SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark One) X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended October 31, 1996 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 1-9186 TOLL BROTHERS, INC. (Exact name of Registrant as specified in its charter) Delaware 23-2416878 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 3103 Philmont Avenue, Huntingdon Valley, Pennsylvania 19006-4298 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (215) 938-8000 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange on Title of each class which registered Common Stock (par value $.01) New York Stock Exchange Pacific Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None 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 X No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. As of December 31, 1996, the aggregate market value of the Common Stock held by non-affiliates of the Registrant was approximately $433,366,000. As of December 31, 1996, there were 33,950,360 shares of Common Stock outstanding. Documents Incorporated by Reference: Toll Brothers, Inc. Proxy Statement with respect to its 1997 Annual Meeting of Shareholders, scheduled to be held on March 5, 1997, is incorporated into Part III hereof. PART I ITEM 1. BUSINESS General Toll Brothers, Inc. ("Toll Brothers" or the "Company"), a Delaware corporation formed in May 1986, commenced its business operations, through predecessor entities, in 1967. Toll Brothers designs, builds, markets and arranges financing for single family detached and attached homes in middle and high income residential communities in thirteen states and five regions around the country. The communities are generally located on land the Company has developed, although, due to the poor economic conditions during the early 1990's, the Company was able to acquire a number of fully approved parcels and several improved subdivisions. Currently, Toll Brothers operates predominantly in major suburban residential areas in southeastern Pennsylvania, central New Jersey, the Virginia and Maryland suburbs of Washington, D.C., the Boston, Massachusetts metropolitan area, southern Connecticut, Westchester County, New York, Orange County and Los Angeles County, California, the suburbs of Raleigh and Charlotte, North Carolina and Scottsdale, Arizona. It is also developing communities in northern Delaware, Nassau County, New York, McKinney, Texas, a northern suburb of Dallas, Austin, Texas and Palm Beach County, Florida. The Company has recently acquired property in the San Francisco Bay area and expects to begin offering homes for sale there in the second half of fiscal 1997. The Company markets its homes primarily to middle and upper-income buyers, emphasizing high quality construction and customer satisfaction. As of October 31, 1996, the Company was offering homes for sale in 100 communities. Single family detached homes were being offered at prices, excluding customized options, generally ranging from $160,000 to $645,000, with an average base sales price of $368,000. Attached home prices, excluding customized options, generally range from $100,000 to $477,000, with an average base sales price of $218,000. In the five years ended October 31, 1996, Toll Brothers delivered 7,860 homes in 177 communities. In recognition of the Company's achievements, it has received numerous awards from national, state and local homebuilder publications and associations. In fiscal 1996, the Company was selected "America's Best Builder" by the National Association of Home Builders (the "NAHB") and Builder magazine in recognition of its excellent financial performance, unique custom-production system for building luxury homes in high volume and the excellence of its designs. The Company also received the National Housing Quality Award from the NAHB, which recognizes the Company's outstanding commitment to total quality management and continuous improvement. In 1994, the Company received one of the first place awards in the "Build America Beautiful" Awards Program, sponsored by Better Homes and Gardens magazine, the NAHB and Keep America Beautiful, Inc., in recognition of the Company's programs to improve the handling of solid waste on construction sites. In addition, the Company was named "The Builder of the Year" in 1988 by Professional Builder magazine. On October 31, 1996 and 1995, the Company had backlogs of $526,194,000 (1,367 homes) and $400,820,000 (1,078 homes), respectively. Substantially all homes in backlog at October 31, 1996 are expected to be delivered by October 31, 1997. As of October 31, 1996, the Company was offering homes for sale in 100 communities and owned or controlled through options, over 8,800 home sites in communities under development, as well as land for approximately 8,500 planned home sites in proposed communities. The Company generally attempts to reduce certain risks homebuilders encounter, by controlling land for future development through options whenever possible (which allows the Company to obtain the necessary government approvals before acquiring title to the land), by beginning construction of homes after an agreement of sale has been executed with a buyer and by using subcontractors to perform home construction and land development work on a fixed-price basis. However, in order to obtain better terms or prices or due to competitive pressures, the Company has purchased several properties outright, or acquired the underlying mortgage, prior to obtaining all of the necessary governmental approvals needed to commence development. The Communities Toll Brothers' communities are generally located in suburban areas near major highways with access to major cities. Through 1981, all communities