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TOL > SEC Filings for TOL > Form 10-Q on 6-Jun-2014All Recent SEC Filings

Show all filings for TOLL BROTHERS INC

Form 10-Q for TOLL BROTHERS INC


6-Jun-2014

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ("MD&A")
This discussion and analysis is based on, should be read with, and is qualified in its entirety by, the accompanying unaudited condensed consolidated financial statements and related notes, as well as our consolidated financial statements, notes thereto, and the related Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the fiscal year ended October 31, 2013. It also should be read in conjunction with the disclosure under "Statement on Forward-Looking Information" in this report.
Unless otherwise stated, net contracts signed represents a number or value equal to the gross number or value of contracts signed during the relevant period, less the number or value of contracts canceled during the relevant period, which includes contracts that were signed during the relevant period and in prior periods. Contracts acquired in an acquisition of a business are not considered signed contracts and are not included in the amounts reported by us in net contracts signed.
OVERVIEW
Financial Highlights
In the six-month period ended April 30, 2014, we recognized $1.50 billion of revenues and net income of $110.8 million, as compared to $940.6 million of revenues and net income of $29.1 million in the six-month period ended April 30, 2013. During the fiscal 2014 six-month period, we recognized an income tax provision of $53.9 million, as compared to $20.2 million in the fiscal 2013 period.
At April 30, 2014, we had $364.8 million of cash, cash equivalents and marketable securities on hand; approximately $849.2 million available under our $1.035 billion revolving credit facility that matures in August 2018; and $500.0 million available under our 364-day senior unsecured credit facility that expires in February 2015. At April 30, 2014, we had $95.0 million of outstanding borrowings and $90.8 million of letters of credit issued under the revolving credit facility.
Our Business
We design, build, market and arrange financing for detached and attached homes in luxury residential communities. We cater to move-up, empty-nester, active-adult, age-qualified and second-home buyers in the United States. We also build and sell homes in urban infill markets through Toll City LivingŪ ("City Living"). At April 30, 2014, we were operating in 20 states.
Over the past several years, we have acquired control of a number of land parcels as for-rent apartment projects, including two student housing sites. At April 30, 2014, we controlled a number of land parcels as for-rent apartment projects containing approximately 5,300 units. Through Toll Brothers Realty Trust ("Trust"), we also have interests in approximately 1,500 operating apartment units in the Washington, D.C. area and in Princeton Junction, New Jersey. See "Toll Brothers Apartment Living/Toll Brothers Campus Living" section of this "Overview."
We operate our own land development, architectural, engineering, mortgage, title, landscaping, security monitoring, lumber distribution, house component assembly, and manufacturing operations. We also develop, own and operate golf courses and country clubs, which generally are associated with several of our master planned communities. We have investments in a number of joint ventures to develop land for the sole use of the venture participants, including ourselves, and to develop land for sale to the joint venture participants and to unrelated builders. We are a participant in joint ventures with unrelated parties to develop luxury condominium projects, including for-sale and rental residential units and commercial space, a single master planned community, and a high-rise luxury for-sale condominium/hotel project.
In the second quarter of fiscal 2014, the Trust refinanced the mortgage on one of its properties and distributed $36.0 million of the net proceeds from the refinancing to its partners. The Company received $12.0 million as its share of the proceeds and recognized this distribution as income in the quarter. This income is included in "Income from unconsolidated entities" in the six-month and three-month periods ended April 30, 2014 in our Condensed Consolidated Statements of Operations.
In addition, we own interests in Toll Brothers Realty Trust II ("Trust II") which invests in commercial real estate opportunities. In the three-month period ended January 31, 2014, Trust II sold substantially all of its assets to an unrelated party. As a result of this sale, we realized a profit of approximately $23.5 million representing our share of the gain on the sale; this gain is included in "Income from unconsolidated entities" in our Condensed Consolidated Statements of Operations. In addition, we recognized $2.9 million of previously deferred gains on the Company's initial sales of the properties to Trust II. This gain was included in "Other income - net" for the three-month period ended January 31, 2014 of our Condensed Consolidated Statement of Operations. In the three-month period ended April 30, 2014, we recognized an additional gain of $0.6 million from the sale of a property by Trust II.


