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UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549
Form 10-Q
(Mark One)
OR
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 an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes No
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
Common Stock, $.01 par value: 74,322,980 shares at June 2, 2004.
TOLL BROTHERS, INC. AND SUBSIDIARIESINDEX
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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, anticipated income to be realized from our investments in joint ventures and the Toll Brothers Realty Trust Group, interest expense, growth and expansion, ability to acquire land, ability to sell homes and properties, ability to deliver homes from backlog, ability to gain approvals and to open new communities, ability to secure materials and subcontractors, average delivered prices of homes, 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,” “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 and political conditions, the consequences of any future terrorist attacks such as those that occurred on September 11, 2001, 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, fluctuations in capital and securities markets, 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 under the caption “Factors That May Affect Our Future Results” in Item 1 of our Annual Report on Form 10-K for the fiscal year ended October 31, 2003. 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.
PART 1. FINANCIAL INFORMATION
TOLL BROTHERS, INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED BALANCE SHEETS(Amounts in thousands)
See accompanying notes
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TOLL BROTHERS, INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF INCOME(Amounts in thousands, except per share data)(Unaudited)
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TOLL BROTHERS, INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(Amounts in thousands)(Unaudited)
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TOLL BROTHERS, INC. AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)
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, 2003 balance sheet amounts and disclosures included herein have been derived from our October 31, 2003 audited financial statements. Since the accompanying condensed consolidated financial statements do not include all the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements, we suggest that they be read in conjunction with the financial statements and notes thereto included in our October 31, 2003 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 our financial position as of April 30, 2004, the results of our operations for the six months and three months ended April 30, 2004 and 2003 and our cash flows for the six months ended April 30, 2004 and 2003. The results of operations for such interim periods are not necessarily indicative of the results to be expected for the full year.
In January 2003, the Financial Accounting Standards Board (the “FASB”) issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an interpretation of ARB No. 51.” A Variable Interest Entity (“VIE”) is an entity with insufficient equity investment or in which the equity investors lack some of the characteristics of a controlling financial interest. Pursuant to FIN 46, an enterprise that absorbs a majority of the expected losses of the VIE must consolidate the VIE. The adoption of FIN 46 for VIEs did not have a material effect on our financial position and results of operations.
In March 2004, the SEC released SEC Accounting Bulletin (“SAB”) No. 105, Application of Accounting Principles to Loan Commitments. SAB No. 105 provides the SEC staff position regarding the application of accounting principles generally accepted in the United States to loan commitments that relate to the origination of mortgage loans that will be held for resale. SAB No. 105 contains specific guidance on the inputs to a valuation-recognition model to measure loan commitments accounted for at fair value. Current accounting guidance requires the commitment to be recognized on the balance sheet at fair value from its inception through its expiration or funding. SAB No. 105 requires that fair-value measurement include only the differences between the guaranteed interest rate in the loan commitment and a market interest rate, excluding any expected future cash flows related to the customer relationship or loan serving. In addition, SAB No. 105 requires the disclosure of loan commitments and any associated hedging strategies. SAB 105 is effective for all loan commitments accounted for as derivatives and entered into subsequent to March 31, 2004. The adoption of SAB No. 105 did not have a material impact on our results of operations, financial condition, or cash flows.
Inventory consisted of the following (amounts in thousands):
Construction in progress includes the cost of homes under construction, land and land development costs and the carrying costs of lots that have been substantially improved.
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We capitalize certain interest costs to inventory during the development and construction period. Capitalized interest is charged to interest expense when the related inventory is delivered. Interest incurred, capitalized and expensed for the six-month and three-month periods ended April 30, 2004 and 2003 is summarized as follows (amounts in thousands):
In March 2004, Toll Brothers Finance Corp., one of our wholly-owned subsidiaries, sold $300 million of 4.95% Senior Notes due 2014. The obligations of Toll Brothers Finance Corp. to pay principal, premiums, if any, and interest is guaranteed jointly and severally on a senior basis by us and substantially all of our home building subsidiaries. The guarantees are full and unconditional. Our non-homebuilding subsidiaries did not guarantee the debt. We have filed a registration statement which will allow the holders of the senior notes to exchange the notes for publicly registered notes. We used a portion of the proceeds from the senior note offering to redeem all of our outstanding $170 million 8 1/8% Senior Subordinated Notes due 2009 at 104.0625 % of principal amount. The remainder of the proceeds was used for general corporate purposes. The redemption resulted in a pre-tax charge in our quarter ended April 30, 2004 of $7.7 million which represents the call premium and the write-off of the unamortized issuance costs.
