Toll Brothers, Inc. quarterly report, Q1 FY2015

Toll Brothers, Inc. — Fiscal 2015 First-Quarter Form 10-Q

Business context and reporting period

The filing covers the three months ended January 31, 2015. Toll Brothers is a U.S. luxury homebuilder operating in 19 states through Traditional Home Building and City Living segments, with related mortgage, title, land development, rental, distressed-asset, and other ancillary businesses.

The results include the Shapell Industries homebuilding operations acquired on February 4, 2014, which primarily expanded the Company’s California operations.

Financial performance and key metrics

Metric	Q1 FY2015	Q1 FY2014	Change
Revenue	$853.5 million	$643.7 million	32.6% increase
Income from operations	$97.1 million	$31.8 million	205.5% increase
Income before taxes	$124.0 million	$71.2 million	74.1% increase
Net income	$81.3 million	$45.6 million	78.4% increase
Diluted earnings per share	$0.44	$0.25	76.0% increase
Operating margin	11.4%	4.9%	Improved
Net margin	9.5%	7.1%	Improved

The Company delivered 1,091 homes valued at $853.5 million, compared with 928 homes valued at $643.7 million. Average selling price increased to approximately $782,300 from $693,600.
Cost of revenues declined to 76.2% of revenue from 79.9%, reflecting product and geographic mix, lower interest costs, higher home prices, and lower inventory write-offs.
SG&A increased 8.6% to $106.3 million, but declined to 12.5% of revenue from 15.2% due to operating leverage.
Income from unconsolidated entities fell to $4.9 million from $22.9 million, principally because the prior-year period included a $23.5 million gain from the sale of substantially all assets of Toll Brothers Realty Trust II.
Other income increased to $22.0 million from $16.5 million, including an $8.1 million gain from a bulk sale of security-monitoring accounts.
The effective tax rate was 34.4%, compared with 36.0% in the prior-year quarter.

Contracts, backlog, and operating footprint

Net contracts signed increased 24.4% to $873.2 million on 1,063 homes, from $701.7 million on 916 homes. Contract units increased 16.0% and average contract value increased 7.2%.
Traditional Home Building contracts increased 30.0% to $829.5 million, driven particularly by the West region. City Living contracts declined 31.2% to $43.7 million, reflecting slower first-quarter demand.
Backlog at January 31, 2015 was $2.74 billion on 3,651 homes, compared with $2.69 billion on 3,667 homes a year earlier.
The Company was selling from 258 communities at January 31, 2015 and expected to reach 270 to 310 communities by October 31, 2015.
Owned or controlled home sites totaled approximately 45,300, including 36,142 owned and 9,158 controlled through options.

Cash flow, balance sheet, debt, and liquidity

Operating cash flow was an outflow of $33.0 million, an improvement from the $250.4 million outflow in the prior-year quarter. Inventory increased by $114.4 million during the quarter.
Investing cash flow was an outflow of $8.1 million, including investments in unconsolidated entities and distressed assets, partly offset by investment returns and marketable-securities sales.
Financing cash flow was an outflow of $44.3 million, primarily from debt repayments and $6.2 million of share repurchases.
Cash and cash equivalents were $500.9 million at January 31, 2015, compared with $586.3 million at October 31, 2014. Including marketable securities, liquidity on hand was approximately $510.9 million.
Total debt carrying value was approximately $3.37 billion, comprising $665.7 million of loans payable, $2.66 billion of senior notes, and $46.6 million of mortgage-company borrowings.
The $1.035 billion revolving credit facility had no outstanding borrowings and approximately $932.9 million of availability, subject to approximately $102.1 million of outstanding letters of credit. The facility matures in August 2018.
At January 31, 2015, the Company reported a leverage ratio of approximately 0.72 to 1.00 versus a maximum of 1.75 to 1.00, and tangible net worth of approximately $3.91 billion versus a required minimum of approximately $2.52 billion.
Land purchase commitments totaled $1.08 billion, against which $70.5 million had been deposited; approximately $1.01 billion of additional cash would be required if all commitments are completed.

Material changes versus the prior comparable period

Revenue growth reflected 17.6% more homes delivered and a 12.8% higher average selling price, with $94.4 million of revenue from Shapell communities.
West-region revenue increased 54.7%, including Shapell deliveries, while City Living revenue increased substantially because of closings at a New York high-rise project.
City Living moved from a $1.1 million pretax loss to $51.3 million of pretax income, supported by higher deliveries, higher-margin urban product, management fees, and a $3.6 million gain related to commercial-space sales.
Inventory increased to $6.63 billion from $6.49 billion. First-quarter inventory impairment charges declined to $1.1 million from $2.0 million.
Investments in and advances to unconsolidated entities increased to $463.6 million from $447.1 million. The Company had up to $83.9 million of additional funding commitments.
The Company repurchased 201,000 shares at an average price of $31.08 and authorized a new 20 million-share repurchase program effective after terminating the prior program.

Guidance, outlook, risks, contingencies, and unusual items

Management stated that customer demand strengthened beginning in the third quarter of fiscal 2014 and continued into the first quarter and second quarter of fiscal 2015. Management was optimistic that this strengthening would continue, but provided no quantitative earnings or revenue guidance.
Key risks include housing-market demand, mortgage availability, interest rates, competition, land approvals, construction costs, subcontractor and material availability, homebuyer cancellations, inventory valuation, and the ability to refinance or obtain additional financing.
Unconsolidated joint ventures had debt commitments of $883.2 million and borrowings of $333.1 million subject to Company guarantees. The estimated maximum exposure based on amounts borrowed was approximately $333.1 million before partner reimbursement; additional guarantees covered approximately $11.0 million of ground-lease payments and insurance deductibles.
The Company had $603.6 million of surety bonds primarily supporting community improvements, plus $97.6 million of other surety bonds. Management did not believe the bonds or letters of credit were likely to be drawn.
Management believed reserves and insurance were sufficient for Pennsylvania and Delaware stucco-related claims, but actual repair costs could differ from estimates. The Company also faced multifamily construction claims in the West region that were still in early investigation.
At January 31, 2015, the Company had $59.8 million of gross unrecognized tax benefits, including interest and penalties; up to $31.1 million could decrease within the following 12 months through statute expirations or settlements.
The Company deferred a $9.3 million gain on the sale of property to a 25%-owned homebuilding joint venture and will recognize it as units are sold to ultimate buyers.
A 1 percentage-point increase in variable interest rates would increase annual interest expense by approximately $5.6 million, assuming constant variable-rate debt.
No material changes to previously disclosed risk factors were reported. Management concluded disclosure controls were effective, and no material change in internal control over financial reporting occurred during the quarter.

Important facts for investors to verify

Whether the reported demand recovery and 24.4% increase in contracts continue beyond the first quarter, especially in City Living and weaker Mid-Atlantic markets.
The conversion of the $2.74 billion backlog into deliveries, revenue, margins, and cash flow, including cancellation trends.
Inventory growth, land purchase commitments, and the assumptions supporting inventory and joint-venture valuations.
Exposure to joint-venture guarantees, surety bonds, letters of credit, construction claims, and stucco-related warranty costs.
The sustainability of unusual or nonrecurring income, including the $8.1 million security-monitoring gain, City Living commercial-space gain, and prior-period joint-venture gains.
Liquidity and covenant compliance as the Company funds inventory, joint ventures, land commitments, and debt maturities.