were located in southeastern Pennsylvania. The Company began selling homes in central New Jersey in 1982, in northern Delaware and Massachusetts in 1987, in Maryland in 1988, in Virginia and Connecticut in 1992, in New York in 1993, in Southern California and North Carolina in 1994, in the suburbs of Dallas, Texas and Florida in 1995 and Austin, Texas in 1996. In addition, in August 1995, the Company acquired certain assets, including two existing communities under development and options on several future communities, of Geoffrey H. Edmunds & Associates, a privately owned Scottsdale, Arizona, luxury homebuilder. The Company has also acquired property in the San Francisco Bay Area and expects to begin offering homes for sale there in the second half of fiscal 1997. The Company emphasizes its high-quality, detached single family homes that are marketed primarily to the "upscale" luxury market, generally those persons who have previously owned a principal residence - the so-called "move-up" market. The Company believes its reputation as a developer of homes for this market enhances its competitive position with respect to the sale of more moderately priced detached homes, as well as attached homes. The Company also markets to the 50+ year-old "empty nester" and believes that this market has strong growth potential. The Company has developed a number of home designs that it believes will appeal to this category of home buyer and integrated these designs into its communities along with its other homes. Each single family home community offers several home plans, with the opportunity to select various exterior styles. The communities are designed to fit existing land characteristics, blending winding streets, cul-de-sacs and underground utilities to establish a pleasant environment. The Company strives to create a diversity of architectural styles within an overall planned community. This diversity arises from variations among the models offered and in exterior design options of homes of the same basic floor plan, from the preservation of existing trees and foliage whenever practicable, and from the curving street layout, which allows relatively few homes to be seen from any vantage point. Normally, homes of the same type or color may not be built next to each other. The communities have attractive entrances with distinctive signage and landscaping. The Company believes this avoids a "development" appearance and gives the community a diversified neighborhood look that enhances home value. Attached home communities are generally one to three stories, provide for limited exterior options and often contain commonly-owned recreational acreage with swimming pools and tennis courts. These communities have associations through which homeowners act jointly for their common interest. It is the Company's belief that the homes built by Toll Brothers in its named communities provide homeowners with additional value upon resale. The Homes Most single family detached-home communities offer at least three different home plans, each with several substantially different architectural styles. For example, the same basic floor plan may be selected with a Colonial, Georgian, Federal or Provincial design, and exteriors may be varied further by the use of stone, stucco, brick or siding. Attached home communities generally offer two or three different floor plans with two, three or four bedrooms. In all of Toll Brothers' communities, certain options are available to the purchaser for an additional charge. The options typically are more numerous and significant on the more expensive homes. Major options include additional garages, additional rooms, finished lofts, and additional fireplaces. As a result of the additional charges for such options, the average sales price was approximately 16% higher than the base sales price during fiscal 1996. The range of base sales prices for the Company's lines of homes as of October 31, 1996, was as follows: Single Family Detached Homes: Move-up $160,000 - $500,000 Executive 247,000 - 602,000 Estate 335,000 - 645,000 Attached Homes: Townhomes 100,000 - 219,000 Carriage Homes 234,000 - 477,000 Contracts for the sale of homes are at fixed prices. The prices at which homes are offered have generally increased from time to time during the sellout period for each community; however, there can be no assurance that sales prices will increase in the future. The Company uses some of the same basic home designs in similar communities. However, the Company is continuously developing new designs to replace or augment existing ones to assure that its homes are responsive to current consumer preferences. For new designs, the Company has its own architectural staff and occasionally engages unaffiliated architectural firms. During the past year, the Company has introduced over 35 new models. The following table summarizes certain information with respect to residential communities of Toll Brothers under development as of October 31, 1996: HOMES UNDER NUMBER OF HOMES HOMES CONTRACT AND HOME SITES STATE COMMUNITIES APPROVED CLOSED NOT CLOSED AVAILABLE Arizona 12 958 88 117 753 California 7 474 85 35 354 Connecticut 6 218 86 38 94 Delaware 4 416 357 31 28 Florida 2 213 30 34 149 Maryland 4 455 60 38 357 Massachusetts 8 830 608 108 114 New Jersey: North central 6 694 205 31 458 Central 20 1,291 421 239 631 South central 7 1,087 317 120 650 New York 9 415 151 78 186 North Carolina 5 565 73 57 435 Pennsylvania 34 4,217 2,072 264 1,881 Texas 3 426 16 27 383 Virginia 14 1,512 394 150 968 Total 141(1) 13,771 4,963 1,367 7,441(2) (1) Of these 141 communities, 100 had homes being offered for sale, 14 had not yet opened for sales, and 27 had been sold