Information pertaining to the calculation of earnings per share for the six-month and three-month periods ended April 30, 2004 and 2003 are as follows (amounts in thousands):
In March 2003, our Board of Directors authorized the repurchase of up to 10 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. During the six-month period ended April 30, 2004, we repurchased approximately .2 million shares. At April 30, 2004, we had approximately 9.6 million shares remaining under the repurchase authorization.
We accrue 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 six-month and three-month periods ended April 30, 2004 and 2003 are as follows (amounts in thousands):
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SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, requires the disclosure of the estimated value of employee option grants and their impact on net income using option pricing models that are designed to estimate the value of options that, unlike employee stock options, can be traded at any time and are transferable. In addition to restrictions on trading, employee stock options may include other restrictions such as vesting periods and periods of time when they cannot be exercised. Further, such models require the input of highly subjective assumptions, including the expected volatility of the stock price. Therefore, in management’s opinion, the existing models do not provide a reliable single measure of the value of employee stock options.
For the purposes of providing the pro forma disclosures, the fair value of options granted was estimated using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants in each of the six-month and three-month periods ended April 30, 2004 and 2003.
Net income and net income per share as reported in these condensed consolidated financial statements and on a pro forma basis, as if the fair-value-based method described in SFAS No. 123 had been adopted, for the six-month and three-month periods ended April 30, 2004 and 2003 were as follows (amounts in thousands, except per share amounts):
At April 30, 2004, we had agreements to purchase land for future development with an aggregate purchase price of approximately $1.96 billion, of which $116.5 million had been paid or deposited. Purchase of the properties is contingent upon satisfaction of certain requirements by us and the sellers.
At April 30, 2004, we had outstanding surety bonds amounting to approximately $678.0 million related primarily to our obligations to various governmental entities to construct improvements in our various communities. We estimate that approximately $289.8 million of work remains to be performed on these improvements. We have an additional $68.6 million of surety bonds outstanding which guarantee other of our obligations. We do not believe that any outstanding bonds will likely be drawn upon.
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At April 30, 2004, we had agreements of sale outstanding to deliver 6,225 homes with an aggregate sales value of approximately $3.74 billion.
At April 30, 2004, we were committed to provide approximately $559.3 million of mortgage loans to our home buyers and to others. All loans with committed interest rates are covered by take-out commitments from third-party lenders, which minimizes our interest rate risk. We also arrange a variety of mortgage programs that are offered to our home buyers through outside mortgage lenders.
We have a $575 million unsecured revolving credit facility with 17 banks that extends through March 2006. Interest is payable on borrowings under the facility at 0.90% (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 April 30, 2004, we had no outstanding borrowings against the facility and approximately $155.2 million of letters of credit outstanding under it. Under the terms of the revolving credit agreement, we are not permitted to allow our maximum leverage ratio (as defined in the agreement) to exceed 2.00 to 1.00 and, at April 30, 2004, we were required to maintain a minimum tangible net worth (as defined in the agreement) of approximately $989 million. At April 30, 2004, our leverage ratio was approximately .76 to 1.00 and our tangible net worth was approximately $1.59 billion. Based upon the minimum tangible net worth requirement of the revolving credit facility, our ability to pay dividends and repurchase our common stock was limited to approximately $597 million at April 30, 2004.
