Toll Brothers, Inc. — Form 10-Q Summary
Business context and reporting period
Quarterly report for the fiscal quarter ended July 31, 2019. Toll Brothers is a luxury homebuilder operating through Traditional Home Building and City Living segments, with five traditional geographic regions: North, Mid-Atlantic, South, West, and California. The company also invests in rental-property, land-development, home-building, and Gibraltar joint ventures.
During the period, Toll Brothers acquired substantially all assets and operations of Sharp Residential, LLC for approximately $92.8 million, adding approximately 950 home sites and 11 selling communities in metropolitan Atlanta.
Key financial metrics
| Metric | Nine months ended July 31, 2019 | Change vs. 2018 | Three months ended July 31, 2019 | Change vs. 2018 |
|---|---|---|---|---|
| Total revenue | $4.845 billion | +3% | $1.766 billion | -8% |
| Home sales revenue | $4.788 billion | +2% | $1.757 billion | -8% |
| Income from operations | $455.9 million | +2% | $171.0 million | -26% |
| Net income | $387.7 million | -11% | $146.3 million | -24% |
| Diluted EPS | $2.63 | Down from $2.81 | $1.00 | Down from $1.26 |
| Operating margin | 9.4% | Approximately flat | 9.7% | Down from 12.0% |
| Net margin | 8.0% | Down from 9.3% | 8.3% | Down from 10.1% |
| Net contracts signed | $5.035 billion; 6,044 homes | -18% in value; -11% in units | $1.869 billion; 2,241 homes | -8% in value; -3% in units |
| Backlog | $5.844 billion; 6,839 homes | -10% in value; -4% in units | Not applicable | Not applicable |
Revenue growth for the nine-month period reflected a 4% increase in average delivered home prices, partly offset by a 2% decline in deliveries. Quarterly revenue declined because deliveries fell 11%, although the average delivered price increased 3%. SG&A increased 6% for the nine-month period and 7% for the quarter, reaching 11.0% and 10.6% of home sales revenue, respectively.
Cash flow, balance sheet, debt, and liquidity
- Cash and cash equivalents were $836.3 million at July 31, 2019, down from $1.182 billion at October 31, 2018.
- Cash provided by operating activities was $22.5 million, compared with $74.0 million of cash used in the prior-year period. Inventory increased $265.0 million.
- Cash used in investing activities was $50.4 million, including the Sharp acquisition, $61.3 million of property and equipment purchases, and $43.3 million invested in unconsolidated entities.
- Cash used in financing activities was $317.9 million, including the $350.0 million redemption of senior notes, $167.5 million of share repurchases, and $48.1 million of dividends, partly offset by net loan borrowings.
- Total inventory was $7.995 billion, up from $7.598 billion at October 31, 2018. Total equity was $4.984 billion.
- Loans payable were $1.089 billion, senior notes were $2.513 billion, and the mortgage company loan facility was $150.0 million. Total debt book value was approximately $3.762 billion.
- The company had no borrowings under its $1.295 billion revolving credit facility, approximately $190.2 million of outstanding letters of credit, and approximately $1.10 billion of remaining availability. The facility matures in May 2021.
- The $800.0 million senior unsecured term loan matures November 1, 2023 and carried a 3.55% interest rate at July 31, 2019. The reported leverage ratio was approximately 0.58 to 1.00, versus a maximum permitted ratio of 1.75 to 1.00.
Material changes versus the prior comparable period
- Nine-month revenue increased modestly, but net income declined 11% because of higher taxes, lower income from unconsolidated entities, increased SG&A, and weaker contract activity.
- Third-quarter revenue and net income declined 8% and 24%, respectively, primarily because of fewer deliveries, higher SG&A, and lower joint-venture earnings.
- Demand moderated in late fiscal 2018 and early fiscal 2019, particularly in California. Management reported improved market conditions late in the second quarter and through the third quarter, but contracts and backlog remained below the prior-year levels.
- California nine-month net contracts declined 45% in value and 48% in units; California quarterly contracts declined 32% in value and 36% in units.
- Traditional Home Building income before taxes declined 2% for the nine-month period and 22% for the quarter. City Living income before taxes declined 1% for the nine-month period but increased 40% for the quarter.
- Inventory impairment charges and write-offs totaled $31.6 million for the nine-month period, compared with $28.7 million in 2018. The company also wrote off $4.2 million of forfeited deposits related to terminated Texas land purchase agreements.
- The company repurchased 4.767 million shares for $167.5 million during the nine-month period and had 15.805 million shares remaining under its authorization at July 31, 2019. It subsequently repurchased approximately 1.8 million additional shares.
- ASC 606 was adopted on November 1, 2018 using the modified retrospective method. The filing states that the adoption did not materially affect the balance sheet or income statement, but land-sale activity and forfeited customer deposits were presented differently from prior periods.
Guidance, outlook, risks, contingencies, and unusual items
- Management stated that it expected adequate resources and access to capital markets and external financing to fund current operations and contractual obligations, while noting that future financing availability cannot be assured.
- At July 31, 2019, the company owned or controlled approximately 57,400 home sites and was selling from 322 communities. Land purchase commitments totaled approximately $2.459 billion, requiring approximately $2.252 billion of additional cash if all parcels are acquired. Apartment-development land commitments were approximately $386.3 million.
- Investments in unconsolidated entities totaled $354.6 million, with $33.0 million of remaining funding commitments. Guarantees related to unconsolidated entities represented estimated maximum exposure of $265.6 million on currently borrowed amounts and $299.2 million if all related loan commitments were drawn.
- Water-intrusion claims remain a significant contingency. Recorded remaining repair costs were approximately $134.5 million and remaining expected insurance and supplier recoveries were approximately $99.6 million at July 31, 2019. The company entered arbitration with certain insurers during the quarter and stated that actual costs and recoveries could differ materially from estimates.
- The Pennsylvania Attorney General is reviewing construction of stucco homes built after January 1, 2005; the company has responded to information requests and a subpoena. Management could not predict the scope or outcome.
- In the third quarter, the company learned that a small percentage of mortgage applicants had experienced identity theft. The investigation had not identified a compromise of company systems; potentially affected applicants were notified and offered credit monitoring.
- Unusual items included a $12.2 million gain from selling a golf club, an $8.4 million gain from land contributed to a rental-property joint venture, and a $3.8 million gain from a joint-venture asset sale. Prior-year results included larger joint-venture asset-sale gains.
- Interest-rate sensitivity was material: holding variable-rate debt constant, a 1% increase in interest rates would increase annual interest expense by approximately $9.6 million.
Important facts for investors to verify
- Whether the decline in net contracts and backlog, particularly in California and City Living, persists or reverses in subsequent quarters.
- Backlog conversion, cancellation levels, pricing, incentives, and gross-margin trends as inventory is delivered.
- Inventory impairment risk, land deposit write-offs, and the recoverability of the $7.995 billion inventory balance.
- Cash generation after land purchases, acquisitions, share repurchases, dividends, and joint-venture funding commitments.
- Debt maturities, refinancing requirements, covenant compliance, and available revolving-credit capacity.
- Potential costs and insurance recoveries related to water-intrusion claims, construction-defect matters, and the Pennsylvania Attorney General review.
- The financial performance and funding needs of unconsolidated and consolidated rental-property joint ventures, including guarantee exposure.
- The effect of mortgage-applicant identity-theft incidents, related remediation costs, regulatory developments, and any future data-security findings.