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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED July 31, 2006
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______TO_______
Commission file number 1-9186
TOLL BROTHERS, INC.
(Exact name of registrant as specified in its charter)
(215) 938-8000
(Registrant’s telephone number, including area code)
Not applicable
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
Accelerated filer
Non-accelerated filer
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
At August 28, 2006, there were approximately 153,481,000 shares of Common Stock, $.01 par value, outstanding.
TOLL BROTHERS, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
Page No.
Statement on Forward-Looking Information
1
PART I.
Financial Information
Item 1.
Financial Statements
Condensed Consolidated Balance Sheets at July 31, 2006 (Unaudited) and October 31, 2005
2
Condensed Consolidated Statements of Income for the Nine-Month and Three-Month periods ended July 31, 2006 and 2005 (Unaudited)
3
Condensed Consolidated Statements of Cash Flows for the Nine Months ended July 31, 2006 and 2005 (Unaudited)
4
Notes to Condensed Consolidated Financial Statements (Unaudited)
5
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
21
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
33
Item 4.
Controls and Procedures
34
PART II.
Other Information
Legal Proceedings
Item 1A.
Risk Factors
35
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults upon Senior Securities
Item 4
Submission of Matters to a Vote of Security Holders
Item 5.
Item 6.
Exhibits
36
SIGNATURES
37
Back to Contents
STATEMENT ON FORWARD-LOOKING INFORMATION
Certain information included herein and in our other reports, SEC filings, statements and presentations is forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995, including, but not limited to, statements concerning our anticipated operating results, financial resources, changes in revenues, changes in profitability, interest expense, growth and expansion, anticipated income to be realized from our investments in unconsolidated entities, the ability to acquire land, the ability to secure governmental approvals and the ability to open new communities, the ability to sell homes and properties, the ability to deliver homes from backlog, the average delivered prices of homes, the ability to secure materials and subcontractors, the ability to maintain the liquidity and capital necessary to expand and take advantage of future opportunities, and stock market valuations. In some cases you can identify those so called forward-looking statements by words such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “project,” “intend,” “can,” “could,” “might,” or “continue” or the negative of those words or other comparable words. Such forward-looking information involves important risks and uncertainties that could significantly affect actual results and cause them to differ materially from expectations expressed herein and in our other reports, SEC filings, statements and presentations. These risks and uncertainties include local, regional and national economic conditions, the demand for homes, domestic and international political events, uncertainties created by terrorist attacks, the effects of governmental regulation, the competitive environment in which we operate, fluctuations in interest rates, changes in home prices, the availability and cost of land for future growth, the availability of capital, uncertainties and fluctuations in capital and securities markets, changes in tax laws and their interpretation, legal proceedings, the availability of adequate insurance at reasonable cost, the ability of customers to finance the purchase of homes, the availability and cost of labor and materials, and weather conditions. Additional information concerning potential factors that we believe could cause our actual results to differ materially from expected and historical results is included in Item 1A “Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended October 31, 2005. Moreover, the financial guidance contained herein related to our expected results of operations for fiscal 2006 and our expected home deliveries, expected prices and expected percentage of completion revenues for fiscal 2007 reflects our expectations as of August 22, 2006 and is not being reconfirmed or updated by this Quarterly Report on Form 10-Q.
If one or more of the assumptions underlying our forward-looking statements proves incorrect, then our actual results, performance or achievements could differ materially from those expressed in, or implied by the forward-looking statements contained in this report. Therefore, we caution you not to place undue reliance on our forward-looking statements. This statement is provided as permitted by the Private Securities Litigation Reform Act of 1995.
When this report uses the words “we,” “us,” and “our,” they refer to Toll Brothers, Inc. and its subsidiaries, unless the context otherwise requires. Reference herein to “fiscal 2007,” “fiscal 2006,” “fiscal 2005,” and “fiscal 2004” refer to our fiscal years ending October 31, 2007 and October 31, 2006, and our fiscal years ended October 31, 2005 and October 31, 2004, respectively.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)
July 31, 2006
October 31, 2005
(unaudited)
ASSETS
Cash and cash equivalents
$
322,550
689,219
Inventory
6,226,783
5,068,624
Property, construction and office equipment, net
96,588
79,524
Receivables, prepaid expenses and other assets
158,101
185,620
Contracts receivable
138,687
Mortgage loans receivable
92,765
99,858
Customer deposits held in escrow
56,698
68,601
Investments in and advances to unconsolidated entities
240,208
152,394
7,332,380
6,343,840
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities
Loans payable
716,036
250,552
Senior notes
1,140,882
1,140,028
Senior subordinated notes
350,000
Mortgage company warehouse loan
83,602
89,674
Customer deposits
430,892
415,602
Accounts payable
290,817
256,557
Accrued expenses
783,937
791,769
Income taxes payable
297,107
282,147
Total liabilities
4,093,273
3,576,329
Minority interest
7,103
3,940
Stockholders’ equity
Preferred stock, none issued
Common stock, 156,292 shares issued and outstanding
1,563
Additional paid-in capital
223,594
242,546
Retained earnings
3,089,480
2,576,061
Treasury stock, at cost - 2,821 shares and 1,349 shares at July 31, 2006 and October 31, 2005, respectively
(82,633
)
(56,599
Total stockholders’ equity
3,232,004
2,763,571
See accompanying notes
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands, except per share data)
(Unaudited)
Nine months ended July 31,
Three months ended July 31,
2006
2005
Revenues:
Traditional home sales
4,168,092
3,751,594
1,488,905
1,536,499
Percentage of completion
41,163
Land sales
7,923
21,608
1,145
10,583
4,314,702
3,773,202
1,531,213
1,547,082
Cost of revenues:
2,912,750
2,539,885
1,052,116
1,023,743
110,519
31,995
6,842
15,707
903
9,612
Interest
88,445
85,532
29,816
35,594
3,118,556
2,641,124
1,114,830
1,068,949
Selling, general and administrative
429,341
349,706
148,117
126,283
Income from operations
766,805
782,372
268,266
351,850
Other:
Equity earnings from unconsolidated entities
36,662
9,539
7,269
4,231
Interest and other
31,992
26,575
9,699
Expenses related to early retirement of debt
(4,056
Income before income taxes
835,459
814,430
285,234
362,608
Income taxes
322,040
318,572
110,602
147,076
Net income
513,419
495,858
174,632
215,532
Earnings per share:
Basic
3.32
3.22
1.14
1.39
Diluted
3.10
2.94
1.07
1.27
Weighted average number of shares:
154,520
153,851
153,723
155,274
165,423
168,426
163,514
169,843
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash flow from operating activities:
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization
21,955
14,355
Amortization of initial benefit obligation
1,455
2,851
Share-based compensation
21,747
(36,662
(9,539
Distributions from unconsolidated entities
5,897
6,786
Deferred tax provision
33,139
27,501
Provision for inventory write-offs
36,998
3,722
Write-off of unamortized debt discount and financing costs
416
Changes in operating assets and liabilities:
Increase in inventory
(918,864
(899,807
Origination of mortgage loans
(656,677
(599,634
Sale of mortgage loans
663,770
616,619
Increase in contracts receivable
(138,687
Decrease (increase) in receivables, prepaid expenses and other assets
25,777
(20,735
Increase in customer deposits
27,193
113,968
Increase in accounts payable and accrued expenses
22,024
297,273
(Decrease) increase in current income taxes payable
(1,014
7,221
Net cash (used in) provided by operating activities
(378,530
56,855
Cash flow from investing activities:
Purchase of property and equipment, net
(33,053
(31,655
Purchases of marketable securities
(2,187,715
(3,599,814
Sale of marketable securities
2,187,715
3,714,843
(88,654
(38,041
Acquisition of joint venture interest
(40,722
12,964
8,199
Net cash (used in) provided by investing activities
(149,465
53,532
Cash flow from financing activities:
Proceeds from loans payable
2,042,189
786,321
Principal payments of loans payable
(1,786,793
(1,059,720
Net proceeds from issuance of public debt
293,597
Redemption of senior subordinated notes
(100,000
Proceeds from stock based benefit plans
12,287
40,640
Purchase of treasury stock
(109,520
(31,112
Change in minority interest
3,163
Net cash provided by (used in) financing activities
161,326
(70,274
Net (decrease) increase in cash and cash equivalents
(366,669
40,113
Cash and cash equivalents, beginning of period
465,834
Cash and cash equivalents, end of period
505,947
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Significant Accounting Policies
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements include the accounts of Toll Brothers, Inc., a Delaware corporation, and its majority-owned subsidiaries (the “Company”). All significant intercompany accounts and transactions have been eliminated. Investments in 50% or less owned partnerships and affiliates are accounted for using the equity method unless it is determined that the Company has effective control of the entity, in which case the entity would be consolidated.
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial information. The October 31, 2005 balance sheet amounts and disclosures included herein have been derived from our October 31, 2005 audited financial statements. Since the accompanying condensed consolidated financial statements do not include all the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements, the Company suggests that they be read in conjunction with the consolidated financial statements and notes thereto included in its October 31, 2005 Annual Report on Form 10-K. In the opinion of management, the accompanying unaudited condensed consolidated financial statements include all adjustments, which are of a normal recurring nature, necessary to present fairly the Company’s financial position as of July 31, 2006, the results of its operations for the nine-month and three-month periods ended July 31, 2006 and 2005 and its cash flows for the nine months ended July 31, 2006 and 2005. The results of operations for such interim periods are not necessarily indicative of the results to be expected for the full year.
Recent Accounting Pronouncements
On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”). In April 2005, the SEC adopted a rule permitting implementation of SFAS 123R at the beginning of the fiscal year commencing after June 15, 2005. Under the provisions of SFAS 123R, an entity is required to treat all stock-based compensation as a cost that is reflected in the financial statements. The Company was required to adopt SFAS 123R beginning in its fiscal quarter ended January 31, 2006. Under the provisions of SFAS 123R, the Company had the choice of adopting the fair-value-based method of expensing of stock options using (1) the “modified prospective method,” whereby the Company recognizes the expense only for periods beginning after October 31, 2005, or (2) the “modified retrospective method,” whereby the Company recognizes the expense for all years and interim periods since the effective date of SFAS 123, or for only those interim periods during the year of initial adoption of SFAS 123R. The Company adopted SFAS 123R using the modified prospective method. See Note 7, “Stock Based Benefit Plans,” for information regarding expensing of stock options in fiscal 2006 and for pro forma information regarding the Company’s expensing of stock options for fiscal 2005.
