e10vq
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-Q
 
 
     
(Mark One)    
 
þ
  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
    For the quarterly period ended July 31, 2009
or
o
  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)
 
 
     
Delaware
  23-2416878
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)
250 Gibraltar Road, Horsham, Pennsylvania
  19044
(Address of principal executive offices)   (Zip Code)
 
 
(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 þ     No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o     No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
             
Large accelerated filer þ
  Accelerated filer o   Non-accelerated filer o
(Do not check if a smaller reporting company)
  Smaller reporting company o
 
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)  Yes o     No þ
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
 
At August 31, 2009, there were approximately 161,315,000 shares of Common Stock, $.01 par value, outstanding.
 


 

 
TOLL BROTHERS, INC. AND SUBSIDIARIES
 
TABLE OF CONTENTS
 
             
        Page No.
 
    1  
 
PART I. Financial Information
  Financial Statements     2  
    Condensed Consolidated Balance Sheets at July 31, 2009 (Unaudited) and October 31, 2008     2  
    Condensed Consolidated Statements of Operations For the Nine Months and Three Months Ended July 31, 2009 and 2008 (Unaudited)     3  
    Condensed Consolidated Statements of Cash Flows For the Nine Months Ended July 31, 2009 and 2008 (Unaudited)     4  
    Notes to Condensed Consolidated Financial Statements (Unaudited)     5  
  Management’s Discussion and Analysis of Financial Condition and Results of Operations     32  
  Quantitative and Qualitative Disclosures About Market Risk     52  
  Controls and Procedures     52  
 
PART II. Other Information
  Legal Proceedings     53  
  Risk Factors     54  
  Unregistered Sales of Equity Securities and Use of Proceeds     54  
  Defaults upon Senior Securities     54  
  Submission of Matters to a Vote of Security Holders     55  
  Other Information     55  
  Exhibits     55  
    56  


 

 
STATEMENT ON FORWARD-LOOKING INFORMATION
 
Certain information included in this report or in other materials we have filed or will file with the Securities and Exchange Commission (the “SEC”) (as well as information included in oral statements or other written statements made or to be made by us) contains or may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended. You can identify these statements by the fact that they do not relate strictly to historical or current facts. They contain words such as “anticipate,” “estimate,” “expect,” “project,” “intend,” “plan,” “believe,” “may,” “can,” “could,” “might,” “should” and other words or phrases of similar meaning in connection with any discussion of future operating or financial performance. Such statements may include, but are not limited to: information related to anticipated operating results; financial resources; changes in revenues; changes in profitability; changes in margins; changes in accounting treatment; interest expense; inventory write-downs; effects of home buyer cancellations; growth and expansion; joint ventures in which we are involved; anticipated income to be realized from our investments in unconsolidated entities; the ability to acquire land; the ability to gain approvals and to open new communities; the ability to sell homes and properties; the ability to deliver homes from backlog; the ability to secure materials and subcontractors; the ability to produce the liquidity and capital necessary to expand and take advantage of opportunities in the future; legal proceedings to which we are a party; potential exposure relating to construction defect, product liability and home warranty issues and the possible impact of any claims relating thereto; industry trends; and stock market valuations. From time to time, forward-looking statements also are included in our Form 10-K and other periodic reports on Forms 10-Q and 8-K, in press releases, in presentations, on our web site and in other materials released to the public.
 
Any or all of the forward-looking statements included in this report and in any other reports or public statements made by us are not guarantees of future performance and may turn out to be inaccurate. This can occur as a result of incorrect assumptions or as a consequence of known or unknown risks and uncertainties. These risks and uncertainties include: local, regional, national and international economic conditions, including the current economic turmoil and uncertainties in the U.S. and global credit and financial markets; demand for homes; domestic and international political events; uncertainties created by terrorist attacks; effects of governmental regulation, including effects from the Emergency Economic Stabilization Act, the American Recovery and Reinvestment Act, and any pending or new stimulus legislation and programs; the competitive environment in which we operate; changes in consumer confidence; volatility and fluctuations in interest rates; unemployment rates; changes in home prices, foreclosure rates and sales activity in the markets where we build homes; the availability and cost of land for future growth; excess inventory and adverse market conditions that could result in substantial inventory write-downs or write-downs in the value of investments in unconsolidated entities; the ability to realize our deferred tax assets; the availability of capital; uncertainties, fluctuations and volatility in the capital and securities markets; liquidity in the credit markets; changes in tax laws and their interpretation; the outcome of various legal proceedings; the availability of adequate insurance at reasonable cost; the impact of construction defect, product liability and home warranty claims, including the adequacy of self-insurance accruals, the applicability and sufficiency of our insurance coverage, and the insurance coverage and ability to pay of other responsible parties relating to such claims; the ability of customers to obtain adequate and affordable financing for the purchase of homes; the ability of home buyers to sell their existing homes; the ability of the participants in various joint ventures to honor their commitments; the availability and cost of labor and building and construction materials; the cost of oil, gas and other raw materials; construction delays; and weather conditions.
 
The factors mentioned in this report or in other reports or public statements made by us will be important in determining our future performance. Consequently, actual results may differ materially from those that might be anticipated from our forward-looking statements. 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.
 
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, 2008.
 
When this report uses the words “we,” “us,” “our,” and the “Company,” they refer to Toll Brothers, Inc. and its subsidiaries, unless the context otherwise requires. Reference herein to “fiscal 2009,” “fiscal 2008,” and “fiscal 2007” refer to our fiscal year ending October 31, 2009, and our fiscal years ended October 31, 2008, and October 31, 2007, respectively.
 
Forward-looking statements speak only as of the date they are made. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise. However, any further disclosures made on related subjects in our subsequent reports on Forms 10-K, 10-Q and 8-K should be consulted. On August 27, 2009, we issued a press release and held a conference call to review the results of operations for the nine-month and three-month periods ended July 31, 2009 and to discuss the current state of our business. The information contained in this report is the same information given in the press release and on the conference call on August 27, 2009, and we are not reconfirming or updating that information in this Form 10-Q.


1


 

 
PART I — FINANCIAL INFORMATION
 
ITEM 1.   FINANCIAL STATEMENTS
 
TOLL BROTHERS, INC. AND SUBSIDIARIES
 
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)
 
                 
    July 31,
    October 31,
 
    2009     2008  
    (Unaudited)        
 
ASSETS
Cash and cash equivalents
  $ 1,657,567     $ 1,633,495  
Inventory
    3,475,433       4,127,475  
Property, construction and office equipment, net
    74,420       86,462  
Receivables, prepaid expenses and other assets
    83,201       113,762  
Mortgage loans receivable
    51,149       49,255  
Customer deposits held in escrow
    19,474       18,913  
Investments in and advances to unconsolidated entities
    144,555       151,771  
Income tax refund receivable
    61,626          
Deferred tax assets
    151,700       405,703  
                 
    $ 5,719,125     $ 6,586,836  
                 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
               
Loans payable
  $ 515,534     $ 613,594  
Senior notes
    1,536,691       1,143,445  
Senior subordinated notes
    47,872       343,000  
Mortgage company warehouse loan
    33,290       37,867  
Customer deposits
    97,809       135,591  
Accounts payable
    85,773       134,843  
Accrued expenses
    626,267       738,596  
Income taxes payable
    157,850       202,247  
                 
Total liabilities
    3,101,086       3,349,183  
                 
Minority interest
    5,283        
Stockholders’ equity:
               
Preferred stock, none issued
               
Common stock, 161,266 and 160,370 shares issued at July 31, 2009 and October 31, 2008, respectively
    1,613       1,604  
Additional paid-in capital
    301,788       282,090  
Retained earnings
    2,309,264       2,953,655  
Treasury stock, at cost — 8 and 1 shares at July 31, 2009 and October 31, 2008, respectively
    (145 )     (21 )
Accumulated other comprehensive loss
    236       325  
                 
Total stockholders’ equity
    2,612,756       3,237,653  
                 
    $ 5,719,125     $ 6,586,836  
                 
 
See accompanying notes


2


 

 
TOLL BROTHERS, INC. AND SUBSIDIARIES
 
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share data)
 
                                 
    Nine Months Ended
       
    July 31,     Three Months Ended July 31,  
    2009     2008     2009     2008  
    (Unaudited)  
 
Revenues
  $ 1,268,725     $ 2,457,037     $ 461,375     $ 796,711  
                                 
Cost of revenues
    1,445,288       2,449,401       511,548       738,926  
Selling, general and administrative expenses
    235,726       333,127       68,617       103,104  
                                 
      1,681,014       2,782,528       580,165       842,030  
                                 
Loss from operations
    (412,289 )     (325,491 )     (118,790 )     (45,319 )
Other:
                               
Loss from unconsolidated entities
    (8,355 )     (135,756 )     (3,739 )     (30,113 )
Expenses related to early retirement of debt
    (2,067 )                        
Interest and other
    32,982       100,486       11,265       20,637  
                                 
Loss before income taxes
    (389,729 )     (360,761 )     (111,264 )     (54,795 )
Income tax provision (benefit)
    254,662       (141,772 )     361,067       (25,500 )
                                 
Net loss
  $ (644,391 )   $ (218,989 )   $ (472,331 )   $ (29,295 )
                                 
Net loss per share:
                               
Basic
  $ (4.00 )   $ (1.38 )   $ (2.93 )   $ (0.18 )
                                 
Diluted
  $ (4.00 )   $ (1.38 )   $ (2.93 )   $ (0.18 )
                                 
Weighted average number of shares:
                               
Basic
    161,026       158,398       161,245       158,761  
Diluted
    161,026       158,398       161,245       158,761  
 
See accompanying notes


3


 

 
TOLL BROTHERS, INC. AND SUBSIDIARIES
 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
 
                 
    Nine Months Ended July 31,  
    2009     2008  
    (Unaudited)  
 
Cash flow from operating activities:
               
Net loss
    (644,391 )   $ (218,989 )
Adjustments to reconcile net loss to net
cash provided by operating activities:
               
Depreciation and amortization
    18,353       21,062  
Stock-based compensation
    9,678       19,884  
Excess tax benefits from stock-based compensation
    (3,570 )     (8,543 )
Impairment of investments in unconsolidated entities
    11,300       146,251  
Income from unconsolidated entities
    (2,945 )     (10,495 )
Distributions of earnings from unconsolidated entities
    813       41,669  
Deferred tax benefit
    (189,677 )     (215,891 )
Deferred tax valuation allowances
    443,680       22,638  
Inventory impairments
    379,928       526,729  
Write-off of unamortized debt issuance costs
    692          
Changes in operating assets and liabilities:
               
Decrease in inventory
    264,283       499,515  
Origination of mortgage loans
    (426,372 )     (720,917 )
Sale of mortgage loans
    424,478       764,389  
Decrease in contracts receivable
            41,853  
Increase in income tax refund receivable
    (61,626 )        
Decrease in receivables, prepaid expenses and other assets
    30,262       23,040  
Decrease in customer deposits
    (38,343 )     (76,030 )
Decrease in accounts payable and accrued expenses
    (120,253 )     (158,665 )
Decrease in current income taxes payable
    (39,319 )     (36,638 )
                 
Net cash provided by operating activities
    56,971       660,862  
                 
Cash flow from investing activities:
               
Purchase of property and equipment
    (2,496 )     (3,554 )
Purchases of marketable securities
            (1,468,440 )
Sale of marketable securities
            1,458,887  
Investments in and advances to unconsolidated entities
    (20,220 )     (46,900 )
Return of investments from unconsolidated entities
    1,443       2,623  
                 
Net cash used in investing activities
    (21,273 )     (57,384 )
                 
Cash flow from financing activities:
               
Net proceeds from issuance of senior notes
    389,400          
Proceeds from loans payable
    450,816       801,558  
Redemption and repurchase of senior subordinated notes
    (295,128 )        
Principal payments of loans payable
    (565,168 )     (823,127 )
Proceeds from stock-based benefit plans
    6,128       13,044  
Excess tax benefits from stock-based compensation
    3,570       8,543  
Purchase of treasury stock
    (1,244 )     (1,476 )
Change in minority interest
            3  
                 
Net cash used in financing activities
    (11,626 )     (1,455 )
                 
Net increase in cash and cash equivalents
    24,072       602,023  
Cash and cash equivalents, beginning of period
    1,633,495       900,337  
                 
Cash and cash equivalents, end of period
  $ 1,657,567     $ 1,502,360  
                 
 
See accompanying notes


4


 

 
 
TOLL BROTHERS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
1.   Significant Accounting Policies
 
Basis of Presentation
 
The accompanying unaudited condensed consolidated financial statements include the accounts of Toll Brothers, Inc. (the “Company”), a Delaware corporation, and its majority-owned subsidiaries. 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, 2008 balance sheet amounts and disclosures included herein have been derived from the Company’s October 31, 2008 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 Annual Report on Form 10-K for the fiscal year ended October 31, 2008. 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, 2009, the results of its operations for the nine-month and three-month periods ended July 31, 2009 and 2008, and its cash flows for the nine-month periods ended July 31, 2009 and 2008. The results of operations for such interim periods are not necessarily indicative of the results to be expected for the full year.
 
Income Taxes — Valuation Allowance
 
Significant judgment is required in estimating valuation allowances for deferred tax assets. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes” (“SFAS 109”), a valuation allowance is established against a deferred tax asset if, based on the available evidence, it is more likely than not that such asset will not be realized. The realization of a deferred tax asset ultimately depends on the existence of sufficient taxable income in either the carryback or carryforward periods under tax law. The Company periodically assesses the need for valuation allowances for deferred tax assets based on SFAS 109’s more-likely-than-not realization threshold criterion. In the Company’s assessment, appropriate consideration is given to all positive and negative evidence related to the realization of the deferred tax assets. This assessment considers, among other matters, the nature, frequency and severity of current and cumulative income and losses, forecasts of future profitability, the duration of statutory carryback or carryforward periods, its experience with operating loss and tax credit carryforwards being used before expiration, and tax planning alternatives.
 
In accordance with SFAS 109, the Company assesses whether a valuation allowance should be established based on its determination of whether it is “more likely than not” that some or all of the deferred tax assets will not be realized. The Company’s assessment of the need for a valuation allowance on its deferred tax assets includes assessing the likely future tax consequences of events that have been recognized in its consolidated financial statements or tax returns. The Company bases its estimate of deferred tax assets and liabilities on current tax laws and rates and, in certain cases, on business plans and other expectations about future outcomes. Changes in existing tax laws or rates could affect actual tax results and future business results may affect the amount of deferred tax liabilities or the valuation of deferred tax assets over time. The Company’s accounting for deferred tax assets represents its best estimate of future events using the guidance provided by SFAS 109.
 
Due to uncertainties in the estimation process, particularly with respect to changes in facts and circumstances in future reporting periods (carryforward period assumptions), it is reasonably possible that actual results could differ from the estimates used in the Company’s historical analyses. The Company’s assumptions require significant


5


 

 
TOLL BROTHERS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
judgment because the residential homebuilding industry is cyclical and is highly sensitive to changes in economic conditions. If the Company’s results of operations are less than projected and there is insufficient objectively verifiable evidence to support the likely realization of its deferred tax assets, a valuation allowance would be required to reduce or eliminate its deferred tax assets.
 
Recent Accounting Pronouncements
 
In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 provides guidance for using fair value to measure assets and liabilities. SFAS 157 also responds to investors’ requests for expanded information about the extent to which a company measures assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. The Company adopted SFAS 157 with respect to financial instruments effective for its fiscal year beginning November 1, 2008. See Note 10, “Fair Value Disclosures” for information concerning the adoption of SFAS 157. In February 2008, the FASB issued FASB Staff Position (“FSP”) FAS 157-2 (“FSP 157-2”) which delays the effective date of SFAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). FSP 157-2 applies to, but is not limited to, long-lived assets (asset groups) measured at fair value for an impairment assessment (i.e., inventory impairment assessments). FSP 157-2 defers the effective date for nonfinancial assets and nonfinancial liabilities of SFAS 157 for the Company to November 1, 2009. The Company is currently evaluating the impact, if any, of SFAS 157 related to nonfinancial assets and nonfinancial liabilities on the Company’s consolidated financial position, results of operations and cash flows.
 
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 permits entities to choose to measure certain financial assets and liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be reported in earnings. The election, called the “fair value option,” enables companies to reduce the volatility in reported earnings caused by measuring related assets and liabilities differently, and is simpler than using the complex hedge-accounting requirements in SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”) to achieve similar results. The Company adopted SFAS 159 effective for its fiscal year beginning November 1, 2008. See Note 10, “Fair Value Disclosures” for information concerning the adoption of SFAS 159.
 
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an Amendment to ARB No. 51” (“SFAS 160”). Under the provisions of SFAS 160, a noncontrolling interest in a subsidiary, or minority interest, must be classified as equity and the amount of consolidated net income (loss) specifically attributable to the minority interest must be clearly identified in the consolidated statement of operations. SFAS 160 also requires consistency in the manner of reporting changes in the parent’s ownership interest and requires fair value measurement of any noncontrolling interest retained in a deconsolidation. SFAS 160 will be effective for the Company’s fiscal year beginning November 1, 2009. The Company is currently evaluating the impact of the adoption of SFAS 160; however, it is not expected to have a material impact on the Company’s consolidated financial position, results of operations and cash flows.
 
In June 2008, the FASB issued FSP Emerging Issues Task Force 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities.” Under this FSP, unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents are considered participating securities and, therefore, are included in computing earnings per share pursuant to the two-class method. The two-class method determines earnings per share for each class of common stock and participating securities according to dividends or dividend equivalents and their respective participation rights in undistributed earnings. This FSP is effective for the Company’s fiscal year beginning November 1, 2009 and requires retrospective application. The adoption of this FSP it is not expected to have a material impact on the Company’s reported earnings per share.
 
