Toll Brothers, Inc. quarterly report, Q2 FY2011

Toll Brothers, Inc. — Fiscal 2011 Second-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, with related mortgage, title, land, golf and other ancillary businesses. The filing covers the three and six months ended April 30, 2011, compared with the corresponding fiscal 2010 periods. The company reported approximately 168.3 million shares outstanding as of June 1, 2011.

Financial Performance and Key Metrics

Metric	Six months ended April 30, 2011	Six months ended April 30, 2010	Three months ended April 30, 2011	Three months ended April 30, 2010
Revenue	$653.8 million	$638.0 million	$319.7 million	$311.3 million
Loss from operations	$(34.3) million	$(125.4) million	$(24.1) million	$(60.1) million
Net loss	$(17.4) million	$(81.2) million	$(20.8) million	$(40.4) million
Loss per diluted share	$(0.10)	$(0.49)	$(0.12)	$(0.24)
Operating margin	(5.3%)	(19.7%)	(7.5%)	(19.3%)
Net margin	(2.7%)	(12.7%)	(6.5%)	(13.0%)

Revenue increased 2.5% for the six-month period and 2.7% for the quarter. Six-month deliveries increased 1.9%, while average selling prices increased 0.5%. Quarterly deliveries increased 8.8%, but the average selling price declined 5.6%, primarily from product and geographic mix.
Cost of revenues declined to 85.4% of revenue for the six months and 86.4% for the quarter, from 97.7% and 98.2%, respectively. Excluding inventory impairments, cost of revenues was 82.6% for the six months and 82.4% for the quarter.
Inventory impairment charges and write-offs totaled $18.0 million for the six months and $12.9 million for the quarter, compared with $75.7 million and $42.3 million, respectively, in the prior-year periods.
SG&A was $128.3 million for the six months and $67.1 million for the quarter. SG&A as a percentage of revenue improved to 19.6% for the six months but increased to 21.0% for the quarter from 19.1%.
Direct interest expense fell to $1.5 million for the six months and $0.4 million for the quarter, compared with $13.5 million and $6.2 million, respectively, in the prior-year periods.
Losses from unconsolidated entities and the non-performing loan portfolio were $21.9 million for the six months and $10.9 million for the quarter, including impairment charges of $39.6 million and $19.6 million, respectively.
The six-month income tax benefit was $31.2 million, including reversals of previously accrued uncertain tax positions and state tax liabilities. The company received a $154.3 million federal tax refund during the second quarter.

Cash Flow, Balance Sheet, Debt and Liquidity

Cash provided by operating activities was $97.6 million for the six months, compared with $223.9 million of cash used in the prior-year period. The improvement was principally driven by the federal tax refund, partially offset by inventory investment.
Cash used in investing activities was $133.5 million, including $101.9 million of net purchases of marketable securities and $42.1 million invested in unconsolidated entities and a non-performing loan portfolio.
Cash used in financing activities was $53.3 million, primarily reflecting debt repayments.
Cash and cash equivalents were $949.9 million at April 30, 2011, compared with $1.039 billion at October 31, 2010. Cash plus marketable securities totaled approximately $1.25 billion at April 30, 2011.
Total inventory increased to $3.385 billion from $3.242 billion at October 31, 2010. Total assets were $5.084 billion and total equity was $2.555 billion.
Debt included $1.545 billion of senior notes, $105.3 million of loans payable and $24.9 million of mortgage-company warehouse borrowings. The filing reports total debt book value of approximately $1.685 billion, including debt discounts.
The company had no borrowings under its $885 million revolving credit facility and had $783.8 million of availability, subject to approximately $101.2 million of outstanding letters of credit. Its leverage ratio was approximately 0.16 to 1.00 versus a maximum of 1.75 to 1.00, and tangible net worth was approximately $2.51 billion versus a required minimum of approximately $1.88 billion.
Land purchase commitments totaled $544.2 million, with estimated additional cash required of $462.4 million if all parcels are acquired. The company also had $371.0 million of surety bonds primarily supporting community improvements.