In fiscal 2010, we formed Gibraltar Capital and Asset Management LLC ("Gibraltar") to invest in distressed real estate opportunities. Gibraltar focuses primarily on residential loans and properties, from unimproved ground to partially and fully improved developments, as well as commercial opportunities. See "Gibraltar Capital Asset and Management LLC" in this "Overview." Acquisition
On February 4, 2014, we completed our acquisition of Shapell Industries, Inc. ("Shapell") pursuant to the Purchase and Sale Agreement (the "Purchase Agreement") dated November 6, 2013, with Shapell Investment Properties, Inc. ("SIPI"). Pursuant to the Purchase Agreement, we acquired, for cash, all of the equity interests in Shapell from SIPI for an aggregate purchase price of $1.60 billion (the "Acquisition"). We acquired the single-family residential real property development business of Shapell, including a portfolio of approximately 4,950 home sites in California, some of which the Company will sell to other builders. This acquisition provides us with a premier California land portfolio including 11 active selling communities, as of the acquisition date, in affluent, high-growth markets: the San Francisco Bay area, metro Los Angeles, Orange County and the Carlsbad market. As part of the acquisition, we assumed contracts to deliver 126 homes with an aggregate value of approximately $105.3 million.
We did not acquire the apartment and commercial rental properties owned and operated by Shapell (the "Shapell Commercial Properties") or Shapell's mortgage lending activities relating to its home building operations. Accordingly, the Purchase Agreement provides that SIPI will indemnify us for any loss arising out of or resulting from, among other things, (i) any liability (other than environmental losses, subject to certain exceptions) related to the Shapell Commercial Properties, and (ii) any liability (other than environmental losses, subject to certain exceptions) to the extent related to Shapell Mortgage, Inc. We financed the Acquisition with a combination of $370.0 million of borrowings under our $1.035 billion unsecured revolving credit facility, $485.0 million from a term loan facility, as well as with $815.7 million in net proceeds from debt and equity financings completed in November 2013. See Note 6, "Loans Payable, Senior Notes and Mortgage Company Loan Facility" and Note 12, "Stock Issuance and Stock Repurchase Program" of our condensed consolidated financial statements for further details. As a result of the Acquisition, Shapell became our wholly-owned subsidiary. Accordingly, the Shapell results are included in our consolidated financial statements from the date of the Acquisition. For the period from February 5, 2014 to April 30, 2014, revenues and operating income from the Shapell operations, excluding $5.1 million of acquisition expenses, were $102.0 million and $6.1 million, respectively.
We expect to selectively sell assets to reduce land concentration and outstanding borrowings; however, the timing and size of any asset sale transactions will be dependent on market and other factors, some of which are outside of our control. We make no assurance that we will be able to complete asset sale transactions on attractive terms or at all. Our Challenging Business Environment and Current Outlook During fiscal 2012 and the first nine months of fiscal 2013, we saw a strong recovery in the number and value of new sales contracts signed. Our net contracts signed in fiscal 2012 and 2013, as compared to fiscal 2011, increased approximately 50% and 90%, respectively, in the number of net contracts signed and 59% and 126%, respectively, in the value of net contracts signed. Although the number and value of fiscal 2012 and 2013 net contracts signed increased over fiscal 2011, they were still significantly below what we recorded in fiscal 2005.
We have experienced a leveling of demand which began in the fourth quarter of fiscal 2013 and has continued into fiscal 2014. In the six-month period ended April 30, 2014, we signed 2,665 contracts with an aggregate value of $1.98 billion, compared to 2,726 contracts with an aggregate value of $1.80 billion in the six-month period ended April 30, 2013. We believe this to be a temporary pause and expect continued growth in the future as demand grows to more normalized levels.
We market our high quality homes to upscale luxury home buyers, generally those persons who have previously owned a principal residence and who are seeking to buy a larger or more desirable home - the so-called "move-up" market. We believe our reputation as a developer of homes for this market enhances our competitive position with respect to the sale of our smaller, more moderately priced, detached homes, as well as our attached homes.
We also market to the 50+ year-old "empty-nester" market, which we believe has strong growth potential. We have developed a number of home designs with features such as one-story living and first-floor master bedroom suites, as well as communities with recreational amenities such as golf courses, marinas, pool complexes, country clubs and recreation centers that we believe appeal to this category of home buyers. We have integrated certain of these designs and features in some of our other home types and communities.
We develop active-adult, age-qualified communities for households in which at least one member is 55 years of age or older. As of April 30, 2014, we were selling from 29 such communities and expect to open additional age-qualified communities during


