Toll Brothers, Inc. — Fiscal 2011 First-Quarter 10-Q Summary
Business context and reporting period
Toll Brothers is a luxury homebuilder operating in 19 states through four geographic segments: North, Mid-Atlantic, South and West. The filing covers the three months ended January 31, 2011, compared with the three months ended January 31, 2010. The company reported that the housing downturn remained severe, although it believed certain markets were stabilizing and that long-term demand and land scarcity could support future growth.
Key financial metrics
| Metric | Q1 Fiscal 2011 | Q1 Fiscal 2010 | Change |
|---|---|---|---|
| Revenue | $334.1 million | $326.7 million | Up 2.3% |
| Cost of revenues | $282.0 million | $317.5 million | Down 11.2% |
| Gross margin | 15.6% | 2.8% | Improved |
| Loss from operations | $10.2 million | $65.3 million | Loss narrowed |
| Operating margin | (3.1%) | (20.0%) | Improved |
| Loss before tax benefit | $17.0 million | $56.8 million | Loss narrowed |
| Income tax benefit | $20.5 million | $16.0 million | Up $4.5 million |
| Net income (loss) | $3.4 million | $(40.8) million | Returned to profitability |
| Diluted earnings (loss) per share | $0.02 | $(0.25) | Improved |
| Cash used in operating activities | $77.2 million | $72.5 million | Use increased |
Revenue reflected a 6.9% increase in average delivered home prices, partly offset by a 4.4% decrease in homes delivered. Cost of revenues declined substantially because inventory impairment charges fell to $5.1 million from $33.4 million and delivered-home costs and incentives were lower. Excluding impairments, cost of revenues was 82.9% of revenue versus 87.0% in the prior-year quarter.
SG&A declined 8.9% to $61.3 million, or 18.4% of revenue, from $67.3 million, or 20.6% of revenue. Directly expensed interest declined to $1.1 million from $7.3 million.
Cash, cash equivalents and marketable securities totaled approximately $1.10 billion at January 31, 2011, down $135.9 million from October 31, 2010. Cash and cash equivalents alone were $886.6 million. Inventory increased to $3.36 billion from $3.24 billion.
Balance-sheet debt consisted of $104.4 million of loans payable, $1.54 billion of senior notes and $19.4 million of mortgage-company warehouse borrowings. Total liabilities were $2.49 billion and total equity was $2.57 billion at January 31, 2011.
Material changes versus the prior comparable period
- Net contracts signed increased 5.2% to $307.2 million, or 548 homes, from $292.1 million, or 526 homes.
- Gross contracts signed increased 4.1% to $325.9 million, or 581 homes.
- Contract cancellations declined to 5.7% of gross contracts from 6.7%, although the North segment experienced higher cancellations.
- Backlog declined 1.8% to $825.2 million, or 1,472 homes, from $840.2 million, or 1,461 homes.
- Communities selling increased to 200 from 195 at October 31, 2010. Management expected 215 to 225 selling communities at October 31, 2011.
- Home sites controlled increased to approximately 35,700 from 31,700 at January 31, 2010 and 34,900 at October 31, 2010. The company acquired control of 1,429 home sites during the quarter.
- Loss from unconsolidated entities was $11.0 million versus income of $0.4 million, including a $20.0 million impairment charge on an investment.
- The company recognized a $20.0 million reclassification from inventory to property, construction and office equipment related to completed commercial retail facilities.
- The tax benefit included an $18.0 million reversal of previously accrued uncertain tax positions and a $2.3 million reversal of state tax liabilities following an audit settlement.
Guidance, outlook, commentary and risks
Management believed the housing market had reached or was approaching a bottom in many markets, but expected continued volatility. It identified improving conditions in the Washington, D.C.-to-Boston corridor, New York City urban projects and Texas, while acknowledging that many markets remained weak and buyers continued to face tighter mortgage standards, higher down payments and difficulty selling existing homes.
Management emphasized the company’s liquidity, balance sheet, geographic diversification, brand and land portfolio as advantages in pursuing distressed land and real-estate opportunities. It also stated that the company expected to reopen approximately 13 of 48 temporarily closed communities before January 31, 2012.
The company had an $885 million revolving credit facility maturing in October 2014, with no borrowings outstanding at January 31, 2011 and approximately $87.5 million of letters of credit outstanding. The facility required a maximum leverage ratio of 1.75 to 1.00 and minimum tangible net worth of approximately $1.89 billion; reported leverage was approximately 0.23 to 1.00 and tangible net worth approximately $2.53 billion.
- Land purchase commitments totaled $557.0 million, with estimated additional cash required of $467.0 million if all parcels were acquired.
- Outstanding surety bonds totaled $430.3 million, including $359.8 million related primarily to community improvements.
- Joint-venture guarantees and related exposures had estimated maximum gross potential liability of approximately $38.4 million, net of accrued amounts, under specified circumstances.
- Chinese-manufactured drywall was confirmed in a small number of West Florida homes; the company believed existing accruals were adequate.
- The company was engaged in discussions with the DOJ and EPA regarding alleged Clean Water Act storm-water violations.
- Joint-venture litigation and bankruptcy proceedings remained ongoing at the reporting date, although the company did not expect a material effect. A securities class-action settlement received final court approval in March 2011 and was to be funded by insurers.
- Future results remain sensitive to home prices, employment, consumer confidence, mortgage availability, cancellations, inventory valuations, land approvals, joint-venture performance and access to financing.
Most important facts for investors to verify
- Whether contract growth and lower cancellation rates continue, particularly given the decline in backlog value.
- Whether the improved gross margin is sustainable after the unusually large prior-year impairment comparison and reduced incentives.
- The carrying value and impairment sensitivity of the $3.36 billion inventory balance.
- The recovery and timing of the expected $141.6 million federal tax refund and the company’s ability to use deferred tax assets.
- Liquidity after funding inventory growth, land commitments, joint-venture exposures and debt maturities.
- Potential additional losses from unconsolidated entities, guarantees, litigation, environmental matters and Chinese drywall claims.
- Compliance with the revolving credit facility’s leverage and tangible-net-worth covenants.