Toll Brothers, Inc. — Fiscal 2016 Form 10-K Summary
Reporting period: Fiscal year ended October 31, 2016. The filing is an annual 10-K; the supplied metadata references 2016 Q4, which corresponds to the fourth quarter included in the annual results.
Business context
Toll Brothers designs, builds, markets, sells and arranges financing for luxury detached and attached homes in the United States, including Traditional Home Building and urban infill City Living products. The company operated in 19 states, sold homes from 310 communities and controlled approximately 48,837 home sites at year-end. It also had for-rent apartment, land development, homebuilding and distressed-real-estate joint ventures.
- Fiscal 2016 deliveries: 6,098 homes from 377 communities.
- Backlog: $3.98 billion, representing 4,685 homes; approximately 97% was expected to be delivered in fiscal 2017.
- November 2016 acquisition: Coleman Real Estate Holdings for approximately $85.2 million in cash, adding approximately 1,750 home sites and 15 selling communities. This occurred after the reporting date.
Key financial metrics
| Metric | Fiscal 2016 | Fiscal 2015 | Change |
|---|---|---|---|
| Revenue | $5.170 billion | $4.171 billion | +24% |
| Income from operations | $490.1 million | $446.9 million | +10% |
| Income before taxes | $589.0 million | $535.6 million | +10% |
| Net income | $382.1 million | $363.2 million | +5% |
| Diluted EPS | $2.18 | $1.97 | +11% |
| Operating margin | 9.5% | 10.7% | Down |
| Net margin | 7.4% | 8.7% | Down |
| Cash flow from operations | $148.8 million | $60.2 million | +147% |
| Inventory | $7.354 billion | $6.998 billion | +5% |
| Total debt | $3.775 billion | $3.790 billion | Down slightly |
Cost of revenues was $4.144 billion, or 80.2% of revenue, compared with 78.4% in fiscal 2015. Selling, general and administrative expense was $535.4 million, or 10.4% of revenue, compared with 10.9%. Income from unconsolidated entities increased to $40.7 million from $21.1 million, while other income declined to $58.2 million from $67.6 million. The effective tax rate increased to 35.1% from 32.2%.
Liquidity, capital resources and debt
- Cash and cash equivalents at October 31, 2016: $633.7 million.
- Available borrowing capacity under the $1.295 billion unsecured revolving credit facility: approximately $961.8 million, with $250.0 million drawn and $83.2 million of letters of credit outstanding.
- Total equity: $4.235 billion; debt-to-total-capitalization ratio: 0.47 to 1.00.
- Debt maturities include $400.0 million of 8.91% senior notes due October 2017, $350.0 million of senior notes due December 2018, and $250.0 million due November 2019.
- Operating cash flow was partly absorbed by a $391.2 million net inventory investment, a $307.4 million increase in receivables, prepaid expenses and other assets, and $124.9 million of net mortgage loan originations.
- Financing activities used $442.3 million, including $392.8 million for share repurchases. No cash dividends were paid.
Material changes versus the prior comparable period
- Revenue rose 24%, driven by a 10% increase in homes delivered and a 12% increase in average delivered price to $847,700.
- Net contracts increased 14% to $5.650 billion, or 6,719 homes. Backlog increased 14% in value and 15% in units.
- Traditional Home Building revenue increased 27%, led by California revenue growth of 93% and West revenue growth of 36%. City Living revenue declined 19% because deliveries fell 58%, although its backlog increased 38%.
- Gross profitability deteriorated primarily because of $125.6 million of net warranty charges in fiscal 2016, compared with $14.7 million in fiscal 2015. Inventory impairment charges declined to $13.8 million from $35.7 million.
- Mid-Atlantic income before taxes declined from $69.1 million to a $29.4 million loss, principally because of the warranty charges related to older homes in Pennsylvania and Delaware.
- Share repurchases increased substantially to $392.8 million from $56.9 million, reducing weighted-average basic shares to 168.3 million from 176.4 million.
Outlook, risks, contingencies and unusual items
Management reported strengthening customer demand from the third quarter of fiscal 2014 through fiscal 2016 and expressed optimism that demand would continue, citing improving economic conditions, household formation and potential millennial demand. The filing does not provide formal fiscal 2017 revenue, earnings or margin guidance.
- Warranty exposure: Estimated water-intrusion liabilities increased to approximately $324.4 million at year-end, with expected insurance and supplier recoveries of approximately $152.6 million. Resolution is expected to take several years, and management could not estimate the range of potential differences from its accrual.
- Joint ventures: Investments totaled $496.4 million, with up to $273.8 million of additional funding commitments. Maximum potential exposure under guarantees was estimated at $875.7 million if all related loan commitments were drawn, or approximately $576.0 million based on amounts borrowed at year-end, before collateral recoveries or partner reimbursements.
- Land commitments: Aggregate land purchase commitments were $1.623 billion, including $1.558 billion of additional cash required after deposits. The company also expected to acquire approximately 3,600 additional home sites from joint ventures at prices not yet determined.
- Housing-cycle risk: Lower demand, higher interest rates, weaker employment or consumer confidence, increased cancellations, pricing pressure, inventory impairments and construction-cost inflation could reduce margins and liquidity.
- Regulatory and development risk: Zoning, entitlement, environmental requirements, infrastructure constraints and legal challenges may delay or prevent community development.
- Interest-rate risk: Based on variable-rate debt outstanding, a 1% increase in interest rates would increase annual interest expense by approximately $9.7 million.
- Other unusual items: California operations were affected by reduced demand at the Porter Ranch community following a nearby natural-gas leak. Management stated that air quality had returned to normal after the leak was sealed and expected operations to recover gradually.
Investor verification checklist
- Verify the assumptions, insurance recoveries and ultimate cash cost of the $324.4 million water-intrusion warranty reserve.
- Review fiscal 2017 conversion of the $3.98 billion backlog, including cancellation rates, pricing and gross margins.
- Assess refinancing requirements for the 2017–2019 debt maturities and the availability of revolving-credit capacity.
- Evaluate inventory carrying values, land commitments and sensitivity to slower sales pace, lower prices or higher construction costs.
- Review the maximum exposure and collateral supporting joint-venture debt guarantees and additional funding commitments.
- Confirm the post-year-end Coleman acquisition accounting, integration costs and effect on future community and delivery volumes.
- Monitor Mid-Atlantic warranty developments, California demand trends and City Living delivery timing.