In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in accordance with SFAS No. 109, “Accounting for Income Taxes” and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 will be effective for the Company’s fiscal year beginning November 1, 2007. The Company is currently reviewing the effect FIN 48 will have on its financial statements.
Stock Split
On June 9, 2005, the Company’s Board of Directors declared a two-for-one split of the Company’s common stock in the form of a stock dividend to stockholders of record on June 21, 2005. The additional shares of stock were distributed as of the close of business on July 8, 2005. All share and per share information has been restated to reflect this split.
Acquisition
In January 2004, the Company entered into a joint venture in which it had a 50% interest with an unrelated party to develop Maxwell Place, a luxury condominium community of approximately 800 units in Hoboken, New Jersey. In November 2005, the Company acquired its partner’s 50% equity ownership interest in this joint venture. As a result of the acquisition, the Company now owns 100% of the joint venture and the joint venture has been included as a consolidated subsidiary of the Company as of the acquisition date. As of the acquisition date, the joint venture had open contracts of sale to deliver 165 units with a sales value of approximately $128.3 million. The Company’s investment in and subsequent purchase of the partner’s interest in the joint venture is not material to the financial position of the Company. The Company is recognizing revenue and costs related to this project using the percentage of completion method of accounting.
Reclassification
The presentation of certain prior period amounts have been reclassified to conform to the fiscal 2006 presentation.
2. Inventory
Inventory consisted of the following (amounts in thousands):
Land and land development costs
2,399,483
1,717,826
Construction in progress - traditional home sales
3,076,811
2,669,050
Construction in progress - percentage of completion
153,828
40,744
Sample homes and sales offices
233,977
202,286
Land deposits and costs of future development
348,801
427,192
Other
13,883
11,526
Construction in progress—traditional home sales includes the cost of homes under construction, land and land development costs and the carrying costs of lots that have been substantially improved. Construction in progress—percentage of completion includes the cost of buildings, land and land development costs and carrying costs of projects that have commenced vertical construction reduced by the amount of costs recognized in cost of revenues for these projects.
6
The Company capitalizes certain interest costs to inventory during the development and construction period. Capitalized interest is charged to cost of revenues when the related inventory is delivered for traditional home sales or when the related inventory is charged to cost of revenues under percentage of completion accounting. Interest incurred, capitalized and charged to cost of revenues for the nine-month and three-month periods ended July 31, 2006 and 2005 is summarized as follows (amounts in thousands):
Interest capitalized, beginning of period
162,672
173,442
176,524
180,797
Interest incurred
100,879
87,069
34,224
28,921
Capitalized interest in inventory acquired
6,100
Charged to cost of revenues
(88,445
(85,532
(29,816
(35,594
Write-off to interest and other
(428
(868
(154
(13
Interest capitalized, end of period
180,778
174,111
7
Interest included in cost of revenues for the nine-month and three-month periods ended July 31, 2006 and 2005 was (amounts in thousands):
83,769
83,542
28,423
34,030
3,683
1,138
993
1,990
255
1,564
The Company provided for inventory write-downs and the expensing of costs that it believed not to be recoverable in the nine-month and three-month periods ended July 31, 2006 and 2005 as follows (amounts in thousands):
Land controlled for future communities
23,498
1,922
21,053
468
Operating communities
13,500
1,800
2,800
700
23,853
1,168
The Company has evaluated its land purchase contracts to determine if the selling entity is a variable interest entity (“VIE”) and, if it is, whether the Company is the primary beneficiary of the entity. The Company does not possess legal title to the land, and its risk is generally limited to deposits paid to the seller. The creditors of the seller generally have no recourse against the Company. At July 31, 2006 and October 31, 2005, the Company had determined that it was not the primary beneficiary of any VIE related to its land purchase contracts and had not recorded any land purchase contracts as inventory.
3. Investments in and Advances to Unconsolidated Entities
The Company has investments in and advances to several joint ventures with unrelated parties to develop land. Some of these joint ventures develop land for the sole use of the venture partners, including the Company, and others develop land for sale to the venture partners and to unrelated builders. The Company recognizes its share of earnings from the sale of home sites to other builders. The Company does not recognize earnings from home sites it purchases from the joint ventures, but instead reduces its cost basis in these home sites by its share of the earnings on the home sites. At July 31, 2006, the Company had approximately $155.1 million invested in or advanced to these joint ventures and was committed to contributing additional capital in an aggregate amount of approximately $252.0 million (net of the Company’s $129.7 million of loan guarantees related to two of the joint ventures’ loans) if required by the joint ventures. At July 31, 2006, three of the joint ventures had an aggregate of $1.29 billion of loan commitments, and had approximately $1.04 billion borrowed against the commitments, of which the Company’s guarantee of its pro-rata share of the borrowings was $104.9 million.
In October 2004, the Company entered into a joint venture in which it has a 50% interest with an unrelated party to convert a 525-unit apartment complex, The Hudson Tea Buildings, located in Hoboken, New Jersey, into luxury condominium units. At July 31, 2006, the Company had investments in and advances to the joint venture of $48.8 million, and was committed to making up to $1.5 million of additional investments in and advances to the joint venture.
The Company has investments in and advances to three joint ventures with unrelated parties to develop luxury condominium projects, including for-sale residential units and commercial space. At July 31, 2006, the Company had investments in and advances to the joint ventures of $21.4 million, and was committed to making up to $182.1 million of additional investments in and advances to the joint ventures if required by the joint ventures. At July 31, 2006, two of the joint ventures had an aggregate of $272.1 million of loan commitments and had approximately $111.4 million borrowed against the commitments. In addition, the Company guaranteed $18.0 million of borrowings of one of the joint ventures.
8
In fiscal 2005, the Company, together with the Pennsylvania State Employees Retirement System (“PASERS”), formed Toll Brothers Realty Trust Group II (“Trust II”) to be in a position to take advantage of commercial real estate opportunities. Trust II is owned 50% by the Company and 50% by PASERS. At July 31, 2006, the Company had an investment of $8.2 million in Trust II. In addition, the Company and PASERS each entered into subscription agreements that expire in September 2007, whereby each agreed to invest additional capital in an amount not to exceed $11.1 million if required by Trust II. The Company provides development and management services to Trust II and recognized fees for such services under the terms of various agreements in the amounts of $1.2 million and $.2 million in the nine-month and three-month periods ended July 31, 2006, respectively. Prior to the formation of Trust II, the Company used Toll Brothers Realty Trust Group (“Trust”) to invest in commercial real estate opportunities.
The Trust, formed in 1998, is effectively owned one-third by the Company; one-third by Robert I. Toll, Bruce E. Toll (and members of his family), Zvi Barzilay (and members of his family), Joel H. Rassman and other current and former members of the Company’s senior management; and one-third by PASERS (collectively, the “Shareholders”). At July 31, 2006, the Company had an investment of $6.7 million in the Trust. The Shareholders entered into subscription agreements whereby each group has agreed to invest additional capital in an amount not to exceed $1.9 million if required by the Trust. The subscription agreements expire in August 2008. The Company provides development, finance and management services to the Trust and recognized fees under the terms of various agreements in the amounts of $1.9 million and $.7 million in the nine-month and three-month periods ended July 31, 2006, respectively. The Company recognized fees under the terms of various agreements in the amounts of $1.2 million and $.4 million in the nine-month and three-month periods ended July 31, 2005, respectively. The Company believes that the transactions between itself and the Trust were on terms no less favorable than it would have agreed to with unrelated parties.
The Company’s investments in these entities are accounted for using the equity method.
4. Accrued Expenses
Accrued expenses at July 31, 2006 and October 31, 2005 consisted of the following (amounts in thousands):
Land, land development and construction costs
366,949
385,031
Compensation and employee benefit costs
121,684
122,836
Insurance and litigation
113,029
92,809
Warranty costs
55,472
54,722
40,195
34,431
86,608
101,940
The Company accrues for the expected warranty costs at the time each home is closed and title and possession have been transferred to the home buyer. Costs are accrued based upon historical experience. Changes in the warranty accrual for the nine-month and three-month periods ended July 31, 2006 and 2005 are as follows (amounts in thousands):
Balance, beginning of period
42,133
54,372
46,058
Additions
26,141
25,265
9,217
9,752
Charges incurred
(25,391
(19,052
(8,117
(7,464
Balance, end of period
48,346
9
5. Employee Retirement Plan
In October 2004, the Company established an unfunded defined benefit retirement plan, effective as of September 1, 2004, which covers four current or former senior executives and one director of the Company. Effective as of February 1, 2006, the Company adopted an additional unfunded defined benefit retirement plan for nine other executives. For the nine-month and three-month periods ended July 31, 2006 and 2005, the Company recognized the following costs related to these plans (amounts in thousands):
Service cost
269
234
101
78
Interest cost
687
582
241
194
503
950
2,411
3,667
845
1,222
The Company used a 5.65% and a 5.69% discount rate in its calculation of the present value of its projected benefit obligations for the fiscal 2006 and 2005 periods, respectively.
6. Income Taxes
The Company’s estimated combined federal and state income tax rate before providing for the effect of permanent book-tax differences (“Base Rate”) was 39.1% for the nine-month and three-month periods ended July 31, 2006 and 2005.