out but not all closings had been completed. Of the 100 communities in which homes were being offered for sale, 92 were single family detached-home communities containing a total of 92 homes under construction but not under contract (exclusive of model homes) and 8 were attached home communities containing a total of 23 homes under construction but not under contract (exclusive of model homes). (2) On October 31, 1996, significant site improvements had not commenced on approximately 3,967 of the 7,441 available home sites. Of the 7,441 available home sites, 768 were not owned, but were controlled through options. Land Policy Before entering into a contract to acquire land, the Company completes extensive comparative studies and analyses on detailed Company-designed forms that assist it in evaluating the acquisition. Toll Brothers generally attempts to follow a policy of acquiring options to purchase land for future communities. However, in order to obtain better terms or prices, or due to competitive pressures, the Company has at times acquired property outright. In addition, the Company has at times acquired the underlying mortgage on a property and subsequently obtained title to that property. The options or purchase agreements are generally on a non-recourse basis, thereby limiting the Company's financial exposure to the amounts invested in property and pre-development costs. The use of options or purchase agreements may somewhat raise the price of land that the Company eventually acquires, but significantly reduces risk. It also allows the Company to obtain necessary development approvals before acquisition of the land, which generally enhances the value of the options and the land eventually acquired. The Company's purchase agreements are typically subject to numerous conditions including, but not limited to, the Company's ability to obtain necessary governmental approvals for the proposed community. Often, the down payment on the agreement will be returned to the Company if all approvals are not obtained, although pre-development costs may not be recoverable. The Company has the ability to extend many of these options for varying periods of time, in some cases by the payment of an additional deposit and in some cases without an additional payment. The Company has the right to cancel any of its land agreements by forfeiture of the Company's down payment on the agreement. In such instances, the Company generally is not able to recover any pre-development costs. During the early 1990's, due to the recession and the difficulties other builders and land developers had in obtaining financing, the number of buyers competing for land in the Company's market areas diminished, while the number of sellers increased, resulting in more advantageous prices for land acquisitions made by the Company. Further, many of the land parcels offered for sale were fully approved, and often improved, subdivisions. Generally, such types of subdivisions previously had not been available for acquisition in the Company's market area. The Company purchased several such subdivisions outright and acquired control of several others through option contracts. Due to the improvement in the economy and the improved availability of capital, during the past several years, the Company has seen an increase in competition for available land in its market areas. The continuation of the Company's development activities over the long term will be dependent upon its continued ability to locate, enter into contracts to acquire, obtain governmental approvals for, consummate the acquisition of, and improve suitable parcels of land. In the Company's view, the rolling recession in the United States creates a bottoming market in some parts of the nation as other markets become strong. While the Company believes that there is significant diversity in its Northeast and Mid-Atlantic markets and that this diversity provides protection from the vagaries of the individual local economies, it believes that a greater geographic diversification will provide additional protection and more opportunities for growth. During the past three years, the Company has expanded into California, North Carolina, Florida, Texas and Arizona. The Company continues to explore additional geographic areas for expansion. The following is a summary of the parcels of land that the Company either owns or controls through options and loan assets at October 31, 1996 for proposed communities, as distinguished from those currently under development: Number of Number of Number of State Communities Acres Homes Planned Arizona 2 170 158 California 5 159 316 Connecticut 2 73 68 Delaware 1 93 151 Florida 1 12 37 Massachusetts 2 302 354 New Jersey: (1) South central 2 470 750 North central 3 209 199 Central 15 1,885 2,026 New York 5 341 254 North Carolina 1 51 98 Pennsylvania 19 1,349 1,543 Texas 8 288 530 Virginia(2) 6 1,220 2,010 Total 72 6,622 8,494(3) (1) New Jersey includes two communities which contain plans for 170 units which will either be rented or sold at lower than market rentals or prices. (2) Virginia includes one community which contains plans for 30 "affordable dwelling units" which will be sold at lower than market prices. (3) Of the 8,494 planned home sites, 3,719 lots were controlled through options and 750 lots were controlled through loan assets secured by liens. The aggregate of loan assets, option deposits and related pre-development costs for proposed communities was approximately $20,349,000 at October 31, 1996. The aggregate purchase price of land parcels under option at October 31, 1996 was approximately $193,733,000. The Company evaluates all of the land under control for proposed communities on an