Toll Brothers, Inc. quarterly report, Q3 FY2014

Toll Brothers, Inc. — Fiscal 2014 Third-Quarter Form 10-Q

Reporting period: Quarter and nine months ended July 31, 2014; comparative periods ended July 31, 2013. Toll Brothers is a luxury homebuilder operating in 20 states through Traditional Home Building and City Living segments, with related mortgage, land development, rental, distressed-asset and ancillary businesses.

Financial performance and position

Metric	Three months ended July 31, 2014	Three months ended July 31, 2013	Nine months ended July 31, 2014	Nine months ended July 31, 2013
Revenue	$1,056.9 million	$689.2 million	$2,560.9 million	$1,629.8 million
Income from operations	$129.6 million	$55.2 million	$229.5 million	$72.3 million
Income before taxes	$151.3 million	$68.3 million	$316.0 million	$117.5 million
Net income	$97.7 million	$46.6 million	$208.5 million	$75.7 million
Diluted EPS	$0.53	$0.26	$1.13	$0.43
Operating margin	12.3%	8.0%	9.0%	4.4%

Revenue increased 53.4% in the quarter and 57.1% year to date, driven by higher deliveries, higher average selling prices and the February 2014 Shapell acquisition.
Homes delivered increased to 1,444 in the quarter from 1,059 and to 3,590 year to date from 2,699. Average delivered home price increased to approximately $731,900 in the quarter and $713,300 year to date.
Cost of revenues declined to 77.3% of revenue in the quarter and 78.8% year to date, versus 79.1% and 80.4%, respectively, in the prior-year periods. SG&A declined to 10.4% of revenue in the quarter and 12.2% year to date, versus 12.9% and 15.1%.
Inventory was $6.59 billion at July 31, 2014, up from $4.65 billion at October 31, 2013. Operating-community inventory was $4.15 billion and land owned for future communities was $2.32 billion.
Cash provided by operating activities was $38.6 million, compared with $456.5 million used in the prior-year period. Investing cash outflow was $1.46 billion, principally reflecting the $1.49 billion cash cost of acquiring Shapell. Financing activities provided $1.02 billion.
Cash and cash equivalents were $374.6 million and marketable securities were $12.0 million at July 31, 2014, compared with $773.0 million and $52.5 million, respectively, at October 31, 2013.
Debt included $636.1 million of loans payable, $2.65 billion of senior notes and $87.8 million of mortgage-company warehouse borrowings. Total reported debt was approximately $3.38 billion.
The $1.035 billion revolving credit facility had no borrowings and approximately $940.3 million of availability, subject to approximately $94.7 million of outstanding letters of credit. A separate $500 million 364-day facility was also undrawn and available through February 3, 2015.
The company reported a leverage ratio of approximately 0.77 versus a 1.75 maximum and tangible net worth of approximately $3.75 billion versus a required minimum of approximately $2.50 billion.

Material changes versus the prior comparable period

Shapell was acquired on February 4, 2014, for an aggregate purchase price of $1.60 billion. The acquisition added approximately 4,950 California home sites and 11 active selling communities at acquisition. Shapell contributed $199.6 million of revenue and $14.0 million of pretax income from February 5 through July 31, excluding $5.2 million of acquisition-related costs.
West segment revenue increased 130.6% year to date, partly due to 231 Shapell home deliveries; West pretax income increased to $153.3 million from $42.9 million.
Net contracts signed increased 4.7% in value year to date to $2.93 billion, despite a 3.4% decline in units to 3,989. In the third quarter, contract value declined 4.4% to $949.1 million and units declined 5.8% to 1,324.
Backlog increased 9.3% year over year to $3.10 billion, representing 4,204 homes, from $2.84 billion and 4,001 homes.
Inventory impairment charges increased to $9.9 million year to date and $6.0 million in the quarter, compared with $2.0 million and $0.2 million, respectively.
Income from unconsolidated entities increased to $38.2 million year to date from $8.8 million, primarily due to a $23.5 million gain from the sale of substantially all Trust II assets and a $12.0 million distribution associated with a Trust refinancing.
Other income increased to $48.4 million year to date from $36.4 million, including $21.0 million of net land-sale income versus $3.0 million in the prior-year period. The prior-year period included $13.2 million of litigation-settlement income that did not recur.
City Living revenue and pretax income declined year to date to $114.1 million and $35.4 million, respectively, from $118.2 million and $37.2 million.

Outlook, risks and unusual items

Management reported that demand had leveled beginning in the fourth quarter of fiscal 2013 and weakened more recently. Cited factors included economic and geopolitical uncertainty, fragile consumer confidence, reduced affordability and limited real personal-income growth. Management characterized the third-quarter weakness as a temporary pause and continued to expect longer-term demand growth.
The company expected to be selling from 255 to 275 communities at October 31, 2014. It controlled approximately 49,000 home sites at July 31, 2014 and expected to open two new City Living buildings in the fourth quarter.
Management stated that existing cash, operating cash flow and available credit should fund current operations and contractual obligations, but cautioned that tight credit markets could make future refinancing or additional financing more difficult or more restrictive.
Land purchase commitments totaled $988.8 million, including $901.2 million of additional cash required if all parcels are acquired, plus approximately $64.3 million of apartment-development land commitments.
Investments in unconsolidated entities totaled $443.3 million, with up to $83.0 million of additional funding commitments. Guarantees covered joint-venture loan commitments of $464.8 million; based on amounts borrowed, estimated maximum exposure was approximately $103.6 million before partner reimbursement.
Outstanding surety bonds totaled $661.7 million, including $585.3 million primarily related to community improvements, and letters of credit totaled $97.7 million. Management did not believe material draws were probable.
Key unusual items included the Shapell acquisition, Trust II and Trust refinancing gains, higher inventory impairments, acquisition-related costs and purchase-accounting effects on Shapell homes sold.
Interest-rate exposure was primarily variable-rate debt of approximately $587.1 million; a 1% increase in rates, holding balances constant, was estimated to increase annual interest expense by approximately $5.9 million.
The company stated that there were no material changes to previously disclosed risk factors, and that disclosure controls and procedures were effective as of July 31, 2014.

Investor verification points

Verify the sustainability of higher deliveries, average selling prices and margins after the Shapell acquisition and related purchase-accounting effects roll off.
Monitor contract activity, cancellations, pricing and backlog conversion, particularly following the reported third-quarter weakening in demand.
Assess inventory concentration, land commitments and the assumptions supporting Level 3 community valuations and impairment testing.
Reconcile liquidity after the acquisition, including cash levels, debt maturities, credit-facility availability and the February 2015 expiration of the 364-day facility.
Evaluate the recurring versus nonrecurring components of pretax income, including Trust and Trust II gains, land sales, Gibraltar results and prior-year litigation income.
Review joint-venture funding commitments, guarantees, surety bonds and letters of credit for potential cash requirements not fully reflected in consolidated debt.