Toll Brothers, Inc. quarterly report, Q1 FY2018

Toll Brothers, Inc. — Fiscal 2018 First-Quarter 10-Q Summary

Business Context and Reporting Period

Toll Brothers is a luxury homebuilder operating through Traditional Home Building and City Living segments. Traditional operations span the North, Mid-Atlantic, South, West, and California regions. The filing covers the three months ended January 31, 2018, compared with the three months ended January 31, 2017. The financial statements are unaudited.

Financial Results and Key Metrics

Metric	Q1 FY2018	Q1 FY2017	Change
Revenue	$1.175 billion	$920.7 million	+28%
Income from operations	$83.7 million	$50.6 million	+65%
Income before taxes	$131.6 million	$109.8 million	+20%
Net income	$132.1 million	$70.4 million	+88%
Diluted earnings per share	$0.83	$0.42	+98%
Operating cash flow	$(329.8) million	$24.2 million	Declined
Cash and cash equivalents	$508.3 million	$373.5 million	Up year over year

Cost of revenues was 79.5% of revenue versus 79.6% in the prior-year quarter. SG&A was 13.4% of revenue versus 14.9%.
Income from operations represented approximately 7.1% of revenue; net income represented approximately 11.2%, including significant tax benefits.
Deliveries increased 20% to 1,423 homes, while the average delivered price increased 7% to approximately $826,000.
Net contracts signed increased 36% in value to $1.69 billion and 20% in units to 1,822 homes.
Backlog increased 28% in value to $5.58 billion and 21% in units to 6,250 homes.
Inventory increased to $7.71 billion from $7.28 billion at October 31, 2017, primarily reflecting continued investment in operating communities and future land.

Debt, Liquidity, and Capital Allocation

Cash and cash equivalents were $508.3 million at January 31, 2018, down from $712.8 million at October 31, 2017.
The Company had total loans payable, senior notes, and mortgage company borrowings of approximately $3.53 billion on the balance sheet. Estimated fair value of debt was approximately $3.66 billion.
In January 2018, Toll Brothers issued $400 million of 4.350% senior notes due 2028 and received net proceeds of $396.4 million.
The $1.295 billion unsecured revolving credit facility had no borrowings outstanding at quarter-end, approximately $143.5 million of letters of credit, and approximately $1.15 billion of remaining availability. The Company subsequently borrowed $100 million under the facility.
The leverage ratio was approximately 0.73 to 1.00 against a maximum of 1.75 to 1.00; tangible net worth was approximately $4.42 billion against a minimum of approximately $2.49 billion.
Financing activities generated $93.7 million, including senior-note proceeds, partly offset by $200.3 million of share repurchases, debt repayments, and $12.3 million of dividends.
The Board authorized a new repurchase program for up to 20 million shares. The Company repurchased 4.427 million shares during the quarter at an average price of $47.43.

Material Changes Versus the Prior Comparable Period

Revenue and deliveries benefited from a larger beginning backlog, higher average pricing, and particularly strong growth in California, the West, and City Living deliveries.
California revenue increased 31%, net contract value increased 93%, and pretax income increased 41%.
City Living revenue increased sharply because of deliveries from a Hoboken, New Jersey building, but City Living pretax income declined 30% because of lower joint-venture earnings, lower-margin deliveries, and a prior-year deferred gain.
Income from unconsolidated entities declined 16% to $38.9 million, although the current period included a $30.8 million gain from the sale of a student housing community by a rental-property joint venture. The prior-year period included a $6.2 million gain from selling part of a rental-property joint venture.
Net income benefited materially from a $31.2 million provisional tax benefit from remeasuring deferred tax liabilities under the Tax Cuts and Jobs Act and a $4.0 million benefit from adoption of stock-compensation accounting guidance. The effective tax rate was negative 0.4% versus 35.9%.
Operating cash flow turned negative primarily because inventory increased by $416.8 million, compared with a $135.8 million increase in the prior-year quarter.

Outlook, Commentary, Risks, and Unusual Items

Management characterized the housing market as strengthening, citing solid demand, limited resale and new-home supply, affluent buyers, employment, consumer confidence, and homeowner equity. Management expects gradually rising interest rates not to disrupt demand, but the filing does not provide formal earnings or delivery guidance.
The Company owned or controlled approximately 49,500 home sites at January 31, 2018, including approximately 32,100 owned sites and 17,400 optioned sites. It was selling from 295 communities.
Land purchase commitments totaled $2.54 billion, with $123.0 million deposited and approximately $2.29 billion of additional cash potentially required over several years. Apartment-development land commitments added approximately $207.3 million.
Investments in unconsolidated entities totaled $449.7 million, with $42.2 million of remaining funding commitments. Guarantees related to unconsolidated entities had estimated maximum exposure of $217.7 million based on amounts borrowed, or $269.6 million if all covered commitments were borrowed.
Warranty accruals included $324.4 million of estimated repair costs for water-intrusion claims and $152.6 million of expected recoveries. The Company stated that actual costs and recoveries could differ materially from estimates.
The SEC is investigating information related to the Company’s fiscal 2016 estimates for stucco and other water-intrusion repair costs. Management cannot predict the scope or outcome.
A supplier recall affected floor joists in approximately 350 homes. The supplier committed to absorb remediation costs; the Company stated the matter was not expected to be material. Approximately 150 affected homes remained in backlog at quarter-end.
Inventory impairment charges were $3.9 million, including a $2.2 million write-down in the North region for a community expected to be sold through a bulk sale.
The Company stated that it expects adequate liquidity and access to capital markets to fund current operations, while warning that economic and housing-market conditions could affect future financing availability.
A 1% increase in variable interest rates, assuming constant debt balances, would increase annual interest expense by approximately $5.5 million.

Most Important Facts for Investors to Verify

Whether strong contract growth and the $5.58 billion backlog convert into deliveries without increased cancellations, price concessions, or margin pressure.
The sustainability of earnings excluding the $31.2 million provisional tax benefit, the $4.0 million stock-compensation tax benefit, and unusual joint-venture gains.
Inventory growth, land commitments, and the ability to generate operating cash flow while expanding communities.
Potential changes to water-intrusion warranty costs, insurance and supplier recoveries, and the outcome of the SEC investigation.
Exposure to joint-venture guarantees, land-development commitments, surety bonds, letters of credit, and other off-balance-sheet obligations.
City Living’s lower backlog and reduced joint-venture earnings relative to the prior period.
Interest-rate sensitivity, refinancing needs, and continued compliance with credit-facility covenants.