For Whom the Bells Toll: Perchance for a Home-Builder?

"No man is an island, entire of itself; every man is a piece of the continent, a part of the main…. Perchance he for whom this bell tolls, may be so ill, as that he knows not it tolls for him; and perchance I may think myself so much better than I am, as that they who are about me...may have caused it to toll for me...and therefore never send to know for whom the bell tolls; it tolls for thee." – Renaissance author John Donne (1572 - 1631), "Meditation XVII."

Citing a slowdown in new contracts signed, luxury homebuilder Toll Brothers, Inc. (TOL-$34.43) reported a 14.7% drop in profit to $687.2 million in FY ended October 31, 2006, or share-net of $4.17 per share, on revenue of $6.1 billion.

Sagging consumer confidence, an overall softening of demand for new homes, and an oversupply of homes available for sale—all these factors continue to drive cancellation rates higher. In the fourth quarter 2006, Toll Brothers wrote-down $115.0 million, which was $15 million higher than the top of management’s previous range.

The Company recognized $152.0 million in FY 2006, compared with $5.2 million in FY 2005. The write-offs in FY 2006 were attributable to land deposit refunds, the write-off associated with the costs of land optioned for future communities primarily in California and Florida, and the write-down of the carrying cost of several communities primarily located in California and Michigan.

Given continued uncertainty, Toll Brothers estimates (pre-tax) land-related write-downs of $60.0 million in fiscal 2007.

Due to the decline in backlog at October 31, 2006, and the number of agreements the Company expects to sign in the first half of FY 2007, Toll Brothers expects to deliver in FY 2007 between 6,300 and 7,300 homes at an average delivered price of between $660,000 and $670,000, earn net income of between $260.0 million and $340.0 million, and achieve diluted earnings of between $1.58 and $2.08 per share.

The Company expects to report guidance around 2:00 PM on Thursday for the 1Q:07. High-low estimates for earnings and share-net fall in the range of between $108.0 million to- $85.0 and 66 cents to- 52 cents, respectively.

Robert I. Toll, chairman and chief executive, has repeatedly said that the current “housing downturn seems to be driven by oversupply and a pullback in buyer confidence as speculators exit markets….not by high interest rates, a weak economy, job losses or other macroeconomic factors."

In addition, CEO Toll believes that the market will rebound once it works its way through excess inventory. Fundamentals are solid and interest rates are still historically low, he said [in December 2006]. “We may be seeing a floor in some markets where deposits and traffic, although erratic from week to week, seem to be dancing on the bottom or slightly above.”

Anticipating a rebound in demand for home sites by midyear, shareholders have been furiously buying building stocks on the premise that Wall Street is overly pessimistic on the industry’s fundamentals. The Philadelphia Housing Sector Index (HGX) and the share price of Toll Brothers have climbed almost 22 percent and 20 percent, respectively, in the last three months.

Despite a lack of earnings’ visibility, as previously mentioned, the share price of Toll Brothers is responding to an uncertain turnaround in the housing sector. For investors looking to buy Toll Brothers, we suggest a wait-and-see approach.

For traders, we see the Street reacting to the Company’s guidance for the critical spring selling months ahead.

In its Proxy recently filed with the SEC, Toll Brothers reported that Robert Toll took home approximately $18.9 million in salary and bonus (combination of cash/stock) in 2006, down from $28.6 million in 2005 and $31.7 million in 2004. [These dollars do not include millions more received per annum in (long-term) stock-option grants.]

In 2006, Toll's bonus should have been $21.5 million, but in December 2005, the executive compensation committee and Messer. Toll amended his Cash Bonus Plan, tying it more closely to the share price of the Common Stock on October 31, 2006. Given the closing price of Toll Brothers’ share price was less than $36.91 on that date [actual closing price: $28.91], Messer. Toll and the company's executive compensation committee agreed to a $4 million reduction in his cash bonus.