In April 2009, the FASB issued FSP No. FAS 107-1 and Accounting Principles Board (“APB”) Opinion No. 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (“FSP 107-1”). FSP 107-1 amends


6


 

 
TOLL BROTHERS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
SFAS No. 107, “Disclosures about Fair Value of Financial Instruments,” and APB Opinion No. 28, “Interim Financial Reporting,” to require disclosures about the fair value of financial instruments during interim reporting periods. FSP 107-1 is effective for interim and annual periods ending after June 15, 2009. The Company has included the required disclosures into this Quarterly Report on Form 10-Q for the quarter ended July 31, 2009. The adoption of FSP 107-1 did not have a material impact on the Company’s consolidated financial statements.
 
In May 2009, the FASB issued SFAS No. 165, “Subsequent Events” (“SFAS 165”). SFAS 165 provides guidance regarding general standards of accounting for, and disclosures of, events that occur after the date of the balance sheet, but before financial statements are issued or are available to be issued. SFAS 165 sets forth: (i) the period after the date of the balance sheet during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, (ii) the circumstances under which an entity should recognize events or transactions occurring after the date of the balance sheet in its financial statements, and (iii) the disclosures that an entity should make about events or transactions that occurred after the date of the balance sheet. SFAS 165 is effective for interim periods ending after June 15, 2009. The Company has evaluated subsequent events occurring after July 31, 2009 through the time of filing this Form 10-Q and has made appropriate disclosures pursuant to SFAS 165.
 
In June 2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial Assets — an amendment of FASB Statement No. 140” (“SFAS 166”). SFAS 166 eliminates the concept of a qualifying special-purpose entity, creates more stringent conditions for reporting a transfer of a portion of a financial asset as a sale, clarifies other sale-accounting criteria, and changes the initial measurement of a transferor’s interest in transferred financial assets. SFAS 166 is applicable for annual periods beginning after November 15, 2009 and interim periods therein and thereafter. SFAS 166 will be effective for the Company’s fiscal year beginning November 1, 2010. The Company is currently assessing the impact, if any, of SFAS 166 on its consolidated financial statements.
 
In June 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)” (“SFAS 167”). SFAS 167 eliminates FASB Interpretation 46(R)’s exceptions to consolidating qualifying special-purpose entities, contains new criteria for determining the primary beneficiary of a variable interest entity, and increases the frequency of required reassessments to determine whether a company is the primary beneficiary of a variable interest entity. SFAS 167 is effective for annual reporting periods beginning after November 15, 2009. Earlier application is prohibited. SFAS 167 will be effective for the Company’s fiscal year beginning November 1, 2010. The Company is currently assessing the impact, if any, of SFAS 167 on its consolidated financial statements.
 
In June 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles — a replacement of FASB Statement No. 162” (“SFAS 168”) as the single source of authoritative nongovernmental U.S. GAAP. SFAS 168 does not change current U.S. GAAP, but is intended to simplify user access to all authoritative U.S. GAAP by providing all authoritative literature related to a particular topic in one place. All existing accounting standard documents will be superseded and all other accounting literature not included in SFAS 168 will be considered nonauthoritative. SFAS 168 is effective for interim and annual periods ending after September 15, 2009. SFAS 168 is effective for the Company’s fiscal 2009 annual reporting period and will not have an impact on the Company’s financial condition or results of operations. The Company is currently evaluating the impact to its financial reporting process of providing SFAS 168 references in its public filings.


7


 

 
TOLL BROTHERS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Reclassification
 
The Company has determined that the amount of recent land sales revenues and costs is immaterial to its statements of operations and, effective November 1, 2008, included the net amount of income realized from these sales in “Other: Interest and other” on the Company’s Condensed Consolidated Statements of Operations included in this Form 10-Q. In order to conform the Company’s Condensed Consolidated Statement of Operations for the nine-month and three-month periods ended July 31, 2008 to the presentation for the nine-month and three-month periods ended July 31, 2009, income realized from land sales for the fiscal 2008 periods was reclassified to “Other: Interest and other” on the Company’s Condensed Consolidated Statement of Operations included in this Form 10-Q. The following amounts have been reclassified from the fiscal 2008 presentation (amounts in thousands):
 
                 
    Nine Months Ended
    Three Months Ended
 
    July 31, 2008     July 31, 2008  
 
Sales
  $ 2,275     $ 959  
Cost of revenues — land sales
    1,910       816  
Cost of revenues — interest on land sales
    128       88  
                 
Reclassified to other: Interest and other
  $ 237     $ 55  
                 
 
The presentation of certain other prior period amounts have been reclassified to conform to the fiscal 2009 presentation.
 
2.   Inventory
 
Inventory at July 31, 2009 and October 31, 2008 consisted of the following (amounts in thousands):
 
                 
    July 31,
    October 31,
 
    2009     2008  
 
Land controlled for future communities
  $ 53,029     $ 69,124  
Land owned for future communities
    755,819       819,005  
Operating communities
    2,666,585       3,239,346  
                 
    $ 3,475,433     $ 4,127,475  
                 
 
Included in operating communities is: the cost of homes under construction, land and land development costs, the carrying cost of home sites in current and future phases of these communities and the carrying cost of model homes.
 
The Company provided for inventory impairment charges and the expensing of costs that it believed not to be recoverable in the nine-month and three-month periods ended July 31, 2009 and 2008 as shown in the table below (amounts in thousands).
 
                                 
    Nine Months Ended
    Three Months Ended
 
    July 31,     July 31,  
    2009     2008     2009     2008  
 
Land controlled for future communities
  $ 24,364     $ 89,374     $ 14,272     $ 9,660  
Land owned for future communities
    133,033       122,100       48,583       36,400  
Operating communities
    222,531       315,255       46,821       59,930  
                                 
    $ 379,928     $ 526,729     $ 109,676     $ 105,990  
                                 


8


 

 
TOLL BROTHERS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Operating communities include communities offering homes for sale, communities that have sold all available homesites but have not completed delivery of the homes, communities that were previously offering homes for sale but are temporarily closed due to business conditions or non-availability of improved homesites, and communities preparing to open for sale. The Company reviews the profitability of each of its operating communities during each fiscal quarter. For those communities operating below certain profitability thresholds, or where other negative factors, such as a decline in market or economic conditions in the market where the community is located, or high cancellation rates and a significant increase in speculative inventory in the community or in the market in general exist, the Company determines the estimated fair value of those communities and whether the estimated fair value exceeds their carrying value. The table below provides, for the periods indicated, the number of operating communities that the Company tested for potential impairment, the number of operating communities in which the Company recognized impairment charges, and the amount of impairment charges recognized, and, as of the end of the period indicated, the fair value of those communities, net of impairment charges ($ amounts in millions).
 
                                 
          Impaired Communities  
                Fair Value of
       
                Communities
       
    Number of
          Net of
       
    Communities
    Number of
    Impairment
    Impairment
 
    Tested     Communities     Charges     Charges  
 
Three months ended:
                               
Fiscal 2009:
                               
January 31
    289       40     $ 216.2     $ 108.3  
April 30
    288       36     $ 181.8       67.4  
July 31
    288       14     $ 67.7       46.8  
                                 
                            $ 222.5  
                                 
Fiscal 2008:
                               
January 31
    211       36     $ 328.2     $ 134.3  
April 30
    297       39     $ 272.2       121.0  
July 31
    296       18     $ 144.5       59.9  
                                 
                            $ 315.2  
                                 
 
At July 31, 2009, the Company evaluated its land purchase contracts to determine if any of the selling entities were variable interest entities (“VIEs”) and, if they were, whether the Company was the primary beneficiary of any of them. Under these land purchase contracts, the Company does not possess legal title to the land and its risk is generally limited to deposits paid to the sellers; the creditors of the sellers generally have no recourse against the Company. At July 31, 2009, the Company had determined that it was the primary beneficiary of one VIE related to a land purchase contract and had recorded $11.7 million of inventory and $6.4 million of accrued expenses. In addition, the Company had determined that it was not the primary beneficiary of 15 VIEs related to land purchase contracts with an aggregate purchase price of $148.8 million, on which it had made aggregate deposits totaling $6.7 million.
 
The Company capitalizes certain interest costs to qualified inventory during the development and construction period of its communities in accordance with SFAS No. 34, “Capitalization of Interest Costs” (“SFAS 34”). Capitalized interest is charged to cost of revenues when the related inventory is delivered. Interest incurred on homebuilding indebtedness in excess of qualified inventory, as defined in SFAS 34, is charged to selling, general and administrative expense in the period incurred. In the six-month and three-month periods ended April 30, 2009, the Company expensed interest of $5.2 million and $4.4 million, respectively, directly to SG&A. During the three-month period ended July 31, 2009, the Company reviewed the methodology it applied in identifying qualified inventory used in the calculation of capitalized interest, and determined that the amount of qualified inventory was


9


 

 
TOLL BROTHERS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
higher than the Company had previously identified and that a portion of the interest previously expensed directly to SG&A in the six-month and three-month periods ended April 30, 2009 should have been capitalized. As a result of this review, the Company reversed and capitalized $4.6 million of previously expensed interest, thereby reducing SG&A by $4.6 million in the three-month period ended July 31, 2009; however, due to the decline in qualified inventory during the three-month period ended July 31, 2009, interest incurred on homebuilding indebtedness exceeded amounts required to be capitalized in the three-month period by $1.2 million. This excess interest was charged to SG&A in the period. Prior to November 1, 2008, qualified inventory exceeded homebuilding indebtedness and all interest incurred was capitalized. Interest incurred, capitalized and expensed for the nine-month and three-month periods ended July 31, 2009 and 2008, was as follows (amounts in thousands):
 
                                 
    Nine Months Ended July 31,     Three Months Ended July 31,  
    2009     2008     2009     2008  
 
Interest capitalized, beginning of period
  $ 238,832     $ 215,571     $ 258,031     $ 235,094  
Interest incurred
    87,527       93,205       31,236       29,524  
Interest expensed to cost of revenues
    (55,138 )     (67,166 )     (23,403 )     (23,082 )
Interest expensed to selling, general and administrative expense
    (1,792 )             3,453          
Write-off against other income
    (1,729 )     (174 )     (1,617 )     (100 )
                                 
Interest capitalized, end of period
  $ 267,700     $ 241,436     $ 267,700     $ 241,436  
                                 
 
Inventory impairment charges are recognized against all inventory costs of a community, such as land, land improvements, cost of home construction and capitalized interest. The amounts included in the table directly above reflect the gross amount of capitalized interest without allocation of any impairment charges recognized. The Company estimates that, had inventory impairment charges been allocated on a pro rata basis to the individual components of inventory, capitalized interest at July 31, 2009 and 2008 would have been reduced by approximately $60.5 million and $42.8 million, respectively.
 
3.   Investments in and Advances to Unconsolidated Entities
 
Development Joint Ventures
 
The Company has investments in, and advances to, a number of joint ventures with unrelated parties to develop land (“Development Joint Ventures”). Some of these Development Joint Ventures develop land for the sole use of the venture participants, including the Company, and others develop land for sale to the joint venture participants and to unrelated builders. The Company recognizes its share of earnings from the sale of home sites by Development Joint Ventures to other builders. With regard to home sites the Company purchases from the Development Joint Ventures, the Company reduces its cost basis in those home sites by its share of the earnings on the home sites. At July 31, 2009, the Company had approximately $58.5 million, net of impairment charges, invested in or advanced to Development Joint Ventures. The Company has a funding commitment of $3.5 million to one Development Joint Venture, should an additional investment in that venture be required.
 
At July 31, 2009, the Development Joint Ventures had aggregate loan commitments of $1.07 billion and had approximately $1.07 billion borrowed against these commitments. With respect to loans obtained by some of the Development Joint Ventures, the Company executed completion guarantees and conditional repayment guarantees. The obligations under such completion guarantees and conditional repayment guarantees are several and not joint, and are limited to the Company’s pro-rata share of the loan obligations of each such respective Development Joint Venture. At July 31, 2009, the maximum liability, if any, under such completion guarantees and conditional repayment guarantees (net of amounts that the Company has accrued) is estimated to be approximately $50.3 million.


10


 

 
TOLL BROTHERS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
As of July 31, 2009, the Company had recognized cumulative impairment charges in connection with its current Development Joint Ventures of $178.9 million. Some of these impairment charges are attributable to investments in a certain Development Joint Venture that the Company did not believe were fully recoverable. The Company recognized impairment charges in connection with its Development Joint Ventures of $5.3 million in the nine-month and three-month periods ended July 31, 2009, and $141.3 million and $28.4 million of impairment charges in the nine-month and three-month periods ended July 31, 2008, respectively.
 
Two of the Development Joint Ventures have received notices of default from their respective lending syndicates. In October 2008, the lending syndicate for one of the Development Joint Ventures completed a foreclosure on the land owned by that Development Joint Venture and filed a lawsuit against its members, including the parent companies of the members, seeking to recover damages under the completion guarantees. Each of the completion guarantees delivered by the members of that Development Joint Venture is several and not joint, therefore, the liability of the Company is limited to the Company’s pro-rata share of any damages awarded under such completion guarantees. In December 2008, the lending syndicate for the second Development Joint Venture filed separate lawsuits against the members of the Development Joint Venture and their parent companies, seeking to recover damages under the completion guarantees and damages allegedly caused by the venture’s failure to repay the lenders. The Company does not believe that these alleged Development Joint Venture defaults and related lawsuits will have a material impact on the Company’s results of operations, cash flows and financial condition.
 
Planned Community Joint Venture
 
The Company is a participant in a joint venture with an unrelated party to develop a single master planned community (the “Planned Community Joint Venture”). The Company and the other participant each contributed assets with an agreed-upon fair value of $48.0 million, including $3.0 million of cash. At July 31, 2009, each participant had agreed to contribute additional funds up to $12.4 million if required. If a participant fails to make a required capital contribution, the other participant may make the additional contribution and diminish the non-contributing participant’s ownership interest. At July 31, 2009, the Company had an investment of $49.2 million in this Planned Community Joint Venture.
 
Condominium Joint Ventures
 
At July 31, 2009, the Company had $24.0 million of investments in four joint ventures with unrelated parties to develop luxury condominium projects, including for-sale residential units and commercial space (“Condominium Joint Ventures”). At July 31, 2009, the Condominium Joint Ventures had aggregate loan commitments of $320.8 million, against which approximately $241.4 million had been borrowed. At July 31, 2009, the Company had guaranteed $13.0 million of the loans and other liabilities of these Condominium Joint Ventures.
 
One of these Condominium Joint Ventures is developing a condominium project in two phases. Construction of the first phase has been substantially completed and deliveries commenced in May 2008; the Company has the right to withdraw from phase two of the project upon the payment of a $30 million termination fee to its partner. As of July 31, 2009, the Company had recognized cumulative impairment charges against its investments in the Condominium Joint Ventures, and its pro-rata share of impairment charges recognized by these Condominium Joint Ventures, in the aggregate amount of $63.9 million. At July 31, 2009, the Company did not have any commitments to make contributions to any Condominium Joint Venture in excess of those that the Company already has accrued.
 
Trust and Trust II
 
In fiscal 2005, the Company, together with the Pennsylvania State Employees Retirement System (“PASERS”), formed Toll Brothers Realty Trust 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 an affiliate of PASERS. At July 31, 2009, the Company had an investment of $11.9 million in Trust II. In addition, the Company and PASERS each


11


 

 
TOLL BROTHERS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
entered into subscription agreements which expire in September 2009, whereby each agreed to invest additional capital in an amount not to exceed $11.1 million if required by Trust II.
 
Prior to the formation of Trust II, the Company used Toll Brothers Realty Trust (the “Trust”) to invest in commercial real estate opportunities. The Trust 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 members of the Company’s current and former senior management; and one-third by an affiliate of PASERS (collectively, the “Shareholders”). At July 31, 2009, the Company’s investment in the Trust was $0.9 million. The Company provides development, finance and management services to the Trust and recognized fees under the terms of various agreements in the amount of $1.6 million in each of the nine-month periods ended July 31, 2009 and 2008, and $0.5 million in each of the three-month periods ended July 31, 2009 and 2008. 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.
 
General
 
At July 31, 2009, the Company had $112.6 million accrued for its commitments to Development Joint Ventures, the Planned Community Joint Venture, Condominium Joint Ventures, Trust II and the Trust. The Company’s investments in these entities are accounted for using the equity method. Impairment charges related to these entities are included in “Loss from unconsolidated entities” in the Company’s Condensed Consolidated Statements of Operations.
 
4.   Accrued Expenses
 
Accrued expenses at July 31, 2009 and October 31, 2008 consisted of the following (amounts in thousands):
 
                 
    July 31,
    October 31,
 
    2009     2008  
 
Land, land development and construction
  $ 136,045     $ 184,017  
Compensation and employee benefits
    77,745       93,529  
Insurance and litigation
    159,099       158,307  
Commitments to unconsolidated entities
    112,590       128,227  
Warranty
    53,437       57,292  
Interest
    36,064       38,624  
Other
    51,287       78,600  
                 
    $ 626,267     $ 738,596  
                 
 
The Company accrues for expected warranty costs at the time each home is closed and title and possession are 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, 2009 and 2008 were as follows (amounts in thousands):
 
                                 
    Nine Months Ended July 31,     Three Months Ended July 31,  
    2009     2008     2009     2008  
 
Balance, beginning of period
  $ 57,292     $ 59,249     $ 54,463     $ 60,816  
Additions — homes closed during the period
    7,450       18,039       2,882       6,719  
Additions — adjustments to accruals for homes closed in prior periods
    988       2,184       699       474  
Charges incurred
    (12,293 )     (17,331 )     (4,607 )     (5,868 )
                                 
Balance, end of period
  $ 53,437     $ 62,141     $ 53,437     $ 62,141  
                                 


12


 

 
TOLL BROTHERS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
 
5.   Senior Notes, Senior Subordinated Notes and Mortgage Warehouse Line
 
On April 13, 2009, the Company, through Toll Brothers Finance Corp., its wholly-owned subsidiary, issued $400 million of 8.91% Senior Notes due 2017 (the “8.91% Senior Notes”). The Company received $389.4 million of net proceeds from the issuance of the 8.91% Senior Notes. The 8.91% Senior Notes are the unsecured obligations of Toll Brothers Finance Corp. The payment of principal and interest on the 8.91% Senior Notes is fully and unconditionally guaranteed, jointly and severally, by the Company and a majority of its homebuilding subsidiaries (together with Toll Brothers Finance Corp., the “8.91% Senior Note Parties”). The 8.91% Senior Notes rank equally in right of payment with all the 8.91% Senior Note Parties’ existing and future unsecured senior indebtedness, including the Company’s bank revolving credit facility. The 8.91% Senior Notes are structurally subordinated to the prior claims of creditors, including trade creditors, of the subsidiaries of the Company that are not guarantors of the 8.91% Senior Notes. The 8.91% Senior Notes are redeemable in whole or in part at any time at the option of the Company, at prices that vary based upon the then-current rates of interest and the remaining original term of the 8.91% Senior Notes.
 