The effective tax rates for the nine-month periods ended July 31, 2006 and 2005 were 38.5% and 39.1%, respectively. For the nine-month period ended July 31, 2006, the difference between the Company’s Base Rate and effective tax rate was primarily due to the impact on the Company’s tax rate from tax-free income, a manufacturing tax credit and the reversal of prior year tax provisions that are no longer needed due to the expiration of tax statutes, offset in part by the non-deductible portion of stock option expense related to incentive stock options and the recognition of estimated interest expense, net of estimated interest income, on expected tax assessments and recoveries due to ongoing tax audits. For the nine-month period ended July 31, 2005, the Company’s Base Rate and effective tax rate were the same due to the effect of recomputing the Company’s net deferred tax liability of approximately $2.9 million, resulting from the change in the Company’s Base Rate from 37% at October 31, 2004 to 39.1% at July 31, 2005, offset by tax-free income.
The effective tax rates for the three-month periods ended July 31, 2006 and 2005 were 38.8% and 40.6%, respectively. For the three-month period ended July 31, 2006, the difference between the Company’s Base Rate and effective tax rate was primarily due to the impact on the Company’s tax rate from a manufacturing tax credit, the reversal of prior year state tax provisions that are no longer needed due to the expiration of tax statutes and tax-free income, offset in part by the non-deductible portion of stock option expense related to incentive stock options and the recognition of estimated interest expense, net of estimated interest income, on expected tax assessments and recoveries due to ongoing tax audits. The difference between the effective rate and the Base Rate in the three-month period ended July 31, 2005 was the effect of recomputing the Company’s net deferred tax liability of approximately $1.4 million and the recalculation of the Company’s state tax provision for the six-month period ended April 30, 2005 resulting from a change in the Company’s estimated allocations of income to the various jurisdictions that it operates in, offset in part by tax-free income.
7. Stock Based Benefit Plans
The Company’s four stock option plans for employees, officers and directors provide for the granting of incentive stock options and non-qualified options with a term of up to ten years at a price not less than the market price of the stock at the date of grant. Options granted generally vest over a four-year period for employees and a two-year period for non-employee directors. At July 31, 2006, the Company’s Stock Incentive Plan (1998) had approximately 8.3 million options available for issuance. No additional options may be granted under the Company’s Stock Option Plan (1986), the Company’s Key Executives and Non-Employee Directors Stock Option Plan (1993) or the Company’s Stock Option and Incentive Stock Plan (1995). Shares issued upon the exercise of a stock option are either from shares held in treasury or newly issued shares.
10
The following table summarizes stock option activity for the four plans during the nine-month and three-month periods ended July 31, 2006:
Nine months endedJuly 31, 2006
Three months endedJuly 31, 2006
Shares(in thousands)
Weighted-AverageExercise Price
Outstanding, beginning of period
26,155
11.04
26,133
12.52
Granted
1,433
35.97
—
Exercised
(1,757
6.57
(439
5.34
Cancelled
(179
28.09
(42
29.06
Outstanding, end of period
25,652
12.62
Exercisable, end of period
20,830
8.96
Intrinsic value (in thousands):
Options outstanding at July 31, 2006
364,441
Options exercisable at July 31, 2006
346,060
Options exercised in the nine months ended July 31, 2006
46,343
Options exercised in the three months ended July 31, 2006
9,244
Options exercised in the nine months ended July 31, 2005
202,505
Options exercised in the three months ended July 31, 2005
79,534
Fair value of options that became vested (in thousands):
In the nine months ended July 31, 2006
23,551
In the three months ended July 31, 2006
In the nine months ended July 31, 2005
17,424
In the three months ended July 31, 2005
Weighted-average remaining contractual life (in years):
All options outstanding at July 31, 2006
4.71
Exercisable options at July 31, 2006
3.89
The intrinsic value of options outstanding and exercisable is the difference between the fair market value of the Company’s common stock on July 31, 2006 ($25.57) and the exercise price of those options on July 31, 2006 that had an exercise price that was less then $25.57. The intrinsic value of options exercised is the difference between the fair market value of the Company’s common stock on the date of exercise and the exercise price.
Prior to the adoption of SFAS 123R, the Company accounted for its stock option plans according to Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” Accordingly, no compensation cost was recognized upon issuance or exercise of stock options in fiscal 2005.
The fair value of each option award in fiscal 2006 and 2005 is estimated on the date of grant using a lattice-based option valuation model that uses ranges of assumptions as disclosed in the following table:
Expected volatility
36.33% - 38.28%
27.0% - 33.46%
Weighted-average volatility
37.55%
31.31%
Risk-free interest rate
4.38% - 4.51%
3.13% - 4.2%
Expected life (years)
4.11 - 9.07
2.8 – 9.07
Dividends
none
Weighted-average grant date fair value per share of options granted
$15.30
$11.67
11
Expected volatilities are based on implied volatilities from traded options on the Company’s stock and the historical volatility of the Company’s stock. The expected life of options granted is derived from the historical exercise patterns and anticipated future patterns and represents the period of time that options granted are expected to be outstanding; the range given above results from certain groups of employees exhibiting different behavior. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. Prior to fiscal 2005, the Company used the Black-Scholes pricing model to value stock options.
During the nine-month and three-month periods ended July 31, 2006, the Company recognized $21.5 million and $5.3 million of expense, respectively, and an income tax benefit of $7.5 million and $1.7 million related to option awards, respectively. Stock option expense is included in the Company’s selling, general and administrative expenses. At July 31, 2006, total compensation cost related to non-vested awards not yet recognized was approximately $36.1 million, unrecognized income tax benefits from non-vested awards was approximately $12.8 million and the weighted average period over which the Company expects to recognize such compensation and tax benefit was 1.2 years. The Company expects to recognize approximately $26.8 million of expense and $9.2 million of income tax benefit for the full fiscal 2006 year related to option awards.
Had the Company adopted SFAS 123R as of November 1, 2004, pro forma income before taxes, income taxes, net income and net income per share for the nine-month and three-month periods ended July 31, 2005 would have been as follows (amounts in thousands, except per share amounts):
AsReported
SFAS 123RAdjustment
Pro Forma
Nine months ended July 31, 2005
(16,927
797,503
(5,206
313,366
(11,721
484,137
Income per share
3.15
2.87
Three months ended July 31, 2005
(5,794
356,814
(1,782
145,294
(4,012
211,520
1.36
1.25
8. Earnings Per Share Information
Information pertaining to the calculation of earnings per share for the nine-month and three-month periods ended July 31, 2006 and 2005 are as follows (amounts in thousands):
Basic weighted average shares
Common stock equivalents
10,903
14,575
9,791
14,569
Diluted weighted average shares
9. Stock Repurchase Program
In March 2003, the Company’s Board of Directors authorized the repurchase of up to 20 million shares of its Common Stock, par value $.01, from time to time, in open market transactions or otherwise, for the purpose of providing shares for its various employee benefit plans. At July 31, 2006, the number of shares remaining under the repurchase authorization was approximately 12.1 million shares.
12
10. Commitments and Contingencies
At July 31, 2006, the aggregate purchase price of land parcels under option, referred to herein as “land purchase contracts,” “options,” or “option agreements,” was approximately $3.74 billion (including $1.17 billion of land to be acquired from joint ventures which the Company has invested in, made advances to or made loan guarantees on behalf of), of which it had paid or deposited approximately $194.6 million. The amount included in the purchase price of such land parcels has not been reduced by any amounts the Company has invested in or made advances to the joint ventures. The Company’s option agreements to acquire the home sites do not typically require the Company to buy the home sites, although the Company may, in some cases, forfeit any deposit balance outstanding if and at the time it terminates an option contract. Of the $194.6 million the Company had paid or deposited on these purchase agreements at July 31, 2006, $138.4 million was non-refundable. Any deposit in the form of a stand-by letter of credit is recorded as a liability at the time the stand-by letter of credit is issued. Included in accrued liabilities is $82.0 million representing the Company’s outstanding stand-by letters of credit issued in connection with its options to purchase home sites.
At July 31, 2006, the Company had outstanding surety bonds amounting to approximately $770.0 million, related primarily to its obligations to various governmental entities to construct improvements in the Company’s various communities. The Company estimates that approximately $307.8 million of work remains on these improvements. The Company has an additional $123.3 million of surety bonds outstanding that guarantee other obligations of the Company. The Company does not believe it is likely that any outstanding bonds will be drawn upon.
At July 31, 2006, the Company had agreements of sale outstanding to deliver 8,025 homes with an aggregate sales value of approximately $5.6 billion, of which the Company has recognized $138.7 million of revenues using percentage of completion accounting.
At July 31, 2006, the Company was committed to providing approximately $960.0 million of mortgage loans to its home buyers and to others. All loans with committed interest rates are covered by take-out commitments from third-party lenders, which minimize the Company’s interest rate risk. The Company also arranges a variety of mortgages through programs that are offered to its home buyers through outside mortgage lenders.
The Company has a $1.8 billion credit facility consisting of a $1.5 billion unsecured revolving credit facility and a $300 million term loan facility (collectively, the “Credit Facility”) with 31 banks, which extends to March 17, 2011. At July 31, 2006, interest was payable on borrowings under the revolving credit facility at 0.475% (subject to adjustment based upon the Company’s debt rating and leverage ratios) above the Eurodollar rate or at other specified variable rates as selected by the Company from time to time. At July 31, 2006, the Company had no outstanding borrowings against the revolving credit facility but had letters of credit of approximately $351.5 million outstanding under it, of which the Company had recorded $82.0 million of liabilities under land purchase agreements. Under the term loan facility, interest is payable at 0.50% (subject to adjustment based upon the Company’s debt rating and leverage ratios) above the Eurodollar rate or at other specified variable rates as selected by the Company from time to time. At July 31, 2006, interest was payable on the $300 million term loan at 5.88%. Under the terms of the Credit Facility, the Company is not permitted to allow its maximum leverage ratio (as defined in the agreement) to exceed 2.00 to 1.00 and was required to maintain a minimum tangible net worth (as defined in the agreement) of approximately $2.23 billion at July 31, 2006. At July 31, 2006, the Company’s leverage ratio was approximately .65 to 1.00 and its tangible net worth was approximately $3.19 billion. Based upon the minimum tangible net worth requirement, the Company’s ability to pay dividends and repurchase its common stock was limited to an aggregate amount of approximately $1.07 billion at July 31, 2006.
