Toll Brothers, Inc. — Fiscal 2015 Third-Quarter Form 10-Q
Reporting period: Quarter and nine months ended July 31, 2015; comparisons are primarily with the corresponding 2014 periods. Toll Brothers operates traditional homebuilding and urban-infill City Living businesses across 19 states, with ancillary mortgage, title, landscaping, security monitoring, manufacturing, golf and country club operations, and investments in unconsolidated entities.
Key Financial Metrics
| Metric | Three months ended July 31 | Change | Nine months ended July 31 | Change |
|---|---|---|---|---|
| Revenue | $1.028 billion | Down 2.7% | $2.734 billion | Up 6.8% |
| Net income | $66.7 million | Down 31.7% | $216.0 million | Up 3.6% |
| Diluted EPS | $0.36 | Down from $0.53 | $1.18 | Up from $1.13 |
| Income from operations | $87.4 million | Down 32.5% | $250.9 million | Up 9.3% |
| Operating margin | 8.5% | Down from 12.3% | 9.2% | Up from 9.0% |
| Net margin | 6.5% | Down from 9.2% | 7.9% | Down from 8.1% |
For the nine months, the Company delivered 3,705 homes valued at $2.734 billion, versus 3,590 homes valued at $2.561 billion. Average delivery price increased to approximately $737,900 from $713,300. Third-quarter deliveries declined to 1,419 homes from 1,444, and average delivery price declined to approximately $724,500 from $731,900.
Cost of revenues was 78.7% of revenue for the nine months, compared with 78.8% in 2014. Excluding inventory write-offs, cost of revenues improved to 77.6% from 78.5%. In the third quarter, cost of revenues increased to 80.2% from 77.3%, or 78.4% excluding write-offs versus 76.8%.
Inventory was $6.991 billion at July 31, 2015, up from $6.490 billion at October 31, 2014. Inventory impairment charges were $31.3 million for the nine months and $18.0 million for the quarter, compared with $9.9 million and $6.0 million, respectively, in the prior-year periods.
Cash Flow, Debt and Liquidity
- Cash and cash equivalents were $394.8 million at July 31, 2015, compared with $586.3 million at October 31, 2014; marketable securities were $10.0 million.
- Operating activities used $111.3 million during the first nine months, versus $38.6 million provided in the prior-year period, primarily reflecting inventory investment, tax payments, mortgage-loan activity and lower income-tax payables.
- Investing activities provided $15.4 million, while financing activities used $95.7 million. Net cash decreased $191.5 million to $394.8 million.
- Total debt was approximately $3.324 billion at July 31, 2015, consisting principally of $866.9 million of loans payable, $2.356 billion of senior notes and $100.0 million of mortgage-company borrowings.
- The $1.035 billion revolving credit facility had $220.0 million drawn and $103.8 million of letters of credit outstanding. Management reported approximately $711.2 million of availability, a leverage ratio of approximately 0.70 to 1.00 versus a 1.75 maximum, and tangible net worth of approximately $4.08 billion versus a $2.61 billion minimum.
- Subsequent to July 31, 2015, the Company borrowed an additional net $130.0 million under the revolving credit facility for land acquisitions.
Material Changes Versus Prior Comparable Period
- Demand strengthened: nine-month net contracts rose 26.6% in value to $3.703 billion and 12.1% in units to 4,473 homes. Third-quarter net contracts rose 30.0% to $1.234 billion and 11.7% to 1,479 homes.
- Backlog increased 19.0% year over year to $3.688 billion, representing 4,447 homes, compared with $3.100 billion and 4,204 homes at July 31, 2014.
- Traditional Home Building contract value increased 28.3% for the nine months, led by the West and North regions; South unit demand declined. City Living contract value increased only 1.9% for the nine months, despite a higher average contract value and fewer units.
- City Living income before taxes increased to $80.3 million from $35.4 million for the nine months, while Traditional Home Building income before taxes declined to $324.6 million from approximately $338.3 million.
- Income from unconsolidated entities declined to $17.1 million from $38.2 million, primarily because the prior-year period included a $23.5 million Trust II gain and a $12.0 million Trust refinancing distribution.
- Other income included an $8.1 million gain from a bulk sale of security-monitoring accounts. Prior-year other income benefited from higher land-sale gains and certain joint-venture-related items.
- Debt declined overall from approximately $3.402 billion at October 31, 2014, while cash declined because of operating investment and the $300.0 million repayment of senior notes at maturity.
Outlook, Risks and Unusual Items
Management stated that customer demand had strengthened since the third quarter of fiscal 2014 and expected to be selling from approximately 270 to 285 communities by October 31, 2015, versus 267 at July 31, 2015. Management believed available liquidity and access to capital markets would be adequate to fund current operations and contractual obligations, but noted that economic conditions and industry uncertainty could affect refinancing and access to additional financing.
- Land purchase commitments totaled $1.263 billion, with $1.187 billion of additional cash required if all parcels are acquired. The Company controlled approximately 45,400 home sites, including approximately 9,700 under options.
- Joint-venture investments totaled $334.9 million, with remaining funding commitments of $71.3 million. Debt guarantees for certain unconsolidated entities had an estimated maximum exposure of $453.1 million based on amounts currently borrowed, or $922.2 million if all commitments were drawn, before partner reimbursement.
- Outstanding surety bonds totaled $742.9 million, including $628.8 million related primarily to community improvements; letters of credit totaled $103.8 million. Management did not believe draws were probable.
- The Company recorded a $5.8 million third-quarter charge for construction-defect claims involving completed multifamily communities in the West. Management stated existing reserves and insurance were sufficient for previously identified Mid-Atlantic stucco-related claims, but actual costs could vary.
- Inventory impairment testing depends on estimates of selling prices, sales pace, discount rates, costs, competition and market conditions. Further impairments could result if conditions deteriorate.
- Mortgage availability remains a risk because buyers face tighter underwriting standards, higher down-payment requirements and narrower appraisal guidelines.
- A 1% increase in variable-rate interest rates would increase annual interest expense by approximately $8.3 million, assuming constant variable-rate debt balances.
- Management reported no material changes to previously disclosed risk factors and concluded that disclosure controls were effective.
Most Important Facts for Investors to Verify
- Whether the strong contract growth and $3.688 billion backlog convert into deliveries without elevated cancellations, incentives or margin pressure.
- Whether inventory growth and the additional $130.0 million borrowing after quarter-end increase leverage or liquidity risk.
- The sustainability of third-quarter operating margins after the $18.0 million inventory write-offs, product-mix effects and construction-defect charge.
- The recoverability of land, operating-community and joint-venture investments, including the $1.263 billion of land purchase commitments.
- The ultimate cost of construction-defect, warranty, insurance and other legal claims, and the adequacy of related reserves and insurance recoveries.
- The timing and earnings contribution of City Living projects, joint ventures, rental developments and other unusual or nonrecurring items, including the $8.1 million security-monitoring gain.