During the three months ended July 31, 2009, the Company redeemed all of the remaining $193.0 million outstanding principal amount of its Toll Corp. 81/4% Senior Subordinated Notes due February 2011 at a cash redemption price of 100.0% of the principal amount plus accrued and unpaid interest, and $100.0 million outstanding principal amount of its Toll Corp. 8.25% Senior Subordinated Notes due December 2011 at a cash redemption price of 101.375% of the principal amount plus accrued and unpaid interest. In addition, during the three months ended July 31, 2009, the Company purchased an additional $2.1 million of its Toll Corp. 8.25% Senior Subordinated Notes due December 2011 through open-market purchases. At July 31, 2009, $47.9 million of the 8.25% Senior Subordinated Notes due December 2011, were outstanding. In the nine-month period ended July 31, 2009 and three-month period ended April 30, 2009, the Company recognized a charge of $2.1 million representing the write-off of unamortized debt issuance costs associated with both series of notes and the call premium on the 8.25% Senior Subordinated Notes due December 2011.
 
On August 13, 2009, TBI Mortgage Company (“TBI Mortgage”), the Company’s wholly-owned mortgage subsidiary, entered into a Master Repurchase Agreement with Comerica Bank, as agent and representative of itself as a buyer and the other buyers named therein (the “Repurchase Agreement”). The Repurchase Agreement replaced TBI Mortgage’s warehouse credit facility which was set to expire on August 13, 2009. The purpose of the Repurchase Agreement is to finance the origination of mortgage loans by TBI Mortgage and is accounted for as a secured borrowing under SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities.” The Repurchase Agreement provides for loan purchases up to $75 million, subject to certain sublimits. In addition, the Repurchase Agreement provides for an accordion feature under which TBI Mortgage may request that the aggregate commitments under the Repurchase Agreement be increased to an amount up to $100 million. The Repurchase Agreement expires on July 29, 2010.
 
At July 31, 2009, the aggregate estimated fair value of the Company’s $515.5 million of loans payable, based upon the interest rates that the Company believes were available to it for loans with similar terms and remaining maturities, was approximately $513.3 million. At July 31, 2009, the aggregate estimated fair value of the Company’s $1.58 billion of senior notes and senior subordinated notes, based upon their indicated market prices, was approximately $1.56 billion. The Company believes that the carrying value of its $33.3 million mortgage warehouse loan outstanding at July 31, 2009 approximates its fair value.


13


 

 
TOLL BROTHERS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
 
6.   Income Taxes
 
A reconciliation of the Company’s effective tax rate from the federal statutory rate for the nine-month and three-month periods ended July 31, 2009 and 2008 is as follows ($ amounts in thousands):
 
                                                                 
    Nine Months Ended July 31,     Three Months Ended July 31,  
    2009     2008     2009     2008  
    $     %     $     %     $     %     $     %  
 
Federal tax benefit at statutory rate
    (136,405 )     (35.0 )     (126,266 )     (35.0 )     (38,942 )     (35.0 )     (19,178 )     (35.0 )
State taxes net of federal benefit
    (11,400 )     (2.9 )     (20,284 )     (5.6 )     (3,978 )     (3.6 )     (3,739 )     (6.8 )
Reversal of tax provisions due to expiration of statutes and settlements
    (59,150 )     (15.2 )     (9,100 )     (2.5 )     (44,150 )     (39.7 )     (9,100 )     (16.6 )
Accrued interest on anticipated tax assessments
    6,828       1.8       6,090       1.7       (29 )             2,030       3.7  
Valuation allowance — federal
    416,760       106.9                       416,760       374.6                  
Valuation allowance — state
    26,920       6.9       13,000       3.6       22,638       20.3       4,550       8.3  
Non-taxable income
                    (3,729 )     (1.0 )                     (535 )     (1.0 )
Tax credits
                    (1,575 )     (0.5 )                                
Other
    11,109       2.8       92               8,768       7.9       472       0.9  
                                                                 
Tax provision (benefit)
    254,662       65.3       (141,772 )     (39.3 )     361,067       324.5       (25,500 )     (46.5 )
                                                                 
 
A reconciliation of the change in the gross unrecognized tax benefits for the nine-month and three-month periods ended July 31, 2009 and 2008 is as follows (amounts in thousands):
 
                                 
    Nine Months Ended July 31,     Three Months Ended July 31,  
    2009     2008     2009     2008  
 
Balance, beginning of period
  $ 320,679     $ 364,300     $ 297,216     $ 329,638  
Increase in benefit as a result of tax positions taken in prior years
    11,000       15,314               11,814  
Increase in benefit as a result of tax positions taken in current year
    6,000       15,391       2,000          
Decrease in benefit as a result of settlements
    (138,329 )     (82,293 )     (124,866 )     (28,740 )
Decrease in benefit as a result of lapse of statute of limitation
    (41,500 )             (16,500 )        
                                 
Balance, end of period
  $ 157,850     $ 312,712     $ 157,850     $ 312,712  
                                 
 
During the nine-month period ended July 31, 2009, the Company reached final settlement of its federal tax returns for fiscal years through 2006, State of California tax returns for fiscal years through 2006, and State of New Jersey and State of Arizona tax returns for fiscal years through 2007. The final settlement with the State of New Jersey and State of Arizona for fiscal years through 2007 occurred during the three-month period ended July 31, 2009. The federal and state settlements resulted in a reduction in the Company’s unrecognized tax benefits. The state impact of any amended federal return remains subject to examination by various states for a period of up to one year after formal notification of such amendments to the states. The Company’s and its subsidiaries’ fiscal 2007 and 2008 federal income tax returns and various state and other income tax returns are in the process of examination or administrative appeal.
 
The Company’s unrecognized net tax benefits are included in “Income taxes payable” on the Company’s Condensed Consolidated Balance Sheets. The Company’s unrecognized tax benefits at July 31, 2009 were $157.9 million. If these unrecognized tax benefits reverse in the future, they would have a beneficial impact on the Company’s effective tax rate at that time. During the next twelve months, it is reasonably possible that the amount of unrecognized tax benefits will change. The anticipated changes will be principally due to the expiration


14


 

 
TOLL BROTHERS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
of tax statutes, settlements with taxing jurisdictions, increases due to new tax positions taken and the accrual of estimated interest and penalties.
 
Potential interest and penalties are recognized as a component of the provision for income taxes. During the nine-month periods ended July 31, 2009 and 2008, the Company recognized in its tax provision, before reduction for applicable taxes, estimated interest and penalties of approximately $11.0 million and $10.5 million, respectively. During the three-month periods ended July 31, 2009 and 2008, the Company recognized in its tax provision, before reduction for applicable taxes, estimated interest and penalties of approximately $0.0 million and $3.5 million, respectively. At July 31, 2009 and October 31, 2008, the Company had accrued interest and penalties, before reduction of applicable taxes, of $50.3 million and $150.5 million, respectively; these amounts were included in “Income taxes payable” on the Company’s Condensed Consolidated Balance Sheets. The decrease in the nine-month period ended July 31, 2009 relates primarily to the payment of interest on settled audits and the reversal of interest accrued in prior years against potential tax assessments no longer needed due to the expiration of the applicable federal and state statute of limitations or the settlement with state tax authorities, offset, in part, by additional interest accrued during the period.
 
The Company recorded significant federal deferred tax assets in fiscal 2007, fiscal 2008 and in the nine-month period ended July 31, 2009. These federal deferred tax assets were generated primarily by inventory impairments and impairments of investments in and advances to unconsolidated entities. At July 31, 2009, the Company’s net federal deferred tax assets, before valuation allowance, were $568.5 million. At July 31, 2009, in accordance with SFAS 109, the Company assessed whether a valuation allowance should be established based on its determination of whether it is “more likely than not” that some portion or all of the deferred tax assets will not be realized. The Company believes that the continued downturn in the housing market, the uncertainty as to its length and magnitude, and the Company’s continued recognition of impairment charges, are significant evidence of the need for a valuation allowance against its net federal deferred tax assets. During the three-month period ended July 31, 2009, the Company recorded a valuation allowance of $416.8 million against its federal deferred tax assets. At July 31, 2009, the Company’s net federal deferred tax asset, after valuation allowance, was $151.7 million. For federal income tax purposes, the Company can carry back tax losses incurred in fiscal 2009 against $462 million of taxable income it reported in fiscal 2007. The Company expects to generate tax losses in fiscal 2009, primarily through the recognition for tax purposes of previously recognized book impairments, applying the fiscal 2009 losses to its fiscal 2007 taxable income available for carry back, and recovering $151.7 million of net federal deferred tax assets. The Company expects that the refund resulting from carry back of the fiscal 2009 tax losses will be received in fiscal 2010.
 
The Company is allowed to carry forward tax losses for 20 years and apply such tax losses to future taxable income to realize federal deferred tax assets. As of July 31, 2009, the Company has not generated tax losses to carry forward. In addition, the Company will be able to reverse its previously recognized valuation allowances during any future period for which it reports income. The Company will continue to review its federal deferred tax assets in accordance with SFAS 109.
 
For state tax purposes, due to past and projected losses in certain jurisdictions where the Company does not have carryback potential and/or cannot sufficiently forecast future taxable income, the Company has recognized cumulative valuation allowances of $78.3 million ($50.9 million, net of federal tax benefit) as of July 31, 2009 against its state deferred tax assets. In the nine-month periods ended July 31, 2009 and 2008, the Company recognized valuation allowances against its state deferred tax assets of $41.4 million ($26.9 million, net of federal tax benefit) and $20.0 million ($13.0 million, net of federal tax benefit), respectively. In the three-month periods ended July 31, 2009 and 2008, the Company recognized a valuation allowance against its state deferred tax assets of $34.8 million ($22.6 million, net of federal tax benefit) and $7.0 million ($4.6 million, net of federal tax benefit), respectively. Future valuation allowances in these jurisdictions may continue to be recognized if the Company believes it will not generate sufficient future taxable income to utilize these state deferred tax assets.


15


 

 
TOLL BROTHERS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
 
7.   Comprehensive Loss
 
All accumulated other comprehensive loss at July 31, 2009 and October 31, 2008 was related to employee retirement plans.
 
The components of other comprehensive loss in the nine-month and three-month periods ended July 31, 2009 and 2008 were as follows (amounts in thousands):
 
                                 
    Nine Months Ended
       
    July 31,     Three Months Ended July 31,  
    2009     2008     2009     2008  
 
Net loss as reported
  $ (644,391 )   $ (218,989 )   $ (472,331 )   $ (29,295 )
Changes in pension liability, net of tax (benefit) provision
    (89 )     (1,026 )     (30 )     109  
                                 
Comprehensive loss
  $ (644,480 )   $ (220,015 )   $ (472,361 )   $ (29,186 )
                                 
 
The Company recognized a tax benefit of $59,000 and $684,000 in the nine-month periods ended July 31, 2009 and 2008, respectively, a tax benefit of $20,000 in the three-month period ended July 31, 2009, and a tax provision of $73,000 in the three-month period ended July 31, 2008, each related to the change in pension liability in other comprehensive loss.
 
8.   Employee Retirement Plan
 
For the nine-month and three-month periods ended July 31, 2009 and 2008, the Company recognized costs and made payments related to its supplemental retirement plans as follows (amounts in thousands):
 
                                 
    Nine Months Ended July 31,     Three Months Ended July 31,  
    2009     2008     2009     2008  
 
Service cost
  $ 99     $ 157     $ 33     $ 52  
Interest cost
    1,024       918       341       306  
Amortization of initial benefit obligation
    807       1,027       269       343  
Amortization of unrecognized gains
    (954 )     (480 )     (318 )     (160 )
                                 
    $ 976     $ 1,622     $ 325     $ 541  
                                 
Benefits paid
  $ 96     $ 92     $ 33     $ 29  
                                 
 
9.   Stock-Based Benefit Plans
 
The fair value of each option award is estimated on the date of grant using a lattice-based option valuation model that uses assumptions noted in the following table. The lattice-based option valuation model incorporates ranges of assumptions for inputs; those ranges are disclosed in the table below. Expected volatilities were based on implied volatilities from traded options on the Company’s stock, historical volatility of the Company’s stock and other factors. The expected lives of options granted were derived from the historical exercise patterns and anticipated future patterns and represent the period of time that options granted are expected to be outstanding; the range given below 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.


16


 

 
TOLL BROTHERS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The weighted-average assumptions and the fair value used for stock option grants for the nine-month and three-month periods ended July 31, 2009 and 2008 were as follows:
 
         
    2009   2008
 
Expected volatility
  46.74% - 50.36%   46.67% - 48.63%
Weighted-average volatility
  48.06%   47.61%
Risk-free interest rate
  1.24% - 1.90%   3.32% - 3.85%
Expected life (years)
  4.29 - 8.52   4.29 - 8.32
Dividends
  none   none
Weighted-average grant date fair value per share of options granted
  $8.60   $9.50
 
In the nine-month period ended July 31, 2009, the Company recognized $9.3 million of stock compensation expense and $3.7 million of income tax benefit related to stock option grants. In the nine-month period ended July 31, 2008, the Company recognized $19.4 million of stock compensation expense and $7.7 million of income tax benefit related to stock option grants.
 
In the three-month period ended July 31, 2009, the Company recognized $1.8 million of stock compensation expense and $0.7 million of income tax benefit related to stock option grants. In the three-month period ended July 31, 2008, the Company recognized $3.4 million of stock compensation expense and $1.3 million of income tax benefit related to stock option grants.
 
The Company expects to recognize approximately $11.1 million of stock compensation expense and $4.4 million of income tax benefit for fiscal 2009 related to stock option grants. The Company recognized $22.6 million of stock compensation expense and $9.0 million of income tax benefit for fiscal 2008 related to stock option grants.
 
On December 18, 2008, the Executive Compensation Committee of the Company’s Board of Directors approved the award of a performance-based restricted stock unit (“Performance-Based RSU”) relating to 200,000 shares of the Company’s common stock to Robert I. Toll. The Performance-Based RSU will vest and Mr. Toll will be entitled to receive the underlying shares if the average closing price of the Company’s common stock on the New York Stock Exchange (“NYSE”), measured over any twenty consecutive trading days ending on or prior to December 19, 2013, increases 30% or more over $21.70, the closing price of the Company’s common stock on the NYSE on December 19, 2008; provided Mr. Toll continues to be employed by the Company or serve as a member of its Board of Directors until December 19, 2011. The Performance-Based RSU will also vest if Mr. Toll dies, becomes disabled or the Company experiences a change of control prior to satisfaction of the aforementioned performance criteria. Using a lattice based option pricing model and assuming an expected volatility of 48.14%, a risk-free interest rate of 1.35%, and an expected life of 3.0 years, the Company determined the aggregate value of the Performance-Based RSU to be $3.6 million. In the nine-month and three-month periods ended July 31, 2009, the Company recognized $742,000 and $304,000, respectively, of stock-based compensation expense related to the Performance-Based RSU.
 
As part of the Company’s cash conservation effort, it issued restricted stock units (“RSUs”) relating to 62,052 shares of the Company’s common stock to a number of employees in lieu of a portion of the employees’ bonuses and in lieu of a portion of one employee’s 2009 salary. These RSUs, although not subject to forfeiture, will vest in annual installments over a four-year period, unless accelerated due to death, disability or termination of employment, as more fully described in the RSU award document. Because the RSUs are non-forfeitable, the value of the RSUs were determined to be equal to the number of shares of the Company’s common stock to be issued pursuant to the RSUs, multiplied by $21.70, the closing price of the Company’s common stock on the NYSE on December 19, 2008, the date the RSUs were awarded. The amount applicable to employee bonuses has been charged to the Company’s accrual for bonuses that it made in fiscal 2008 and the amount applicable to salary deferral ($130,000) was charged to selling, general and administrative expense in the three-month period ended January 31, 2009.


17


 

 
TOLL BROTHERS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
 
10.   Fair Value Disclosures
 
Effective November 1, 2008, the Company adopted SFAS 157 for its financial instruments measured at fair value on a recurring basis. SFAS 157 provides a framework for measuring fair value in generally accepted accounting principles, expands disclosures about fair value measurements, and establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The fair value hierarchy can be summarized as follows:
 
  Level 1:   Fair value determined based on quoted prices in active markets for identical assets or liabilities.
 
  Level 2:   Fair value determined using significant observable inputs, generally either quoted prices in active markets for similar assets or liabilities or quoted prices in markets that are not active.
 
  Level 3:   Fair value determined using significant unobservable inputs, such as pricing models, discounted cash flows, or similar techniques.
 
Effective November 1, 2008, the Company adopted SFAS 159 on a prospective basis for residential mortgage loans it holds for sale. In accordance with the provisions of SFAS 159, residential mortgage loans held for sale originated subsequent to November 1, 2008 are measured at fair value. Residential mortgage loans held for sale originated prior to November 1, 2008 are carried at lower of cost or market. The adoption of SFAS 159 for residential mortgage loans held for sale improves the consistency of mortgage loan valuation between the date the borrower locks in the interest rate on the pending mortgage loan and the date of the mortgage loan sale. In addition, the recognition of net origination costs and fees associated with residential mortgage loans originated on or after November 1, 2008 are no longer deferred until the time of sale. There were no required cumulative adjustments to retained earnings because the Company continued to account for residential mortgage loans held for sale originated prior to November 1, 2008 at the lower of cost or market. The implementation of this standard did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.
 