The Company is involved in various claims and litigation arising in the ordinary course of business. The Company believes that the disposition of these matters will not have a material adverse effect on the business or on the financial condition of the Company.
In January 2006, the Company received a request for information pursuant to Section 308 of the Clean Water Act from Region 3 of the Environmental Protection Agency (“EPA”) requesting information about storm water discharge practices in connection with our homebuilding projects in the states that comprise EPA Region 3. To the extent the EPA’s review were to lead the EPA to assert violations of state and/or federal regulatory requirements and request injunctive relief and/or civil penalties, the Company would defend and attempt to resolve any such asserted violations. At this time the Company cannot predict the outcome of the EPA’s review.
13
11. Supplemental Disclosure to Statements of Cash Flows
The following are supplemental disclosures to the statements of cash flows for the nine months ended July 31, 2006 and 2005 (amounts in thousands):
Cash flow information:
Interest paid, net of amount capitalized
34,802
28,775
Income taxes paid
289,916
283,850
Non-cash activity:
Cost of inventory acquired through seller financing
131,962
65,770
Contribution of inventory, net of related debt to unconsolidated entities
4,500
Income tax benefit related to exercise of employee stock options
17,164
70,909
Stock bonus awards
10,926
30,396
Contribution to employee retirement plan
Investment in unconsolidated entities made by letter of credit
4,600
Acquisition of joint venture assets and liabilities
Fair value of assets acquired
181,473
Liabilities assumed
110,548
Cash paid
40,722
Reduction in investment and advances to unconsolidated entities
30,203
12. Supplemental Guarantor Information
Toll Brothers Finance Corp., a 100% owned indirect subsidiary (the “Subsidiary Issuer”) of the Company, is the issuer of four series of senior notes aggregating $1.15 billion. The obligations of the Subsidiary Issuer to pay principal, premiums, if any, and interest are guaranteed jointly and severally on a senior basis by the Company and substantially all of its 100% owned home building subsidiaries (the “Guarantor Subsidiaries”). The guarantees are full and unconditional. The Company’s non-home building subsidiaries and certain home building subsidiaries (the “Non-Guarantor Subsidiaries”) do not guarantee the debt. Separate financial statements and other disclosures concerning the Guarantor Subsidiaries are not presented because management has determined that such disclosures would not be material to investors. The Subsidiary Issuer has not had and does not have any operations other than the issuance of the four series of senior notes and the lending of the proceeds from the senior notes to subsidiaries of the Company. Supplemental consolidating financial information of the Company, the Subsidiary Issuer, the Guarantor Subsidiaries, the Non-Guarantor Subsidiaries and the eliminations to arrive at the Company on a consolidated basis are as follows:
14
Condensed Consolidating Balance Sheet at July 31, 2006 ($ in thousands) (unaudited):
TollBrothers,Inc.
SubsidiaryIssuer
GuarantorSubsidiaries
Non-GuarantorSubsidiaries
Eliminations
Consolidated
271,516
51,034
5,888,275
338,508
88,268
8,320
5,101
80,373
71,982
645
72,453
66,234
54,420
2,278
Investments in and advances to consolidated entities
3,531,057
1,155,512
(1,367,811
(90,460
(3,228,298
1,160,613
5,327,702
540,661
(3,227,653
484,167
231,869
398,898
31,994
278,345
12,472
19,731
655,889
108,320
(3
299,053
(1,946
2,167,299
466,311
Common stock
2,003
(2,003
4,420
2,734
(7,154
3,155,983
62,510
(3,218,493
Treasury stock, at cost
3,160,403
67,247
(3,227,650
15
Condensed Consolidating Balance Sheet at October 31, 2005 ($ in thousands):
Cash & cash equivalents
664,312
24,907
4,951,168
117,456
Property, construction & office equipment – net
70,438
9,086
5,453
123,815
89,115
(32,763
Investments in & advances to unconsolidated entities
Investments in & advances to consolidated entities
3,047,664
1,155,164
(1,503,295
3,318
(2,702,851
1,160,617
4,527,433
343,740
(2,735,614
Liabilities:
162,761
87,791
256,548
20,589
701,627
102,425
(32,872
284,093
1,886,538
277,953
Stockholders’ equity:
2,636,475
57,110
(2,693,585
2,640,895
61,847
(2,702,742
16
Condensed Consolidating Statement of Income for the Nine Months Ended July 31, 2006
($ in thousands) (unaudited):
Toll Brothers, Inc.
Subsidiary Issuer
Guarantor Subsidiaries
Non- Guarantor Subsidiaries
Home sales
4,248,468
Costs and expenses:
2,910,189
3,882
(1,321
55,875
54,644
50,204
77,385
11,060
(50,204
3,050,291
69,586
(51,525
32
525
429,978
23,798
(24,992
(32
(50,729
768,199
(27,150
76,517
Equity earnings
50,729
30,630
36,017
(85,384
Earnings from subsidiaries
835,491
(835,491
8,867
(844,358
315,983
3,467
(319,450
519,508
5,400
(524,908
Condensed Consolidating Statement of Income for the Three Months Ended July 31, 2006
19,413
21,750
1,509,463
1,050,725
1,319
72
14,611
17,384
16,734
28,092
731
(15,741
1,094,331
19,434
(15,669
176
148,172
8,774
(9,021
(16
(16,910
266,960
(6,458
24,690
16,910
11,021
11,293
(29,525
285,250
(285,250
4,835
(290,085
105,549
1,890
(107,439
179,701
2,945
(182,646
17
Condensed Consolidating Statement of Income for the Nine Months Ended July 31, 2005
2,537,476
3,547
(1,138
40,818
85,399
133
(40,818
2,638,582
3,680
(41,956
434
350,146
19,284
(20,193
(35
(41,252
784,474
(22,964
62,149
41,252
24,508
31,767
(70,952
814,465
(814,465
8,803
(823,268
315,318
3,442
(318,760
499,147
5,361
(504,508
Condensed Consolidating Statement of Income for the Three Months Ended July 31, 2005
1,022,524
1,241
(22
15,394
35,545
50
(15,395
1,067,681
1,291
(15,417
153
126,742
6,930
(7,559
(17
(15,547
352,659
(8,221
22,976
15,547
10,883
(25,638
362,625
(362,625
2,662
(365,287
145,361
1,108
(146,469
217,264
1,554
(218,818
18
Condensed Consolidating Statement of Cash Flows for the Nine Months Ended July 31, 2006
854
19,020
2,081
Share based compensation
(844,657
(74,207
(72,453
(66,234
(Increase) decrease in receivables, prepaid expenses and other assets
(483,394
(99,159
111,686
496,640
(Decrease) increase in customer deposits
(2,523
29,716
Increase (decrease) in accounts payable and accrued expenses
13,336
(858
(27,806
9,084
28,268
Decrease in current income taxes payable
97,233
(500,382
24,619
(31,888
(1,165
Purchase of marketable securities
(2,150,940
(36,775
2,150,940
36,775
Investments in unconsolidated entities
Net cash used in investing activities
(148,300
1,395,876
646,313
(1,139,990
(646,803
(97,233
255,886
2,673
(392,796
26,127
Cash and cash equivalents,beginning of period
19
Condensed Consolidating Statement of Cash Flows for the Nine Months Ended July 31, 2005
481
12,575
1,299
Write-off of unamortized debt issuance costs
(Increase) decrease in inventory
(899,865
58
(570,504
(298,928
352,671
(22,990
519,016
4,850
247,455
29,080
(14,508
Increase in current income taxes payable
Net cash provided by (used in) operating activities
(9,528
(293,597
330,187
29,793
(27,780
(3,875
3,709,843
5,000
Net cash provided by investing activities
52,407
1,125
239,992
546,329
(493,985
(565,735
Proceeds from issuance of senior notes
Net cash (used in) provided by financing activities
9,528
(353,993
(19,406
Net increase in cash and cash equivalents
28,601
11,512
456,836
8,998
485,437
20,510
20
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
For the nine-month period ended July 31, 2006, total revenues increased 14% and net income increased 4% as compared to the comparable period of fiscal 2005. For the three-month period ended July 31, 2006, total revenues and net income declined by 1% and 19%, respectively, as compared to the comparable period of fiscal 2005.
We have continued to experience a slowdown in new contracts signed. This slowdown, which began in the beginning of the fourth quarter of our fiscal 2005, has continued throughout the first nine months of fiscal 2006 and into the fourth quarter of fiscal 2006, as we reported on August 22, 2006, the date of our most recently provided financial guidance. The value of new contracts signed was $3.75 billion for the nine-month period ended July 31, 2006 and $1.05 billion for the three-month period ended July 31, 2006, a decline of 33% and 45%, respectively, compared to the value of new contracts signed in the comparable periods of fiscal 2005. In addition, our backlog at July 31, 2006 of $5.59 billion decreased 13% over our backlog at July 31, 2005. Backlog consists of homes under contract but not yet delivered for our traditional home sales, and unrecognized revenue for projects accounted for under the percentage of completion method.
We believe this slowdown is attributable to a decline in consumer confidence, an overall softening of demand for new homes and an oversupply of homes available for sale. We attribute the reduction in demand to concerns on the part of prospective home buyers about the direction of home prices, due in part to many homebuilders advertising price reductions and increased sales incentives, and concerns about being able to sell their existing homes. In addition, we believe speculators and investors are no longer helping to fuel demand. We try to avoid selling homes to speculators and we generally do not build unattached homes without having a signed agreement of sale. Nonetheless, we have been impacted by an overall increase in the supply of homes available for sale in many markets, as speculators attempt to sell the homes they previously purchased or cancel contracts for homes under construction, and as builders who, as part of their business strategy, were building homes in anticipation of capturing additional sales in a demand driven market attempt to reduce their inventories by lowering prices and adding incentives. In addition, based on the high cancellation rates reported by other builders, and on the increased cancellation rates we have experienced, non-speculative buyer cancellations are also adding to the supply of homes in the marketplace. In the nine-month and three-month periods ended July 31, 2006, our cancellation rates were approximately 12% and 18% of contracts signed, respectively. This compares to our historical average cancellation rate of approximately 7%, and an average cancellation rate of 4.6% in each of fiscal 2005 and 2004.