ongoing basis with respect to economic and market feasibility. During the year ended October 31, 1996 such feasibility analyses resulted in approximately $1,001,000 of capitalized costs related to proposed communities being charged to expense because they were no longer deemed to be recoverable. There can be no assurance that the Company will be successful in securing necessary development approvals for the land currently under its control or for land which the Company may acquire control of in the future or, that upon obtaining such development approvals, the Company will elect to complete its purchases under such options. The Company has generally been successful in the past in obtaining governmental approvals, has substantial land currently under its control for which it is seeking such approvals (as set forth in the table above), and devotes significant resources to locating suitable additional land for development and to obtaining the required approvals on land under its control. Failure to locate sufficient suitable land or to obtain necessary governmental approvals, however, may impair the ability of the Company over the long term to maintain current levels of development activities. The Company generally has not purchased land for speculation or with the contemplation of selling it for profit. The Company believes that it has an adequate supply of land in its existing communities and in land held for future development (assuming that all properties are developed) to maintain its operations at its current levels for several years. Community Development The Company expends considerable effort in developing a concept for each community, which includes determination of size, style and price range of the homes, layout of the streets and individual lots, and overall community design. After obtaining the necessary governmental subdivision and other approvals, which can sometimes require several years to obtain, the Company then improves the land by grading and clearing the site, installing roads, underground utility lines and pipes, erecting distinctive entrance structures, and staking out individual home sites. Each community is managed by a project manager who is located at the site. Working with construction supervisors, marketing personnel and, when required, other Company and outside professionals such as engineers, architects and legal counsel, the project manager is responsible for supervising and coordinating the various developmental steps from acquisition through the approval stage, marketing, construction and customer service, including monitoring the progress of work and controlling expenditures. Major decisions regarding each community are made by senior members of the Company's management. The Company recognizes revenue only upon the closing of a home sale (the point at which title and possession are transferred to the buyer), which generally occurs shortly after construction is substantially completed. The most significant variable affecting the timing of the Company's revenue stream, other than housing demand, is receipt of final regulatory approvals, which, in turn, permits the Company to begin the process of obtaining executed contracts for sales of homes. Receipt of such final approvals is not seasonal. Although the Company's sales and construction activities vary somewhat with the seasons, affecting the timing of closings, any such seasonal effect is relatively insignificant compared to the effect of receipt of final governmental approvals. Subcontractors perform all home construction and land development work, generally under fixed-price contracts. Toll Brothers acts as a general contractor and purchases some, but not all, of the building supplies it requires (see "PROPERTIES - Manufacturing/Distribution Facility"). The Company is not, and does not anticipate, experiencing a shortage of either subcontractors or supplies of building materials. The Company's construction superintendents and assistant superintendents coordinate subcontracting activities and supervise all aspects of construction work and quality control. One of the ways the Company seeks to achieve home buyer satisfaction is by providing its construction superintendents with incentive compensation arrangements based on each home buyer's responses on pre-closing and post-closing checklists. The Company maintains insurance to protect against certain risks associated with its activities. These insurance coverages include, among others, general liability, "all-risk" property, workers' compensation, automobile, and employee fidelity. The Company believes the amounts and extent of such insurance coverages are adequate. Marketing The Company believes that its marketing strategy, which emphasizes its more expensive "Estate" and "Executive" lines of homes, has enhanced the Company's reputation as a builder-developer of high-quality upscale housing. The Company believes this reputation results in greater demand for all of the Company's lines of homes. The Company generally includes attractive decorative moldings such as chair rails, crown moldings, dentil moldings and other aesthetic features, even in its less expensive homes, on the basis that this additional construction expense is important to its marketing effort. In addition to relying on management's extensive experience, the Company determines the prices for its homes through a Company-designed value analysis program that compares a Toll Brothers home with homes offered by other builders in the relevant marketing area. The Company accomplishes this by assigning a positive or negative dollar value to differences in product features, such as amenities, location and marketing. Toll Brothers expends great effort