Toll Brothers, Inc. — Fiscal 2017 Form 10-K Summary
Business context and reporting period
The filing covers the fiscal year ended October 31, 2017, including fourth-quarter results. Toll Brothers designs, builds, markets, sells and finances luxury detached and attached homes in 20 states through its Traditional Home Building and City Living segments. It also develops land, operates ancillary businesses, and invests in for-rent apartments, land development, home building and other real-estate joint ventures.
At October 31, 2017, the Company operated 396 communities, including 305 selling communities, and owned or controlled approximately 48,300 home sites. Backlog was $5.06 billion, representing 5,851 homes, approximately 97% of which management expected to deliver in fiscal 2018. In November 2016, Toll Brothers acquired substantially all of Coleman Real Estate Holdings for approximately $83.1 million in cash, adding approximately 1,750 home sites and 15 selling communities at acquisition.
Financial and operating metrics
| Metric | Fiscal 2017 | Fiscal 2016 | Change |
|---|---|---|---|
| Revenue | $5.815 billion | $5.170 billion | +12% |
| Income from operations | $644.9 million | $490.1 million | +32% |
| Income before taxes | $814.3 million | $589.0 million | +38% |
| Net income | $535.5 million | $382.1 million | +40% |
| Diluted EPS | $3.17 | $2.18 | +45% |
| Operating cash flow | $959.7 million | $148.8 million | Material increase |
| Total debt | $3.220 billion | $3.775 billion | Down $555.4 million |
| Cash and cash equivalents | $712.8 million | $633.7 million | +12% |
| Inventory | $7.281 billion | $7.354 billion | Down 1% |
| Total equity | $4.537 billion | $4.235 billion | +7% |
Cost of revenues declined to 78.5% of revenue from 80.2%, producing an implied gross margin of approximately 21.5%, compared with 19.8% in fiscal 2016. SG&A increased to $607.8 million from $535.4 million and rose slightly to 10.5% of revenue from 10.4%. Income before taxes represented 14.0% of revenue versus 11.4% in fiscal 2016; the effective tax rate was 34.2% versus 35.1%.
The Company delivered 7,151 homes, up 17%, while average delivered price declined 4% to approximately $813,000. Net contracts increased 21% in value to $6.83 billion and 22% in units to 8,175 homes. Backlog increased 27% in value and 25% in units. City Living revenue increased 49% to $383.1 million, and City Living income before taxes increased 113% to $193.9 million, partly reflecting deliveries from newly completed high-rise projects and stronger joint-venture earnings.
Fiscal 2017 operating cash flow benefited from net income, a $129.7 million reduction in inventory, a $114.9 million decrease in mortgage loans held for sale and a $185.7 million deferred tax provision. Investing cash flow was a $7.7 million use, including $122.3 million of investments in unconsolidated entities and the Coleman acquisition. Financing cash flow was a $872.9 million use, including debt repayment, $290.9 million of share repurchases and $38.6 million of dividends, partly offset by $455.5 million of net senior-note proceeds.
At year-end, the Company had no borrowings under its $1.295 billion revolving credit facility and approximately $1.15 billion of remaining borrowing availability, subject to approximately $140.1 million of outstanding letters of credit. The revolving facility matures in May 2021 and the $500 million term loan matures in August 2021. Total debt included $2.462 billion of senior notes, $637.4 million of loans payable and $120.1 million under the mortgage company loan facility.
Material changes versus the prior comparable period
- Revenue, deliveries, contracts and backlog all increased substantially, reflecting stronger housing demand and the Coleman acquisition.
- Profitability improved materially because of higher volume, better cost absorption and the absence of the $125.6 million net warranty charge recognized primarily for Pennsylvania and Delaware water-intrusion claims in fiscal 2016.
- Income from unconsolidated entities increased to $116.1 million from $40.7 million, driven by higher condominium deliveries and gains from selling interests in two rental-property joint ventures.
- Inventory impairments and write-offs were $14.8 million, compared with $13.8 million. Fiscal 2017 included $5.4 million of impairment charges on two Maryland communities and a $2.0 million impairment of a land-development joint venture.
- The Company reduced debt through repayment of senior notes and other borrowings, including redemption of $287.5 million of exchangeable notes and repayment at maturity of $400 million of senior notes due October 2017. It issued $450 million of 4.875% senior notes due 2027.
- The Board initiated quarterly dividends of $0.08 per share during fiscal 2017. The Company repurchased $290.9 million of common stock during the year and repurchased approximately 4.2 million additional shares after year-end at an average price of $47.47 per share.
Guidance, outlook, risks and unusual items
Management described the housing market as strengthening, citing low interest rates, limited housing supply, improving employment, consumer confidence, equity values and demand from affluent buyers. The filing does not provide a specific fiscal 2018 revenue, earnings or delivery forecast beyond the expectation that approximately 97% of year-end backlog would be delivered in fiscal 2018.
- Defective floor joists: Approximately 350 homes were affected by a supplier recall; 34 buyers canceled and 17 transferred contracts. Approximately 270 affected homes remained in backlog at year-end. The supplier committed to absorb remediation costs, and management did not expect a material financial impact.
- Warranty and water-intrusion exposure: The Company recorded approximately $251.8 million of remaining estimated repair costs and $119.7 million of expected recoveries at October 31, 2017. Actual costs and recoveries could differ materially, and resolution is expected to take several years.
- SEC investigation: In April 2017, the SEC requested documents concerning fiscal 2016 estimates for stucco and other water-intrusion repair costs. Management could not predict the scope or outcome.
- Tax reform: Congress passed a federal tax reform bill in December 2017. Management was evaluating the impact but preliminarily believed the legislation would significantly reduce the effective tax rate. The filing does not provide a quantified fiscal 2018 benefit.
- Land and joint-venture commitments: Land purchase commitments totaled approximately $2.24 billion, with $2.14 billion of additional cash required if all parcels are acquired. The Company had $481.8 million invested in unconsolidated entities and commitments for up to $52.5 million of additional funding.
- Guarantees: The Company estimated maximum exposure of $228.9 million on repayment and carry-cost guarantees related to borrowings of unconsolidated entities at year-end, excluding collateral recoveries and partner reimbursements.
- Housing-cycle and execution risks: Demand, mortgage availability, interest rates, construction costs, labor and material availability, regulatory approvals, land values, cancellations, natural disasters, competition and California concentration could materially affect results.
- Liquidity and refinancing: Senior notes become due at various dates from December 2018 through March 2027. Variable-rate debt was approximately $632.3 million; a 1% increase in rates would increase annual interest expense by approximately $6.3 million, assuming balances remain constant.
Most important facts for an investor to verify
- Whether backlog converts to deliveries at the expected pace and whether cancellations, incentives or price reductions increase.
- The sustainability of fiscal 2017 margins after excluding the unusually large fiscal 2016 warranty charge and including higher labor and material costs.
- Updated estimates for water-intrusion warranty liabilities, insurance and supplier recoveries, related litigation and the SEC investigation.
- The effect of tax reform on the effective tax rate, deferred tax assets and demand in higher-priced markets.
- California and City Living concentration, including the timing and profitability of high-rise deliveries.
- Cash requirements for land commitments, joint-venture funding, guarantees, debt maturities, dividends and share repurchases.
- Compliance with credit-facility covenants and continued availability of revolving credit, letters of credit and surety bonds.
- Reliance on joint-venture distributions and unusual gains from asset sales when assessing recurring earnings and cash flow.