declined 3% year over year to $5.493 billion, representing 6,428 homes.
Profitability declined because of lower revenue, less favorable geographic and product mix, higher land, labor and material costs, purchase-accounting effects from acquisitions, higher SG&A and lower joint-venture earnings.
SG&A included $7.5 million of severance costs following the pandemic. The company also reversed an $8.0 million accrual for discretionary fiscal 2019 benefit-plan contributions.
Inventory impairment charges were $15.2 million year to date, including a $10.7 million charge related to termination of a Mid-Atlantic land purchase agreement. This compared with $27.0 million in the prior-year period.
The company repurchased 15.938 million shares for $633.6 million during the six months, compared with 0.788 million shares for $25.2 million in the prior-year period.
The company acquired Thrive Residential for approximately $60.3 million in cash, adding approximately 680 owned or controlled home sites and operations in Atlanta and Nashville.
The company adopted the new lease standard on November 1, 2019, recording a $114.5 million right-of-use asset and a $118.5 million lease liability. The adoption did not materially affect earnings or cash flow.

Guidance, outlook, risks and unusual items

The filing does not provide clear numerical fiscal 2020 revenue, delivery or earnings guidance. Management stated that traffic and deposits improved from March and April levels as restrictions eased, but remained cautious because the duration and economic effects of COVID-19 were highly uncertain.

Management expects to have adequate resources and access to capital to fund current operations and contractual obligations, but noted uncertainty regarding refinancing and future financing availability.
The company reduced new land-acquisition spending and implemented remote work, virtual sales, appointment-only model-home access, enhanced construction safety protocols, deferred non-emergency warranty work and workforce reductions.
Land purchase commitments totaled $2.616 billion, with $2.426 billion of additional cash required if all commitments are completed. Apartment-development land commitments were approximately $165.0 million, with $7.6 million deposited.
The company had $364.0 million invested in unconsolidated entities and up to $45.3 million of additional funding commitments. Its estimated maximum exposure under repayment and carry-cost guarantees was $137.2 million for debt already borrowed and $190.6 million if all related loan commitments were drawn.
Water-intrusion and construction-defect claims remain subject to significant estimation uncertainty. Recorded remaining repair costs were approximately $85.1 million and expected recoveries were approximately $70.5 million at April 30, 2020. Related arbitration and legal proceedings could produce materially different outcomes.
The Pennsylvania Attorney General continues reviewing stucco-home construction, and management cannot predict the scope or outcome.
Other risks include housing demand, unemployment, mortgage availability, interest rates, land and labor costs, construction delays, inventory impairments, joint-venture performance, legal claims, cybersecurity incidents and the ongoing implementation of a new ERP system.

Most important facts for investors to verify

Whether post-April 30 contract activity, traffic, deposits and cancellations recovered sustainably as restrictions eased.
Whether backlog conversion, gross margins and SG&A leverage improve or deteriorate as COVID-19 effects continue.
Cash burn, inventory growth, land-acquisition spending and actual availability under the revolving credit facility.
Compliance with debt covenants and the company’s ability to refinance maturities under future capital-market conditions.
Potential changes in inventory impairment assumptions, particularly in higher-cost or pandemic-affected markets.
Developments in water-intrusion claims, insurance recoveries, the Pennsylvania Attorney General review and joint-venture guarantees.
The effect of the Thrive acquisition and prior acquisitions on deliveries, pricing, margins and backlog.