Toll Brothers, Inc. — Fiscal 2018 Second-Quarter Form 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 and six months ended April 30, 2018, compared with the same periods in 2017. Financial statements are unaudited.
Financial performance and key metrics
| Metric | Six months ended April 30, 2018 | Six months ended April 30, 2017 | Three months ended April 30, 2018 | Three months ended April 30, 2017 |
|---|---|---|---|---|
| Revenue | $2.775 billion | $2.284 billion | $1.599 billion | $1.364 billion |
| Income from operations | $218.1 million | $190.0 million | $134.4 million | $139.3 million |
| Net income | $243.9 million | $195.1 million | $111.8 million | $124.6 million |
| Diluted EPS | $1.55 | $1.15 | $0.72 | $0.73 |
| Operating margin | 7.9% | 8.3% | 8.4% | 10.2% |
| Net margin | 8.8% | 8.5% | 7.0% | 9.1% |
Six-month revenue increased 21%, driven by 17% higher deliveries and a 4% increase in average delivered price. Second-quarter revenue increased 17%, with deliveries up 15% and average delivered price up 2%. SG&A increased 14% for both periods, but declined as a percentage of revenue to 11.7% from 12.4% for the six months and to 10.4% from 10.8% for the quarter.
Cost of revenues increased to 80.5% of revenue for the six months from 79.3%, and to 81.2% for the quarter from 79.0%. Management cited higher material and labor costs, product mix and increased inventory impairments. Inventory impairment charges were $17.7 million for the six months and $13.8 million for the quarter, compared with $8.9 million and $4.3 million, respectively, in the prior-year periods.
Net cash used in operating activities was $324.9 million, compared with $243.1 million provided in the prior-year period. The 2018 use was primarily associated with a $540.9 million inventory increase, mortgage loan origination activity and higher receivables and other assets. Investing activities provided $39.9 million, and financing activities provided $47.3 million. Cash declined to $475.1 million from $712.8 million at October 31, 2017.
At April 30, 2018, inventory was $7.872 billion, up from $7.281 billion at October 31, 2017. Total debt book value was approximately $3.624 billion, consisting principally of $2.860 billion of senior notes, $649.3 million of loans payable and $103.6 million of mortgage company borrowings. The company issued $400 million of 4.350% senior notes due 2028 in January 2018.
The $1.295 billion unsecured revolving credit facility had no borrowings outstanding and approximately $146.4 million of letters of credit. Approximately $1.15 billion remained available. The leverage ratio was approximately 0.72 to 1.00 versus a maximum of 1.75 to 1.00, and tangible net worth was approximately $4.44 billion versus a required minimum of approximately $2.45 billion.
Material changes versus the prior comparable period
- Net income increased 25% for the six months but decreased 10% for the second quarter.
- Pre-tax income declined 8% for the six months and 23% for the quarter, primarily because of lower income from unconsolidated entities and higher corporate costs.
- Income from unconsolidated entities fell to $41.4 million from $92.3 million for the six months and to $2.6 million from $45.9 million for the quarter. The prior year benefited from substantial joint-venture disposition gains; 2018 included a $30.8 million gain from a student-housing sale.
- Traditional Home Building pre-tax income increased 7% for the six months and 2% for the quarter. City Living pre-tax income declined 45% and 60%, respectively.
- Net contracts signed increased 25% in value and 11% in units for the six months, and 18% in value and 6% in units for the quarter.
- Backlog increased 27% in value to $6.36 billion and 17% in units to 7,030 homes at April 30, 2018, compared with April 30, 2017.
- The company repurchased 6.2 million shares for $291.5 million during the six months and had 16.876 million shares remaining under its authorization at April 30, 2018. Dividends increased to $0.19 per share for the six months from $0.08.
- The effective tax rate declined to 14.2% from 36.9% for the six months and to 26.8% from 37.4% for the quarter. The change primarily reflected the Tax Cuts and Jobs Act, including a provisional $31.2 million deferred-tax benefit, and stock-based compensation tax benefits.
Guidance, outlook, management commentary, risks and unusual items
Management described demand as solid and improving, citing limited housing supply, affluent buyers, employment, consumer confidence, home-equity gains and the company’s land position. Management expected gradually rising interest rates not to disrupt demand and stated that it had adequate resources to fund current operations and contractual obligations, while cautioning that future financing availability cannot be assured.
The company owned or controlled approximately 51,000 home sites at April 30, 2018, including approximately 32,000 owned sites and 19,000 optioned sites. It was selling from 283 communities and had approximately $2.68 billion of land purchase commitments, requiring approximately $2.38 billion of additional cash if all parcels are acquired. Apartment-development land commitments totaled approximately $214.0 million.
Water-intrusion and stucco claims remain a significant contingency. Recorded aggregate estimated repair costs were $324.4 million, with estimated recoveries of $152.6 million. The company stated that actual costs and recoveries could differ materially and that it could not estimate the range of possible differences. The SEC is investigating estimated repair costs for stucco and other water-intrusion claims, and the Pennsylvania Attorney General is reviewing construction of stucco homes. The scope and outcome of both matters were not predictable.
Guarantees supporting unconsolidated entities represented estimated maximum exposure of $228.7 million for currently borrowed debt and $301.4 million if all applicable commitments were borrowed, excluding collateral recoveries and partner reimbursements. Joint ventures had $721.8 million of borrowings and $1.19 billion of aggregate loan commitments subject to relevant guarantees.
A supplier floor-joist recall affected approximately 350 homes. Remediation was completed, and the supplier was expected to reimburse related costs. Management did not expect the matter to be material.
A May 2018 sale by a rental-property joint venture was expected to provide Toll Brothers $12.1 million of cash and approximately $8.6 million of gain in the third quarter of fiscal 2018. No formal earnings or delivery guidance is provided in the filing text.
Important facts for investors to verify
- Whether inventory growth, rising construction costs and the higher impairment charge continue to pressure gross margins and operating cash flow.
- The sustainability of the $6.36 billion backlog, including cancellation rates, delivery timing and exposure to higher interest rates.
- The amount and timing of cash required for the $2.68 billion of land commitments and additional apartment-development commitments.
- The eventual financial and regulatory impact of the SEC investigation and Pennsylvania Attorney General review concerning stucco and water-intrusion claims.
- Whether City Living’s lower earnings and reduced backlog reflect temporary project timing or a sustained slowdown.
- The realization of tax benefits and the final accounting impact of the Tax Cuts and Jobs Act, which remained provisional at April 30, 2018.
- Potential obligations under unconsolidated-entity guarantees, surety bonds of approximately $914.1 million in aggregate, and $146.4 million of letters of credit.
- Debt maturities, refinancing requirements and sensitivity to interest rates; the filing estimates that each one-percentage-point increase in variable borrowing rates would increase annual interest expense by approximately $6.2 million.