in creating its model homes, which play an important role in the Company's marketing. In its models, Toll Brothers creates an attractive atmosphere, with bread baking in the oven, fires burning in fireplaces, and background music. Interior decorations vary among the models and are carefully selected based upon the lifestyles of the prospective buyers. During the past several years, the Company has received a number of awards from various homebuilder associations for its interior merchandising. The sales office located in each community is generally staffed by Company sales personnel, who are compensated with salary and commission. In addition, a significant portion of Toll Brothers' sales is derived from the introduction of customers to its communities by local cooperating realtors. The Company advertises extensively in newspapers, other local and regional publications and on billboards. The Company also uses videotapes and attractive color brochures to describe each community. The Company has established a web site on the Internet (http://www.tollbrothers.com) to provide its customers with additional information on the Company and its homes. All Toll Brothers homes are sold under the Company's one-year limited warranty as to workmanship and two-year limited warranty as to mechanical equipment. Many of those warranties are supplemented by privately insured programs, which provides the homebuyer a limited ten-year warranty as to structural integrity. Customer Financing The Company makes arrangements with a variety of mortgage lenders to provide home buyers a range of conventional mortgage financing programs. By making available an array of attractive mortgage programs to qualified purchasers, the Company is able to better coordinate and expedite the entire sales transaction by ensuring that mortgage commitments are received and that closings take place on a timely and efficient basis. During fiscal 1996, approximately 56% of the Company's closings were financed through mortgage programs offered by the Company. In addition, during the same period, the Company's home buyers, on average, financed approximately 71% of the purchase price of their homes. The Company secures the availability of a variety of competitive market rate mortgage products from both national and regional lenders. Such availability is generally obtained at no cost to the Company and is committed for varying lengths of time and amounts. The Company also obtains forward commitments for fixed and variable rate mortgage financing which contain various rate protection features. Such commitments have generally cost the Company from zero to one-half of one percent of the mortgage funds reserved and typically have terms of 9 to 18 months. As of October 31, 1996, there were approximately $106 million of such commitments available, which expire at various dates through December 1997. Competition The homebuilding business is highly competitive and fragmented. The Company competes with numerous homebuilders of varying size, ranging from local to national in scope, some of which have greater sales and financial resources than the Company. Resales of homes also provide competition. The Company competes primarily on the basis of price, location, design, quality, service and reputation; however, during the past several years, the Company's financial stability, relative to others in its industry, has become an increasingly favorable competitive factor. The Company believes that, due to the increased availability of capital, competition has increased during the past several years. Regulation and Environmental Matters The Company is subject to various local, state and federal statutes, ordinances, rules and regulations concerning zoning, building design, construction and similar matters, including local regulations which impose restrictive zoning and density requirements in order to limit the number of homes that can eventually be built within the boundaries of a particular locality. In addition, the Company is subject to registration and filing requirements in connection with the construction, advertisement and sale of homes in its communities in certain states and localities in which it operates. These laws have not had a material effect on the Company, except to the extent that application of such laws may have caused the Company to conclude that development of a proposed community would not be economically feasible, even if any or all necessary governmental approvals were obtained (See "Business-Land Policy"). The Company may also be subject to periodic delays or may be precluded entirely from developing communities due to building moratoriums in the areas in which it operates. Generally, such moratoriums relate to insufficient water or sewage facilities or inadequate road capacity. In order to secure certain approvals, the Company may have to provide affordable housing at below market rental or sales prices. The impact on the Company will depend on how the various state and local governments in which the Company engages, or intends to engage, in development implement their programs for affordable housing. To date, these restrictions have not had a material impact on the Company. The Company is also subject to a variety of local, state and federal statutes, ordinances, rules and regulations concerning protection of health and the environment ("environmental laws"), as well as the effects of environmental factors. The particular environmental laws which apply to any given community vary greatly according to the community site, the site's environmental conditions and the present and former uses of the site. These environmental laws may result in delays, may cause the Company to incur