Toll Brothers, Inc. quarterly report, Q2 FY2014

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

Business Context and Reporting Period

Toll Brothers designs, builds, markets and finances luxury detached and attached homes, including urban infill projects, and operates related mortgage, title, land-development, rental and ancillary businesses. The filing covers the three and six months ended April 30, 2014, compared with the corresponding 2013 periods. The company operated in 20 states through Traditional Home Building and City Living segments.

On February 4, 2014, Toll Brothers completed its $1.60 billion cash acquisition of Shapell Industries, adding approximately 4,950 California home sites and 11 active selling communities. Shapell results are included from the acquisition date.

Key Financial Metrics

Metric	Six months ended April 30, 2014	Six months ended April 30, 2013	Three months ended April 30, 2014	Three months ended April 30, 2013
Revenue	$1.504 billion	$940.6 million	$860.4 million	$516.0 million
Income from operations	$99.8 million	$17.1 million	$68.1 million	$16.4 million
Operating margin	6.6%	1.8%	7.9%	3.2%
Net income	$110.8 million	$29.1 million	$65.2 million	$24.7 million
Net margin	7.4%	3.1%	7.6%	4.8%
Diluted earnings per share	$0.60	$0.17	$0.35	$0.14

Six-month revenue increased 59.9%, driven by 2,146 home deliveries versus 1,640 and a higher average delivered-home price of approximately $700,900 versus $573,500. Second-quarter revenue increased 66.7%, with 1,218 homes delivered versus 894 and an average delivered-home price of approximately $706,400 versus $577,200.

Cost of revenues declined to 79.9% of revenue for the six-month period from 81.4%; excluding inventory impairments, the ratio was 79.7% versus 81.2%.
SG&A declined to 13.4% of revenue from 16.8% for the six-month period and to 12.1% from 15.4% for the quarter. SG&A included $5.9 million of acquisition costs for the six months and $5.1 million for the quarter.
Income from unconsolidated entities increased to $37.2 million for the six months from $8.1 million and to $14.3 million for the quarter from $5.0 million.
Inventory impairment charges were $3.9 million for the six months and $1.9 million for the quarter, compared with $1.7 million and $1.0 million, respectively, in the prior-year periods.

Cash Flow, Balance Sheet, Debt and Liquidity

At April 30, 2014, cash and cash equivalents were $351.8 million and marketable securities were $13.0 million, compared with $773.0 million and $52.5 million at October 31, 2013.
Operating activities used $66.2 million during the first six months, an improvement from $445.4 million used in the prior-year period. Inventory increased by $319.8 million.
Investing activities used $1.476 billion, principally the $1.489 billion net cash purchase price for Shapell and $80.7 million invested in unconsolidated entities.
Financing activities provided $1.121 billion, including debt and equity financing used to fund the Shapell acquisition.
Total debt at April 30, 2014 consisted of $747.1 million of loans payable, $2.654 billion of senior notes and $56.8 million of mortgage-company warehouse borrowings.
The company had approximately $849.2 million available under its $1.035 billion revolving credit facility and $500.0 million available under a 364-day facility. Revolver borrowings were $95.0 million, with $90.8 million of letters of credit outstanding.
The company reported a leverage ratio of approximately 0.81 versus a covenant maximum of 1.75 and tangible net worth of approximately $3.65 billion versus a minimum of approximately $2.45 billion.

Material Changes Versus the Prior Comparable Period

The Shapell acquisition materially increased revenue, inventory and Western-region assets. Shapell contributed $102.0 million of revenue and $6.1 million of operating income from February 5 through April 30, excluding acquisition-related costs.
Inventory rose to $6.548 billion from $4.650 billion, including land owned for future communities of $2.385 billion versus $1.288 billion.
Backlog increased to $3.207 billion for 4,324 homes at April 30, 2014, from $2.532 billion for 3,655 homes at April 30, 2013.
Net contracts signed increased in value 9.7% for the six months to $1.977 billion, although units declined 2.2% to 2,665. The average contract value increased 12.2%.
Traditional Home Building revenue increased 60.6% for the six months, led by the West, where revenue increased 110.5%. City Living revenue increased 40.9%.
Reported earnings benefited from nonrecurring or variable items, including a $23.5 million gain from Trust II’s asset sale, a $12.0 million distribution from Toll Brothers Realty Trust, $2.9 million of previously deferred gains, and a $9.1 million reversal of previously accrued uncertain-tax-position provisions.
The company issued 7.2 million common shares in November 2013 and received $220.4 million of net proceeds. It repurchased only 3,000 shares during the second quarter.

Guidance, Outlook, Commentary and Risks

Management described demand as having leveled off beginning in the fourth quarter of fiscal 2013 and continuing into fiscal 2014, but characterized the pause as temporary and expected continued growth toward more normalized levels.
The company expects to be selling from approximately 250 to 290 communities at October 31, 2014, versus 252 at April 30, 2014. It does not expect to reopen its 20 temporarily closed communities within the next 12 months.
Management expects to selectively sell assets to reduce land concentration and outstanding borrowings, but cautioned that timing, pricing and completion are dependent on market conditions and are not assured.
The company controlled approximately 50,400 home sites at April 30, including approximately 37,700 owned sites, and had aggregate land purchase commitments of $1.118 billion, requiring approximately $1.022 billion of additional cash if all parcels are acquired.
Investments in unconsolidated entities totaled $441.8 million, with an additional $101.7 million of potential funding commitments. Guarantees covered joint-venture loan commitments of up to $424.8 million; borrowings under those commitments were $61.4 million.
Outstanding surety bonds totaled $632.1 million, and letters of credit totaled $93.8 million. Management did not believe it was probable that these instruments would be drawn.
Homebuilding results remain sensitive to housing demand, mortgage availability, selling prices, sales pace, cancellations, land and construction costs, interest rates, regulatory approvals, inventory valuations and the ability to refinance debt.
A 1% increase in interest rates, assuming variable-rate debt balances remain constant, would increase annual interest expense by approximately $6.5 million.
Management stated that there were no material changes to previously disclosed risk factors and that disclosure controls were effective as of April 30, 2014.

Important Facts for Investors to Verify

Whether post-acquisition Shapell sales, margins and California land absorption meet expectations after purchase-accounting adjustments.
Whether the apparent improvement in operating margins is sustainable after excluding acquisition costs, land-sale gains, Trust-related distributions, tax-position reversals and other unusual items.
The pace and value of new contracts, particularly the decline in unit contracts and weakness in the Mid-Atlantic and City Living businesses.
Inventory growth, impairment sensitivity and the company’s ability to fund approximately $1.022 billion of remaining land commitments without excessive leverage.
Debt maturities, variable-rate exposure, refinancing availability and compliance with revolving-credit and term-loan covenants.
Potential cash requirements from joint-venture funding commitments, guarantees, surety bonds, letters of credit and mortgage commitments.
The timing and economics of planned asset sales and whether proceeds are sufficient to reduce borrowings and land concentration.