We have an unsecured term loan of $222.5 million from 11 banks at a weighted-average interest rate of 7.43% repayable in July 2005. Under the terms of the term loan agreement, we are not permitted to allow our maximum leverage ratio (as defined in the agreement) to exceed 2.25 to 1.00 and, at April 30, 2004, we were required to maintain a minimum tangible net worth (as defined in the agreement) of approximately $811 million. At April 30, 2004, our leverage ratio was approximately .76 to 1.00 and our tangible net worth was approximately $1.6 billion. Based upon the minimum tangible net worth requirement of the term loan, our ability to pay dividends and repurchase our common stock was limited to approximately $785 million at April 30, 2004.
We are involved in various claims and litigation arising in the ordinary course of business. We believe that the disposition of these matters will not have a material effect on our business or on our financial condition.
The following are supplemental disclosures to the statements of cash flows for the six months ended April 30, 2004 and 2003 (amounts in thousands):
Toll Brothers Finance Corp., a wholly-owned, indirect subsidiary (the “Subsidiary Issuer”), is the issuer of three series of senior notes aggregating $850 million. The obligations of the Subsidiary Issuer to pay principal, premiums, if any, and interest is guaranteed jointly and severally on a senior basis by Toll Brothers, Inc. and substantially all of our wholly-owned homebuilding subsidiaries (the “Guarantor
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Subsidiaries”). The guarantees are full and unconditional. Our non-homebuilding subsidiaries and certain homebuilding subsidiaries (the “Non-Guarantor Subsidiaries”) did 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 three series of senior notes and the lending of the proceeds from the senior notes to subsidiaries of Toll Brothers, Inc. Supplemental consolidating financial information of Toll Brothers, Inc., the Subsidiary Issuer, the Guarantor Subsidiaries, the Non-Guarantor Subsidiaries and the eliminations to arrive at Toll Brothers, Inc. on a consolidated basis are as follows:
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Home sales revenue of $1.40 billion in the six-month period ended April 30, 2004 represents an increase of 21% over the $1.16 billion recognized in the comparable period of fiscal 2003. Home sales revenue of $814 million in the three-month period ended April 30, 2004 represents an increase of 35% over the $601 million recognized in the comparable period of fiscal 2003. Net income earned of $122.5 million and $72.4 million in the six-month and three-month periods ended April 30, 2004, respectively, represent increases of 25% and 37%, respectively, over net income of $98.3 million and $52.9 million in the comparable periods of fiscal 2003. Contracts signed of $2.51 billion (4,117 homes) for the six months ended April 30, 2004 represents a 66% increase over the $1.51 billion (2,733 homes) of contracts signed in the comparable period of fiscal 2003. Contracts signed of $1.60 billion (2,600 homes) in the three months ended April 30, 2004 represent a 73% increase over the $926.5 million (1,667 homes) of contracts signed in the comparable period of fiscal 2003.
In addition, the $3.74 billion sales value of homes under contract but not yet delivered to home buyers (“backlog”) at April 30, 2004 was 69% higher than our $2.21 billion backlog at April 30, 2003 and 42% higher than our $2.64 billion backlog at October 31, 2003. Since many of these homes will be delivered over the next twelve months, we believe the size of the backlog gives us excellent visibility into our potential home sales revenues during that period.
Based on our strong backlog, the expected increase in the number of our selling communities and the current strength of the luxury new home market, we believe that we are on track to produce revenue and net income growth of 20% or more in both fiscal 2004 and fiscal 2005.
We currently own or control nearly 58,000 home sites in 44 affluent markets, a substantial number of which sites already have the approvals necessary for development. We believe that as the approval process becomes 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 will allow us to continue to grow for a number of years to come. Because of the strong demand for our homes, we have been able to increase the base selling prices in many of our communities during the past several years.
Because of the length of time that it takes to obtain the necessary approvals on a property, complete the land improvements on it, and build and deliver a home after a home buyer signs an agreement of sale, we and other home builders are subject to many risks. We attempt to reduce risks 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 with a buyer; and generally 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 April 30, 2004, we had $287.5 million of cash and cash equivalents and approximately $420 million available under our bank revolving credit facility. During the second quarter of 2004, we issued $300 million of 4.95% senior notes due 2014. We used $170 million of the proceeds from these notes to prepay our 8 1/8% senior subordinated notes due 2009. With these resources, our strong cash flow from operations before inventory growth and our history of success in accessing the public debt markets, we believe we have the resources available to continue to grow in fiscal 2005 and beyond.