A summary of assets and (liabilities) at July 31, 2009 related to the Company’s financial instruments, measured at fair value on a recurring basis, is set forth below (amounts in thousands).
 
                 
    Fair Value
    Fair
 
Financial Instrument
  Hierarchy     Value  
 
Residential Mortgage Loans Held for Sale
    Level 2     $ 51,142  
Forward Loan Commitments — Residential Mortgage Loans Held for Sale
    Level 2     $ (55 )
Interest Rate Lock Commitments (“IRLCs”)
    Level 2     $ (278 )
Forward Loan Commitments — IRLCs
    Level 2     $ 278  
 
At July 31, 2009, the carrying value of cash and cash equivalents approximates fair value.
 
As of July 31, 2009, the unpaid principal balance of mortgage loans held for sale was approximately equal to the aggregate fair value. Differences between the unpaid balance and the fair value of these loans are recognized as a gain or loss in current earnings and included in interest and other. Interest income on mortgage loans held for sale is calculated based upon the stated interest rate of each loan and is included in interest and other.
 
IRLCs represent individual borrower agreements that commit the Company to lend at a specified price for a specified period as long as there is no violation of any condition established in the commitment contract. These commitments have varying degrees of interest rate risk. The Company utilizes best-efforts forward loan commitments (“Forward Commitments”) to hedge the interest risk of the IRLCs and residential mortgage loans held for sale. Forward Commitments represent contracts with third-party investors for the future delivery of loans whereby the Company agrees to make delivery at a specified future date at a specified price. The IRLCs and Forward Commitments are considered derivative financial instruments under SFAS 133, which requires derivative financial instruments to be recorded at fair value. The Company estimates the fair value of such commitments based on the estimated fair value of the underlying mortgage loan and, in the case of IRLCs, the probability that the mortgage


18


 

 
TOLL BROTHERS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
loan will fund within the terms of the IRLC. To manage the risk of nonperformance of investors regarding the Forward Commitments, the Company assesses the credit worthiness of the investors on a periodic basis.
 
11.   Loss per Share Information
 
Information pertaining to the calculation of loss per share for the nine-month and three-month periods ended July 31, 2009 and 2008 is as follows (amounts in thousands):
 
                                 
    Nine Months Ended
    Three Months Ended
 
    July 31,     July 31,  
    2009     2008     2009     2008  
 
Basic weighted average shares
    161,026       158,398       161,245       158,761  
Common stock equivalents
                               
                                 
Diluted weighted average shares
    161,026       158,398       161,245       158,761  
                                 
 
Common stock equivalents represent the dilutive effect of outstanding in-the-money stock options using the treasury stock method. For the nine-month and three-month periods ended July 31, 2009 and 2008, there were no incremental shares attributed to outstanding options to purchase common stock because the Company had a net loss in each of the periods and any incremental shares would be anti-dilutive. Had the Company had net income in the nine-month periods ended July 31, 2009 and 2008, 4.1 million common stock equivalents would have been included in the fiscal 2009 period’s diluted weighted-average shares and 6.2 million common stock equivalents would have been included in the fiscal 2008 period’s diluted weighted-average shares. Had the Company had net income in the three-month periods ended July 31, 2009 and 2008, 3.9 million common stock equivalents would have been included in the fiscal 2009 period’s diluted weighted-average shares and 6.0 million common stock equivalents would have been included in the fiscal 2008 period’s diluted weighted-average shares.
 
During the nine-month periods ended July 31, 2009 and 2008, the Company issued 908,000 and 1,857,000 shares, respectively, of its common stock under its stock incentive plans and employee stock purchase plan. During the three-month periods ended July 31, 2009 and 2008, the Company issued 145,000 and 85,000 shares, respectively, of its common stock under its stock incentive plans and employee stock purchase plan.
 
At July 31, 2009, the exercise price of approximately 8.7 million outstanding stock options was higher than the average closing price of the Company’s common stock on the NYSE for the three-month period ended July 31, 2009. At July 31, 2008, the exercise price of approximately 5.4 million outstanding stock options was higher than the average closing price of the Company’s common stock on the NYSE for the three-month period ended July 31, 2008.
 
12.   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, 2009, the Company was authorized to repurchase approximately 11.9 million shares.
 
13.   Shareholder Rights Plan
 
On June 17, 2009, the Company adopted a shareholder rights plan (the “Rights Plan”) to help preserve the value of the Company’s deferred tax assets, by reducing the risk of limitation of net operating loss carryforwards and certain other tax benefits under Section 382 of the Internal Revenue Code.
 
In connection with the Rights Plan, the Company declared a dividend of one right for each share of common stock outstanding as of the close of business on July 17, 2009. Under the Rights Plan, any stockholder or group that acquires beneficial ownership of 4.95 percent or more of Toll Brothers’ outstanding stock (an “acquiring person”)


19


 

 
TOLL BROTHERS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
without the approval of the Company’s Board of Directors, could be subject to significant dilution in its holdings. Existing stockholders holding 4.95 percent or more of the Company’s common stock will not be considered acquiring persons unless they acquire additional shares, subject to certain exceptions described in the Rights Plan. In addition, at its discretion, the Company’s Board of Directors may exempt certain transactions and certain persons whose acquisition of securities is determined not to jeopardize the Company’s net deferred tax assets.
 
The rights will expire on July 16, 2019 or earlier if (i) the Company’s Board of Directors determines the Rights Plan is no longer needed to preserve the deferred tax assets due to the implementation of legislative changes, (ii) the Board of Directors determines, at the beginning of a specified period, that no tax benefits may be carried forward, (iii) the Rights Plan is not approved by the Company’s stockholders by June 17, 2010, or (iv) certain other events occur as described in the Rights Plan. Upon approval of the Rights Plan by the Company’s stockholders, the Company’s Board of Directors intends to take action to redeem the Company’s pre-existing shareholder rights plan, which was adopted in 2007.
 
14.   Legal Proceedings
 
The Company is involved in various claims and litigation arising principally in the ordinary course of business.
 
In January 2006, the Company received a request for information pursuant to Section 308 of the Clean Water Act from Region 3 of the U.S. Environmental Protection Agency (“EPA”) concerning storm water discharge practices in connection with its homebuilding projects in the states that comprise EPA Region 3. The Company provided information to the EPA pursuant to the request. The U.S. Department of Justice (“DOJ”) has now assumed responsibility for the oversight of this matter and has advised that the Company has violated regulatory requirements applicable to storm water discharges and that it may seek injunctive relief and/or civil penalties. The Company is now engaged in settlement discussions with representatives from the DOJ and the EPA.
 
In April 2007, a securities class action suit was filed against Toll Brothers, Inc. and Robert I. Toll and Bruce E. Toll in the U.S. District Court for the Eastern District of Pennsylvania on behalf of a purported class of purchasers of the Company’s common stock between December 9, 2004 and November 8, 2005. In August 2007, an amended complaint was filed adding additional directors and officers as defendants. The amended complaint filed on behalf of the purported class alleges that the defendants violated federal securities laws by issuing various materially false and misleading statements that had the effect of artificially inflating the market price of the Company’s stock. It further alleges that the individual defendants sold shares for substantial gains during the class period. The purported class is seeking compensatory damages, counsel fees, and expert costs.
 
In November 2008, a shareholder derivative action was filed in the Chancery Court of Delaware against Robert I. Toll, Zvi Barzilay, Joel H. Rassman, Bruce E. Toll, Paul E. Shapiro, Robert S. Blank, Carl B. Marbach, and Richard J. Braemer. The plaintiff purports to bring his claims on behalf of Toll Brothers, Inc. and alleges that the director and officer defendants breached their fiduciary duties to the Company and its stockholders with respect to the stock sales alleged in the securities class action discussed above, by selling while in possession of material inside information about the Company. The plaintiff seeks contribution and indemnification from the individual director and officer defendants for any liability found against the Company in the securities class action suit. In addition, again purportedly on the Company’s behalf, the plaintiff seeks disgorgement of the defendants’ profits from their stock sales.
 
On March 4, 2009, a second shareholder derivative action was brought in federal district court in Philadelphia, PA. This case has been brought against the eleven current members of the Company’s board of directors. The complaint alleges breaches of fiduciary duty, waste of corporate assets, and unjust enrichment during the period from February 2005 to November 2006. The complaint further alleges that certain of the defendants sold Company stock during this period while in possession of the allegedly non-public, material information about the role of speculative investors in the Company’s sales and plaintiff seeks disgorgement of profits from these sales. The


20


 

 
TOLL BROTHERS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
complaint also asserts a claim for equitable indemnity for costs and expenses incurred by the Company in connection with defending the securities class action discussed above.
 
On April 1, 2009, a third shareholder derivative action was filed, also in federal district court in Philadelphia, PA, against the current members of the Company’s board of directors and Joseph R. Sicree, the Company’s Chief Accounting Officer. This Complaint is identical to the previous shareholder complaint filed in Philadelphia and on July 14, 2009, the two cases were consolidated.
 
The Company’s Certificate of Incorporation and Bylaws provide for indemnification of its directors and officers. The Company has also entered into individual indemnification agreements with each of its directors and executive officers.
 
Due to the high degree of judgment required in determining the amount of potential loss related to the various claims and litigation in which the Company is involved in, including those noted above, and the inherent variability in predicting future settlements and judicial decisions, the Company cannot estimate a range of reasonably possible losses in excess of its accruals for these matters. The Company believes that adequate provision for resolution of all claims and pending litigation has been made for probable losses and the disposition of these matters will not have a material adverse effect on the Company’s results of operations and liquidity or on its financial condition.
 
15.   Commitments and Contingencies
 
Generally, the Company’s option and purchase agreements to acquire land parcels do not require the Company to purchase those land parcels, although the Company may, in some cases, forfeit any deposit balance outstanding if and when it terminates an option and purchase agreement. If market conditions are weak, approvals needed to develop the land are uncertain or other factors exist that make the purchase undesirable, the Company may not expect to acquire the land. Whether an option and purchase agreement is legally terminated or not, the Company reviews the amount recorded for the land parcel subject to the option and purchase agreement to determine if the amount is recoverable. While the Company may not have formally terminated the option and purchase agreements for those land parcels that it does not expect to acquire, it has written off any non-refundable deposits and costs previously capitalized to such land parcels in the periods that it determined such costs were not recoverable. At July 31, 2009, the aggregate purchase price of land parcels under option and purchase agreements, excluding parcels under option that the Company does not expect to acquire, was approximately $540.0 million (including $148.5 million of land to be acquired from unconsolidated entities in which the Company has investments). Of the $540.0 million aggregate purchase price of land parcels subject to option and purchase agreements that the Company expects to acquire, at July 31, 2009, it had deposited $63.9 million on such parcels, was entitled to receive a credit for prior investments in unconsolidated entities of approximately $36.7 million and, if the Company acquired all of these land parcels, would be required to pay an additional $439.4 million. Of the additional $439.4 million the Company would be required to pay, it had recorded $120.5 million of this amount in accrued expenses at July 31, 2009. The Company has additional land parcels under option that have been excluded from the aforementioned aggregate purchase amounts since it does not believe that it will complete the purchase of these land parcels and no additional funds will be required from the Company to terminate these contracts.
 
At July 31, 2009, the Company had investments in and advances to a number of unconsolidated entities, was committed to invest or advance additional funds and had guaranteed a portion of the indebtedness and/or loan commitments of these entities. See Note 3, “Investments in and Advances to Unconsolidated Entities” for more information regarding the Company’s commitments to these entities.
 
At July 31, 2009, the Company had outstanding surety bonds amounting to $404.3 million, primarily related to its obligations to various governmental entities to construct improvements in the Company’s various communities. The Company estimates that $119.2 million of work remains on these improvements. The Company has an additional $80.6 million of surety bonds outstanding that guarantee other obligations of the Company. The Company does not believe it is probable that any outstanding bonds will be drawn upon.


21


 

 
TOLL BROTHERS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
At July 31, 2009, the Company had outstanding agreements of sale to deliver 1,626 homes with an aggregate sales value of $930.7 million.
 
The Company’s mortgage subsidiary provides mortgage financing for a portion of the Company’s home closings. For those home buyers to whom the Company’s mortgage subsidiary provides mortgages, it determines whether the home buyer qualifies for the mortgage he or she is seeking based upon information provided by the home buyer and other sources. For those home buyers that qualify, the Company’s mortgage subsidiary provides the home buyer with a mortgage commitment that specifies the terms and conditions of a proposed mortgage loan based upon then-current market conditions. Prior to the actual closing of the home and funding of the mortgage, the home buyer will lock in an interest rate based upon the terms of the commitment. At the time of rate lock, the Company’s mortgage subsidiary agrees to sell the proposed mortgage loan to one of several outside recognized mortgage financing institutions (“investors”), which is willing to honor the terms and conditions, including interest rate, committed to the home buyer. The Company believes that these investors have adequate financial resources to honor their commitments to its mortgage subsidiary. At July 31, 2009, the Company’s mortgage subsidiary was committed to fund $439.8 million of mortgage loans. Of these commitments, $109.8 million are IRLCs. The Company’s mortgage subsidiary has commitments from investors to acquire $109.8 million of these IRLCs and $50.4 million of its mortgage loans receivable. The Company’s home buyers have not “locked-in” the interest rate on the remaining $330.0 million.
 
As of July 31, 2009, the Company has confirmed the presence of defective Chinese-made drywall in a small number of its West Florida homes, which were delivered between June 2006 and November 2007. The anticipated cost of the remediation of these homes is included in the amounts that the Company has previously accrued. The Company is inspecting homes, gathering information from its drywall subcontractors and suppliers, and continuing to investigate this issue. The Company is currently unable to reasonably estimate its total possible loss or exposure relating to Chinese-made drywall in its homes.
 
16.   Business Segments
 
Revenue and (loss) income before income taxes for each of the Company’s geographic segments for the nine-month and three-month periods ended July 31, 2009 and 2008 were as follows (amounts in millions):
 
                                 
    Nine Months Ended July 31,     Three Months Ended July 31,  
    2009     2008     2009     2008  
 
Revenue:
                               
North
  $ 428.4     $ 693.4     $ 145.5     $ 227.4  
Mid-Atlantic
    364.5       668.3       129.7       214.4  
South
    212.0       438.4       83.1       144.4  
West
    263.8       656.9       103.1       210.5  
                                 
Total
  $ 1,268.7     $ 2,457.0     $ 461.4     $ 796.7  
                                 
(Loss) income before income taxes:
                               
North
  $ (71.5 )   $ 54.3     $ (45.2 )   $ 24.0  
Mid-Atlantic
    (23.5 )     (28.3 )     (5.9 )     (16.0 )
South
    (43.6 )     (161.8 )     (11.5 )     5.1  
West
    (181.9 )     (149.6 )     (35.5 )     (48.0 )
Corporate and other
    (69.2 )     (75.4 )     (13.2 )     (19.9 )
                                 
Total
  $ (389.7 )   $ (360.8 )   $ (111.3 )   $ (54.8 )
                                 


22


 

 
TOLL BROTHERS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
“Corporate and other” is comprised principally of general corporate expenses such as the Offices of the Chief Executive Officer and President, and the corporate finance, accounting, audit, tax, human resources, risk management, marketing and legal groups, offset in part by interest income and income from the Company’s ancillary businesses.
 
Total assets for each of the Company’s geographic segments at July 31, 2009 and October 31, 2008 are shown in the table below (amounts in millions).
 
                 
    July 31, 2009     October 31, 2008  
 
North
  $ 1,113.5     $ 1,244.7  
Mid-Atlantic
    1,116.0       1,220.3  
South
    603.3       688.0  
West
    875.3       1,134.0  
Corporate and other
    2,011.0       2,299.8  
                 
Total
  $ 5,719.1     $ 6,586.8  
                 
 
“Corporate and other” is comprised principally of cash and cash equivalents, deferred tax assets and the assets of the Company’s manufacturing facilities and mortgage subsidiary.


23


 

 
TOLL BROTHERS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The Company provided for inventory impairment charges and the expensing of costs that it believed not to be recoverable, and write-downs of investments in unconsolidated entities that it does not believe it will be able to recover (including the Company’s pro-rata share of impairment charges recognized by the unconsolidated entities in which it has an investment) for the nine-month and three-month periods ended July 31, 2009 and 2008 as shown in the table below; the carrying value of inventory and investments in unconsolidated entities for each of the Company’s geographic segments at July 31, 2009 and October 31, 2008 are also shown (amounts in millions).
 
