Toll Brothers, Inc. — Fiscal 2022 Third-Quarter Form 10-Q
Business context and reporting period
Toll Brothers is a U.S. luxury homebuilder operating through Traditional Home Building and Urban Infill (City Living), with five Traditional Home Building regions. The filing covers the three and nine months ended July 31, 2022, compared with the corresponding 2021 periods. The interim financial statements are unaudited.
Key financial metrics
| Metric | Q3 2022 | Q3 2021 | 9M 2022 | 9M 2021 |
|---|---|---|---|---|
| Total revenue | $2.495 billion | $2.255 billion | $6.563 billion | $5.749 billion |
| Home sales revenue | $2.256 billion | $2.234 billion | $6.130 billion | $5.481 billion |
| Income from operations | $361.7 million | $276.7 million | $818.4 million | $580.2 million |
| Net income | $273.5 million | $234.9 million | $646.0 million | $459.3 million |
| Diluted EPS | $2.35 | $1.87 | $5.41 | $3.63 |
| Operating margin | 14.5% | 12.3% | 12.5% | 10.1% |
| Net margin | 11.0% | 10.4% | 9.8% | 8.0% |
Q3 home deliveries declined 7% to 2,414 homes, while the average delivered price increased 9% to $934,700. For the nine-month period, deliveries increased 2% to 6,750 homes and the average delivered price increased 10% to $908,200. Home sales cost of revenues was 74.0% of home sales revenue in Q3 and 75.4% for the nine-month period, versus 77.3% and 78.1%, respectively, in the prior-year periods.
Cash and cash equivalents were $316.5 million at July 31, 2022, down from $1.638 billion at October 31, 2021. Cash, cash equivalents and restricted cash totaled $396.6 million. Nine-month operating cash flow was negative $246.6 million, compared with positive $448.4 million in 2021, primarily because of a $1.288 billion increase in inventory. Investing cash flow was negative $94.9 million, and financing cash flow was negative $946.3 million.
Inventory increased to $9.409 billion from $7.916 billion at October 31, 2021. Total debt, including loans payable, senior notes and the mortgage company facility, was approximately $3.316 billion, compared with $3.571 billion at fiscal year-end. The company had no borrowings under its $1.905 billion revolving credit facility at July 31, 2022, with approximately $1.81 billion available after letters of credit; it borrowed $400 million under the facility in August 2022. Debt to total capitalization was 0.37 to 1.00.
Material changes versus the prior comparable period
- Q3 total revenue rose 11%, operating income rose 31%, and net income rose 16%. For nine months, revenue rose 14%, operating income rose 41%, and net income rose 41%.
- Land sales and other revenue increased substantially to $238.5 million in Q3 from $21.1 million and to $433.2 million for nine months from $267.7 million, primarily reflecting land sales to joint ventures and other transactions.
- Net contracts signed declined sharply in Q3 to 1,266 homes valued at $1.664 billion, down 60% in units and 44% in value. For nine months, net contracts declined 26% in units and 9% in value.
- Backlog remained strong at 10,725 homes valued at $11.185 billion, up 1% in units and 19% in value from July 31, 2021.
- Traditional Home Building pretax income increased 53% in Q3 and 55% for nine months. City Living pretax income declined to a $4.5 million loss in Q3 and $7.9 million of income for nine months, compared with $65.9 million and $111.1 million, respectively, in the prior-year periods.
- The prior-year nine-month period included a $35.2 million pretax charge for early retirement of debt; no comparable charge occurred in 2022. Fiscal 2022 also included a $9.0 million gain from the bulk sale of smart-home monitoring accounts.
- The company repurchased 7.257 million shares for $383.9 million during the first nine months and paid $66.9 million of dividends. The May 2022 authorization permits repurchases of up to 20 million shares, with 18.319 million shares remaining at July 31.
Guidance, outlook, management commentary, risks and unusual items
Management reported a significant weakening in new-home demand during Q3, attributing it to sharply higher mortgage rates, reduced affordability after home-price increases, inflation concerns, stock-market volatility and broader economic uncertainty. Management stated that near-term demand improvement is unclear, although it continues to believe long-term housing fundamentals are favorable.
Supply-chain disruptions, labor shortages and municipality-related delays reduced deliveries and extended build times. Management does not expect these conditions to improve significantly in the near term and cautioned that further delays could increase costs and pressure margins.
Management expects available cash, operating cash flow, joint-venture distributions and borrowing capacity to fund operations and commitments for at least the next twelve months. Principal expected uses include inventory and land investment, joint-venture funding, debt repayment, share repurchases and dividends. The company identified $400 million of senior notes due April 15, 2023.
On August 25, 2022, the company entered into a $192.5 million settlement with Southern California Gas Company related to the Aliso Canyon natural-gas leak. Management expected approximately $140 million of net pre-tax gain in other income, plus approximately $8 million of additional benefit from amounts offset against previously incurred expenses, partially offset by a planned $10 million charitable foundation contribution. The filing states that approximately $150 million of net cash proceeds were received in the fourth quarter of fiscal 2022.
At July 31, 2022, the company had $767.6 million invested in unconsolidated entities and $238.2 million of remaining funding commitments. Guarantees related to unconsolidated entities had estimated maximum exposure of $306.5 million on debt already borrowed and $544.6 million if all related loan commitments were borrowed; these estimates exclude recoveries, partner reimbursements and certain project-completion or indemnity exposures.
Other risks include land and inventory valuation, home warranty and water-intrusion claims, interest-rate volatility, the transition from LIBOR to alternative reference rates, mortgage-market conditions, construction costs, legal proceedings, regulatory requirements, natural disasters, cybersecurity and economic or pandemic-related disruptions. The filing states that no material changes occurred to previously disclosed risk factors.
Most important facts for investors to verify
- Whether the steep Q3 decline in net contracts persists and how it affects future deliveries, backlog conversion and inventory levels.
- Whether price reductions, incentives, cancellations or higher construction costs reverse the recent margin improvement.
- The pace of inventory growth and the resulting effect on operating cash flow and liquidity.
- The timing and accounting treatment of the Aliso Canyon settlement gain and the related cash proceeds.
- Ability to refinance or repay the $400 million of senior notes due in April 2023 while continuing land investment, dividends and share repurchases.
- Exposure to joint-venture guarantees, land-purchase commitments, surety bonds, letters of credit and warranty or water-intrusion claims.
- Compliance with credit-facility covenants and the effect of rising variable interest rates and the LIBOR transition on borrowing costs.