TOL

Toll Brothers, Inc. 10-Q Summary

Business Context and Reporting Period

This filing is a Quarterly Report on Form 10-Q for Toll Brothers, Inc., a luxury homebuilder, for the period ended July 31, 2007. The company operates in four geographic segments: North, Mid-Atlantic, South, and West. The report highlights a significant slowdown in the housing market, characterized by declining consumer confidence, increased contract cancellations, and an oversupply of homes.

Key Financial Metrics

Note: Total Debt includes Loans Payable ($715.8M), Senior Notes ($1.14B), Senior Subordinated Notes ($350M), and Mortgage Warehouse Loan ($127.2M).

Material Changes vs. Prior Period

• Revenue Decline: Revenues decreased 19.4% for the nine-month period and 20.8% for the three-month period compared to the prior year. This was driven by a 17.4% decrease in homes delivered and a 2.5% decrease in average selling prices.
• Profitability Drop: Net income fell 77% for the nine-month period and 85% for the three-month period. Income from operations dropped from $766.8 million to $90.8 million (nine months) and from $268.3 million to $2.4 million (three months).
• Inventory Write-Downs: The company recognized significant inventory write-downs totaling $363.9 million for the nine months ended July 31, 2007, compared to $37.0 million in the prior year. For the three-month period, write-downs were $147.3 million versus $23.9 million previously.
• Goodwill Impairment: A $9.0 million goodwill impairment charge was recognized in the first quarter of fiscal 2007 related to the Detroit market.
• Backlog Reduction: Backlog decreased 34.4% to $3.67 billion, reflecting lower new contract signings and higher cancellation rates.
• Contract Cancellations: Cancellation rates rose significantly to 24% of gross contracts signed in the nine-month period, compared to 12% in the prior year.

Guidance, Outlook, and Risks

• Market Outlook: Management attributes the slowdown to a decline in consumer confidence, softening demand, an oversupply of homes, and the inability of buyers to sell existing homes. The sub-prime mortgage market turmoil is cited as a direct and indirect impact on sales.
• Liquidity Position: The company maintains a strong balance sheet with $771.7 million in cash and approximately $1.17 billion available under its revolving credit facility. Management believes this provides a competitive advantage to navigate the downturn.
• Strategic Adjustments: The company has reduced its land position to approximately 63,000 lots (down from 82,000 a year prior) and is re-evaluating optioned land positions. It is also increasing the use of fixed-price contracts with subcontractors to mitigate inflation risks.
• Risks: Key risks include the dislocation in the secondary mortgage market, tightening credit standards, and the potential for further inventory write-downs if market conditions deteriorate. The company is also facing a securities class action lawsuit and an EPA inquiry regarding storm water discharge.

Investor Verification Checklist

• Inventory Valuation: Verify the assumptions used for the $363.9 million in inventory write-downs and the remaining fair value of the 28 communities subject to write-downs ($344.1 million).
• Cancellation Trends: Monitor the 24% contract cancellation rate and its impact on future revenue recognition and speculative inventory levels.
• Backlog Quality: Assess the composition of the $3.67 billion backlog, specifically the mix of completed contract vs. percentage of completion accounting and the risk of further cancellations.
• Debt Covenants: Confirm compliance with the Credit Facility's leverage ratio (currently 0.46 to 1.00, well below the 2.00 limit) and tangible net worth requirements.
• Legal Proceedings: Track the status of the securities class action lawsuit and the EPA investigation regarding storm water discharge.