                                                 
    Carrying Value     Impairments  
    July 31,
    October 31,
    Nine Months Ended July 31,     Three Months Ended July 31,  
    2009     2008     2009     2008     2009     2008  
 
Inventory:
                                               
Land controlled for future communities:
                                               
North
  $ 29.5     $ 33.7     $ 13.5     $ 21.6     $ 9.1     $ 2.3  
Mid-Atlantic
    11.8       24.6       7.5       10.1       3.4       0.4  
South
    2.8       3.7       0.3       41.9       0.1       0.0  
West
    8.9       7.1       3.1       15.8       1.7       7.0  
                                                 
      53.0       69.1       24.4       89.4       14.3       9.7  
                                                 
Land owned for future communities:
                                               
North
    211.3       217.9       41.6       6.2       16.0       0.9  
Mid-Atlantic
    368.3       382.2       17.6       67.7       7.4       21.5  
South
    62.1       52.7       1.2       33.5       1.2          
West
    114.1       166.2       72.6       14.7       24.0       14.0  
                                                 
      755.8       819.0       133.0       122.1       48.6       36.4  
                                                 
Operating communities:
                                               
North
    800.7       952.9       49.7       45.7       28.2       6.5  
Mid-Atlantic
    703.5       858.8       24.0       45.3       2.0       21.9  
South
    480.2       560.4       44.4       111.1       11.4       5.7  
West
    682.2       867.3       104.4       113.1       5.2       25.8  
                                                 
      2,666.6       3,239.4       222.5       315.2       46.8       59.9  
                                                 
Total
  $ 3,475.4     $ 4,127.5     $ 379.9     $ 526.7     $ 109.7     $ 106.0  
                                                 
Investments in unconsolidated entities:
                                               
North
  $ 24.0     $ 26.8     $ 6.0     $ 5.0             $ 5.0  
South
    49.6       48.4                                  
West
    58.2       64.8       5.3       141.3     $ 5.3       28.4  
Corporate
    12.8       11.8                                  
                                                 
Total
  $ 144.6     $ 151.8     $ 11.3     $ 146.3     $ 5.3     $ 33.4  
                                                 


24


 

 
TOLL BROTHERS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
 
17.   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, 2009 and 2008 (amounts in thousands):
 
                 
    2009     2008  
 
Cash flow information:
               
Interest paid, net of amount capitalized
  $ 8,407     $ 8,978  
Income taxes paid
  $ 145,530     $ 88,117  
Income tax refunds
  $ 43,958          
Non-cash activity:
               
Reduction of investments in unconsolidated entities due to reduction in letters of credit
  $ 8,707     $ 8,661  
Reclassification of investment in unconsolidated entities to loan payable
          $ 2,109  
(Decrease) increase in investment in unconsolidated entities due to accrual of commitments
  $ (8,199 )   $ 101,430  
Reclassification of accrued liabilities to loan payable
  $ 7,800     $ 2,163  
Cost of inventory acquired through seller financing
  $ 3,555     $ 7,344  
Cost of inventory accrued under specific performance contracts
  $ 14,889          
Cost of other inventory acquired
  $ 1,779          
Land returned to seller subject to loan financing
          $ 7,750  
Contribution of inventory to a consolidated joint venture
  $ 5,283          
Income tax benefit related to exercise of employee stock options
  $ 5,019     $ 11,630  
Adoption of FIN 48
          $ 47,460  
Reclassification of inventory to property, construction and office equipment
          $ 16,103  
Miscellaneous increases (decreases) to investments in unconsolidated entities
  $ 81     $ (951 )
Stock awards
  $ 27     $ 26  
 
18.   Supplemental Guarantor Information
 
A 100% owned subsidiary of the Company, Toll Brothers Finance Corp. (the “Subsidiary Issuer”), issued $300 million of 6.875% Senior Notes due 2012 on November 22, 2002; $250 million of 5.95% Senior Notes due 2013 on September 3, 2003; $300 million of 4.95% Senior Notes due 2014 on March 16, 2004; $300 million of 5.15% Senior Notes due 2015 on June 2, 2005; and $400 million of 8.91% Senior Notes due 2017 on April 13, 2009. The obligations of the Subsidiary Issuer to pay principal, premiums, if any, and interest is guaranteed jointly and severally on a senior basis by the Company and substantially all of the Company’s 100%-owned home building subsidiaries (the “Guarantor Subsidiaries”). The guarantees are full and unconditional. The Company’s non-home building subsidiaries and several of its 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 financial investors. Prior to the senior debt issuances, the Subsidiary Issuer did not have any operations.
 
Supplemental condensed 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 is presented below (amounts in thousands $).


25


 

 
TOLL BROTHERS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Condensed Consolidating Balance Sheet at July 31, 2009 ($ in thousands):
 
                                                 
    Toll
                Non-
             
    Brothers,
    Subsidiary
    Guarantor
    Guarantor
             
    Inc.     Issuer     Subsidiaries     Subsidiaries     Eliminations     Consolidated  
 
ASSETS
                                               
Cash and cash equivalents
                    1,547,411       110,156               1,657,567  
Inventory
                    3,206,968       268,465               3,475,433  
Property, construction and office equipment, net
                    72,885       1,535               74,420  
Receivables, prepaid expenses and other assets
    60       6,164       63,799       14,745       (1,567 )     83,201  
Mortgage loans receivable
                            51,149               51,149  
Customer deposits held in escrow
                    18,533       941               19,474  
Income tax refund receivable
    61,626                                       61,626  
Investments in and advances to unconsolidated entities
                    103,912       40,643               144,555  
Investments in and advances to consolidated entities
    2,559,220       1,559,909       (1,188,153 )     (233,738 )     (2,697,238 )      
Deferred tax assets
    151,700                                       151,700  
                                                 
      2,772,606       1,566,073       3,825,355       253,896       (2,698,805 )     5,719,125  
                                                 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
                                               
Loans payable
                    416,731       98,803               515,534  
Senior notes
            1,536,691                               1,536,691  
Senior subordinated notes
                    47,872                       47,872  
Mortgage company warehouse loan
                            33,290               33,290  
Customer deposits
                    91,927       5,882               97,809  
Accounts payable
                    83,801       1,972               85,773  
Accrued expenses
            29,382       381,255       217,329       (1,699 )     626,267  
Income taxes payable
    159,850                       (2,000 )             157,850  
                                                 
Total liabilities
    159,850       1,566,073       1,021,586       355,276       (1,699 )     3,101,086  
                                                 
Minority interest
                    5,283                       5,283  
Stockholders’ equity:
                                               
Common stock
    1,613                       2,003       (2,003 )     1,613  
Additional paid-in capital
    301,788               4,420       2,734       (7,154 )     301,788  
Retained earnings
    2,309,264               2,793,830       (106,117 )     (2,687,713 )     2,309,264  
Treasury stock, at cost
    (145 )                                     (145 )
Accumulated other comprehensive income
    236               236               (236 )     236  
                                                 
Total stockholders’ equity
    2,612,756             2,798,486       (101,380 )     (2,697,106 )     2,612,756  
                                                 
      2,772,606       1,566,073       3,825,355       253,896       (2,698,805 )     5,719,125  
                                                 


26


 

 
TOLL BROTHERS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Condensed Consolidating Balance Sheet at October 31, 2008 ($ in thousands):
 
                                                 
    Toll
                Non-
             
    Brothers,
    Subsidiary
    Guarantor
    Guarantor
             
    Inc.     Issuer     Subsidiaries     Subsidiaries     Eliminations     Consolidated  
 
ASSETS
                                               
Cash and cash equivalents
                    1,515,617       117,878               1,633,495  
Inventory
                    3,727,937       399,538               4,127,475  
Property, construction and office equipment, net
                    84,460       2,002               86,462  
Receivables, prepaid expenses and other assets
    39       3,549       63,228       48,462       (1,516 )     113,762  
Mortgage loans receivable
                            49,255               49,255  
Customer deposits held in escrow
                    18,728       185               18,913  
Investments in and advances to unconsolidated entities
                    105,828       45,943               151,771  
Investments in and advances to consolidated entities
    3,036,158       1,160,470       (764,163 )     (252,697 )     (3,179,768 )      
Deferred tax assets
    405,703                                       405,703  
                                                 
      3,441,900       1,164,019       4,751,635       410,566       (3,181,284 )     6,586,836  
                                                 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
                                               
Loans payable
                    426,060       187,534               613,594  
Senior notes
            1,143,445                               1,143,445  
Senior subordinated notes
                    343,000                       343,000  
Mortgage company warehouse loan
                            37,867               37,867  
Customer deposits
                    110,312       25,279               135,591  
Accounts payable
                    128,971       5,872               134,843  
Accrued expenses
            20,574       465,791       253,951       (1,720 )     738,596  
Income taxes payable
    204,247                       (2,000 )             202,247  
                                                 
Total liabilities
    204,247       1,164,019       1,474,134       508,503       (1,720 )     3,349,183  
                                                 
Stockholders’ equity:
                                               
Common stock
    1,604                       2,003       (2,003 )     1,604  
Additional paid-in capital
    282,090               4,420       2,734       (7,154 )     282,090  
Retained earnings
    2,953,655               3,272,756       (102,674 )     (3,170,082 )     2,953,655  
Treasury stock, at cost
    (21 )                                     (21 )
Accumulated other comprehensive income
    325               325               (325 )     325  
                                                 
Total stockholders’ equity
    3,237,653             3,277,501       (97,937 )     (3,179,564 )     3,237,653  
                                                 
      3,441,900       1,164,019       4,751,635       410,566       (3,181,284 )     6,586,836  
                                                 


27


 

 
TOLL BROTHERS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Condensed Consolidating Statement of Operations for the nine months ended July 31, 2009 ($ in thousands):
 
                                                 
    Toll
                Non-
             
    Brothers,
    Subsidiary
    Guarantor
    Guarantor
             
    Inc.     Issuer     Subsidiaries     Subsidiaries     Eliminations     Consolidated  
 
Revenues
                    1,139,724       129,001               1,268,725  
                                                 
Cost of revenues
            59,745       1,304,526       139,984       (58,967 )     1,445,288  
Selling, general and administrative
    37       1,781       233,982       17,011       (17,085 )     235,726  
                                                 
Loss from operations
    (37 )     (61,526 )     (398,784 )     (27,994 )     76,052       (412,289 )
Other:
                                               
Loss from unconsolidated entities
                    (3,055 )     (5,300 )             (8,355 )
Interest and other
            61,526       12,147       20,482       (63,240 )     30,915  
Loss from subsidiaries
    (389,692 )                             389,692        
                                                 
Loss before income tax benefit
    (389,729 )           (389,692 )     (12,812 )     402,504       (389,729 )
Income tax benefit
    254,662               104,187       (8,343 )     (95,844 )     254,662  
                                                 
Net loss
    (644,391 )           (493,879 )     (4,469 )     498,348       (644,391 )
                                                 
 
Condensed Consolidating Statement of Operations for the three months ended July 31, 2009 ($ in thousands):
 
                                                 
    Toll
                Non-
             
    Brothers,
    Subsidiary
    Guarantor
    Guarantor
             
    Inc.     Issuer     Subsidiaries     Subsidiaries     Eliminations     Consolidated  
 
Revenues
                    429,886       31,489               461,375  
                                                 
Cost of revenues
            25,360       478,355       32,805       (24,972 )     511,548  
Selling, general and administrative
    15       811       68,035       5,846       (6,090 )     68,617  
                                                 
Loss from operations
    (15 )     (26,171 )     (116,504 )     (7,162 )     31,062       (118,790 )
Other:
                                               
Loss from unconsolidated entities
                    1,561       (5,300 )             (3,739 )
Interest and other
            26,171       3,694       7,821       (26,421 )     11,265  
Earnings from subsidiaries
    (111,249 )                             111,249        
                                                 
Loss before income tax benefit
    (111,264 )           (111,249 )     (4,641 )     115,890       (111,264 )
Income tax benefit
    361,067               224,634       (5,242 )     (219,392 )     361,067  
                                                 
Net loss
    (472,331 )           (335,883 )     601       335,282       (472,331 )
                                                 


28


 

 
TOLL BROTHERS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Condensed Consolidating Statement of Operations for the nine months ended July 31, 2008 ($ in thousands):
 
                                                 
    Toll
                Non-
             
    Brothers,
    Subsidiary
    Guarantor
    Guarantor
             
    Inc.     Issuer     Subsidiaries     Subsidiaries     Eliminations     Consolidated  
 
Revenues
                    2,452,670       4,367             2,457,037  
                                                 
Costs of revenues
            49,460       2,443,636       5,507       (49,202 )     2,449,401  
Selling, general and administrative
    1       525       333,908       21,922       (23,229 )     333,127  
                                                 
Loss from operations
    (1 )     (49,985 )     (324,874 )     (23,062 )     72,431       (325,491 )
Other:
                                               
Loss from unconsolidated entities
                    (50,762 )     (84,994 )             (135,756 )
Interest and other
            49,985       13,281       25,602       11,618       100,486  
Loss from subsidiaries
    (360,760 )                             360,760        
                                                 
Loss before income taxes
    (360,761 )           (362,355 )     (82,454 )     444,809       (360,761 )
Income tax benefit
    (141,772 )             (167,883 )     (33,487 )     201,370       (141,772 )
                                                 
Net loss
    (218,989 )           (194,472 )     (48,967 )     243,439       (218,989 )
                                                 
 
Condensed Consolidating Statement of Operations for the three months ended July 31, 2008 ($ in thousands):
 
                                                 
    Toll
                Non-
             
    Brothers,
    Subsidiary
    Guarantor
    Guarantor
             
    Inc.     Issuer     Subsidiaries     Subsidiaries     Eliminations     Consolidated  
 
Revenues
                    795,794       917             796,711  
                                                 
Costs of revenues
            16,735       736,726       1,579       (16,114 )     738,926  
Selling, general and administrative
            176       103,637       7,407       (8,116 )     103,104  
                                                 
Loss from operations
          (16,911 )     (44,569 )     (8,069 )     24,230       (45,319 )
Other:
                                               
Loss from unconsolidated entities
                    (30,113 )                     (30,113 )
Interest and other
            16,911       18,292       8,237       (22,803 )     20,637  
Loss from subsidiaries
    (54,795 )                             54,795        
                                                 
(Loss) income before income taxes
    (54,795 )           (56,390 )     168       56,222       (54,795 )
Income tax benefit
    (25,500 )             (43,341 )     (1,183 )     44,524       (25,500 )
                                                 
Net (loss) income
    (29,295 )           (13,049 )     1,351       11,698       (29,295 )
                                                 


29


 

 
TOLL BROTHERS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Condensed Consolidating Statement of Cash Flows for the nine months ended July 31, 2009 ($ in thousands):
 
                                                 
    Toll
                Non-
             
    Brothers,
    Subsidiary
    Guarantor
    Guarantor
             
    Inc.     Issuer     Subsidiaries     Subsidiaries     Eliminations     Consolidated  
 
Cash flow from operating activities:
                                               
Net loss
    (644,391 )             (493,879 )     (4,469 )     498,348       (644,391 )
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
                                               
Depreciation and amortization
    21       1,751       15,911       670               18,353  
Stock-based compensation
    9,678                                       9,678  
Excess tax benefits from stock-based compensation
    (3,570 )                                     (3,570 )
Impairment of investment in unconsolidated entities
                    6,000       5,300               11,300  
Loss (income) from unconsolidated entities
                    2,355       (5,300 )             (2,945 )
Distributions of earnings from unconsolidated entities
                    813                       813  
Deferred tax provision
    (189,677 )                                     (189,677 )
Deferred tax valuation allowances
    443,680                                       443,680  
Inventory impairments
                    344,628       35,300               379,928  
Write-off of unamortized debt issuance costs
                    692                       692  
Changes in operating assets and liabilities:
                                               
Decrease in inventory
                    166,835       97,448               264,283  
Origination of mortgage loans
                            (426,372 )             (426,372 )
Sale of mortgage loans
                            424,478               424,478  
Decrease in contracts receivable
                                             
Income tax refund receivable
    (61,626 )                                     (61,626 )
Decrease (increase) in receivables, prepaid expenses and other assets
    476,897       (399,959 )     431,984       19,797       (498,457 )     30,262  
Decrease in customer deposits
                    (18,190 )     (20,153 )             (38,343 )
(Decrease) increase in accounts payable and accrued expenses
    (147 )     8,808       (89,786 )     (39,237 )     109       (120,253 )
Decrease in current income taxes payable
    (39,319 )                                     (39,319 )
                                                 
Net cash provided by (used in) operating activities
    (8,454 )     (389,400 )     367,363       87,462             56,971  
                                                 
Cash flow from investing activities:
                                               
Purchase of property and equipment
                    (2,293 )     (203 )             (2,496 )
Purchases of marketable securities
                                             
Sale of marketable securities
                                             
Investments in and advances to unconsolidated entities
                    (20,220 )                     (20,220 )
Return of investments from unconsolidated entities
                    1,443                       1,443  
                                                 
Net cash used in investing activities
                (21,070 )     (203 )           (21,273 )
                                                 
Cash flow from financing activities:
                                             
Net proceeds from issuance of senior notes
            389,400                               389,400  
Proceeds from loans payable
                            450,816               450,816  
Redemption and repurchase of senior subordinated notes
                    (295,128 )                     (295,128 )
Principal payments of loans payable
                    (19,371 )     (545,797 )             (565,168 )
Proceeds from stock-based benefit plans
    6,128                                       6,128  
Excess tax benefits from stock-based compensation
    3,570                                       3,570  
Purchase of treasury stock
    (1,244 )                                     (1,244 )
Change in minority interest
                                             
                                                 
Net cash (used in) provided by financing activities
    8,454       389,400       (314,499 )     (94,981 )           (11,626 )
                                                 
Net increase (decrease) in cash and cash equivalents
                31,794       (7,722 )           24,072  
Cash and cash equivalents, beginning of period
                    1,515,617       117,878               1,633,495  
                                                 
Cash and cash equivalents, end of period
                1,547,411       (110,156 )           1,657,567  
                                                 


30


 

 
TOLL BROTHERS, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Condensed Consolidating Statement of Cash Flows for the nine months ended July 31, 2008 ($ in thousands):
 
                                                 
    Toll
                Non-
             
    Brothers,
    Subsidiary
    Guarantor
    Guarantor
             
    Inc.     Issuer     Subsidiaries     Subsidiaries     Eliminations     Consolidated  
 
Cash flow from operating activities:
                                               
Net loss
    (218,989 )             (194,472 )     (48,967 )     243,439       (218,989 )
Adjustments to reconcile net loss to net
                                               
cash provided by (used in) operating activities:
                                               
Depreciation and amortization
            854       19,628       580               21,062  
Stock-based compensation
    19,884                                       19,884  
Excess tax benefit from
                                               
stock-based compensation
    (8,543 )                                     (8,543 )
Impairment of investments in unconsolidated entities
                    61,251       85,000               146,251  
(Income) loss from unconsolidated entities
                    (11,608 )     113               (10,495 )
Distributions of earnings from unconsolidated entities
                    41,669                       41,669  
Deferred tax benefit
    (215,891 )                                     (215,891 )
Deferred tax valuation allowances
    22,638                                       22,638  
Inventory write-offs
                    526,729                       526,729  
Changes in operating assets and liabilities:
                                               
Decrease (increase) in inventory
                    556,710       (57,195 )             499,515  
Origination of mortgage loans
                            (720,917 )             (720,917 )
Sale of mortgage loans
                            764,389               764,389  
Decrease (increase) in contracts receivable
                    42,793       (940 )             41,853  
Decrease (increase) in receivables, prepaid
                                               
expenses and other assets
    420,260       1,478       (171,962 )     21,825       (248,561 )     23,040  
(Decrease) increase in customer deposits
                    (78,975 )     2,945               (76,030 )
Decrease in accounts payable
                                               
and accrued expenses
    (2,832 )     (2,332 )     (116,345 )     (42,278 )     5,122       (158,665 )
Decrease in current income taxes payable
    (36,638 )                                     (36,638 )
                                                 
Net cash provided by (used in) operating activities
    (20,111 )           675,418       5,555             660,862  
                                                 
Cash flow from investing activities:
                                               
Purchase of property and equipment
                    (3,122 )     (432 )             (3,554 )
Purchase of marketable securities
                    (1,239,715 )     (228,725 )             (1,468,440 )
Sale of marketable securities
                    1,230,162       228,725               1,458,887  
Investments in and advances to
                                               
unconsolidated entities
                    (42,964 )     (3,936 )             (46,900 )
Distributions of investments in unconsolidated entities
                    2,623                       2,623  
                                                 
Net cash used in investing activities
                (53,016 )     (4,368 )           (57,384 )
                                                 
Cash flow from financing activities:
                                               
Proceeds from loans payable
                    435       801,123               801,558  
Principal payments of loans payable
                    (39,509 )     (783,618 )             (823,127 )
Proceeds from stock-based benefit plans
    13,044                                       13,044  
Excess tax benefit from
                                               
stock-based compensation
    8,543                                       8,543  
Purchase of treasury stock
    (1,476 )                                     (1,476 )
Change in minority interest
                            3               3  
                                                 
Net cash (used in) provided by financing activities
    20,111             (39,074 )     17,508             (1,455 )
                                                 
Net increase in cash and cash equivalents
                583,328       18,695             602,023  
Cash and cash equivalents, beginning of period
                    783,891       116,446               900,337  
                                                 
Cash and cash equivalents, end of period
                1,367,219       135,141             1,502,360  
                                                 


31


 

ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (“MD&A”)
 
On August 27, 2009, we issued a press release and held a conference call to review the results of operations for the nine-month and three-month periods ended July 31, 2009 and to discuss the current state of our business. The information contained in this report is the same information given in the press release and on the conference call on August 27, 2009, and we are not reconfirming or updating that information in this Form 10-Q.
 