the next few years. For the six-month periods ended April 30, 2014 and 2013, the value of net contracts signed in active-adult communities were 9% and 7% of total contracts signed in the respective periods. As a percentage of the total number of contracts signed in the six-month periods ended April 30, 2014 and 2013, active-adult communities were 13% and 10%, respectively. Of the value and number of net contracts signed in fiscal 2013, approximately 9% and 12%, respectively, were in active-adult communities and in fiscal 2012, approximately 8% and 10%, respectively, were in such communities.
In order to serve a growing market of affluent move-up families, empty-nesters and young professionals seeking to live in or close to major cities, we have developed and are developing a number of high-density, high-, mid- and low-rise urban luxury communities. These communities are currently marketed under the Toll City Living brand. These communities, which we are currently developing or planning to develop on our own or through joint ventures, are located in Phoenix, Arizona; Hoboken, New Jersey; the boroughs of Manhattan and Brooklyn, New York; and Philadelphia, Pennsylvania and its suburbs.
We believe that the demographics of the move-up, empty-nester, active-adult, age-qualified and second-home upscale markets will provide us with the potential for growth in the coming decade. According to the U.S. Census Bureau, the number of households earning $100,000 or more (in constant 2012 dollars) at September 2013 stood at 26.9 million, or approximately 22% of all U.S. households. This group has grown at three times the rate of increase of all U.S. households since 1980. According to Harvard University's June 2013 "The State of the Nation's Housing," the growth and aging of the current population, assuming the economic recovery is sustained over the next few years, supports the addition of about 1.16 million new household formations per year during the next decade. Preliminary estimates using the Census Bureau's 2012 population projections suggest even stronger growth in net new households of 1.28 million between now and 2020. According to the April 2014 U.S. Census Bureau's New Home Sales Report, new home inventory stands at just 5.3 months' supply, based on current sales paces. If demand and pace increase, the 5.3 months' supply could quickly be drawn down.
According to the U.S. Census Bureau, during the period 1970 through 2007, total housing starts in the United States averaged approximately 1.6 million per year, while in the period 2008 through 2013, total housing starts averaged approximately 0.9 million per year. During the 2006-2011 downturn, the pipeline of approved and improved home sites dwindled in many markets as many builders and developers lacked both the capital and the economic benefit for bringing sites through approvals. We believe that, as demand continues to strengthen, builders and developers with approved land in well-located markets will be poised to benefit. We believe that this will be particularly true for us because much of our land portfolio is in the Washington, D.C. to Boston corridor and in California where land is scarce and approvals are more difficult to obtain. We continue to believe that many of our communities are in desirable locations that are difficult to replace and in markets where approvals have been increasingly difficult to obtain. We believe that many of these communities have substantial embedded value that may be realized in the future as the housing recovery strengthens.
Competitive Landscape
Based on our experience during prior downturns in the housing industry, we believe that attractive land acquisition opportunities arise in difficult times for those builders that have the financial strength to take advantage of them. In the current environment, we believe our strong balance sheet, liquidity, access to capital, broad geographic presence, diversified product line, experienced personnel, and national brand name all position us well for such opportunities now and in the future.
We continue to see reduced competition from the small and mid-sized private builders that had been our primary competitors in the luxury market. We believe that many of these builders are no longer in business and that access to capital by the remaining private builders continues to be severely constrained. There are fewer and more selective lenders serving our industry as the market rebounds and we believe it is likely that those lenders will gravitate to the home building companies that offer them the greatest security, the strongest balance sheets, and the broadest array of potential business opportunities. While some builders may re-emerge with new capital, the scarcity of attractive land is a further impediment to their re-emergence. We believe that reduced competition, combined with attractive long-term demographics, will reward those well-capitalized builders that can persevere through the current challenging environment.
We believe that geographic and product diversification, access to lower-cost capital, and strong demographics benefit those builders, like us, who can control land and persevere through the increasingly difficult regulatory approval process. We believe that these factors favor a large publicly traded home building company with the capital and expertise to control home sites and gain market share. We also believe that over the past five years, many builders and land developers reduced the number of home sites that were taken through the approval process. The process continues to be difficult and lengthy, and the political pressure from no-growth proponents continues to increase, but we believe our expertise in taking land through the approval process and our already-approved land positions will allow us to grow in the years to come as market conditions improve.