Despite this slowdown, we remain cautiously optimistic about the future growth of our business. Our industry demographics remain strong due to the continuing regulation-induced constraints on lot supplies and the growing number of affluent households. We continue to believe the excess supply of available homes is a short-term phenomenon and that the market environment of tight supply and growing demand will eventually return.
On August 22, 2006, we filed a Form 8-K with the Securities and Exchange Commission (the “SEC”) that provided financial guidance related to our expected results of operations for fiscal 2006. The guidance contained in this Form 10-Q is the same guidance given in the Form 8-K filed on August 22, 2006. We have not reconfirmed or updated this guidance since the filing of the Form 8-K. The guidance stated that, based on our performance for the nine months ended July 31, 2006, the expected delivery dates in our current backlog and management’s estimate of the number of homes that we will sell and deliver in the quarter ending October 31, 2006, we believe that in fiscal 2006 we will: deliver between 8,600 and 8,900 homes with an anticipated average delivered price between $685,000 and $690,000; recognize between $215 million and $220 million of revenues using the percentage of completion method of accounting related to several qualifying projects that are under construction; earn net income between $727 million and $763 million; and achieve diluted earnings per share between $4.41 and $4.63.
The guidance we gave on August 22, 2006 also stated that, based on the size of our current backlog, the expected demand for our product and the increased number of selling communities from which we are operating, we believe that we will deliver between 7,000 and 8,000 of our traditional homes in fiscal 2007 with an anticipated average delivered price between $635,000 and $645,000, and that, in addition to the revenues from the deliveries of our traditional homes, we expect to recognize between $450 million and $550 million of revenues from projects accounted for under the percentage of completion method of accounting.
Geographic and product diversification, access to lower-cost capital, a versatile and abundant home mortgage market and strong, favorable demographics are creating opportunities for those builders that can control land and persevere through the increasingly difficult regulatory approval process and the current reduction in demand for new homes. We believe that this evolution in our industry favors the large publicly traded home building companies with the capital and expertise to control home sites and gain market share. While many public homebuilders, including ourselves, have announced significant cutbacks of land under contract, we believe that once demand returns, there could be a shortage of available home sites to meet the demand. We currently own or control more than 82,000 home sites in 50 markets we consider to be affluent, a substantial number of which sites already have the approvals necessary for development. We believe that as the approval process continues to become more difficult, and as the political pressure from no-growth proponents increases, our expertise in taking land through the approval process and our already approved land positions should allow us to meet our expectations of demand for our homes for a number of years to come.
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. We attempt to reduce our risk by controlling land for future development through options whenever possible, thus allowing us to obtain the necessary governmental approvals before acquiring title to the land; generally commencing construction of a home only after executing an agreement of sale and receiving a substantial down payment from a buyer; and using subcontractors to perform home construction and land development work on a fixed-price basis.
Our revenues have grown on average over 20% per year in the last decade. We have funded this growth through the reinvestment of profits, bank borrowings and capital market transactions. At July 31, 2006, we had $322.6 million of cash and cash equivalents and approximately $1.15 billion available under our bank revolving credit facility which extends to March 2011. With these resources and our history of success in accessing the public debt markets, we believe we have the resources available to continue to grow in the future.
CRITICAL ACCOUNTING POLICIES
We believe the following critical accounting policies reflect the more significant judgments and estimates used in the preparation of our consolidated financial statements.
Inventory is stated at the lower of cost or fair value in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”). In addition to direct land acquisition, land development and home construction costs, costs include interest, real estate taxes and direct overhead related to development and construction, which are capitalized to inventories during the period beginning with the commencement of development and ending with the completion of construction.
Once a parcel of land has been approved for development, it generally takes four to five years to fully develop, sell and deliver all the homes in one of our typical communities. Longer or shorter time periods are possible depending on the number of home sites in a community and the demand for those home sites. Our master planned communities, consisting of several smaller communities, may take up to 10 years or more to complete. Because our inventory is considered a long-lived asset under U.S. generally accepted accounting principles, we are required to regularly review the carrying value of each of our communities and write down the value of those communities for which we believe the values are not recoverable. When the profitability of a current community deteriorates, the sales pace declines significantly or some other factor indicates a possible impairment in the recoverability of the asset, we evaluate the property in accordance with the guidelines of SFAS 144. If this evaluation indicates that an impairment loss should be recognized, we charge cost of sales for the estimated impairment loss in the period determined.
In addition, we review all land held for future communities or future sections of current communities, whether owned or under contract, to determine whether or not we expect to proceed with the development of the land as originally contemplated. Based upon this review, we decide (1) as to land that is under a purchase contract but not owned, whether the contract will likely be terminated or renegotiated, and (2) as to land we own, whether the land will likely be developed as contemplated or in an alternative manner, or should be sold. We then further determine which costs that have been capitalized to the property are recoverable and which costs should be written off. We recognized $37.0 million and $23.9 million of write-offs of costs related to current and future communities in the nine-month and three-month periods ended July 31, 2006, respectively, as compared to $3.7 million and $1.2 million in the comparable periods of fiscal 2005. The write-offs in the nine-month period ended July 31, 2006 were attributable primarily to the write-off of deposits and predevelopment costs attributable to a number of land purchase contracts that we decided not to go forward with and the write-down of the carrying cost of several communities in Michigan and Massachusetts. The write-offs in the three-month period ended July 31, 2006 were attributable primarily to the write-off of deposits and predevelopment costs attributable to a number of land purchase contracts that we decided not to go forward with and the write-down of the carrying cost of one community in Michigan.
22
We have a significant number of land purchase contracts, sometimes referred to herein as “land purchase contracts,” “options,” or “option agreements,” which we evaluate in accordance with the Financial Accounting Standards Board (“FASB”) Interpretation No. 46 “Consolidation of Variable Interest Entities, an interpretation of ARB No. 51” as amended by FIN 46R (together, “FIN 46”). Pursuant to FIN 46, an enterprise that absorbs a majority of the expected losses or receives a majority of the expected residual returns of a variable interest entity (“VIE”) is considered to be the primary beneficiary and must consolidate the operations of the VIE. A VIE is an entity with insufficient equity investment or in which the equity investors lack some of the characteristics of a controlling financial interest. For land purchase contracts with sellers meeting the definition of a VIE, we perform a review to determine which party is the primary beneficiary of the VIE. This review requires substantive judgment and estimation. These judgments and estimates involve assigning probabilities to various estimated cash flow possibilities relative to the entity’s expected profits and losses and the cash flows associated with changes in the fair value of the land under contract. Because, in most cases, we do not have any ownership interests in the entities with which we contract to purchase land, we generally do not have the ability to compel these entities to provide assistance in our review. In many instances, these entities provide us little, if any, financial information.
Revenue and Cost Recognition
Traditional Home Sales Revenues
Because the construction time for one of our traditional homes is generally less than one year, revenues and cost of revenues from traditional home sales are recorded at the time each home is delivered and title and possession are transferred to the buyer. Closing normally occurs shortly after construction is substantially completed.
Land, land development and related costs, both incurred and estimated to be incurred in the future, are amortized to the cost of homes closed based upon the total number of homes to be constructed in each community. Any changes resulting from a change in the estimated number of homes to be constructed or in the estimated costs subsequent to the commencement of delivery of homes are allocated to the remaining undelivered homes in the community. Home construction and related costs are charged to the cost of homes closed under the specific identification method. The estimated land, common area development and related costs of master planned communities, including the cost of golf courses, net of their estimated residual value, are allocated to individual communities within a master planned community on a relative sales value basis. Any changes resulting from a change in the estimated number of homes to be constructed or in the estimated costs are allocated to the remaining home sites in each of the communities of the master planned community.
Percentage of Completion Revenues
We are developing several projects that will take substantially more than one year to complete. For projects that qualify, revenues and costs are recognized using the percentage of completion method of accounting in accordance with SFAS No. 66, “Accounting for Sales of Real Estate” (“SFAS 66”). Under the provisions of SFAS 66, revenues and costs are recognized when construction is beyond the preliminary stage, the buyer is committed to the extent of being unable to require a refund except for non-delivery of the unit, sufficient units in the project have been sold to ensure that the property will not be converted to rental property, the sales proceeds are collectible and the aggregate sales proceeds and the total cost of the project can be reasonably estimated. Revenues and costs of individual projects are recognized on the individual project’s aggregate value of units for which the home buyers have signed binding agreements of sale and made or is obligated to make an adequate cash deposit and are based on the percentage of total estimated construction costs that have been incurred. Total estimated revenues and construction costs are reviewed periodically and any change will be applied to the current and future periods. We began recognizing revenue and costs using percentage of completion accounting on several projects in fiscal 2006.
23
Land Sales Revenues
Land sales revenues and cost of revenues are recorded at the time that title and possession of the property have been transferred to the buyer. We recognize the pro rata share of revenues and cost of revenues of land sales to entities in which we have a 50% or less interest based upon the ownership percentage attributable to the non-Company investors. Any profit not recognized in a transaction reduces our investment in the entity.
Use of Estimates
In the ordinary course of doing business, we must make estimates and judgments that affect decisions on how we operate and the reported amounts of assets, liabilities, revenues and expenses. These estimates include, but are not limited to, those related to the recognition of income and expenses, impairment of assets, estimates of future improvement and amenity costs, capitalization of costs to inventory, provisions for litigation, insurance and warranty costs, and income taxes. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. On an ongoing basis, we evaluate and adjust our estimates based on the information currently available. Actual results may differ from these estimates and assumptions or conditions.