OVERVIEW
 
The slowdown that we have experienced since fiscal 2005 continued through the third quarter of fiscal 2009. The slowdown, which we believe started with a decline in consumer confidence, an overall softening of demand for new homes and an oversupply of homes available for sale, has been exacerbated by, among other things, a decline in the overall economy, increasing unemployment, fear of job loss, a significant decline in the securities markets, a decline in home prices, the large number of homes that are or will be available due to foreclosures, the inability of some of our home buyers to sell their current home, the deterioration in the credit markets, and the direct and indirect impact of the turmoil in the mortgage loan market.
 
The value of net new contracts signed in fiscal 2008 was 78% lower than the value of net new contracts signed in fiscal 2005, and, despite some improvement since late March 2009 in potential homebuyers visiting our communities and making refundable deposits to purchase homes, the value of net new contracts signed in the nine-month and three-month periods ended July 31, 2009 was 35% and 5% lower, respectively, than the value of net new contracts signed in the comparable periods of fiscal 2008. Net new contracts signed in the nine months and three months ended July 31, 2009 were $873.9 million (1,685 homes) and $447.7 million (837 homes), respectively. Net new contracts signed in the nine months and three months ended July 31, 2008 were $1.34 billion (2,388 homes) and $469.9 million (812 homes), respectively. The number of net new contracts signed in the three months ended July 31, 2009 was 3% higher than the number of net new contracts signed in the three months ended July 31, 2008. Compared to our fiscal quarter ended April 30, 2009, net new contracts signed in our fiscal quarter ended July 31, 2009 increased by 50% in total value and by 44% in the number of net new contracts signed. The increase in the number of net new contracts signed in the third quarter of fiscal 2009, as compared to the fiscal 2008 period, marks the first time in over three years that we have reported an increase in the number of net new contracts signed on a year-over-year basis. In addition, in the three months ended July 31, 2009, our contract cancellation rate (the number of current quarter contracts cancelled divided by the number of gross contracts signed in the quarter) was 8.5%, as compared to 19.4% in the three months ended July 31, 2008 and 21.7% in the three months ended April 30, 2009. While our fiscal year 2009 third-quarter results reflect continuing challenging housing market conditions, we do see signs for optimism. We believe declining cancellations and more solid demand indicate that the housing market is stabilizing.
 
We continue to seek a balance between our short-term goal of selling homes in a tough market and our long-term goal of maximizing the value of our communities. We continue to believe that many of our communities are in locations that are difficult to replace and in markets where approvals have been increasingly difficult to achieve. We believe that many of these communities have substantial embedded value that will be realizable in the future and that this value should not necessarily be sacrificed in the current soft market.
 
We are concerned about the dislocation in the secondary mortgage industry. We maintain relationships with a widely diversified group of mortgage financial institutions, many of which are among the largest and, we believe, most reliable in the industry. We believe that regional and community banks continue to recognize the long term value in creating relationships with high quality, affluent customers such as our home buyers, and these banks continue to provide such customers with financing. Some of the major banks that had previously exited the market appear to be cautiously re-entering it, but are not as aggressive as they once were. Nevertheless, tightened credit standards have shrunk the pool of potential home buyers and the availability of certain loan products previously available to our home buyers. Mortgage market liquidity issues and higher borrowing rates may impede some of our home buyers from closing, while others may find it more difficult to sell their existing homes as their prospective buyers face the problem of obtaining a mortgage. We believe that our home buyers generally should be able to


32


 

continue to secure mortgages, due to their typically lower loan-to-value ratios and attractive credit profiles as compared to the average home buyer.
 
Based on our experience during prior downturns in the housing industry, we believe that unexpected opportunities may arise in difficult times for those builders that are well-prepared. In the current challenging environment, we believe our strong balance sheet, our liquidity and access to capital, our broad geographic presence, our diversified product lines, our experienced personnel and our national brand name all position us well for such opportunities now and in the future. At July 31, 2009, we had $1.66 billion of cash and cash equivalents on hand and approximately $1.35 billion available under our revolving credit facility which extends to March 2011. On April 13, 2009, we sold $400 million of 8.91% senior notes due 2017 and received $389.4 million of net proceeds from the sale. During the three-month period ended July 31, 2009, we redeemed $293.0 million of senior subordinated notes due 2011 and purchased $2.1 million of these notes on the open market. We believe we have the resources available to fund attractive opportunities, should they arise.
 
When our industry recovers, we believe that we will see reduced competition from the small and mid-sized private builders who are our primary competitors in the luxury market. We believe that the access of these private builders to capital is already severely constrained. We envision that there will be fewer and more selective lenders serving our industry at that time and that those lenders likely will gravitate to the homebuilding companies that offer them the greatest security, the strongest balance sheets and the broadest array of potential business opportunities. We believe that this reduced competition, combined with attractive long-term demographics, will reward those well-capitalized builders who can persevere through the current challenging environment.
 
Notwithstanding the current market conditions, we believe that geographic and product diversification, access to lower-cost capital, and strong demographics have in the past and will in the future, as market conditions improve over time, benefit those builders that can control land and persevere through the increasingly difficult regulatory approval process. We believe that these factors favor the large publicly traded home building companies with the capital and expertise to control home sites and gain market share. We believe that, as builders and land developers reduce the number of home sites being taken through the approval process and this process continues to become more difficult, and if the political pressure from no-growth proponents continues to increase, our expertise in taking land through the approval process and our already approved land positions will allow us to grow in the years to come, as market conditions improve.
 
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 certain risks by: controlling land for future development through options (also referred to herein as “land purchase contracts” or “option and purchase agreements”) whenever we can, thus allowing the necessary governmental approvals to be obtained before acquiring title to the land; generally commencing construction of a detached home only after executing an agreement of sale and receiving a substantial down payment from the buyer; and using subcontractors to perform home construction and land development work on a fixed-price basis. Our risk reduction strategy of generally not commencing the construction of a home until we had an agreement of sale with a buyer was effective in the past, but due to the significant number of cancellations of agreements of sale that we have had in the current downturn in the housing market, many of which were for homes on which we had commenced construction, and the increase in the number of multi-family communities that we have under construction, the number of homes under construction for which we do not have an agreement of sale has increased from our historical levels.
 
In response to current market conditions, we have been reevaluating and renegotiating or canceling many of our land purchase contracts. As a result, we reduced our land position from a high of approximately 91,200 home sites at April 30, 2006, to approximately 35,400 home sites at July 31, 2009, of which we owned approximately 30,800. Of the 30,800 home sites owned at July 31, 2009, significant improvements were completed on approximately 12,300. In addition, we intend to sell certain parcels of land that we have identified as non-strategic. At July 31, 2009, we were selling from 215 communities compared to 273 communities at October 31, 2008 and 290 communities at July 31, 2008. We expect to be selling from approximately 205 communities at October 31, 2009.
 
Given the current business climate and the numerous uncertainties related to sales paces, sales prices, mortgage markets, cancellations, market direction and the potential for and magnitude of future impairments, it is


33


 

difficult to provide guidance. Subject to the risks reported elsewhere in our reports filed with the SEC and the preceding uncertainties, based upon fiscal year 2009 deliveries to date, our backlog at July 31, 2009 and the pace of activity at our communities, we currently estimate that we will deliver between 475 and 725 homes in the three-month period ended October 31, 2009 at an average sales price of between $550,000 and $575,000 per home. We believe that, as a result of sales incentives given to our home buyers and slower delivery paces per community, our cost of sales as a percentage of revenues, before impairment charges and write-downs, will be higher in the fourth quarter of fiscal 2009 than in the comparable period of fiscal 2008. Additionally, based on lower projected revenues in the fourth quarter of fiscal 2009, as compared to the fiscal 2008 period, we expect our selling, general and administrative expenses to be lower in total dollars in the fourth quarter of fiscal 2009 than in the fiscal 2008 period, but higher as a percentage of revenues in the fourth quarter of fiscal 2009 than in the fiscal 2008 period.
 
CONTRACTS AND BACKLOG
 
The value of net new contracts signed was $873.9 million (1,685 homes) in the nine months ended July 31, 2009, a 34.9% decrease compared to the value of contracts signed in the nine-month period ended July 31, 2008 of $1.34 billion (2,388 homes). The decrease in the nine-month period is attributable to a 29.4% decrease in the number of net new contracts signed and a 7.7% decrease in the average value of each contract. The value of net new contracts signed was $447.7 million (837 homes) in the three months ended July 31, 2009, a 4.7% decrease compared to the value of net new contracts signed in the three-month period ended July 31, 2008 of $469.9 million (812 homes). The decrease in the three-month period is attributable to a 7.6% decrease in the average value of each contract signed, offset, in part, by a 3.1% increase in the number of net new contracts signed. The increase in the number of net new contracts signed in the three-month period of fiscal 2009, as compared to the fiscal 2008 period, was primarily due to the increased demand for our homes and the decline in the number of contracts cancelled in the fiscal 2009 period, as compared to the fiscal 2008 period.
 
We continue to believe that the decrease in the number of net new contracts signed in the nine-month period of fiscal 2009, as compared to the fiscal 2008 period, was attributable to the continued slowdown that we have experienced since fiscal 2005. (See “Overview” above for an expanded discussion related to the decrease in the number of net new contracts signed and the slowdown in our business.)
 
The decline in the average sales price of net new contracts signed in the nine-month period ended July 31, 2009, as compared to the comparable period of fiscal 2008, was due primarily to higher sales incentives given to homebuyers in the fiscal 2009 period as compared to the fiscal 2008 period, a shift in the number of net new contracts signed to less expensive areas and/or product in the fiscal 2009 period, as compared to fiscal 2008 period, and a 1.2% higher average value of contracts cancelled during the fiscal 2009 period, as compared to the fiscal 2008 period.
 
The decline in the average sales price of net new contracts signed in the three-month period ended July 31, 2009, as compared to the fiscal 2008 period, was due primarily to higher sales incentives given to homebuyers in the fiscal 2009 period, as compared to the fiscal 2008 period, a shift in the number of contracts signed to less expensive areas and/or product in the fiscal 2009 period, as compared to the fiscal 2008 period, and a 16.2% higher average value of contracts cancelled during the fiscal 2009 period, as compared to the fiscal 2008 period.
 
At July 31, 2009, we were offering sales incentives, on average, of $84,000 or 12.6% of the sales value of the home, as compared to, on average, $57,000 or 8.5% of the sales value of the home at July 31, 2008. The amount and type of incentive varies on a community-by-community basis, and in some cases on a homesite by homesite basis within a community. In addition, the amount of sales incentives offered to a home buyer on a speculative home that we have available will generally be higher than the amount of sales incentives that we will offer on a to be built home.
 
In the nine-month period ended July 31, 2009, home buyers cancelled $290.1 million (396 homes) of signed contracts, as compared to $550.3 million (760 homes) in the nine-month period ended July 31, 2008. As a percentage of the number of gross contracts signed in the nine-month periods ended July 31, 2009 and 2008, home buyers cancelled 19.0% and 24.1%, respectively, and 24.9% and 29.1%, respectively of the value of gross contracts signed. In the three-month period ended July 31, 2009, home buyers cancelled $54.9 million (78 homes) of signed contracts, as compared to $118.2 million (195 homes) in the three-month period ended July 31, 2008. As a percentage of the number of gross contracts signed in the three-month periods ended July 31, 2009 and 2008, home


34


 

buyers cancelled 8.5% and 19.4%, respectively, and 10.9% and 20.1%, respectively, of the value of gross contracts signed.
 
Our backlog at July 31, 2009 of $930.7 million (1,626 homes) decreased 46.8%, as compared to our backlog at July 31, 2008 of $1.75 billion (2,592 homes). Backlog consists of homes under contract but not yet delivered to our home buyers. The decrease in backlog at July 31, 2009, as compared to the backlog at July 31, 2008, was primarily attributable to the continuing decline in the new home market which resulted in a lower backlog at October 31, 2008, as compared to the backlog at October 31, 2007, and the decrease in the value and number of net new contracts signed in the nine-month period of fiscal 2009 as compared to the nine-month period of fiscal 2008, offset, in part, by lower deliveries in the nine-month period of fiscal 2009, as compared to the nine-month period of fiscal 2008.
 
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
 
Inventory is stated at the lower of cost or fair value, as determined 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 also include interest, real estate taxes and direct overhead related to development and construction, which are capitalized to inventory during the period beginning with the commencement of development and ending with the completion of construction. For those communities that have been temporarily closed, no additional interest is allocated to the community’s inventory until it re-opens and other carrying costs are expensed as incurred. Once a parcel of land has been approved for development and we open the community, it may take four or more 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 sales and delivery pace of the homes in a community. Our master planned communities, consisting of several smaller communities, may take up to ten years or more to complete. Because of the downturn in our business, the estimated community lives will likely be significantly longer. Because our inventory is considered a long-lived asset under U.S. generally accepted accounting principles, we are required, under SFAS 144, 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.
 
Current Communities:  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, the asset is reviewed for impairment by comparing the estimated future undiscounted cash flow for the community to its carrying value. If the estimated future undiscounted cash flow is less than the community’s carrying value, the carrying value is written down to its estimated fair value. Estimated fair value is primarily determined by discounting the estimated future cash flow of each community. The impairment is charged to cost of revenues in the period in which the impairment is determined. In estimating the future undiscounted cash flow of a community, we use various estimates such as: (a) the expected sales pace in a community, based upon general economic conditions that will have a short-term or long-term impact on the market in which the community is located and on competition within the market, including the number of home sites available and pricing and incentives being offered in other communities owned by us or by other builders; (b) the expected sales prices and sales incentives to be offered in a community; (c) costs expended to date and expected to be incurred in the future, including, but not limited to, land and land development costs, home construction costs, interest costs and overhead costs; (d) alternative product offerings that may be offered in a community that will have an impact on sales pace, sales price, building cost or the number of homes that can be built on a particular site; and (e) alternative uses for the property such as the possibility of a sale of the entire community to another builder or the sale of individual home sites.
 
In the three-month period ended July 31, 2009, we reviewed the fair value of 288 operating communities, determined that the fair value of 14 of these communities was below our carrying value, and recognized impairment charges of $46.8 million on these communities. At July 31, 2009, the carrying value of these communities, net of the impairment charges recognized, was $67.7 million.


35


 

Future Communities:  We evaluate 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. This evaluation encompasses the same types of estimates used for current communities described above, as well as an evaluation of the regulatory environment in which the land is located and the estimated probability of obtaining the necessary approvals, the estimated time and cost it will take to obtain the approvals and the possible concessions that will be required to be given in order to obtain the approvals. Concessions may include cash payments to fund improvements to public places such as parks and streets, dedication of a portion of the property for use by the public or as open space or a reduction in the density or size of the homes to be built. Based upon this review, we decide (a) as to land under contract to be purchased, 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 whether costs that have been capitalized to the community are recoverable or should be written off. The write-off is charged to cost of revenues in the period in which the need for the write-off is determined.
 
The estimates used in the determination of the estimated cash flows and fair value of both current and future communities are based on factors known to us at the time such estimates are made and our expectations of future operations and economic conditions. Should the estimates or expectations used in determining estimated fair value deteriorate in the future, we may be required to recognize additional impairment charges and write-offs related to current and future communities.
 
Variable Interest Entities:  We have land purchase contracts and several investments in unconsolidated entities 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 FASB Interpretation No. 46R (collectively referred to as “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 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 substantial 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. At July 31, 2009, we determined that we were the primary beneficiary of one VIE related to a land purchase contract and had recorded $11.7 million of inventory and $6.4 million of accrued expenses related to this VIE.
 
