TOL

Toll Brothers, Inc. 10-Q Summary

Business Context and Reporting Period

This report covers the quarterly period ended July 31, 2006, for Toll Brothers, Inc., a luxury homebuilder. The company operates in 50 markets across the United States, focusing on traditional home sales, land sales, and percentage-of-completion projects (primarily high-rise condominiums). The filing includes unaudited financial statements for the nine-month and three-month periods ended July 31, 2006, compared to the same periods in fiscal 2005.

Key Financial Metrics

Note: Operating cash flow was negative due to significant increases in inventory and contracts receivable.

Material Changes vs. Prior Period

• Revenue Trends: Nine-month revenues increased 14% year-over-year, driven by a 5% increase in homes delivered and a 6% increase in average selling price. However, three-month revenues declined 1% due to a 7% drop in deliveries.
• Profitability: Net income for the nine months rose 4% to $513.4 million. Conversely, net income for the three-month period fell 19% to $174.6 million.
• Ordering Activity: New contracts signed dropped significantly. For the nine months, the value of new contracts fell 33% to $3.75 billion. For the three-month period, the decline was 45% to $1.05 billion.
• Cancellation Rates: Cancellation rates increased to approximately 12% for the nine-month period and 18% for the three-month period, compared to a historical average of 7%.
• Inventory Write-offs: The company recognized $37.0 million in inventory write-offs for the nine-month period, a sharp increase from $3.7 million in the prior year, primarily due to land contract deposits and community write-downs in Michigan and Massachusetts.
• Stock-Based Compensation: The adoption of SFAS 123R resulted in $21.5 million of stock option expense for the nine-month period, which was not present in the comparable 2005 period.

Guidance, Outlook, and Risks

Management Commentary: Management attributes the slowdown in new contracts to declining consumer confidence, an oversupply of homes, and reduced speculative buying. Despite the current market softness, the company remains cautiously optimistic due to strong demographics and constraints on lot supply.

Financial Guidance (Fiscal 2006): Based on guidance provided on August 22, 2006 (not updated in this filing):

• Deliveries: 8,600 to 8,900 homes.
• Average Price: $685,000 to $690,000.
• Net Income: $727 million to $763 million.
• Diluted EPS: $4.41 to $4.63.
• Percentage of Completion Revenue: $215 million to $220 million.

Risks and Contingencies:

• Market Risk: Exposure to interest rate fluctuations on variable-rate debt; a 1% increase in rates would increase annual interest costs by approximately $5.2 million.
• Regulatory: An ongoing EPA review regarding storm water discharge practices in EPA Region 3; potential penalties or injunctive relief cannot be predicted.
• Liquidity: While the company has $322.6 million in cash and $1.15 billion available under its credit facility, its ability to pay dividends is restricted by credit agreement covenants to approximately $1.07 billion.

Key Facts for Investor Verification

• Backlog Decline: Verify the sustainability of the 13% year-over-year decline in total backlog ($5.59 billion) and the 18% decline in traditional home backlog.
• Cancellation Rates: Monitor the elevated cancellation rates (12-18%) and their impact on future revenue recognition and inventory levels.
• Inventory Write-offs: Assess the magnitude of the $37.0 million write-off in the nine-month period and the specific communities affected (Michigan, Massachusetts).
• Cash Flow Usage: Review the $378.5 million cash outflow from operations, driven by inventory buildup, to ensure liquidity remains sufficient for ongoing development.
• Land Commitments: Note the $3.74 billion in aggregate purchase price for land under option, with $194.6 million deposited, representing significant future capital requirements.