OFF-BALANCE SHEET ARRANGEMENTS
We have investments in and advances to several joint ventures, Toll Brothers Realty Trust Group (“Trust”) and Toll Brothers Realty Trust Group II (“Trust II”). At July 31, 2006, we had investments in and advances to these entities of $240.2 million, were committed to invest or advance an additional $448.6 million in the aggregate to these entities, if needed, and had guaranteed up to approximately $147.7 million of these entities’ indebtedness and/or loan commitments. See Note 3 to the Condensed Consolidated Financial Statements, “Investments in and Advances to Unconsolidated Entities” for more information regarding these entities. We do not believe that these arrangements, individually or in the aggregate, have or are reasonably likely to have a current or future material effect on our financial condition, results of operations, liquidity or capital resources. Our investments in these entities are accounted for using the equity method.
24
RESULTS OF OPERATIONS
The following table sets forth, for the nine-month and three-month periods ended July 31, 2006 and 2005, a comparison of certain income statement items related to our operations (amounts in millions):
%
Revenues
4,168.1
3,751.6
1,488.9
1,536.5
Costs
2,912.8
69.9
2,539.9
67.7
1,052.1
70.7
1,023.7
66.6
1,255.3
1,211.7
436.8
512.8
138.7
41.2
110.5
79.7
32.0
77.7
28.2
9.2
7.9
21.6
1.1
10.6
6.8
86.4
15.7
72.7
0.9
78.9
9.6
90.8
5.9
0.2
1.0
Interest*
88.4
2.0
85.5
2.3
29.8
1.9
35.6
Total
4,314.7
3,773.2
1,531.2
1,547.1
3,118.6
72.3
2,641.1
70.0
1,114.8
72.8
1,068.9
69.1
1,196.1
1,132.1
416.4
478.1
Selling, general and administrative*
429.3
10.0
349.7
9.3
148.1
9.7
126.3
8.2
766.8
782.4
268.3
351.9
36.7
9.5
7.3
4.2
26.6
(4.1
835.5
814.4
285.2
362.6
322.0
318.6
110.6
147.1
513.4
495.9
174.6
215.5
*
Percentages are based on total revenues.
Note: Amounts may not add due to rounding.
Traditional Home Sales Revenues and Costs
Home sales revenues for the nine months ended July 31, 2006 were higher than those for the comparable period of 2005 by approximately $416.5 million, or 11%. Home sales revenues for the three months ended July 31, 2006 were lower than those for the comparable period of 2005 by approximately $47.6 million, or 3%.
The increase in revenues in the nine-month period ended July 31, 2006, as compared to the comparable period of fiscal 2005, was attributable to a 5% increase in the number of homes delivered and a 6% increase in the average price of the homes delivered. The decrease in the three-month period ended July 31, 2006, as compared to the comparable period of fiscal 2005, was attributable to a 7% decrease in the number of homes delivered offset in part by a 4% increase in the average price of the homes delivered. The increase in the number of homes delivered in the nine-month period ended July 31, 2006, as compared to the comparable period of fiscal 2005, was primarily due to the higher backlog of homes at October 31, 2005 as compared to October 31, 2004, which was primarily the result of a 19% increase in the number of new contracts signed in fiscal 2005 over fiscal 2004. The decrease in the number of homes delivered in the three-month period ended July 31, 2006, as compared to the comparable period of fiscal 2005, was primarily due to the slowdown in new contracts signed in the fourth quarter of fiscal 2005 and the first quarter of fiscal 2006 and a significant number of cancellations of contracts of homes to be delivered during the quarter ended July 31, 2006. The increase in the average price of the homes delivered in the fiscal 2006 periods, as compared to the comparable periods of fiscal 2005, was the result of increased selling prices and the delivery of fewer smaller, lower-priced products such as attached homes and age-qualified homes.
25
The value of new sales contracts signed was $3.50 billion (4,871 homes) in the nine-month period ended July 31, 2006, a 36% decrease compared to the value of contracts signed in the comparable period of fiscal 2005 of $5.49 billion (7,996 homes). This decrease is attributable to a 39% decrease in the number of new contracts signed, offset in part by a 5% increase in the average value of each contract.
For the three-month period ended July 31, 2006, the value of new sales contracts signed was $1.01 billion (1,400 homes), a 46% decrease compared to the value of contracts signed in the comparable period of fiscal 2005 of $1.87 billion (2,705 homes). This decrease is attributable to a 48% decrease in the number of new contracts signed, offset in part by a 5% increase in the average value of each contract.
We believe this slowdown is attributable to a decline in consumer confidence, an overall softening of demand for new homes and an oversupply of homes available for sale. We attribute the reduction in demand to concerns on the part of prospective home buyers about the direction of home prices, due in part to many homebuilders advertising price reductions and increased sales incentives, and concerns about being able to sell their existing homes. In addition, we believe speculators and investors are no longer helping to fuel demand. We try to avoid selling homes to speculators and we generally do not build unattached homes without having a signed agreement of sale. Nonetheless, we have been impacted by an overall increase in the supply of homes available for sale in many markets as speculators attempt to sell the homes they previously purchased or cancel contracts for homes under construction, and as builders who, as part of their business strategy, were building homes in anticipation of capturing additional sales in a demand driven market attempt to reduce their inventories by lowering prices and adding incentives. In addition, based on the high cancellation rates reported by other builders, and on the increased cancellation rates we have experienced, non-speculative buyer cancellations are also adding to the supply of homes in the marketplace. In the nine-month and three-month periods ended July 31, 2006, our cancellation rates were approximately 12% and 18% of contracts signed, respectively. This compares to our historical average cancellation rate of approximately 7%, and an average cancellation rate of 4.6% in each of fiscal 2005 and 2004.
Despite this slowdown, we remain cautiously optimistic about the future growth of our business. Our industry demographics remain strong due to the continuing regulation-induced constraints on lot supplies and the growing number of affluent households. We believe the excess supply of available homes is a short-term phenomenon and that the market environment of tight supply and growing demand will return.
At July 31, 2006, we were selling from 295 communities compared to 230 communities at July 31, 2005 and October 31, 2005. We expect to be selling from approximately 300 communities at October 31, 2006.
At July 31, 2006, our backlog of traditional homes under contract was $5.18 billion (7,362 homes), 18% lower than the $6.29 billion (9,330 homes) backlog at July 31, 2005. The decrease in backlog at July 31, 2006 compared to the backlog at July 31, 2005 is primarily attributable to the decrease in the value and number of new contracts signed in the nine-month period ended July 31, 2006 as compared to the comparable period of fiscal 2005, and by higher deliveries in the nine-month period ended July 31, 2006 as compared to the comparable period of fiscal 2005, offset in part by a higher backlog at October 31, 2005 as compared to the backlog at October 31, 2004.
Home costs before interest expense as a percentage of home sales revenue were higher in the nine-month and three-month periods ended July 31, 2006 as compared to the comparable periods of fiscal 2005. The increases were largely the result of the costs of land and construction increasing faster then selling prices, higher sales incentives given on the homes delivered in the fiscal 2006 periods as compared to those delivered in the fiscal 2005 periods, higher overhead costs and higher inventory write-offs. We recognized $37.0 million and $23.9 million of write-offs of costs related to current and future communities in the nine-month and three-month periods ended July 31, 2006, respectively, as compared to $3.7 million and $1.2 million in the comparable periods of fiscal 2005. The write-offs in the nine-month period ended July 31, 2006 were attributable primarily to the write-off of deposits and predevelopment costs attributable to a number of land purchase contracts that we decided not to go forward with and the write-down of the carrying cost of several communities in Michigan and Massachusetts. The write-offs in the three-month period ended July 31, 2006 were attributable primarily to the write-off of deposits and predevelopment costs attributable to a number of land purchase contracts that we decided not to go forward with and the write-down of the carrying cost of one community in Michigan.
26
As we stated in the guidance we provided on August 22, 2006 (which is not being reconfirmed or updated in this Form 10-Q), based on the size of our current backlog and the expected demand for our product, we believe that: we will deliver between 8,600 and 8,900 homes in fiscal 2006 and that the average delivered price of those homes will be between $685,000 and $690,000; for the full 2006 fiscal year, we expect that home costs before interest expense as a percentage of home sales revenues will be between 69.9% and 70.0% as compared to 67.8% for the full 2005 fiscal year; and in the fiscal year ending October 31, 2007, we expect to deliver between 7,000 and 8,000 homes at an average delivered price of between $635,000 and $645,000.
Percentage of Completion Revenues and Costs
We are developing several projects for which we are recognizing revenues and costs using the percentage of completion method of accounting. Revenues and costs of individual projects are recognized on the individual project’s aggregate value of units for which home buyers have signed binding agreements of sale and are based on the percentage of total estimated construction costs that have been incurred. Total estimated revenues and construction costs are reviewed periodically and any change is applied to current and future periods. We began recognizing revenue and costs using percentage of completion accounting on several projects in fiscal 2006. In the nine-month and three-month periods ended July 31, 2006, we recognized $138.7 million and $41.2 million of revenues, respectively, and $110.5 million and $32.0 million of costs before interest expense, respectively, on these projects. At July 31, 2006, our backlog of homes in communities that we account for using the percentage of completion method of accounting was $413.6 million compared to $142.5 million at July 31, 2005.
The guidance we gave on August 22, 2006 stated that, for the full 2006 fiscal year, we believe that, revenues recognized under the percentage of completion accounting method will be between $215 million and $220 million and costs before interest expense will be approximately 79.0% of revenues, and that, in the fiscal year ending October 31, 2007, we expect to recognize between $450 million and $550 million of revenues under the percentage of completion accounting method.
Land Sales Revenues and Costs
We are developing several communities in which we expect to sell a portion of the land to other builders or entities. The amount and profitability of land sales will vary from period to period depending upon the timing of the sale and delivery of the specific land parcels. In the nine-month and three-month periods ended July 31, 2006, land sales were $7.9 million and $1.1 million, respectively. Cost of land sales before interest expense was approximately $6.8 million and $.9 million in the nine-month and three-month periods ended July 31, 2006, respectively. In the nine-month and three-month periods ended July 31, 2005, land sales were $21.6 million and $10.6 million, respectively. Cost of land sales before interest expense was $15.7 million and $9.6 million in the nine-month and three-month periods ended July 31, 2005, respectively.
