Toll Brothers, Inc. — Fiscal 2018 Form 10-K Summary
Business context and reporting period
The filing covers the fiscal year ended October 31, 2018; the requested “2018 Q4” is included in the annual filing, with quarterly data for the three months ended October 31, 2018. Toll Brothers designs, builds, markets, sells, and finances luxury detached and attached homes in 19 states and the District of Columbia. It also operates City Living urban developments, rental-apartment ventures, mortgage, title, land-development, manufacturing, landscaping, and home-technology businesses.
At October 31, 2018, the Company controlled approximately 53,400 home sites across 638 communities, including 315 selling communities. Backlog was $5.52 billion, representing 6,105 homes, with approximately 96% expected to be delivered in fiscal 2019.
Financial performance, cash flow, margins, debt, and liquidity
| Metric | Fiscal 2018 | Fiscal 2017 | Change |
|---|---|---|---|
| Revenue | $7.143 billion | $5.815 billion | +23% |
| Income before taxes | $933.9 million | $814.3 million | +15% |
| Net income | $748.2 million | $535.5 million | +40% |
| Diluted EPS | $4.85 | $3.17 | +53% |
| Operating cash flow | $602.4 million | $965.0 million | -38% |
| Cash and cash equivalents | $1.182 billion | $712.8 million | +66% |
| Total debt | $3.698 billion | $3.220 billion | +15% |
- Homes delivered increased 16% to 8,265, while average delivered price increased 6% to approximately $864,300.
- Net contracts signed increased 11% to $7.604 billion, or 8,519 homes. Average contract value increased 7% to approximately $892,600.
- Cost of revenues was 79.4% of revenue versus 78.5% in fiscal 2017, implying a gross margin of approximately 20.6% versus 21.5%. Operating margin was approximately 11.0%, and net margin was approximately 10.5%.
- SG&A declined to 9.6% of revenue from 10.4%. Income from operations rose 21% to $786.2 million.
- The effective tax rate declined to 19.9% from 34.2%, aided principally by the Tax Cuts and Jobs Act, including a $35.5 million deferred-tax remeasurement benefit.
- Operating cash flow was reduced by a $143.6 million increase in inventory, an $85.4 million increase in receivables and other assets, and a $38.9 million increase in mortgage loans held for sale.
- Investing activities provided $81.3 million, principally from returns on investments in unconsolidated entities. Financing activities used $214.3 million, including $503.2 million for share repurchases and $61.7 million for dividends, partly offset by $396.5 million of net proceeds from issuing $400 million of 4.35% senior notes due 2028.
- The Company had approximately $1.13 billion available under its $1.295 billion revolving credit facility, no revolver borrowings, and $165.4 million of outstanding letters of credit. The facility matures in May 2021.
- Debt to total capitalization was 0.44 to 1.00. On November 1, 2018, the term loan was increased from $500 million to $800 million and extended to November 2023.
Material changes versus the prior comparable period
- Fiscal 2018 benefited from higher deliveries, higher average selling prices, increased community activity, and strong California and West segment performance.
- Traditional Home Building income before taxes increased 26% to $965.0 million. California revenue increased 42% and income before taxes increased 43%; West revenue increased 26% and income before taxes increased 39%.
- City Living revenue declined 16% to $321.0 million and income before taxes declined 60% to $78.1 million, primarily because fiscal 2017 benefited from major building delivery activity and substantially higher earnings from related joint ventures.
- Income from unconsolidated entities declined 27% to $85.2 million, although fiscal 2018 included $67.2 million of gains from asset sales by three rental-property joint ventures.
- Inventory impairments and write-offs increased to $35.2 million from $14.8 million, reflecting weaker demand, cost increases, and decisions to pursue bulk lot sales in certain communities.
- Warranty accruals declined to $258.8 million from $329.3 million. The Company continued to address water-intrusion claims involving older homes in Pennsylvania and Delaware.
- The Company repurchased 12.1 million shares for $503.2 million during fiscal 2018 and paid $0.41 per share in dividends, compared with $0.24 per share in fiscal 2017.
Guidance, outlook, risks, contingencies, and unusual items
- Demand moderated in the fourth quarter: contract value and units declined 15% and 13%, respectively, year over year. Demand softened further from November through mid-December 2018. Management attributed the decline to rising interest rates, higher home prices, and weaker buyer sentiment.
- The Company expects to open communities in Salt Lake City and Portland during fiscal 2019. It expects approximately 96% of October 31, 2018 backlog to be delivered by October 31, 2019, but does not provide formal earnings or revenue guidance in the filing.
- Key risks include housing-demand deterioration, mortgage availability and rates, affordability, competition, California concentration, inventory impairments, land-approval delays, construction costs, labor and material availability, weather and natural disasters, environmental regulation, and high-rise project execution.
- Water-intrusion claims remain material. Recorded aggregate estimated repair costs for known and unknown claims were $324.4 million, with expected insurance and supplier recoveries of approximately $152.6 million. Remaining estimated repair costs were approximately $177.6 million and remaining expected recoveries were approximately $109.3 million at October 31, 2018. Actual costs and recoveries could differ materially.
- The Pennsylvania Attorney General was reviewing stucco-home construction after January 1, 2005; management could not predict the scope or outcome. The SEC separately concluded its investigation of related repair-cost estimates without action.
- The Company had $431.8 million invested in unconsolidated entities and up to $39.5 million of additional funding commitments. It estimated maximum exposure under joint-venture repayment and carry-cost guarantees at $254.7 million on debt outstanding at October 31, 2018, excluding collateral recoveries and partner reimbursement.
- Land purchase commitments totaled approximately $2.53 billion, with $168.4 million deposited and approximately $2.29 billion of additional cash required if all purchases are completed. Surety bonds totaled $853.1 million, and letters of credit totaled $165.4 million.
- Unusual or nonrecurring items included the Tax Act benefit, $67.2 million of rental-joint-venture asset-sale gains, a $10.7 million gain from a bulk sale of security-monitoring accounts, a $3.5 million commercial-property write-down, and $35.2 million of inventory impairments.
Most important facts for an investor to verify
- Whether the late-fiscal-2018 and early-fiscal-2019 demand slowdown persists, particularly in California, City Living, and other higher-priced markets.
- Backlog conversion, cancellation rates, sales incentives, pricing, and gross-margin performance as the $5.52 billion backlog is delivered.
- Inventory aging, impairment exposure, land commitments, and the Company’s ability to reduce land purchases if demand weakens.
- Water-intrusion warranty claims, the Pennsylvania Attorney General review, recorded recoveries, and potential changes to reserves.
- Debt maturities, including the $250 million of senior notes due in November 2019, variable-rate exposure, and compliance with revolving-credit and term-loan covenants.
- Cash generation after share repurchases, dividends, inventory investment, joint-venture funding, and mortgage-loan activity.
- The sustainability of fiscal 2018 earnings excluding Tax Act benefits, joint-venture asset-sale gains, the security-account sale, and other unusual items.