Income Taxes — Valuation Allowance
 
Significant judgment is required in estimating valuation allowances for deferred tax assets. In accordance with SFAS No. 109, “Accounting for Income Taxes” (“SFAS 109”), a valuation allowance is established against a deferred tax asset if, based on the available evidence, it is more likely than not that such asset will not be realized. The realization of a deferred tax asset ultimately depends on the existence of sufficient taxable income in either the carryback or carryforward periods under tax law. We periodically assess the need for valuation allowances for deferred tax assets based on SFAS 109’s more-likely-than-not realization threshold criteria. In our assessment, appropriate consideration is given to all positive and negative evidence related to the realization of the deferred tax assets. This assessment considers, among other matters, the nature, frequency and magnitude of current and cumulative income and losses, forecasts of future profitability, the duration of statutory carryback or carryforward periods, our experience with operating loss and tax credit carryforwards being used before expiration, and tax planning alternatives.
 
Our assessment of the need for a valuation allowance on our deferred tax assets includes assessing the likely future tax consequences of events that have been recognized in our consolidated financial statements or tax returns. We base our estimate of deferred tax assets and liabilities on current tax laws and rates and, in certain cases, on business plans and other expectations about future outcomes. Changes in existing tax laws or rates could affect our actual tax results and our future business results may affect the amount of our deferred tax liabilities or the valuation


36


 

of our deferred tax assets over time. Our accounting for deferred tax assets represents our best estimate of future events.
 
Due to uncertainties in the estimation process, particularly with respect to changes in facts and circumstances in future reporting periods (carryforward period assumptions), it is possible that actual results could differ from the estimates used in our historical analyses. Our assumptions require significant judgment because the residential homebuilding industry is cyclical and is highly sensitive to changes in economic conditions. If our results of operations are less than projected and there is insufficient objectively positive verifiable evidence to support the likely realization of our deferred tax assets, a valuation allowance would be required to reduce or eliminate our deferred tax assets.
 
We generated significant federal deferred tax assets in fiscal 2007, fiscal 2008 and the in the nine-month period ended July 31, 2009. These federal deferred tax assets were generated primarily by inventory impairments and impairments of investments in and advances to unconsolidated entities. At July 31, 2009, our net federal deferred tax asset, before valuation allowance, was $568.5 million. At July 31, 2009, in accordance with SFAS 109, we assessed whether a valuation allowance should be established based on our determination of whether it is “more likely than not” that some portion or all of the deferred tax assets will not be realized. We believe that the continued downturn in the housing market, the uncertainty as to its length and magnitude, and our continued recognition of impairment charges, are significant evidence of the need for a valuation allowance against our net federal deferred tax assets. During the three-month period ended July 31, 2009, we recorded a valuation allowance of $416.8 million against our federal deferred tax asset. At July 31, 2009, our net federal deferred tax asset, after valuation allowance, was $151.7 million. For federal income tax purposes, we can carry back tax losses incurred in fiscal 2009 against $462 million of taxable income reported in fiscal 2007. We expect to generate tax losses in fiscal 2009, primarily through the recognition for tax purposes of previously recognized book impairments, applying the fiscal 2009 losses to our fiscal 2007 taxable income available for carry back, and recovering $151.7 million of net federal deferred tax assets. We expect that the refund resulting from the carry back of the fiscal 2009 tax losses will be received in fiscal 2010.
 
We are allowed to carry forward tax losses for 20 years and apply such tax losses to future taxable income to realize federal deferred tax assets. As of July 31, 2009, we have not generated taxable losses to carry forward. In addition, we will be able to reverse previously recognized valuation allowances during any future period in which we report income. We will continue to review our federal deferred tax assets in accordance with SFAS 109.
 
For state tax purposes, due to past losses and projected future losses in certain jurisdictions where we do not have carryback potential and/or cannot sufficiently forecast future taxable income, we recognized cumulative valuation allowances of $78.3 million ($50.9 million, net of federal tax benefit) as of July 31, 2009 against our state deferred tax assets. In the nine-month periods ended July 31, 2009 and 2008, we recognized valuation allowances against our state deferred tax assets of $41.4 million ($26.9 million, net of federal tax benefit) and $20.0 million ($13.0 million, net of federal tax benefit), respectively. In the three-month periods ended July 31, 2009 and 2008, we recognized a valuation allowance against our state deferred tax assets of $34.8 million ($22.6 million, net of federal tax benefit) and $7.0 million ($4.6 million, net of federal tax benefit), respectively. Future valuation allowances in these jurisdictions may continue to be recognized if we believe we will not generate sufficient future taxable income to utilize these state deferred tax assets.
 
Revenue and Cost Recognition
 
The construction time of our homes is generally less than one year, although some homes may take more than one year to complete. Revenues and cost of revenues from these 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. In addition, we have several high-rise/mid-rise projects which do not qualify for percentage of completion accounting in accordance with SFAS No. 66, “Accounting for Sales of Real Estate” (“SFAS 66”), that are included in this category of revenues and costs. During fiscal 2007 and 2008, we completed construction on four projects for which we used the percentage of completion accounting method to recognize revenues and costs; the remaining units in these projects will be accounted for using the completed contract method


37


 

of accounting. Based upon the current accounting rules and interpretations, we do not believe that any of our current or future communities qualify for percentage of completion accounting.
 
For our standard attached and detached homes, 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.
 
For high-rise/mid-rise projects, land, land development, construction and related costs, both incurred and estimated to be incurred in the future, are generally amortized to the cost of units closed based upon an estimated relative sales value of the units closed to the total estimated sales value. Any changes resulting from a change in the estimated total costs or revenues of the project are allocated to the remaining units to be delivered.
 
Forfeited customer deposits are recognized in other income in the period in which we determine that the customer will not complete the purchase of the home and when we determine that we have the right to retain the deposit.
 
Sales Incentives:  In order to promote sales of our homes, we grant our home buyers sales incentives from time-to-time. These incentives will vary by type of incentive and by amount on a community-by-community and home-by- home basis. Incentives that impact the value of the home or the sales price paid, such as special or additional options, are generally reflected as a reduction in sales revenues. Incentives that we pay to an outside party, such as paying some or all of a home buyer’s closing costs, are recorded as an additional cost of revenues. Incentives are recognized at the time the home is delivered to the home buyer and we receive the sales proceeds.
 
OFF-BALANCE SHEET ARRANGEMENTS
 
The trends, uncertainties or other factors that have negatively impacted our business and the industry in general and which are discussed in the overview section of this MD&A have also impacted the unconsolidated entities in which we have investments. We review each of our investments in unconsolidated entities on a quarterly basis to determine the recoverability of our investment. We evaluate the recoverability of our investment in unconsolidated entities using similar methodology that we use to evaluate our inventories. This evaluation entails a detailed cash flow analysis using many estimates including but not limited to expected sales pace, expected sales prices, expected incentives, costs incurred and anticipated, sufficiency of financing and capital, competition, and market conditions. When markets deteriorate and it is no longer probable that we can recover our investment in a joint venture we impair our investment. If a joint venture has its own loans or is principally a joint venture to hold an option, such impairment may result in the majority or all of our investment being impaired. See “Critical Accounting Policies — Inventory” in this MD&A for more detailed disclosure on our evaluation of inventory.
 
We have investments in and advances to various unconsolidated entities. At July 31, 2009, we had investments in and advances to these entities, net of impairment charges recognized, of $144.6 million and were committed to invest or advance $27.0 million (net of amounts accrued) of additional funds to certain of these entities if they require additional funding. At July 31, 2009, we had accrued $112.6 million for our commitments to all of our unconsolidated entities. In addition, we guarantee certain debt of a number of these unconsolidated entities on a several and pro-rata basis. At July 31, 2009, we guaranteed an aggregate of approximately $63.3 million (net of amounts that we have accrued) of debt relating to four joint ventures, which had aggregate borrowings of approximately $842.7 million.
 
In connection with certain land joint ventures to which we are a party, we executed completion guarantees and conditional repayment guarantees. The obligations under the completion guarantees and conditional repayment guarantees are several and not joint, and are limited to the Company’s pro-rata share of the loan obligations of the


38


 

respective joint ventures. At July 31, 2009, the maximum amount of the completion guarantees and conditional repayment guarantees (net of amounts that the Company has accrued) is estimated to be approximately $50.3 million, if any liability is determined to be due thereunder. The $50.3 million of these guarantees are included in the $63.3 million of guarantees disclosed above.
 
Our investments in these entities are accounted for using the equity method.
 
RESULTS OF OPERATIONS
 
The following table sets forth, for the nine-month and three-month periods ended July 31, 2009 and 2008, a comparison of certain statement of operations items ($ in millions):
 
                                                                 
    Nine Months Ended July 31,     Three Months Ended July 31,  
    2009     2008     2009     2008  
    $     %     $     %     $     %     $     %  
 
Revenues
    1,268.7               2,457.0               461.4               796.7          
                                                                 
Cost of revenues
    1,445.3       113.9       2,449.4       99.7       511.5       110.9       738.9       92.7  
Selling, general and administrative
    235.7       18.6       333.1       13.6       68.6       14.9       103.1       12.9  
                                                                 
      1,681.0               2,782.5               580.2               842.0          
                                                                 
Loss from operations
    (412.3 )     (32.5 )     (325.5 )     (13.2 )     (118.8 )     (25.7 )     (45.3 )     (5.7 )
Other:
                                                               
Loss from unconsolidated entities
    (8.4 )             (135.8 )             (3.7 )             (30.1 )        
Expenses related to early retirement of debt
    (2.1 )                                                        
Interest and other
    33.0               100.5               11.3               20.6          
                                                                 
Loss before income taxes
    (389.7 )             (360.8 )             (111.3 )             (54.8 )        
Income tax provision (benefit)
    254.7               (141.8 )             361.1               (25.5 )        
                                                                 
Net loss
    (644.4 )             (219.0 )             (472.3 )             (29.3 )        
                                                                 
 
 
Note: Due to rounding, amounts may not add.
 
REVENUES AND COST OF REVENUES
 
In the nine-month period ended July 31, 2009, we recognized $1.27 billion of revenues and a net loss of $644.4 million, as compared to $2.46 billion of revenues and a net loss of $219.0 million in the nine-month period ended July 31, 2008. In the nine-month period ended July 31, 2009, we recognized inventory and joint venture impairment charges and write-offs of $391.2 million, as compared to $673.0 million of inventory and joint venture impairment charges and write-offs in the nine-month period ended July 31, 2008. In addition, in the nine months ended July 31, 2009, we recognized $443.7 million of valuation allowances against our federal and state deferred tax assets, as compared to $13.0 million of valuation allowances against our state deferred tax assets in the nine-month period ended July 31, 2008. (See “Critical Accounting Policies: Income Taxes — Valuation Allowance” above for an expanded discussion related to the valuation allowances recognized.)
 
In the three-month period ended July 31, 2009, we recognized $461.4 million of revenues and a net loss of $472.3 million, as compared to $796.7 million of revenues and a net loss of $29.3 million in the three-month period ended July 31, 2008. In the three-month period ended July 31, 2009, we recognized inventory and joint-venture impairment charges and write-offs of $115.0 million, as compared to $139.4 million of inventory and joint venture impairment charges and write-offs in the three-month period ended July 31, 2008. In addition, in the three months ended July 31, 2009, we recognized $439.4 million of valuation allowances against our federal and state deferred tax assets, as compared to $4.6 million of valuation allowances against our state deferred tax assets in the three-


39


 

month period ended July 31, 2008. (See “Critical Accounting Policies: Income Taxes — Valuation Allowance” above for an expanded discussion related to the valuation allowances recognized.)
 
Revenues for the nine months ended July 31, 2009, excluding $39.1 million of revenues recognized under the percentage of completion accounting method recognized in the fiscal 2008 period, were lower than those for the fiscal 2008 period by approximately $1.15 billion, or 47.5%. This decrease was attributable to a 42.5% decrease in the number of homes delivered and an 8.7% decrease in the average price of the homes delivered. The decrease in the number of homes delivered in the nine-month period ended July 31, 2009 was primarily due to a 48.2% decline in our backlog at October 31, 2008, as compared to our backlog at October 31, 2007, and a 29.4% decrease in the number of net new contracts signed in the nine-month period of fiscal 2009, as compared to the fiscal 2008 period.
 
The 8.7% decrease in the average price of the homes delivered in the fiscal 2009 period, as compared the fiscal 2008 period, was due to the impact of a shift in product mix to lower priced product and less expensive areas, and an increase in incentives given on homes closed in the fiscal 2009 period, as compared to the fiscal 2008 period. Average sales incentives given on homes delivered in the nine-month period of fiscal 2009 amounted to approximately $90,000 per home or 13.0% of the price of the home, as compared to approximately $70,000 per home, or 9.6% of the price of the home, in the fiscal 2008 period.
 
Revenues for the three months ended July 31, 2009, excluding $5.6 million of revenues recognized under the percentage of completion accounting method recognized in the fiscal 2008 period, were lower than those for the comparable period of fiscal 2008 by approximately $329.7 million, or 41.7%. This decrease was attributable to a 36.3% decrease in the number of homes delivered and an 8.4% decrease in the average price of the homes delivered. The decrease in the number of homes delivered in the three-month period ended July 31, 2009 was primarily due to a 55% decline in backlog at April 30, 2009, as compared to our backlog at April 30, 2008. The 8.4% decrease in the average price of the homes delivered in the fiscal 2009 period, as compared the fiscal 2008 period, was due to the impact of a shift in product mix to lower priced product and less expensive areas, and an increase in incentives given on homes closed in the fiscal 2009 period, as compared to the fiscal 2008 period. Average sales incentives given on homes delivered in the three-month period ended July 31, 2009 amounted to approximately $103,000 per home or 15.1% of the price of the home delivered, as compared to approximately $76,000 per home, 10.7% of the price of the home, in the fiscal 2008 period.
 
Cost of revenues as a percentage of home sales revenue was 113.9% in the nine-month period ended July 31, 2009, as compared to 99.7% in the nine-month period ended July 31, 2008. In the nine-month periods ended July 31, 2009 and 2008, we recognized inventory impairment charges and write-offs of $379.9 million and $526.7 million, respectively. Land, land development and home and home related construction costs, including interest, (“home costs”) were 84.0% of revenues in the nine-month period ended July 31, 2009, as compared to 78.2% in the fiscal 2008 period. The increase in the home costs percentage was due primarily to higher sales incentives on the homes delivered, higher interest costs and a change in the mix of product delivered. Sales incentives as a percentage of revenues was 14.9% in the nine-month period ended July 31, 2009, and 10.5% in the nine-month period ended July 31, 2008. Interest cost as a percentage of revenues was 4.3% in the nine-month period ended July 31, 2009, as compared to 2.7% in the fiscal 2008 period. The higher interest cost percentage was due to inventory generally being held for a longer period of time and fewer qualifying assets to which interest can be allocated, resulting in higher amounts of capitalized interest allocated to qualifying inventory.
 
Cost of revenues as a percentage of home sales revenue was 110.9% in the three-month period ended July 31, 2009, as compared to 92.7% in the three-month period ended July 31, 2008. In the three-month periods ended July 31, 2009 and 2008, we recognized inventory impairment charges and write-offs of $109.7 million and $106.0 million, respectively. Home costs were 87.1% of revenues in the three-month period ended July 31, 2009, as compared to 79.4% in the fiscal 2008 period. The increase in the home costs percentage was due primarily to higher sales incentives on the homes delivered, higher interest costs and a change in the mix of product delivered. Sales incentives as a percentage of revenues was 17.7% in the three-month period ended July 31, 2009, and 11.9% in the three-month period ended July 31, 2008. Interest cost as a percentage of revenues was 5.1% in the three-month period ended July 31, 2009, as compared to 2.9% in the fiscal 2008 period. The higher interest cost percentage was due to inventory generally being held for a longer period of time and fewer qualifying assets to which interest can be allocated, resulting in higher amounts of capitalized interest allocated to qualifying inventory.


40


 

 
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES (“SG&A”)
 
SG&A spending decreased by $97.4 million, or 29.2%, in the nine-month period ended July 31, 2009, as compared to the nine-month period ended July 31, 2008. As a percentage of revenues, SG&A was 18.6% in the nine-month period ended July 31, 2009, as compared to 13.6% in the fiscal 2008 period. The reduction in spending was due primarily to reduced compensation and related costs and reduced costs for advertising, promotions and marketing offset, in part, by the expensing of interest incurred not eligible to be capitalized in the nine-month period ended, 2009 and the higher amount of deferred marketing costs that were written off with regard to closed communities in the fiscal 2009 period, as compared to the fiscal 2008 period. Due to the decline in qualified inventory, interest incurred on homebuilding indebtedness exceeded amounts eligible for capitalization in the nine-month period of fiscal 2009 by $1.8 million which was expensed to SG&A in the fiscal 2009 period. Prior to November 1, 2008, qualified inventory exceeded homebuilding indebtedness and all interest incurred was capitalized. The write-off of deferred marketing costs related to closed communities in the nine-month periods of fiscal 2009 and 2008 were $4.9 million and $1.7 million, respectively.
 
SG&A spending decreased by $34.5 million, or 33.4%, in the three-month period ended July 31, 2009, as compared to the three-month period ended July 31, 2008. As a percentage of revenues, SG&A was 14.9% in the three-month period ended July 31, 2009, as compared to 12.9% in the fiscal 2008 period. The reduction in spending was due primarily to reduced compensation and related costs, reduced costs for advertising, promotions and marketing and the reversal of previously expensed interest (see paragraph below), offset, in part, by the higher amount of deferred marketing costs that were written off with regard to closed communities in the fiscal 2009 period, as compared to the fiscal 2008 period. The write-off of deferred marketing costs related to closed communities in the three-month periods of fiscal 2009 and 2008 were $0.7 million and $0.0 million, respectively.
 
In the six-month and three-month periods ended April 30, 2009, we expensed interest directly to SG&A of $5.2 million and $4.4 million, respectively. During the three-month period ended July 31, 2009, we reviewed the methodology we applied in identifying qualified inventory used in the calculation of capitalized interest, and determined that the amount of qualified inventory was higher than we had previously identified and that a portion of the amounts of interest previously expensed directly to SG&A in the six-month and three-month periods ended April 30, 2009 should be capitalized. As a result of this review, we reversed $4.6 million of previously expensed interest, thereby reducing SG&A by $4.6 million in the three-month period ended July 31, 2009. However, due to the decline in qualified inventory during the three-month period ended July 31, 2009, interest incurred on homebuilding indebtedness exceeded amounts required to be capitalized in the three-month period of fiscal 2009 by $1.2 million. This excess interest was charged to SG&A in the fiscal 2009 period.
 