“Given the slowing of the economy for homebuilding, he and the board felt it was appropriate,” CFO Joel Rassman told the Associated Press.

Lest our readers commend Robert Toll for this symbolic gesture, read on:

• During fiscal 2006, the Company sold a home to a daughter of Robert I. Toll and her husband, an employee of the Company, for a price of $1,582,186, which reflects a discount of $48,934 from the normal purchase price. Purportedly, “the discount is consistent with the Company’s policy of providing home purchase discounts to immediate family members of Company employees.”

[Ed. note. Toll Brothers employs more than 5,500 people. We doubt that this discount policy applies to ALL employees. A call to management seeking comment was not returned.]

• The Company is building and selling a home to a son of Robert I. Toll, too, for a price of approximately $2,098,550, which reflects a discount of $87,440 from the normal purchase price.
• The Company is building and selling a home to a daughter of Vice Chairman Bruce E. Toll and her husband, for a price of approximately $2,468,075, which reflects a discount of $105,925 from the normal purchase price. Bruce Toll, the brother of Robert Toll, serves as Vice Chairman of the Board.

Bruce E. Toll was President until April 1998 and Chief Operating Officer until November 1998. He is the founder and president of BET Investments, a commercial real estate company, and the owner of several car dealerships. Mr. Toll is also the Chairman of Philadelphia Media Holdings, L.L.C., which is the parent company of the Philadelphia Inquirer and the Philadelphia Daily News.

• Even though Messer. Toll is involved in the aforementioned activities, the Board still felt it worthy to effect an “Advisory and Non-Competition Agreement” with Bruce Toll back in November 2004. The Advisory Agreement provides, among other things, that (a) the Company will retain Mr. Bruce E. Toll as “Special Advisor to the Chairman” for a period of three years at compensation of $675,000 per year, (b) he will be paid $675,000 for each of the three years following the term (or termination) of the Advisory Agreement, too (so long as he does not violate certain non-competition and other provisions—Ha! Ha!), and (c) he will be entitled to group health insurance of the type and amount currently being provided to Company executives.
• In addition, Mr. Bruce E. Toll was designated a participant in the Company’s Supplemental Executive Retirement Plan, which provides an annual benefit of $230,000 for 20 years.
• During fiscal 2006, the Company provided Bruce E. Toll with additional perquisites with an estimated value of approximately $22,665. Such perquisites include group health insurance and contributions to the Company’s 401(k) plan. It is expected that the provision of perquisites like these will continue in fiscal 2007. [Ed. note. If he is no longer involved in the day-to-day affairs of Toll Brothers, why is the Company still making 401(k) contributions on his behalf? (Rhetorical) Might it be his last name is Toll?]
• The Audit Committee, concerned with “the safety and security of Company executives while traveling on Company business” and the extensive amount of time lost due to such travel, approved the chartering, from time to time, for business purposes, of an aircraft that is owned and operated by Grey Falcon, LLC and Grey Falcon Management, L.P., companies solely owned by Robert I. Toll and an affiliate of Robert I. Toll (surprise!). In fiscal 2006, Mr. Toll’s companies have received or are entitled to receive fees for chartering the aircraft of approximately $323,505 from the Company.
• As if the senior executives do not make enough monies--in fiscal 2004, the Company adopted an unfunded SERP. The SERP provides for annual benefits of $500,000 for Robert I. Toll, $260,000 for COO Zvi Barzilay, and $250,000 for CFO Joel H. Rassman.

Management anticipates that SG&A as a percentage of total revenues for 2007 will rise about 200 basis points, coming in between 11.2% and 11.7% of total revenues. The Company blames an anticipated reduction in revenues, the expenses associated with opening new communities, and advertising expenditures to help promote sales. Add to this list, unnecessary perquisites to the Toll Brothers, too.

Editor David J Phillips does not hold a financial interest in any home-building companies. The 10Q Detective has a Full Disclosure policy.