Material Changes Versus the Prior Comparable Period

Net losses narrowed substantially, primarily because of lower inventory impairments, lower direct interest expense and improved home-delivery economics.
Net contracts signed increased 6.8% in value for the six months and 7.8% for the quarter. Net contracts totaled $808.1 million for 1,427 homes for the six months and $500.9 million for 879 homes for the quarter.
Cancellation rates improved to 4.6% of gross contracts for the six months and 3.9% for the quarter, versus 5.7% and 5.1%, respectively, in the prior-year periods.
Backlog increased to $1.006 billion, representing 1,760 homes, from $993.5 million and 1,738 homes at April 30, 2010.
The company was selling from 203 communities at April 30, 2011, compared with 195 at October 31, 2010, and expected to be selling from 215 to 225 communities at October 31, 2011.
Geographically, six-month revenue increased in the South and West but declined in the North and was approximately flat in the Mid-Atlantic. The North and Mid-Atlantic generated income before taxes, while the South, West and corporate and other activities remained loss-making.
Inventory increased despite a reduction in the number of temporarily closed communities. The company controlled approximately 35,900 home sites, including approximately 30,500 owned sites, compared with approximately 34,900 controlled sites at October 31, 2010.

Guidance, Outlook, Risks and Unusual Items

Management stated that the housing market remained difficult but believed many markets were near a bottom. It cited potential pent-up demand, improving mortgage availability, reduced competition and the value of approved land positions as long-term opportunities.
Management expected approximately 215 to 225 selling communities at fiscal year-end and approximately 11 of 45 temporarily closed communities to reopen by April 30, 2012.
The company entered into contracts or otherwise acquired control of approximately 2,200 to 2,250 home sites during the first six months, reflecting a more opportunistic land-acquisition strategy.
Principal risks include housing demand and prices, employment and consumer confidence, mortgage availability, interest rates, land and regulatory approvals, construction costs and delays, inventory and joint-venture impairments, liquidity and refinancing conditions, legal proceedings, warranty and construction-defect claims, and weather.
One development joint venture had a $327.9 million loan subject to litigation and bankruptcy proceedings. The loan was non-recourse to Toll Brothers, but the company had several completion and conditional repayment guarantees limited to its pro rata share. Management stated that adequate provisions had been recorded and did not expect a material adverse effect.
The company was in settlement discussions with the DOJ and EPA regarding alleged Clean Water Act storm-water violations. It also disclosed shareholder derivative litigation related to historical stock sales and securities litigation.
The company recognized $39.6 million of impairment charges on unconsolidated investments, including $20.0 million in the first quarter and $19.6 million in the second quarter. It also acquired a 60% participation in an 83-loan non-performing loan portfolio for $42.1 million.
The company had confirmed defective Chinese-made drywall in a small number of West Florida homes and stated that previously accrued amounts were adequate.
Management stated that there were no material changes to the risk factors disclosed in the fiscal 2010 Form 10-K and that disclosure controls were effective as of April 30, 2011.

Most Important Facts for Investors to Verify

Whether improved contract signings, lower cancellations and higher backlog translate into profitable deliveries rather than further margin pressure from product mix.
The sustainability of lower inventory impairment charges and the sensitivity of inventory values to home prices, sales pace and interest rates.
The recoverability of $185.3 million invested in or advanced to unconsolidated entities and the potential effect of further joint-venture impairments or guarantee claims.
The timing and amount of senior-note maturities, refinancing access and compliance with revolving-credit covenants.
Whether the $154.3 million tax refund and other tax benefits are non-recurring and how deferred-tax valuation allowances may affect future earnings.
The ultimate exposure from the development joint-venture litigation, DOJ/EPA storm-water matter, shareholder derivative claims and warranty or Chinese-drywall remediation.
Whether the planned increase in controlled land and selling communities improves future growth without materially increasing cash requirements or inventory risk.