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 SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” In addition to direct acquisition, land development and
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home construction costs, costs include interest, real estate taxes and direct overhead costs 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.
It takes approximately 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. 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 accounting principles generally accepted in the United States, we are required to 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 No. 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 planned. Based upon this review, we decide: (a) as to land that is under a purchase contract but not owned, whether the contract will likely be terminated or renegotiated; and (b) 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.
Revenue and cost of sales are recorded at the time each home, or lot, is closed, title and possession are transferred to the buyer and the proceeds are received by us.
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 to 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 change in the estimated cost is allocated to the remaining lots in each of the communities of the master planned community.
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.
We have investments in and advances to three joint ventures with independent third parties to develop and sell land that was owned or is currently owned by our venture partners. We recognize our share of earnings from the sale of lots to other builders. We do not recognize earnings from lots we purchase from the joint ventures, but instead reduce our cost basis in these lots by our share of the earnings on the lots.
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We are obligated to purchase 180 lots from one of the joint ventures in which we have an interest (45 of which we have purchased to date), and have the right to purchase an additional 45 lots. We are also obligated to purchase several land parcels, containing approximately 385 lots, from the second venture, of which we purchased 106 lots as of April 30, 2004. The third venture has sold all the land that it owned and is currently in the process of completing the final land improvements on the site, which could take 12 months or more to complete. Two of the joint ventures participate in the profits earned from home sales on lots sold by the ventures above certain agreed upon levels. At April 30, 2004, we had approximately $28.7 million invested in or advanced to the three joint ventures and were committed to contribute additional capital in an aggregate amount of approximately $16.9 million if the joint ventures require it.
In addition, we have a minority interest in a joint venture with unrelated third parties which is building The Sky Club, a 326-unit, 17-story two-tower structure, located in Hoboken, New Jersey. At April 30, 2004, our investment in this joint venture was $4.0 million. We do not have any commitment to contribute additional capital to this joint venture.
In January 2004, we entered into a joint venture, in which we have a 50% interest, with another unrelated third party builder to develop an 832-home luxury condominium community on the Hoboken, New Jersey waterfront. At April 30, 2004, we had investments and advances to the venture of $28.6 million and are committed to make up to $1.9 million of additional investments and advances to it. In addition, we and our joint venture partner each have guaranteed $7.5 million of principal amount of one of the loans obtained by this joint venture.
We also own 50% of a joint venture with an unrelated third party that is currently building and selling an active-adult, age-qualified community. At April 30, 2004, our investment in this joint venture was $1.4 million. We do not have any commitment to contribute additional capital to this joint venture.
To take advantage of commercial real estate opportunities, Toll Brothers Realty Trust Group (the “Trust”) was formed in 1998. The Trust is effectively owned one-third by us, 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 members of our senior management, and one-third by the Pennsylvania State Employees Retirement System. We provide development, finance and management services to the Trust and receive fees for our services. The Trust currently owns and operates several office buildings and an 806-unit apartment complex which it developed in Virginia, and is currently building a 635-unit apartment complex in New Jersey. At April 30, 2004, our investment in the Trust was $5.8 million. The Trust has a $25 million revolving credit facility that extends through June 2005. As collateral for this facility, we and the other groups of investors each entered into a subscription agreement whereby each group of investors agreed to invest up to an additional $9.3 million if required by the Trust. The subscription agreements expire in August 2005.
Other than the guarantee discussed above, we do not currently guarantee any indebtedness of the joint ventures or the Trust. Our total commitment to these entities is not material to our financial condition. These investments are accounted for using the equity method.