LOSS FROM UNCONSOLIDATED ENTITIES
 
We are a participant in several joint ventures and in the Trust and Trust II. We recognize our proportionate share of the earnings and losses from these entities. The trends, uncertainties or other factors that have negatively impacted our business and the industry in general and which are discussed in the “Overview” section of this MD&A have also impacted the unconsolidated entities in which we have investments. 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 entity 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 months ended July 31, 2009, we recognized $8.4 million of losses from unconsolidated entities, as compared to $135.8 million of losses in the comparable period of fiscal 2008. The loss in the nine-month period ended July 31, 2009 was attributable to $11.3 million of impairment charges recognized on our investments in unconsolidated entities. The loss in the nine-month period ended July 31, 2008 was attributable to $146.3 million of impairment charges recognized on our investments in unconsolidated entities.
 
In the three months ended July 31, 2009, we recognized $3.7 million of losses from unconsolidated entities, as compared to $30.1 million of losses in the fiscal 2008 period. The losses in the three-month period ended July 31, 2009 and 2008 were attributable to $5.3 million and $33.4 million, respectively, of impairment charges recognized on our investments in unconsolidated entities.


41


 

 
INTEREST AND OTHER INCOME
 
For the nine months ended July 31, 2009 and 2008, interest and other income was $33.0 million and $100.5 million, respectively. The decrease in other income in the nine-month period ended July 31, 2009, as compared to fiscal 2008 period, was primarily due to a $40.2 million gain recognized in the fiscal 2008 period on a condemnation judgement in our favor, a $16.2 million decline in interest income in the fiscal 2009 period, as compared to the fiscal 2008 period, a $3.8 million decline in income from ancillary businesses and management fee income in the fiscal 2009 period, as compared to the fiscal 2008 period, a $7.5 million decline in retained customer deposits in the fiscal 2009 period, as compared to the fiscal 2008 period and the recognition of a $2.1 million charge in the fiscal 2009 period in connection with the redemption of $293.0 million of our senior subordinated notes that was announced in April 2009.
 
For the three months ended July 31, 2009 and 2008, interest and other income was $11.3 million and $20.6 million, respectively. The decrease in other income in the three-month period ended July 31, 2009, as compared to the fiscal 2008 period, was primarily due to a $6.8 million decline in interest income in the fiscal 2009 period, as compared to the fiscal 2008 period, and a $3.6 million decline in retained customer deposits in the fiscal 2009 period, as compared to the fiscal 2008 period, offset, in part, by an increase in income from ancillary businesses and management fee income in the fiscal 2009 period, as compared to the fiscal 2008 period.
 
LOSS BEFORE INCOME TAXES
 
For the nine-month periods ended July 31, 2009 and 2008, we reported a loss before income tax provision (benefit) of $389.7 million and $360.8 million, respectively. For the three-month periods ended July 31, 2009 and 2008, we reported a loss before income tax benefit of $111.3 million and $54.8 million, respectively.
 
INCOME TAXES
 
In the nine-month and three-month periods ended July 31, 2009, we recognized a provision for taxes of $254.7 million and $361.1 million, respectively. Excluding the valuation allowances against our federal and state deferred tax assets in each of the nine-month and three-month periods ended July 31, 2009 and 2008, as discussed in the “Critical Accounting Policies — Income Taxes — Valuation Allowance” in this MD&A, we recognized a tax benefit in the nine-month period ended July 31, 2009 of $189.0 million at an effective rate of 48.5% and $78.3 million at an effective rate of 70.4% in the three-month period ended July 31, 2009. In the nine-month and three-month periods ended July 31, 2008, we recognized a tax benefit, net of state valuation allowances, at effective rates of 42.9% and 54.8%, respectively.
 
The difference in the effective tax rate for the nine-month and three-month periods of fiscal 2009, as compared to the fiscal 2008 periods, excluding the federal and state deferred tax asset valuation allowances we recognized, was primarily due to: an increase in the reversal in the fiscal 2009 periods, as compared to fiscal 2008 periods of state tax provision, net of federal tax provision, accrued in prior years against potential tax assessments, which were no longer needed due to our settlement of various federal and state audits and the expiration of the applicable statute of limitations for federal and state tax purposes; a lower blended state tax rate in the fiscal 2009 periods, as compared to the fiscal 2008 periods due to the combination of a shift in the state tax jurisdictions where the losses occurred and the applicable state income tax rates in those jurisdictions; and an increase in the fiscal 2008 rates due to tax free income recognized in the fiscal 2008 periods but not in the fiscal 2009 periods. (See “Critical Accounting Policies: Income Taxes — Valuation Allowance” above for an expanded discussion related to the valuation allowances recognized.)
 
CAPITAL RESOURCES AND LIQUIDITY
 
Funding for our business has been provided principally by cash flow from operating activities before inventory additions, unsecured bank borrowings and the public debt and equity markets. Prior to fiscal 2008, we 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 backlog, invest in unconsolidated entities, purchase our stock and repay debt.


42


 

At July 31, 2009, we had $1.66 billion of cash on hand. Cash flow provided by operating activities was $57.0 million. Cash provided by operating activities was primarily generated by a reduction in inventory and the receipt of an income tax refund on previously paid taxes, offset, in part, by the payment of accounts payable and accrued liabilities and income tax payments made for the settlement of previously accrued tax audits. The decreases in inventory, accounts payable and accrued liabilities were due primarily to the decline in our business as previously discussed. We used $21.3 million of cash in our investing activities in the nine-month period ended July 31, 2009, primarily for investments made in our unconsolidated entities. We also used $11.6 million of cash in financing activities in the nine-month period ended July 31, 2009, principally for the repayment and redemption of $860.3 million of debt (primarily our senior subordinated debt and mortgage company warehouse loan), offset, in part, by the issuance of $400 million of senior notes in the public debt markets (net proceeds amounted to $389.4 million), $450.8 million of other borrowings (primarily from our mortgage company warehouse loan), stock-based benefit plans and the tax benefits of stock-based compensation.
 
In the nine-month period ended July 31, 2008, we generated $602.0 million of cash, principally from operating activities. In the fiscal 2008 period, cash flow from operating activities was generated primarily from net income before inventory and investment impairment losses, reductions in inventory, and a decrease in contracts receivable related to percentage of completion accounting, offset, in part, by a decrease in accounts payable and accrued expenses (excluding accruals of estimated liabilities to various joint ventures), a decrease in customer deposits and an increase in deferred tax assets. The decreased inventory, contracts receivable, accounts payable and customer deposits were due primarily to the decline in our business as previously discussed.
 
At July 31, 2009, the aggregate purchase price of land parcels under option and purchase agreements was approximately $540.0 million (including $148.5 million of land to be acquired from joint ventures in which we have invested). Of the $540.0 million of land purchase commitments, we had paid or deposited $63.9 million, we will receive a credit for prior investments in joint ventures of approximately $36.7 million and, if we acquire all of these land parcels, we will be required to pay $439.4 million. Of the $439.4 million we would be required to pay, we recorded $120.5 million of this amount in accrued expenses at July 31, 2009. The purchases of these land parcels are scheduled over the next several years. We have additional land parcels under option that have been excluded from the aforementioned aggregate purchase amounts since we do not believe that we will complete the purchase of these land parcels and no additional funds will be required from us to terminate these contracts.
 
In general, our 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 those which we deliver. In addition, we generally do not begin construction of our single-family detached homes until we have a signed contract with the home buyer, although in the past several years, due to the high cancellation rate of customer contracts and the increase in the number of attached-home communities from which we were operating (all of the units of which are generally not sold prior to the commencement of construction), the number of speculative homes in our inventory increased significantly. Should our business remain at its current level or decline from present levels, we believe that our inventory levels would continue to decrease as we complete and deliver the homes under construction but do not commence construction of as many new homes, as we complete the improvements on the land we already own and as we sell and deliver the speculative homes that are currently in inventory, resulting in additional cash flow from operations. In addition, we might continue to delay or curtail our acquisition of additional land, as we have since the second half of fiscal 2006, which would further reduce our inventory levels and cash needs. At July 31, 2009, we owned or controlled through options approximately 35,400 home sites, as compared to approximately 39,800 at October 31, 2008, approximately 48,500 at July 31, 2008 and approximately 91,200 at April 30, 2006, our peak in terms of home sites owned or controlled through options. Of the 35,400 home sites owned or controlled through options at July 31, 2009, we owned approximately 30,800; of our owned home sites, significant improvements were completed on approximately 12,300.
 
We have a $1.89 billion credit facility consisting of a $1.56 billion unsecured revolving credit facility and a $331.7 million term loan facility (collectively, the “Credit Facility”) with 30 banks, which extends to March 2011. At July 31, 2009, we had no outstanding borrowings against the revolving credit facility but had letters of credit of approximately $203.7 million outstanding under it. Under the terms of the Credit Facility, our maximum leverage ratio (as defined in the agreement) may not exceed 2.00 to 1.00 and at July 31, 2009, we were required to maintain a


43


 

minimum tangible net worth (as defined in the agreement) of approximately $1.94 billion. At July 31, 2009, our leverage ratio was approximately 0.23 to 1.00 and our tangible net worth was approximately $2.59 billion.
 
On April 13, 2009, through our wholly-owned subsidiary Toll Brothers Finance Corp., we issued $400 million of 8.91% Senior Notes due 2017. We received $389.4 million of net proceeds from the issuance of these senior notes.
 
During the three-month period ended July 31, 2009, we redeemed all of the remaining $193.0 million outstanding principal amount of our 81/4% Senior Subordinated Notes due February 2011 at a cash redemption price of 100.0% of the principal amount plus accrued and unpaid interest, and $100.0 million outstanding principal amount of our 8.25% Senior Subordinated Notes due December 2011 at a cash redemption price of 101.375% of the principal amount plus accrued and unpaid interest. In addition, we purchased an additional $2.1 million principal amount of our 8.25% Senior Subordinated Notes due December 2011 through open market purchases. At July 31, 2009, $47.9 million of our 8.25% Senior Subordinated Notes due December 2011 were outstanding. In the nine-month period ended July 31, 2009, we recognized a charge of $2.1 million representing the write-off of unamortized debt issuance costs associated with both series of notes and the call premium on the 8.25% Senior Subordinated Notes due December 2011.
 
On August 13, 2009, TBI Mortgage Company, our wholly-owned mortgage subsidiary, entered into a Master Repurchase Agreement with Comerica Bank, as agent and representative of itself as a buyer and the other buyers named therein. The agreement replaced TBI Mortgage Company’s warehouse credit facility which was set to expire on August 13, 2009. The purpose of the agreement is to finance the origination of mortgage loans by TBI Mortgage Company. The agreement provides for loan purchases up to $75 million, subject to certain sublimits. In addition, the agreement provides for an accordion feature under which TBI Mortgage Company may request that the aggregate commitments under the agreement be increased to an amount up to $100 million. The agreement expires on July 29, 2010.
 
We believe that we will be able to continue to fund our current operations and meet our contractual obligations through a combination of existing cash resources and our existing sources of credit. Due to the deterioration of the credit markets and the uncertainties that exist in the economy and for home builders in general, we cannot be certain that we will be able to replace existing financing or find sources of additional financing in the future.
 
INFLATION
 
The long-term impact of inflation on us is manifested in increased costs for land, land development, construction and overhead. 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 will affect our profits. Prior to the current downturn in the economy and the decline in demand for homes, the sales prices of our homes generally increased. Because the sales price of each of our homes is fixed at the time a buyer enters into a contract to purchase 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. The slowdown in the homebuilding industry over the past several years and the decline in the sales prices of our homes, without a corresponding reduction in the costs, have had an adverse impact on our profitability.
 
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.


44


 

GEOGRAPHIC SEGMENTS
 
We operate in four geographic segments around the United States: the North, consisting of Connecticut, Illinois, Massachusetts, Michigan, Minnesota, New Jersey and New York; the Mid-Atlantic, consisting of Delaware, Maryland, Pennsylvania, Virginia and West Virginia; the South, consisting of Florida, Georgia, North Carolina, South Carolina, and Texas; and the West, consisting of Arizona, California, Colorado and Nevada.
 
The following tables summarize information related to revenues, gross contracts signed, contract cancellations, net contracts signed and sales incentives provided on units delivered by geographic segment for the nine-month and three-month periods ended July 31, 2009 and 2008, and information related to backlog by geographic segment at July 31, 2009 and 2008.
 
Revenues:
 
                                                                 
    Nine Months Ended July 31,     Three Months Ended July 31,  
    2009     2008     2009     2008     2009     2008     2009     2008  
    Units     Units     (In millions)     (In millions)     Units     Units     (In millions)     (In millions)  
 
North(a)
    690       941     $ 428.4     $ 658.6       250       339     $ 145.5     $ 221.8  
Mid-Atlantic
    630       1,094       364.5       668.3       228       360       129.7       214.4  
South(a)
    391       868       212.0       434.1       152       295       83.1       144.4  
West
    394       761       263.8       656.9       162       250       103.1       210.5  
Other
                            39.1                               5.6  
                                                                 
      2,105       3,664     $ 1,268.7     $ 2,457.0       792       1,244     $ 461.4     $ 796.7  
                                                                 
 
Gross Contracts Signed:
 
                                                                 
    Nine Months Ended July 31,     Three Months Ended July 31,  
    2009     2008     2009     2008     2009     2008     2009     2008  
    Units     Units     (In millions)     (In millions)     Units     Units     (In millions)     (In millions)  
 
North
    604       764     $ 314.5     $ 473.9       285       270     $ 144.5     $ 157.3  
Mid-Atlantic
    640       995       353.2       570.2       282       330       154.3       179.2  
South
    435       753       215.9       377.6       166       209       86.2       106.2  
West
    402       636       280.3       470.0       182       198       117.6       145.4  
                                                                 
      2,081       3,148     $ 1,163.9     $ 1,891.7       915       1,007     $ 502.6     $ 588.1  
                                                                 
 
Contracts Cancelled:
 
                                                                 
    Nine Months Ended July 31,     Three Months Ended July 31,  
    2009     2008     2009     2008     2009     2008     2009     2008  
    Units     Units     (In millions)     (In millions)     Units     Units     (In millions)     (In millions)  
 
North
    165       176     $ 130.2     $ 125.2       39       20     $ 24.9     $ 9.2  
Mid-Atlantic
    87       150       64.0       101.7       23       56       16.2       35.7  
South
    76       206       45.2       101.9       6       77       5.0       34.9  
West
    68       228       50.7       221.5       10       42       8.8       38.4  
                                                                 
      396       760     $ 290.1     $ 550.3       78       195     $ 54.9     $ 118.2  
                                                                 


45


 

Net New Contracts Signed:
 
                                                                 
    Nine Months Ended July 31,     Three Months Ended July 31,  
    2009     2008     2009     2008     2009     2008     2009     2008  
    Units     Units     (In millions)     (In millions)     Units     Units     (In millions)     (In millions)  
 
North
    439       588     $ 184.3     $ 348.7       246       250     $ 119.6     $ 148.1  
Mid-Atlantic
    553       845       289.3       468.5       259       274       138.1       143.5  
South
    359       547       170.7       275.7       160       132       81.2       71.3  
West
    334       408       229.6       248.5       172       156       108.8       107.0  
                                                                 
      1,685       2,388     $ 873.9     $ 1,341.4       837       812     $ 447.7     $ 469.9  
                                                                 
 
Contract Cancellation Rates
(as a percentage of gross contracts signed):
 
                                                                 
    Nine Months Ended July 31,     Three Months Ended July 31,  
    2009     2008     2009     2008     2009     2008     2009     2008  
    Units     Units     Value     Value     Units     Units     Value     Value  
 
North
    27.3 %     23.0 %     41.4 %     26.4 %     13.7 %     7.4 %     17.3 %     5.8 %
Mid-Atlantic
    13.6 %     15.1 %     18.1 %     17.8 %     8.2 %     17.0 %     10.5 %     19.9 %
South
    17.5 %     27.4 %     20.9 %     27.0 %     3.6 %     36.8 %     5.8 %     32.8 %
West
    16.9 %     35.8 %     18.1 %     47.1 %     5.5 %     21.2 %     7.5 %     26.4 %
Total
    19.0 %     24.1 %     24.9 %     29.1 %     8.5 %     19.4 %     10.9 %     20.1 %
 
Backlog at July 31 :
 
                                 
    2009     2008     2009     2008  
    Units     Units     (In millions)     (In millions)  
 
North
    619       1,075     $ 318.5     $ 738.9  
Mid-Atlantic
    481       724       287.1       477.0  
South
    322       472       163.8       279.5  
West
    204       321       161.3       259.2  
Less revenue recognized on units remaining in backlog(b)
                            (4.3 )
                                 
      1,626       2,592     $ 930.7     $ 1,750.3  
                                 
 
 
(a) Excludes deliveries from projects accounted for using the percentage of completion accounting method. Information regarding these deliveries in the nine months and three months ended July 31, 2008 is as follows:
 
                                 
    As of July 31  
    Nine Months     Three Months  
    2008     2008     2008     2008  
    Units     (In millions)     Units     (In millions)  
 
North
    69     $ 40.9       11     $ 6.2  
South
    13       37.8                  
                                 
      82     $ 78.7       11     $ 6.2  
                                 
 
(b) Amounts represent revenues recognized on projects accounted for using the percentage of completion accounting method. Based upon the current accounting rules and interpretations, we do not believe that any of our current or future communities qualify for percentage of completion accounting.


46


 

 
Sales Incentives:
 
                                                                 
    Nine Months Ended July 31,     Three Months Ended July 31,  
                % of Gross Revenues(a)                 % of Gross Revenues(a)  
    2009     2008     2009     2008     2009     2008