substantial compliance and other costs, and can prohibit or severely restrict development in certain environmentally sensitive regions or areas. The Company maintains a policy of engaging, prior to consummating the purchase of land, independent environmental consultants to assess such land for the potential of hazardous or toxic materials, wastes or substances. Because it has generally obtained such assessments for the land it has purchased, the Company has not been significantly affected to date by the presence of such materials. Employees As of October 31, 1996, the Company employed 1,155 full-time persons; of these, 43 were in executive positions, 134 were engaged in sales activities, 130 in project management activities, 345 in administrative and clerical activities, 321 in construction activities, 77 in engineering activities and 105 in the panel plant operations. The Company considers its employee relations to be good. ITEM 2. PROPERTIES Headquarters Toll Brothers' corporate offices, containing approximately 45,000 square feet, are located in a modern facility at 3103 Philmont Avenue, Huntingdon Valley, Montgomery County, Pennsylvania. The facility was purchased by the Company in September 1988. Manufacturing/Distribution Facility Toll Brothers owns a facility of approximately 200,000 square feet in which it manufactures open wall panels, roof and floor trusses, and certain interior and exterior millwork to supply a portion of the Company's construction needs. This operation also permits Toll Brothers to purchase wholesale lumber, plywood, windows, doors, certain other interior and exterior millwork and other building materials to supply its communities. The Company believes that increased efficiency, cost savings and productivity result from the operation of this plant and from such wholesale purchases of material. This plant generally does not sell or supply to any purchasers other than Toll Brothers. The property, which is located in Morrisville, Pennsylvania, is adjacent to U.S. Route 1, a major thoroughfare, and is served by rail. Regional and Other Facilities The Company leases office and warehouse space in various locations, none of which is material to the business of the Company. ITEM 3. LEGAL PROCEEDINGS The Company is involved in various claims and litigation arising in the ordinary course of business. The Company believes that the disposition of these matters will not have a material adverse effect on the business or the financial condition of the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the fourth quarter of the fiscal year ended October 31, 1996. EXECUTIVE OFFICERS OF THE REGISTRANT The section entitled "Proposal One: Election of Directors" of the Company's Proxy Statement for the 1997 Annual Meeting of Shareholders is incorporated herein by reference. The following table includes information with respect to all executive officers of the Company as of October 31, 1996. All executive officers serve at the pleasure of the Board of Directors of the Company. Name Age Positions Robert I. Toll 55 Chairman of the Board, Chief Executive Officer and Director Bruce E. Toll 53 President, Chief Operating Officer, Secretary and Director Zvi Barzilay 50 Executive Vice President and Director Joel H. Rassman 51 Senior Vice President, Treasurer, Chief Financial Officer and Director Robert and Bruce Toll, who are brothers, co-founded the Company's predecessors' operations in 1967. Their principal occupations since inception have been related to their various homebuilding and other real estate related activities. Zvi Barzilay joined the Company as a project manager in 1980 and has been an officer since 1983. In 1994, Mr. Barzilay was elected a Director of the Company. Joel H. Rassman has been a senior vice president of the Company since joining the Company in 1984. Mr. Rassman was elected a Director of the Company by the Board of Directors in 1996. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS The Company's common stock is principally traded on the New York Stock Exchange (Symbol:TOL). It is also listed on the Pacific Stock Exchange. The following table sets forth the price range of the Company's common stock on the New York Stock Exchange for each fiscal quarter during the two years ended October 31, 1996. Three Months Ended 1996 October 31 July 31 April 30 January 31 High $17 7/8 $18 5/8 $20 5/8 $23 1/2 Low $16 $14 5/8 $15 3/8 $16 5/8 1995 October 31 July 31 April 30 January 31 High $19 $17 1/4 $13 3/4 $12 1/4 Low $15 1/2 $11 5/8 $11 1/8 $9 1/8 The Company has not paid any cash dividends on its common stock to date and expects that for the foreseeable future it will follow a policy of retaining earnings in order to finance the continued development of its business. Payment of dividends is within the discretion of the Company's Board of Directors and will depend upon the earnings, capital requirements and operating and financial condition of the Company, among other factors. The Company's 10 1/2% Senior Subordinated Notes due March 15, 2002 and 9 1/2% Senior Subordinated Notes due March 15, 2003, contain restrictions on the amount of dividends the Company may pay on its common stock. In addition, the Company's Bank Revolving Credit Agreement requires the maintenance of minimum shareholders' equity which restricts the amount of dividends the Company may pay. As of October 31, 1996, under the most restrictive of the agreements, the Company could pay up to approximately $73,678,000 of cash dividends. At December 31, 1996, there were approximately 703 record holders of the Company's common stock. ITEM 6. SELECTED FINANCIAL DATA The following table sets forth selected consolidated financial and housing data of the Company as of