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The following table sets forth, for the six-month and three-month periods ended April 30, 2004 and 2003, a comparison of certain income statement items related to our operations (amounts in millions):
Home sales revenue for the six-month and three-month periods ended April 30, 2004 was higher than those for the comparable period of 2003 by approximately $245 million, or 21%, and $213 million, or 35%, respectively. The increase in the six-month period was attributable to a 2% increase in the average price of the homes delivered and a 19% increase in the number of homes delivered. The increase in the three-month period was attributable to a 3% increase in the average price of the homes delivered and a 32% increase in the number of homes delivered. The increases in the average price of homes delivered in the fiscal 2004 periods were the result of increased base selling prices, offset in part by a shift in the location of homes delivered to less expensive areas and an increase in the number of deliveries of smaller, lower priced attached and age-qualified product. The increases in the number of homes delivered in the fiscal 2004 periods were primarily due to the higher backlog of homes at October 31, 2003 as compared to October 31, 2002 which was primarily the result of a 20% increase in the number of new contracts signed in fiscal 2003 over fiscal 2002.
The value of new sales contracts signed in the six months ended April 30, 2004, was $2.51 billion (4,117 homes), a 66% increase over the $1.51 billion (2,733 homes) value of new sales contracts signed in the comparable period of fiscal 2003. The value of new sales contracts signed in the three months ended April 30, 2004 was $1.60 billion (2,600 homes), a 73% increase over the $926.5 million (1,667 homes) value of new sales contracts signed in the comparable period of fiscal 2003. The increase in the six-month period was attributable to a 10% increase in the average selling price of the homes (due primarily to the location and size of homes sold and increases in base selling prices) and a 51% increase in the number of units sold. The increase in the three-month period was attributable to an 11% increase in the average selling price of the homes (due primarily to the location and size of homes sold and increases in base selling prices) and a 56%
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increase in the number of units sold. The increase in the number of units sold in the six-month and three-month periods was attributable to the continued demand for our product and the increase in the number of communities from which we are selling. We were selling from 205 communities at April 30, 2004 compared to 176 communities at April 30, 2003 and 200 communities at October 31, 2003. We expect to be selling from approximately 220 communities at October 31, 2004.
We believe that the demand for our product is attributable to an increase in the number of affluent households, the maturation of the baby boom generation, a constricted supply of available new home sites, attractive mortgage rates and the belief held by potential customers that the purchase of a home is a stable investment in the recent period of economic uncertainty. At April 30, 2004, we had nearly 58,000 home sites under our control nationwide in markets we consider to be affluent.
At April 30, 2004, our backlog of homes under contract was $3.74 billion (6,225 homes), 69% higher than the $2.21 billion (3,937 homes) backlog at April 30, 2003. The increase in backlog at April 30, 2004 compared to the backlog at April 30, 2003 is primarily attributable to a higher backlog at October 31, 2003 as compared to the backlog at October 31, 2002 and the increase in the value and number of new contracts signed in the first six months of fiscal 2004 as compared to the first six months of fiscal 2003, offset, in part, by an increase in the number of homes delivered in the first six months of fiscal 2004 compared to the first six months of fiscal 2003. Based on the size of our current backlog, the expected continuation of demand for our product, the increased number of selling communities from which we are operating and the additional communities we expect to open in the coming months, we believe that we will produce revenue and net income growth of 20% or more in both fiscal 2004 and 2005.
For the full 2004 fiscal year, we expect that we will deliver between 6,050 and 6,250 homes and that the average delivered price of the homes will be between $555,000 and $565,000.
Home costs as a percentage of home sales decreased in both the six-month period and three-month period ended April 30, 2004 as compared to the comparable periods of fiscal 2003. The decreases were primarily the result of selling prices increasing faster than costs, and lower inventory write-offs. We incurred $1.2 million in write-offs in the six months ended April 30, 2004 as compared to $2.3 million in the comparable period of fiscal 2003. For the three months ended April 30, 2004, we incurred $.3 million in write-offs as compared to $2.1 million in the comparable period of fiscal 2003.
For the full 2004 fiscal year, we expect that home costs as a percentage of housing revenues will be between 50 and 60 basis points lower than in fiscal 2003.
We are developing several communities in which we sell a portion of the land to other builders. The amount of land sales will vary from quarter to quarter depending upon the scheduled timing of the delivery of the land parcels. Land sales were $8.0 million and $2.0 million for the six months and three months ended April 30, 2004, respectively. For the six months and three months ended April 30, 2003, land sales were $13.4 million and $4.0 million, respectively.
