TOL

Toll Brothers, Inc. 10-Q Summary: Period Ended July 31, 2008

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended July 31, 2008, and the nine-month period ended July 31, 2008, for Toll Brothers, Inc., a luxury homebuilder. The company operates in four geographic segments: North, Mid-Atlantic, South, and West. The reporting period reflects a severe downturn in the housing market, characterized by declining demand, increased contract cancellations, and significant inventory impairments.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Revenues decreased 29% for the nine months and 34% for the three months ended July 31, 2008, compared to the prior year. This was driven by a 27% decrease in homes delivered (nine months) and a 31% decrease (three months), alongside a shift to lower-priced products and higher sales incentives.
• Profitability Reversal: The company reported a net loss of $219.0 million for the nine months ended July 31, 2008, compared to net income of $117.5 million in the prior year period. The loss was primarily due to inventory impairment charges of $526.7 million and joint venture impairment charges of $146.3 million.
• Contract Activity: Net new contracts signed declined 49% in value for the nine months and 35% for the three months. Cancellations represented 24.1% of gross contracts signed in the nine-month period.
• Backlog Reduction: Backlog decreased 52% to $1.75 billion (2,592 homes) from $3.67 billion (4,997 homes) at July 31, 2007.
• Liquidity Improvement: Despite the operating loss, cash and cash equivalents increased to $1.50 billion, driven by strong operating cash flow of $660.9 million, largely due to inventory reductions and lower construction activity.

Guidance, Outlook, and Risks

• Guidance (as of Sept 4, 2008): Management expects home deliveries for the quarter ending October 31, 2008, to be between 850 and 1,050 homes, resulting in full fiscal year deliveries of 4,500 to 4,700 homes. The average delivered price is expected to be between $640,000 and $650,000 for the quarter.
• Market Outlook: Management attributes the slowdown to softening demand, consumer confidence issues, and turmoil in the mortgage and credit markets. They anticipate the pace of sales could slow further until credit markets stabilize.
• Key Risks:
  • Inventory Impairment: Continued deterioration in market conditions may require additional write-downs of land and inventory.
  • Joint Venture Obligations: The company has significant commitments and guarantees related to unconsolidated joint ventures, some of which are in default or facing liquidity issues.
  • Legal Proceedings: Ongoing securities class action litigation and environmental investigations (EPA/DOJ) regarding storm water discharge practices.
  • Financing: Tightening credit standards may impede home buyers' ability to secure mortgages, affecting closings.

Investor Verification Checklist

• Inventory Valuation: Verify the assumptions used for the $526.7 million in inventory impairment charges and the remaining fair value of the $4.55 billion inventory balance.
• Joint Venture Exposure: Review the status of the $141.8 million invested in unconsolidated entities and the $50.3 million in maximum guarantee obligations, particularly regarding the two joint ventures in default.
• Backlog Quality: Assess the risk of further cancellations given the 24.1% cancellation rate in the nine-month period and the 52% drop in total backlog value.
• Liquidity Position: Confirm the availability of the $1.30 billion revolving credit facility and the company's ability to meet debt covenants (leverage ratio was 0.19 to 1.00, well below the 2.00 limit).
• Legal Contingencies: Monitor the outcome of the securities class action suit and the DOJ's review of storm water discharge practices.