and for each of the five fiscal years ended October 31, 1996. It should be read in conjunction with the Consolidated Financial Statements and Notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations." Summary Consolidated Income Statement Data (Amounts in thousands, except per share data) Year Ended October 31 1996 1995 1994 1993 1992 Revenues $760,707 $646,339 $504,064 $395,261 $281,471 ======== ======== ======== ======== ======== Income before income taxes, extraordinary item and change in accounting $ 85,793 $79,439 $ 56,840 $43,928 $ 28,864 ======== ======= ======== ======= ======== Income before extraordinary item and change in accounting $ 53,744 $49,932 $ 36,177 $27,419 $ 17,354 Extraordinary loss (668) (816) Cumulative effect of change in accounting 1,307 -------- ------- -------- -------- --------- Net income $ 53,744 $49,932 $ 36,177 $ 28,058 $ 16,538 Earnings per share Primary Income before extraordinary item and change in accounting $ 1.56 $ 1.47 $ 1.08 $ .82 $ .52 Extraordinary loss (.02) (.02) Cumulative effect of change in accounting .04 -------- ------- -------- -------- --------- Net income $ 1.56 $ 1.47 $ 1.08 $ .84 $ .50 ======== ======= ======== ======== ========= Weighted average number of shares outstanding 34,492 33,909 33,626 33,467 33,234 ======== ======= ======== ======== ======== Fully-diluted Income before extraordinary item and change in accounting $ 1.50 $ 1.41 $ 1.05 $ .82 $ .52 Extraordinary loss (.02) (.02) Cumulative effect of change in accounting .04 -------- ------- -------- -------- -------- Net income $ 1.50 $ 1.41 $ 1.05 $ .84 $ .50 ======== ======= ======== ======== ======== Weighted average number of shares outstanding 36,891 36,651 35,664 33,583 33,237 ======== ======= ======== ======== ======== Summary Consolidated Balance Sheet Data (Amounts in thousands) October 31 1996 1995 1994 1993 1992 Inventory $772,471 $623,830 $506,347 $402,515 $287,844 ======== ======== ======== ======== ======== Total assets $837,926 $692,457 $586,893 $475,998 $384,836 ======== ======== ======== ======== ======== Debt Loans payable $132,109 $ 59,057 $ 17,506 $ 24,779 $ 25,756 Subordinated debt 208,415 221,226 227,969 174,442 128,854 Collateralized mortgage obligations payable 2,816 3,912 4,686 10,810 24,403 -------- -------- -------- -------- -------- Total $343,340 $284,195 $250,161 $210,031 $179,013 ======== ======== ======== ======== ======== Shareholders' equity $314,677 $256,659 $204,176 $167,006 $136,412 ======== ======== ======== ======== ======== Housing Data Year ended October 31: 1996 1995 1994 1993 1992 Number of homes closed 2,109 1,825 1,583 1,324 1,019 Sales value of homes closed (in thousands) $759,303 $643,017 $501,822 $392,560 $279,841 Number of homes contracted 2,398 1,846 1,716 1,595 1,202 Sales value of homes contracted (in thousands) $884,677 $660,467 $586,941 $490,883 $342,811 As of October 31: Number of homes in backlog 1,367 1,078 1,025 892 621 Sales value of homes in backlog (in thousands) $526,194 $400,820 $370,560 $285,441 $187,118 Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION RESULTS OF OPERATIONS The following table sets forth certain income statement items related to the Company's operations as percentages of total revenues: Year Ended October 31: 1996 1995 1994 ---- ---- ---- Revenues 100.0% 100.0% 100.0% ------ ------ ------ Costs and expenses: Land and housing construction 76.4 75.0 75.4 Selling, general and administrative 9.1 9.2 9.7 Interest 3.2 3.4 3.6 --- --- --- Total costs and expenses 88.7 87.6 88.7 ---- ---- ---- Operating income 11.3% 12.4% 11.3% ===== ===== ===== FISCAL 1996 COMPARED TO FISCAL 1995 Revenues for fiscal 1996 of $761 million exceeded those of fiscal 1995 by $114 million or 18%. This increase in revenues was due to an increase in both the number of homes and average price per home delivered. The increase in the number of homes delivered was due to the higher backlog of homes at October 31, 1995 as compared to October 31, 1994 and to the greater number of homes sold during fiscal 1996 as compared to fiscal 1995. The increase in the number of homes sold was the result of the higher number of selling communities that the Company had in 1996 over 1995 and an increase in the average number of homes sold per community. The increase in the average delivered price per home was due principally to a change in product mix to larger homes, a shift to more expensive locations, an increase in the value of options that the homebuyers selected and increases in selling prices in a number of the Company's communities. The increase in the average delivered price was partially offset by an increase in sales incentives provided to the homebuyers. Land and construction costs as a percentage of revenues increased in fiscal 1996 as compared to fiscal 1995. The increase was due principally to increased material and overhead costs, increased costs of sales incentives and the additional start-up costs, generally higher construction costs and the inefficiencies of production associated with the Company's expansion into California, Arizona, Texas, North Carolina and Florida. The increased overhead costs were due principally to the severe winter weather conditions that the Company encountered in many of its markets in fiscal 1996. The cost increases were partially offset by the lower amount of inventory writedowns in 1996($4.6 million) as compared to 1995($5.4 million). Selling, general and administrative expenses amounted to $69.7 million or 9.1% of revenues in fiscal 1996 as compared to $59.7 million or 9.2% of revenues in fiscal 1995. The increased spending was attributable to the greater number of communities that the Company was operating in 1996 as compared to 1995 as