For the full 2004 fiscal year, land sales are expected to be approximately $15 million compared to $27.4 million in fiscal 2003. We expect that cost of land as a percentage of land sales revenue will be approximately 85% in fiscal 2004 compared to a 65% cost of land in fiscal 2003.
We are a participant in several joint ventures and in Toll Brothers Realty Trust Group. We recognize our proportionate share of the earnings from these entities. (See “Off-Balance Sheet Arrangements” for a narrative of our investments in and commitments to these entities.) Earnings from unconsolidated entities will vary significantly from quarter to quarter. Earnings from unconsolidated entities for the six-month and three-month periods ended April 30, 2004 were $1.4 million and $.7 million, respectively compared to $.1 million for the six-month period ended April 30, 2003 and a loss of $.1 million for the three-month period ended April 30, 2003.
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For fiscal 2004, we expect to realize approximately $12 million of income from our investments in the joint ventures and the Trust compared to $1.0 million in fiscal 2003.
For the six months ended April 30, 2004, interest and other income decreased $1.7 million, as compared to the comparable period of fiscal 2003. This decrease was primarily the result of lower income realized from our ancillary businesses and retained customer deposits, offset, in part, by increases in interest income and management and construction fee income.
For the three months ended April 30, 2004, interest and other income decreased $.7 million, as compared to the comparable period of fiscal 2003. This decrease was primarily the result of decreases in income realized from our ancillary businesses, interest income and retained customer deposits, offset, in part, by higher construction fee income.
For the full 2004 fiscal year, we expect interest and other income to be approximately $13 million compared to $15.8 million in fiscal 2003.
In the six-month and three-month periods ended April 30, 2004, SG&A spending increased by approximately $33 million and $22 million, or 25% and 33%, respectively, as compared to the comparable periods of fiscal 2003. This increased spending was principally due to higher sales commissions and higher costs incurred to operate the greater number of selling communities that we had during the fiscal 2004 periods as compared to the comparable periods of fiscal 2003. In addition, in anticipation of the significant growth that is expected in fiscal 2005 and beyond,we have increased the number of personnel to manage this growth.
For the full 2004 fiscal year, we expect that SG&A as a percentage of total revenues will be between 30 and 50 basis points higher than fiscal 2003.
We determine interest expense on a specific lot-by-lot basis for our 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 as a percentage of revenues was lower for the six-month and three-month periods ended April 30, 2004 as compared to the comparable periods of fiscal 2003. For the full 2004 fiscal year, we expect interest expense as a percentage of total revenues to be slightly lower than the fiscal 2003 percentage.
We recognized a pre-tax charge of $7.7 million in the quarter ended April 30, 2004 representing the premium paid on redemption of our 8 1/8% Senior Subordinated Notes due 2009 and the write-off of unamortized bond issuance costs related to those notes. No similar charge was incurred in the comparable quarter of fiscal 2003.
We recognized a pretax charge of $3.9 million in the quarter ended January 31, 2003 representing the premium paid on redemption of our 8 3/4% Senior Subordinated Notes due 2006 and the write-off of unamortized bond issuance costs related to those notes.
Income before taxes increased in the six-month and three-month periods ended April 30, 2004 by 24% and 37%, respectively, as compared to the comparable periods of fiscal 2003.
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Income taxes were provided at an effective rate of 36.7% for each of the six-month and three-month periods ended April 30, 2004. Income taxes were provided at an effective rate of 36.8% for each of the six-month and three- month periods ended April 30, 2003, respectively. The difference in rate in the six-month and three-month periods of fiscal 2004 as compared to the comparable periods of fiscal 2003 was due primarily to higher tax-free income in the fiscal 2004 periods as compared to the fiscal 2003 periods.
Funding for our operations has been provided principally by cash flow from operating activities, unsecured bank borrowings and the public debt and equity markets.
In general, cash flow from operations 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 immediately buy lots to replace the ones delivered. Accordingly, we believe that cash flow from operating activities before inventory additions is currently a better gauge of liquidity.