The guidance we gave on August 22, 2006 stated that, for the full fiscal 2006 year, land sales are expected to be approximately $12.4 million, and cost of land sales before interest expense is expected to be approximately 87.7 % of land sales revenue.
Interest Expense
We determine interest expense on a specific lot-by-lot basis for our traditional homebuilding operations and on a parcel-by-parcel basis for land sales. As a percentage of total revenues, interest expense varies depending on many factors, including the period of time that we owned the land, the length of time that the homes delivered during the period were under construction, and the interest rates and the amount of debt carried by us in proportion to the amount of our inventory during those periods. Interest expense for projects using the percentage of completion method of revenue recognition is determined based on the total estimated interest for the project and the percentage of total estimated construction costs that have been incurred to date.
Interest expense as a percentage of revenues was slightly lower in the nine-month and three-month periods ended July 31, 2006 as compared to the comparable periods of fiscal 2005.
27
The guidance we gave on August 22, 2006 stated that, for the full 2006 fiscal year, we expect interest expense as a percentage of total revenues to be approximately 2.1%.
Selling, General and Administrative Expenses (“SG&A”)
SG&A spending increased by $79.6 million, or 23%, in the nine-month period ended July 31, 2006, and by $21.8 million, or 17%, in the three-month period ended July 31, 2006, in each case as compared to the comparable periods of fiscal 2005. The increased spending in both the nine-month and three-month periods was principally due to the costs incurred to support the increase in revenues in the nine month period of fiscal 2006 over the comparable period of fiscal 2005; the costs associated with the increase in the number of selling communities that we had during both periods of fiscal 2006 as compared to the comparable periods of fiscal 2005; and the expensing of stock option awards pursuant to SFAS 123R in both periods of fiscal 2006, which expense we did not have in the comparable periods of fiscal 2005. During the nine-month and three-month periods ended July 31, 2006, we recognized $21.5 million and $5.3 million of expense, respectively, related to stock option awards.
The guidance we gave on August 22, 2006 stated that, for the full 2006 fiscal year, we expect that SG&A as a percentage of revenues will be between 9.5% and 9.6% of revenues as compared to 8.3% for the full 2005 fiscal year.
Equity Earnings from Unconsolidated Entities
We are a participant in several joint ventures with unrelated parties and in the Trust and Trust II. We recognize our proportionate share of the earnings from these entities. See Note 3 to the Condensed Consolidated Financial Statements, “Investments in and Advances to Unconsolidated Entities” for more information regarding our investments in and commitments to these entities. Many of our joint ventures are land development projects or high-rise/mid-rise construction projects and do not generate revenues and earnings for a number of years during the development of the property. Once development is complete, the joint ventures will generally, over a relatively short period of time, generate revenues and earnings until all the assets of the entities are sold. Because there is not a steady flow of revenues and earnings from these entities, the earnings recognized from these entities will vary significantly from quarter to quarter and year to year. In the nine-month and three-month periods ended July 31, 2006, we recognized $36.7 million and $7.3 million, respectively, of earnings from unconsolidated entities as compared to $9.5 million and $4.2 million in the comparable periods of fiscal 2005.
The guidance we gave on August 22, 2006 stated that, for fiscal 2006, we expect to recognize approximately $49.0 million of earnings from our investments in these joint ventures and in the Trust and Trust II.
Interest and Other Income
For the nine months ended July 31, 2006, interest and other income was $32.0 million, an increase of $5.4 million from the $26.6 million recognized in the comparable period of fiscal 2005. The increase was primarily the result of higher management and construction fee income, higher forfeited customer deposits and higher interest income, offset, in part, by lower broker fees and lower income realized from our ancillary businesses recognized in the fiscal 2006 period as compared to the comparable period of fiscal 2005.
For the three months ended July 31, 2006, interest and other income was $9.7 million, a decrease of $.9 million from the $10.6 million recognized in the comparable periods of fiscal 2005. The decrease was primarily the result of lower interest income, income realized from our ancillary businesses and brokerage fee income, offset, in part, by higher forfeited customer deposits and higher management and construction fee income recognized in the fiscal 2006 period compared to the comparable period of fiscal 2005.
The guidance we gave on August 22, 2006 stated that, for the full 2006 fiscal year, we expect interest and other income to be approximately $39.0 million compared to $41.2 million in fiscal 2005.
28
Income before Income Taxes
For the nine-month period ended July 31, 2006, income before taxes was $835.5 million, a 3% increase over the $814.4 million realized in the comparable period of fiscal 2005. For the three-month period ended July 31, 2006, income before taxes was $285.2 million, a 21% decrease over the $362.6 million realized in the comparable period of fiscal 2005. The guidance we gave on August 22, 2006 stated that, for the full 2006 fiscal year, we expect income before income taxes to be between $1.19 billion and $1.24 billion.
Income Taxes
Income taxes were provided at an effective rate of 38.5% and 38.8% for the nine-month and three-month periods ended July 31, 2006, respectively, compared to 39.1% and 40.6% for the comparable periods of fiscal 2005. The difference in rates in fiscal 2006 periods as compared to the comparable periods of fiscal 2005 was primarily due to a manufacturing tax credit that we first became eligible for in fiscal 2006, the reversal of prior year tax provisions in the fiscal 2006 periods that we no longer needed due to the expiration of tax statutes, the recognition of estimated interest expense, net of estimated interest income in the fiscal 2006 periods on expected tax assessments and recoveries due to ongoing tax audits and the effect on the fiscal 2005 periods rates due to recomputing our net deferred tax liability, resulting from the change in our Base Rate from 37% at October 31, 2004 to 39.1% at July 31, 2005.
The guidance we gave on August 22, 2006 stated that, for the full fiscal 2006 year, we expect that our effective tax rate will be approximately 38.7% as compared to 39.1% in fiscal 2005.
CAPITAL RESOURCES AND LIQUIDITY
Funding for our business has been provided principally by cash flow from operating activities, unsecured bank borrowings and the public debt and equity markets. We have used our cash flow from operating activities, bank borrowings and the proceeds of public debt and equity offerings to acquire additional land for new communities, fund additional expenditures for land development, fund construction costs needed to meet the requirements of our backlog and the increasing number of communities in which we are offering homes for sale, invest in unconsolidated entities, repurchase our stock, and repay debt.
Cash flow from operating activities decreased in the nine-month period ended July 31, 2006 as compared to the comparable period of fiscal 2005. This decrease was primarily the result of increased inventory levels and the increase in contracts receivable related to projects that are using percentage of completion accounting, offset in part by our revenue growth in the fiscal 2006 period as compared to the fiscal 2005 period.
We expect that our inventory of land and land development costs will continue to increase and we are currently negotiating and searching for additional opportunities to obtain control of land for future communities. At July 31, 2006, the aggregate purchase price of land parcels under option and purchase agreements was approximately $3.74 billion (including approximately $1.17 billion of land to be acquired from joint ventures which we have invested in, made advances to or made loan guarantees on behalf of) of which we had paid or deposited approximately $194.6 million. In addition, we expect contracts receivable to continue to increase as we add additional projects that are accounted for using the percentage of completion accounting method and as more revenues are recognized under existing projects accounted for under the percentage of completion accounting method. We do not expect to deliver any of the homes in current projects accounted for using the percentage of completion method of accounting until fiscal 2007.
In general, cash flow from operating activities assumes that, as each home is delivered, we will purchase a home site to replace it. Because we own several years’ supply of home sites, we do not need to buy home sites immediately to replace the ones delivered. In addition, we generally do not begin construction of our traditional single-family homes until we have a signed contract with the home buyer. Should our business decline significantly, our inventory would decrease as we complete and deliver the homes under construction but do not commence construction of as many new homes, resulting in a temporary increase in our cash flow from operations. In addition, under such circumstances, we might delay or curtail our acquisition of additional land, which would further reduce our inventory levels and cash needs.
29
In both the fiscal 2006 and 2005 periods, we have had a significant amount of cash invested in either short-term cash equivalents or short-term interest-bearing marketable securities. In addition, we have made a number of investments in unconsolidated entities related to the acquisition and development of land for future home sites or in entities that are constructing or converting apartment buildings into luxury condominiums. Our investment activities related to marketable securities and investments in and distributions of investments from unconsolidated entities are included in the Condensed Consolidated Statements of Cash Flows in the section “Cash flow from investing activities.”
In March 2006, we amended and extended our unsecured revolving credit facility and added a $300 million term loan facility. The amended revolving credit facility provides borrowing of up to $1.5 billion and extends to March 2011. At July 31, 2006, interest was payable on borrowings under the revolving credit facility at 0.475% (subject to adjustment based upon our debt ratings and leverage ratio) above the Eurodollar rate or other specified variable rates as selected by us from time to time. At July 31, 2006, we had no borrowings outstanding against the revolving credit facility, but had approximately $351.5 million of letters of credit outstanding under it. The $300 million term loan extends to March 2011 and interest is payable on borrowings under the term loan at 0.50% (subject to adjustment based upon our debt ratings and leverage ratio) above the Eurodollar rate or other specified variable rates as selected by us from time to time. Prior to the amendment to the revolving credit facility and entering into the term loan, we had periodically elected to maintain a loan balance outstanding on the revolving credit facility although we had significant amounts of available cash and cash equivalents.
To reduce borrowing costs, extend the maturities of our long-term debt and raise additional funds for general corporate purposes, during the last several fiscal years we issued four series of senior notes aggregating $1.15 billion. We used the proceeds from the issuance of the senior notes to redeem $470 million of senior subordinated notes and, together with other available cash, to repay a $222.5 million bank term loan. In addition, we raised approximately $86.2 million from the issuance of six million shares of our common stock in a public offering in August 2003.
We believe that we will be able to continue to fund our expected growth and meet our contractual obligations through a combination of existing cash resources, cash flow from operating activities, our existing sources of credit and access to the public debt and equity markets.