Land Acquisition and Development
Because of the length of time that it takes to obtain the necessary approvals on a property, complete the land improvements on it, and deliver a home after a home buyer signs an agreement of sale, we are subject to many risks. In certain cases, we attempt to reduce some of these risks by utilizing one or more of the following methods: controlling land for future development through options (also referred to herein as "land purchase contracts" or "option and purchase agreements"), thus allowing the necessary governmental approvals to be obtained before acquiring title to the land; generally commencing construction of a detached home only after executing an agreement of sale and receiving a substantial down payment from the buyer; and using subcontractors to perform home construction and land development work on a fixed-price basis. Based on our belief that the housing market is in the early stages of recovery and the increased attractiveness of land available for purchase, we have increased our land positions. During fiscal 2013 and 2012, we acquired control of approximately 12,500 home sites (net of options terminated) and 6,100 home sites (net of options terminated), respectively. During the six-month period ended April 30, 2014, we acquired control of approximately 3,900 home sites (net of lot options terminated and land we expect to sell). In February 2014, we acquired all of the equity interests in the single-family residential real property development business of Shapell, including a portfolio of approximately 4,950 home sites in California of which we currently expect to develop approximately 4,400 home sites and sell the remaining to other builders. See "Overview - Acquisition" in this MD&A for more information about the Shapell acquisition.
At April 30, 2014, we controlled approximately 50,400 home sites of which we owned approximately 37,700. Significant improvements were completed on approximately 13,800 of the home sites we owned. At April 30, 2014, we were selling from 252 communities, including 11 well-established selling communities in California that we acquired in February 2014 as part of the Shapell acquisition. We were selling from 232 communities at October 31, 2013 and 225 at April 30, 2013. In addition, we expect to purchase approximately 3,800 additional home sites from several joint ventures in which we have interests. We expect to be selling from 250 to 290 communities at October 31, 2014. At April 30, 2014, we had 20 communities that were temporarily closed due to market conditions. We do not expect to re-open any of these communities during the next twelve months.
Availability of Customer Mortgage Financing We maintain relationships with a widely diversified group of mortgage financial institutions, many of which are among the largest and, we believe, most reliable in the industry. We believe that regional and community banks continue to recognize the long-term value in creating relationships with high-quality, affluent customers such as our home buyers, and these banks continue to provide such customers with financing.
We believe that our home buyers generally are, and will continue to be, better able to secure mortgages due to their typically lower loan-to-value ratios and attractive credit profiles as compared to the average home buyer. Nevertheless, in recent years, tightened credit standards have reduced the pool of potential home buyers and hindered accessibility of or eliminated certain loan products previously available to our home buyers. Our home buyers continue to face stricter mortgage underwriting guidelines, higher down payment requirements and narrower appraisal guidelines than in the past. In addition, some of our home buyers continue to find it more difficult to sell their existing homes as prospective buyers of their homes may face difficulties obtaining a mortgage. In addition, other potential buyers may have little or negative equity in their existing homes and may not be able or willing to purchase a larger or more expensive home.
While the range of mortgage products available to a potential home buyer is not what it was in the period 2005 through 2007, we have seen improvements over the past several years. Indications from industry participants, including commercial banks, mortgage banks, mortgage real estate investment trusts and mortgage insurance companies are that availability, parameters and pricing of jumbo loans are all improving. We believe that improvement should not only enhance financing alternatives for existing jumbo loan buyers, but also help to offset the reduction in Fannie Mae/Freddie Mac-eligible loan amounts in some markets. Based on the mortgages provided by our mortgage subsidiary, we do not expect the change in the Fannie Mae/Freddie Mac-eligible loan amounts to have a significant impact on our business.
There has been significant media attention given to mortgage put-backs, a practice by which a buyer of a mortgage loan tries to recoup losses from the loan originator. This has not been, and we do not believe this is, a material issue for our mortgage subsidiary. Of the approximately 18,300 loans sold by our mortgage subsidiary since November 1, 2004, only 30 have been the subject of either actual indemnification payments or take-backs or contingent liability loss provisions related thereto. We believe that this is due to (i) our typical home buyer's financial position and sophistication; (ii) on average, our home buyers who use mortgage financing to purchase a home pay approximately 30% of the purchase price in cash; (iii) our general practice of not originating certain loan types such as option adjustable rate mortgages and down payment assistance products, and our origination of few sub-prime and high loan-to-value/no documentation loans; (iv) our elimination of "early payment default" provisions from each of our agreements with our mortgage investors several years ago; and (v) the quality of our controls,