Cash flow from operating activities, before inventory additions, has improved as operating results have improved. One of the main factors that determine cash flow from operating activities, before inventory additions, is the level of revenues from the delivery of homes and land sales. We anticipate that cash flow from operating activities, before inventory additions, will continue to be strong in fiscal 2004 due to the expected increase in home deliveries in fiscal 2004 as compared to fiscal 2003. We expect that our inventory will continue to increase and we are currently negotiating and searching for additional opportunities to obtain control of land for future communities. At April 30, 2004, we had commitments to acquire land of approximately $1.96 billion, of which approximately $116.5 million had been paid or deposited. We have used our cash flow from operating activities, before inventory additions, 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 increased backlog and the increasing number of communities in which we are offering homes for sale; repurchase our stock; and repay debt.
We generally do not begin construction of a home until we have a signed contract with the home buyer. Because of the significant amount of time between the time a home buyer enters into a contract to purchase a home and the time that the home is built and delivered, we believe we can estimate with reasonable accuracy the number of homes we will deliver in the next six to nine months. 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.
At April 30, 2004, we had a $575 million unsecured revolving credit facility with 17 banks which extends to March 2006. At April 30, 2004, we had no borrowings and approximately $155.2 million of letters of credit outstanding under the facility.
In March 2004, Toll Brothers Finance Corp., one of our indirect wholly-owned subsidiaries, sold $300 million of 4.95% Senior Notes due 2014 in a private placement. The obligations of Toll Brothers Finance Corp. to pay principal, premiums, if any, and interest are guaranteed jointly and severally on a senior basis, by us and substantially all of our home building subsidiaries. The guarantees are full and unconditional. Our non-homebuilding subsidiaries did not guarantee the debt. We have filed a registration statement enabling the holders of the senior notes to exchange the notes for publicly registered notes. We used a portion of the proceeds from the senior notes to redeem all of our outstanding $170 million 8 1/8% Senior Subordinated Notes due 2009 at 104.0625% of principal amount. The redemption resulted in a pre-tax charge in our quarter ended April 30, 2004 of approximately $7.7 million which represented the call premium and the write-off of the unamortized issuance costs.
We believe that we will be able to continue to fund our activities through a combination of existing cash resources, cash flow from operating activities, our existing sources of credit, and the public debt markets.
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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. Since the sales prices of homes are fixed at the time a buyer enters into a contract to acquire a home and 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 costs, as well as in 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.
HOUSING DATA
(For the six months and three months ended April 30, 2004 and 2003)
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HOUSING DATA (continued)
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 such debt until we are required or elect to refinance such debt.
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The table below sets forth, at April 30, 2004, our debt obligations, principal cash flows by scheduled maturity, weighted-average interest rates and estimated fair value (amounts in thousands):
Based upon the amount of variable rate debt outstanding at April 30, 2004 and holding the variable rate debt balance constant, each one percentage point increase in interest rates would increase our interest costs by approximately $.7 million per year.
Management, including our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended) (the “Evaluation Date”) and, based on that evaluation, concluded that, as of the Evaluation Date, we had sufficient controls and procedures for recording, processing, summarizing and reporting information that is required to be disclosed in our reports under the Securities Exchange Act of 1934, as amended, within the time periods specified in the SEC’s rules and forms.
There has not been any change in our internal control over financial reporting during our quarter ended April 30, 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
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. There are no proceedings required to be disclosed pursuant to Item 103 of Regulation S-K.
During the three months ended April 30, 2004, we repurchased the following shares under our repurchase program (amounts in thousands, except per share amounts):
Pursuant to the provisions of our stock option plans, participants are permitted to use the value of our common stock that they own to pay for the exercise of options. During the three months ended April 30, 2004, we received 2,098 shares with an average fair market value per share of $44.23 for the exercise of stock options.
None
Our 2004 Annual Meeting of Stockholders was held on March 18, 2004.
The following proposals were submitted to and approved by security holders at the Annual Meeting. There were 73,533,213 shares of our common stock eligible to vote at the 2004 Annual Meeting.
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During the quarter ended April 30, 2004, we furnished or filed the following Current Reports on Form 8-K:
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SIGNATURES
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.
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