INFLATION
The long-term impact of inflation on us is manifested in increased costs for land, land development, construction and overhead, as well as in increased sales prices of our homes. We generally contract for land significantly before development and sales efforts begin. Accordingly, to the extent land acquisition costs are fixed, increases or decreases in the sales prices of homes may affect our profits. Because the sales price of each of our homes is fixed at the time a buyer enters into a contract to acquire a home, and because we generally contract to sell our homes before we begin construction, any inflation of costs in excess of those anticipated may result in lower gross margins. We generally attempt to minimize that effect by entering into fixed-price contracts with our subcontractors and material suppliers for specified periods of time, which generally do not exceed one year.
In general, housing demand is adversely affected by increases in interest rates and housing costs. Interest rates, the length of time that land remains in inventory and the proportion of inventory that is financed affect our interest costs. If we are unable to raise sales prices enough to compensate for higher costs, or if mortgage interest rates increase significantly, affecting prospective buyers’ ability to adequately finance home purchases, our revenues, gross margins and net income would be adversely affected. Increases in sales prices, whether the result of inflation or demand, may affect the ability of prospective buyers to afford new homes.
30
HOUSING DATA
Region
Units
$ millions
Northeast (CT, MA, NJ, NY, RI)
411
310
276.8
184.0
Mid-Atlantic (DE, MD, PA, VA)
678
886
447.4
554.4
Midwest (IL, MI)
105
178
74.6
110.7
Southeast (FL, NC, SC)
371
236
212.7
139.0
Southwest (AZ, CO, NV, TX)
459
361
308.0
239.2
West (CA)
339
169.4
309.2
Total traditional
2,157
2,310
Percentage of completion *
Total consolidated entities
1,530.1
Unconsolidated entities
57
14.2
25.7
2,180
2,367
1,544.3
1,562.2
New Contracts
222
431
146.4
280.0
Mid-Atlantic (DE, MD, PA, VA, WV)
476
758
309.5
522.9
Midwest (IL, MI, MN)
130
149
90.4
108.4
593
120.8
330.9
238
544
197.4
391.7
158
230
149.5
238.2
1,400
2,705
1,014.0
1,872.1
43
41
36.3
44.1
1,443
2,746
1,050.3
1,916.2
111
19.2
63.4
1,473
2,857
1,069.5
1,979.6
Backlog
At July 31,
1,013
1,420
697.2
922.0
1,951
2,639
1,306.5
1,750.8
482
505
329.4
358.3
1,597
2,009
920.7
1,651
1,926
1,246.1
1,315.1
668
831
677.1
893.0
7,362
9,330
5,177.0
6,291.3
Undelivered
663
160
552.3
142.5
Revenue recognized
(138.7
Net percentage of completion
413.6
8,025
9,490
5,590.6
6,433.8
237
12.6
149.4
8,044
9,727
5,603.2
6,583.2
31
1,070
793
698.1
447.6
1,954
2,308
1,295.5
1,400.0
329
414
232.6
256.8
1,160
588
634.3
328.7
1,177
914
821.8
584.0
409
795
485.8
734.5
6,099
5,812
4,306.8
167
207
95.3
90.5
6,266
6,019
4,402.1
3,842.1
1,185
493.4
770.0
1,575
2,702
1,035.6
1,778.5
368
473
243.0
330.8
737
1,434
477.9
794.0
979
1,489
758.8
1,049.5
713
492.7
762.9
4,871
7,996
3,501.4
5,485.7
283
104
253.0
78.2
5,154
8,100
3,754.4
5,563.9
83
270
51.9
164.1
5,237
8,370
3,806.3
5,728.0
Mid- and High-Rise projects that are accounted for under the percentage of completion method.
PERCENTAGE OF COMPLETION DATA
Northeast
25.9
Southeast
15.3
32.2
15.0
Mid-Atlantic
1.4
Midwest
1.2
1.5
29.1
507
88
396.3
44.5
52
21.3
77
115.8
98.0
Southwest
17.7
Less revenue recognized
88.0
48.4
213.4
8.4
17.8
33.7
12.2
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk primarily due to fluctuations in interest rates. We utilize both fixed-rate and variable-rate debt. For fixed-rate debt, changes in interest rates generally affect the fair market value of the debt instrument, but not our earnings or cash flow. Conversely, for variable-rate debt, changes in interest rates generally do not impact the fair market value of the debt instrument, but do affect our earnings and cash flow. We do not have the obligation to prepay fixed-rate debt prior to maturity, and, as a result, interest rate risk and changes in fair market value should not have a significant impact on our fixed-rate debt until we are required or elect to refinance it.
The table below sets forth, at July 31, 2006, our debt obligations by scheduled maturity, weighted-average interest rates and estimated fair value (amounts in thousands):
Fixed-Rate Debt
Variable-Rate Debt (1)(2)
Fiscal Year of Expected Maturity
Amount
Weighted -AverageInterestRate
Weighted-AverageInterestRate
95,478
7.47
6.46
2007
78,779
6.54
124,671
6.24
2008
28,662
5.17
150
3.68
2009
3,178
6.34
2010
800
10.00
Thereafter
1,571,022
6.31
312,995
5.79
Discount
(9,118
1,768,801
6.65
521,718
6.01
Fair value at July 31, 2006
1,701,219
(1)
We have a $1.8 billion credit facility consisting of a $1.5 billion, unsecured revolving credit facility and a $300 million term loan facility (collectively, the “Credit Facility”) with 31 banks, which extends to March 17, 2011. At July 31, 2006, interest was payable on borrowings under the revolving credit facility at 0.475% (subject to adjustment based upon our debt rating and leverage ratios) above the Eurodollar rate or at other specified variable rates as selected by us from time to time. At July 31, 2006, we had no outstanding borrowings against the revolving credit facility, but had letters of credit of approximately $351.5 million outstanding under it. Under the term loan facility, interest is payable at 0.50% (subject to adjustment based upon our debt rating and leverage ratios) above the Eurodollar rate or at other specified variable rates as selected by us from time to time. At July 31, 2006, interest was payable on the term loan at 5.88%.
(2)
One of our subsidiaries has a $125 million line of credit with four banks to fund mortgage originations. The line is due within 90 days of demand by the banks and bears interest at the banks’ overnight rate plus an agreed upon margin. At July 31, 2006, the subsidiary had $83.6 million outstanding under the line at an average interest rate of 6.46%. Borrowing under this line is included in the 2006 fiscal year maturities.
Based upon the amount of variable rate debt outstanding at July 31, 2006 and holding the variable rate debt balance constant, each one percentage point increase in interest rates would increase our interest costs by approximately $5.2 million per year.
ITEM 4. CONTROLS AND PROCEDURES
A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives.
Our chief executive officer and chief financial officer, with the assistance of management, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report (the “Evaluation Date”). Based on that evaluation, our chief executive officer and chief financial officer concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective to ensure that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.
There has not been any change in internal control over financial reporting during our quarter ended July 31, 2006 that has materially affected or is reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are involved in various claims and litigation arising principally in the ordinary course of business. We believe that the disposition of these matters will not have a material adverse effect on our business or our financial condition.
In January 2006, we received a request for information pursuant to Section 308 of the Clean Water Act from Region 3 of the Environmental Protection Agency (the “EPA”) requesting information about storm water discharge practices in connection with our homebuilding projects in the states that comprise EPA Region 3. To the extent the EPA’s review were to lead the EPA to assert violations of state and/or federal regulatory requirements and request injunctive relief and/or civil penalties, we would defend and attempt to resolve any such asserted violations. At this time we cannot predict the outcome of the EPA’s review.
There are no other proceedings required to be disclosed pursuant to Item 103 of Regulation S-K.
ITEM 1A. RISK FACTORS
There has been no material change in our risk factors as previously disclosed in our Form 10-K for the fiscal year ended October 31, 2005 in response to Item 1A to Part I of such Form 10-K.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
During the three months ended July 31, 2006 we repurchased the following shares of our common stock (amounts in thousands, except per share amounts):
Period
Total Number of Shares Purchased
Average Price Paid Per Share
Total Number of Shares Purchased as Part of a Publicly Announced Plan or Program (1)
Maximum Number of Shares that May Yet be Purchased Under the Plan or Program (1)
May 1, 2006 through May 31, 2006
1,117
28.90
12,679
June 1, 2006 through June 30, 2006
560
27.52
12,119
July 1, 2006 through July 31, 2006
24.63
12,116
1,680
28.43
On March 26, 2003, we announced that our Board of Directors had authorized the repurchase of up to 20 million shares of our common stock, par value $.01, from time to time, in open market transactions or otherwise, for the purpose of providing shares for our various employee benefit plans. The Board of Directors did not fix an expiration date for the repurchase program.
Except as set forth above, we have not repurchased any of our equity securities.
Our bank credit agreement requires us to maintain a minimum tangible net worth (as defined in the credit agreement), which restricts the amount of dividends we may pay. In addition, our senior subordinated notes contain restrictions on the amount of dividends we may pay on our common stock. At July 31, 2006, under the most restrictive of these provisions, we could have paid up to approximately $960 million of cash dividends.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS
3.1
By-laws of Toll Brothers, Inc., As Amended and Restated June 15, 2006, are hereby incorporated by reference to Exhibit 3.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on June 20, 2006.
4.1*
Twelfth Supplemental Indenture dated as of April 30, 2006 by and among the parties listed on Schedule I thereto, and J.P. Morgan Trust Company, National Association, as successor Trustee.
10.1*
Toll Brothers, Inc. Supplemental Executive Retirement Plan, as amended and restated, effective as of June 15, 2006.
10.2*
Amendment to the Toll Bros., Inc. Non-Qualified Deferred Compensation Plan, effective as of January 1, 2005.
31.1*
Certification of Robert I. Toll pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*
Certification of Joel H. Rassman pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1*
Certification of Robert I. Toll pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2*
Certification of Joel H. Rassman pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Filed electronically herewith.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
TOLL BROTHERS, INC. (Registrant)
Date: September 1, 2006
By:
Joel H. Rassman
Joel H. Rassman Executive Vice President, Treasurer and Chief Financial Officer (Principal Financial Officer)
Joseph R. Sicree
Joseph R. Sicree Senior Vice President and Chief Accounting Officer (Principal Accounting Officer)