processes and personnel in our mortgage subsidiary. We have recently entered into two agreements with investors that contain limited early payment default provisions. As of April 30, 2014, we sold 21 loans under these agreements. We believe that these limited early payment default provisions will not expose us to a significant risk.
The Dodd-Frank Wall Street Reform and Consumer Protection Act provides for a number of new requirements relating to residential mortgage lending practices. These include, among others, minimum standards for mortgages and related lender practices, the definitions and parameters of a Qualified Mortgage and a Qualified Residential Mortgage, future risk retention requirements, limitations on certain fees, prohibition of certain tying arrangements, and remedies for borrowers in foreclosure proceedings in the event that a lender violates fee limitations or minimum standards. We do not believe that the effect of these requirements on our mortgage subsidiary will be significant, although it will restrict us from providing a comprehensive package of services to some of our home buyers due to fee restrictions imposed upon our home buyers as to what they are permitted to pay to our affiliated businesses. Gibraltar Capital and Asset Management LLC We continue to look for distressed real estate opportunities through Gibraltar. Gibraltar continues to selectively review new opportunities, including bank portfolios and other distressed real estate investments.
In the six-month period ended April 30, 2013, Gibraltar acquired four loans directly and invested in a loan participation for an aggregate purchase price of approximately $26.0 million. No loans were acquired in the six-month period ended April 30, 2014.
At April 30, 2014, Gibraltar had investments in distressed loans of approximately $18.8 million, investments in foreclosed real estate of $76.7 million, and an investment in a structured asset joint venture of $22.8 million. In the six-month periods ended April 30, 2014 and 2013, we recognized income from Gibraltar's operations, including Gibraltar's equity in the earnings (losses) from its investment in a structured asset joint venture, of $5.9 million and $4.2 million, respectively. In the three-month periods ended April 30, 2014 and 2013, we recognized income from Gibraltar's operations, including Gibraltar's equity in the earnings (losses) from its investment in a structured asset joint venture, of $2.6 million and $2.1 million, respectively. Toll Brothers Apartment Living/Toll Brothers Campus Living Over the past several years, we have acquired control of a number of land parcels as for-rent apartment projects, including two student housing sites. At April 30, 2014, we controlled a number of land parcels as for-rent apartment projects containing approximately 5,300 units. These projects, which are located in the metro-Boston to metro-Washington, D.C. corridor, are being developed or will be developed with partners under the brand names Toll Brothers Apartment Living and Toll Brothers Campus Living. A number of these sites had been acquired by us as part of a larger purchase or were originally acquired to develop as for-sale homes. Of the 5,300 planned units, 1,500 are owned by joint ventures in which we have a 50% interest; approximately 1,900 are owned by us; 1,200 of them are under contract to be purchased; and 700 of them are under letters of intent. Through the Trust, we also have interests in approximately 1,500 operating apartment units in the Washington, D.C. area and in Princeton Junction, New Jersey.
CONTRACTS AND BACKLOG
The aggregate value of net contracts signed increased $174.2 million or 9.7% in the six-month period ended April 30, 2014, as compared to the six-month period ended April 30, 2013. The value of net contracts signed was $1.98 billion (2,665 homes) and $1.80 billion (2,726 homes) in the six-month periods ended April 30, 2014 and 2013, respectively. The increase in the aggregate value of net contracts signed in the fiscal 2014 period, as compared to the fiscal 2013 period, was the result of a 12.2% increase in the average value of each contract signed, offset, in part, by a 2.2% decline in the number of net contracts signed. The increase in the average value of each contract signed in the fiscal 2014 period, as compared to the fiscal 2013 period, was due primarily to a change in mix of contracts signed to more expensive areas and/or higher priced products, increased prices, and reduced incentives given on new contracts signed. The decrease in the number of net contracts signed was primarily due to the previously discussed leveling in demand, as well as the negative impact on our business due to the severe weather we have seen in many of our markets in the fiscal 2014 period.
The aggregate value of net contracts signed increased $87.0 million or 7.3% in the three-month period ended April 30, 2014, as compared to the three-month period ended April 30, 2013. The value of net contracts signed was $1.27 billion (1,749 homes) and $1.19 billion (1,753 homes) in the three-month periods ended April 30, 2014 and 2013, respectively. The increase in the aggregate value of net contracts signed in the fiscal 2014 period, as compared to the fiscal 2013 period, was the result of a 7.6% increase in the average value of each contract signed, offset, in part, by a 0.2% decline in the number of net contracts signed. The increase in the average value of each contract signed in the fiscal 2014 period, as compared to the fiscal 2013 period, was due primarily to a . . .

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