Toll Brothers, Inc. annual report, FY2019

Toll Brothers, Inc. — Fiscal 2019 Form 10-K Summary

Business context and reporting period

The filing covers the fiscal year ended October 31, 2019, including fourth-quarter results. Toll Brothers designs, builds, markets and finances luxury and affordable-luxury homes, urban condominiums and, through joint ventures, for-rent apartments. At year-end, the Company operated in 23 states and the District of Columbia, sold homes from 333 communities and owned or controlled approximately 59,200 home sites.

Fiscal 2019 included the acquisitions of Sharp Residential and Sabal Homes for approximately $162.4 million in cash, adding approximately 2,550 home sites and 22 selling communities in Georgia and South Carolina.

Financial and operating metrics

Metric	Fiscal 2019	Fiscal 2018	Change
Total revenue	$7.224 billion	$7.143 billion	1%
Home sales revenue	$7.080 billion	$7.143 billion	(1)%
Income from operations	$680.8 million	$786.2 million	(13)%
Income before taxes	$787.2 million	$933.9 million	(16)%
Net income	$590.0 million	$748.2 million	(21)%
Diluted EPS	$4.03	$4.85	(17)%
Operating cash flow	$437.7 million	$588.2 million	(26)%

Home deliveries declined 2% to 8,107 homes, while average delivered price increased 1% to approximately $873,400.
Home sales cost of revenues was 80.2% of home sales revenue versus 79.4% in 2018, implying home gross margin of approximately 19.8% versus 20.6%.
SG&A increased 7% to $734.5 million and rose to 10.4% of home sales revenue from 9.6%.
Income before taxes represented 10.9% of total revenue versus 13.1% in 2018; net margin was approximately 8.2% versus 10.5%.
Inventory was $7.873 billion, up from $7.598 billion. Inventory impairments and write-offs increased to $42.4 million from $35.2 million.
Cash, cash equivalents and marketable securities were $1.286 billion. The Company had approximately $1.73 billion available under its $1.905 billion revolving credit facility, with no outstanding revolver borrowings and $177.9 million of letters of credit.
Total debt was $3.921 billion, consisting principally of $2.660 billion of senior notes, $1.111 billion of loans payable and $150.0 million under the mortgage company facility. Debt-to-total-capitalization was 0.44 to 1.00.
Cash used in investing activities was $75.9 million, principally reflecting acquisitions, capital expenditures and investments in unconsolidated entities. Cash used in financing activities was $258.5 million, including $233.5 million of share repurchases, $63.6 million of dividends and repayment of $600.0 million of senior notes, partially offset by issuance of $400.0 million of 3.80% senior notes due 2029.

Material changes versus the prior comparable period

Net contracts signed declined 12% in value to $6.711 billion and 5% in units to 8,075 homes. Average contract value declined 7% to approximately $831,100.
Backlog value declined 5% to $5.257 billion, although backlog units increased 3% to 6,266. Approximately 93% of backlog units were expected to be delivered in fiscal 2020. Average backlog price declined 7% to approximately $839,000.
Demand moderated from late fiscal 2018 through the first three quarters of fiscal 2019, particularly in California, due to affordability pressures and higher mortgage rates. Demand improved in the fourth quarter; contracts signed increased 18% in units and 12% in dollars year over year for that quarter.
Traditional Home Building revenue was essentially flat at $6.828 billion. South revenue increased 19%, while California revenue declined 4% and West revenue declined 2%. California remained the largest and most profitable region, generating $2.129 billion of revenue and $452.4 million of pretax income.
City Living revenue declined 21% to $253.2 million, while deliveries increased 21% to 204 homes because the mix shifted toward lower-priced buildings. City Living pretax income declined 10% to $70.1 million.
Income from unconsolidated entities declined 71% to $24.9 million, primarily because fiscal 2018 included $67.2 million of gains from apartment joint-venture asset sales. Fiscal 2019 included a $3.8 million gain from an apartment joint-venture sale.
Other income increased to $81.5 million, including $35.1 million of gains from selling seven golf clubs and an office building, compared with a $10.7 million security-monitoring account sale gain in fiscal 2018.
The effective tax rate increased to 25.1% from 19.9%. Fiscal 2018 benefited from the Tax Cuts and Jobs Act and related deferred-tax remeasurement benefits.
The Company adopted ASC 606 using the modified retrospective method. The adoption changed the presentation of land sales and retained customer deposits and reduced opening retained earnings by approximately $18.0 million, but management stated that the adoption did not materially affect the consolidated statements of operations or balance sheet.

Guidance, outlook, commentary, risks and unusual items

Management entered fiscal 2020 citing healthy consumer confidence, strong household formation and limited housing supply in most markets. The Company planned to broaden its geographic footprint, price points and product offerings, including more affordable-luxury communities, with the objective of increasing community count, revenue growth and capital efficiency. The filing does not provide a specific fiscal 2020 revenue, earnings or delivery forecast.

Housing and affordability: Demand is sensitive to employment, consumer confidence, mortgage availability, interest rates, home prices and competition from existing homes. Higher costs or reduced affordability could lower sales, increase cancellations and compress margins.
California concentration: California generated a significant portion of revenue and pretax income and is exposed to affordability, regulatory, drought, wildfire, earthquake, environmental and population-growth risks.
Inventory and land: The Company had approximately $2.361 billion of aggregate land purchase commitments, with approximately $2.192 billion of additional cash required if all parcels are acquired. Inventory impairment estimates depend on sales prices, sales pace, costs and discount rates.
Warranty and litigation exposure: Accrued warranty liabilities were $201.9 million. Remaining estimated repair costs for Pennsylvania and Delaware water-intrusion claims were $124.6 million, with $97.9 million of expected insurance recoveries. The Company stated that actual costs and recoveries could differ materially and that it could not estimate the range of potential differences.
Legal proceeding: The Pennsylvania Attorney General is reviewing stucco-home construction after January 1, 2005 and issued a subpoena in fiscal 2019. Management could not predict the scope or outcome.
Joint ventures and guarantees: Investments in unconsolidated entities totaled $366.3 million, with $38.8 million of additional funding commitments. Estimated maximum exposure under repayment and carry-cost guarantees was $239.6 million on borrowings outstanding and $299.1 million if all related loan commitments were drawn, before collateral recoveries or partner reimbursements.
Debt and interest-rate risk: The Company’s revolving facility and $800.0 million term loan mature in November 2024. A 1% increase in variable interest rates would increase annual interest expense by approximately $9.6 million, assuming debt balances remain constant.
Cybersecurity and systems: The Company disclosed unauthorized access to mortgage-applicant data on a service provider’s system during the third quarter of fiscal 2019. It also continued a complex, multi-year ERP implementation; acquired Sharp and Sabal were excluded from management’s internal-control assessment for fiscal 2019.

Most important facts for an investor to verify

Whether the fourth-quarter improvement in contracts signed continued into fiscal 2020 and translated into higher backlog conversion.
Whether California demand, pricing, incentives and margins stabilize, given the region’s contribution to earnings.
Inventory aging, future impairment risk and the pace of land acquisitions relative to demand and liquidity.
The ultimate cost and insurance recovery associated with Pennsylvania and Delaware water-intrusion claims, including the Pennsylvania Attorney General review.
Joint-venture debt, guarantees, funding commitments and the ability to monetize rental-property investments.
Compliance with debt covenants, refinancing needs beginning in 2022 and available liquidity after share repurchases, dividends and land commitments.
Execution and control implications of the ERP implementation and integration of Sharp and Sabal.