Toll Brothers, Inc. quarterly report, Q3 FY2013

Toll Brothers, Inc. — Fiscal 2013 Third-Quarter Form 10-Q Summary

Business context and reporting period

Toll Brothers is a luxury homebuilder operating across four U.S. geographic segments: North, Mid-Atlantic, South, and West. This unaudited Form 10-Q covers the three and nine months ended July 31, 2013, compared with the corresponding 2012 periods. The filing reflects an improving housing market, stronger demand, increased land acquisition, and expansion of the company’s backlog.

Financial performance and key metrics

Metric	Three months ended July 31, 2013	Three months ended July 31, 2012	Nine months ended July 31, 2013	Nine months ended July 31, 2012
Revenue	$689.2 million	$554.3 million	$1.630 billion	$1.250 billion
Income from operations	$55.2 million	$31.5 million	$72.3 million	$10.8 million
Operating margin	8.0%	5.7%	4.4%	0.9%
Net income	$46.6 million	$61.6 million	$75.7 million	$75.7 million
Diluted earnings per share	$0.26	$0.36	$0.43	$0.45

Revenue increased 24.3% in the quarter and 30.4% year to date, driven by higher deliveries and average selling prices. Deliveries increased 10.0% in the quarter and 22.8% year to date.
Gross cost of revenues declined to 79.1% of revenue in the quarter and 80.4% year to date, compared with 80.8% and 82.1%, respectively, in the prior comparable periods. Inventory impairments were $0.2 million in the quarter and $2.0 million year to date, versus $3.1 million and $13.2 million in 2012.
Net income was lower in the quarter primarily because the 2012 period benefited from a $18.7 million tax benefit, while 2013 included a $21.7 million tax provision. Year-to-date net income was essentially unchanged despite substantially higher pretax income.
Cash and cash equivalents were $899.3 million at July 31, 2013, compared with $778.8 million at October 31, 2012. Marketable securities were $122.5 million, down from $439.1 million.
Operating cash flow was negative $456.5 million year to date, principally because inventory increased by $751.4 million. Investing cash flow was positive $278.7 million, and financing cash flow was positive $298.4 million.
Total inventory increased to $4.517 billion from $3.761 billion, primarily reflecting higher operating-community inventory. Investments in unconsolidated entities increased to $356.8 million from $330.6 million.
Debt at July 31, 2013 included $2.426 billion of senior notes, $97.7 million of loans payable, and $65.7 million of mortgage-company warehouse borrowings. The filing reports total debt book value of approximately $2.593 billion.

Material changes versus the prior comparable period

Net contracts signed increased 35.0% in units and 49.2% in value during the first nine months. Contracts totaled 4,131 homes with an aggregate value of $2.795 billion, compared with 3,061 homes valued at $1.874 billion in 2012.
Backlog increased 75.2% to 4,001 homes valued at $2.835 billion at July 31, 2013, compared with 2,559 homes valued at $1.619 billion one year earlier.
The company controlled approximately 47,200 home sites at July 31, 2013, including approximately 33,400 owned sites. It acquired control of approximately 9,500 sites during the first nine months.
Income from unconsolidated entities declined to $8.8 million year to date from $19.3 million, mainly because certain condominium joint ventures were substantially completed in the prior period.
Other income increased to $36.4 million year to date from $22.0 million, including $13.2 million of net income from the settlement of three derivative lawsuits.
The company issued $400 million principal amount of 4.375% senior notes due 2023 and repaid $59.1 million of 6.875% senior notes due 2012.
On August 1, 2013, after the reporting date, the company entered into a new $1.035 billion unsecured five-year credit facility maturing August 1, 2018, replacing its $885 million facility. No borrowings were outstanding under the prior facility at July 31, 2013.

Guidance, outlook, commentary, risks, and unusual items

Management described continued recovery in housing demand, supported by improving consumer confidence, declining unemployment, higher home prices, reduced housing inventory, and low mortgage rates. Demand remained below historical levels and depended on sustained economic and financial-market stabilization.
The company expected to open approximately 23 communities during the quarter ending October 31, 2013 and expected to be selling from approximately 225 communities at that date.
The company planned to develop approximately 4,400 for-rent apartment units, with projects expected to begin generating revenue in 2015.
Land purchase commitments totaled approximately $1.582 billion, with $72.0 million deposited and approximately $1.510 billion of additional cash required if all parcels are acquired. Additional apartment-related commitments included approximately $61.3 million, plus a potential $79.3 million acquisition subject to due diligence.
Investments in unconsolidated entities carried $110.6 million of additional funding commitments. Debt guarantees for unconsolidated entities had an estimated maximum exposure of $59.9 million based on current borrowings, or $227.5 million if all related loan commitments were drawn, before partner reimbursements. The company also guaranteed approximately $11.8 million of ground lease payments and insurance deductibles.
Surety bonds totaled $492.3 million, and letters of credit totaled $82.4 million. Management believed draws on these instruments were not probable.
Key risks include housing demand and pricing, mortgage availability, interest rates, land and construction costs, inventory valuation, approval delays, joint-venture funding and guarantees, construction defects and warranty claims, litigation, tax matters, and access to capital.
The filing states that there were no material changes to previously disclosed risk factors. Management concluded that disclosure controls were effective and that no material change occurred in internal control over financial reporting during the quarter.

Important facts for investors to verify

Whether the substantial increase in backlog and contracts converts into deliveries and cash flow without elevated cancellations or margin pressure.
Whether inventory growth and approximately $1.5 billion of potential land-acquisition cash requirements remain consistent with demand and liquidity.
The sustainability of operating-margin improvement after excluding lower impairment charges and the $13.2 million litigation settlement.
The effect of tax provisions, deferred tax assets, valuation allowances, and uncertain tax positions on future earnings and cash taxes.
Exposure under joint-venture commitments, debt guarantees, letters of credit, surety bonds, and potential additional funding requirements.
Compliance with the new credit facility’s 1.75-to-1.00 maximum leverage covenant and approximately $2.23 billion minimum tangible-net-worth covenant.
Whether mortgage availability, interest rates, economic conditions, and regional housing trends support management’s recovery outlook.