well as the additional costs associated with the Company's geographic expansion. Interest expense is determined on a specific lot-by-lot basis and will vary depending on many factors including the period of time that the land under the home was owned, the length of time that the house was under construction, and the interest rates and amount of debt carried by the Company in proportion to the amount of inventory during those periods. FISCAL 1995 COMPARED TO FISCAL 1994 Revenues for fiscal 1995 of $646.3 million exceeded those of 1994 by $142.2 million or 28%. This increase was primarily the result of the greater number of homes delivered in 1995 which was principally due to the higher backlog at the beginning of fiscal 1995 as compared to the backlog at the beginning of fiscal 1994, the greater number of contracts that were signed in 1995 compared to 1994 and to a greater number of communities delivering homes in 1995 as compared to 1994. In addition, the average price per home increased due to a change in product mix to larger homes, a shift in location of homes closed to more expensive locations and increases in selling prices. As of October 31, 1995, the backlog of homes under contract amounted to $400.8 million (1,078 homes), an 8% increase over the backlog as of October 31, 1994. In fiscal 1995, the Company signed new contracts of $660.4 million (1,846 homes), as compared to $586.9 million (1,716 homes) in fiscal 1994. The increase in new contracts in 1995 over 1994 was primarily due to the increase in the number of communities in which the Company was offering homes for sale, a shift in location of the communities to more expensive areas, an increase in the size of the homes that our customers purchased and increases in selling prices. The increase was partially offset by a decline in the number of homes sold per community. Land and housing construction costs amounted to $485.0 million (75.0% of revenues) in 1995 as compared to $380.2 million (75.4% of revenues)in 1994. As a percentage of revenues, land and land development costs, job overhead costs and write-offs of inventory and previously capitalized costs that the Company no longer considered realizable, were lower in 1995 than in 1994. The percentage decrease was partially offset by increased material and subcontractor costs. The Company provided for write-offs of inventory and previously capitalized costs that it no longer considered realizable of $5.4 million in 1995 and $7.0 million in 1994. Selling, general and administrative expenses ("SG&A") in 1995 and 1994 amounted to $59.7 million (9.2% of revenues) and $48.8 million (9.7% of revenues), respectively. The increased spending in 1995 was the result of an increase in selling expense due to the larger number of communities in which the Company was offering homes for sale in 1995 as compared to 1994 and an increase in general and administrative expenses, primarily payroll and payroll-related costs, due to the overall growth and increased profitability of the Company. The decline in SG&A, as a percentage of revenues, was due to revenues increasing at a faster rate than SG&A spending. Interest expense is determined on a specific lot-by-lot basis and will vary depending on many factors including the period of time that the land was owned, the period of time that the house was under construction, and the interest rates and the amount of debt carried by the Company in proportion to the amount of its inventory during those periods. As a percentage of revenues, interest expense was lower in 1995 as compared to 1994. The decline was principally the result of an 11% increase in the average price of homes closed in 1995 over 1994 while capitalized interest per home closed in 1995 only increased 6%. INCOME TAXES Income taxes for fiscal 1996, 1995 and 1994 were provided at effective rates of 37.4%, 37.1% and 36.4%, respectively. CAPITAL RESOURCES AND LIQUIDITY Funding for the Company's residential development activities is principally provided by cash flows from operations, public debt and equity markets, and unsecured bank borrowings. Cash flow from operations, before inventory additions, improved as operating results improved and the Company anticipates that the cash flow from operations will continue to improve as a result of an increase in revenues from the delivery of homes from the existing backlog as well as from new sales agreements. The Company has used the cash flow from operations and borrowings under its revolving credit facility to acquire additional land for new communities, to fund additional expenditures for land development and construction costs needed to meet the requirements of the increased backlog, the continuing expansion of the number of communities in which the Company is offering homes for sale and to reduce debt. The Company expects that inventories will continue to increase and is currently negotiating and searching for additional opportunities to obtain control of land for future communities. The Company has a $250 million unsecured revolving credit facility with fifteen banks which extends through June 2000. The facility reduces by 50% in June 1999 unless extended as provided for in the agreement. As of October 31, 1996, the Company had $50 million of loans and approximately $26.1 million of letters of credit outstanding under the facility. In addition, the Company has a $50,000,000 loan commitment from two banks under which the Company will borrow the funds in March 1997 for a period of five years at a fixed interest rate of 7.82%. In November 1996, the Company issued $100,000,000 of 8 3/4% Senior Subordinated Notes to the public. The notes mature in November 2006. The net proceeds are to be used for general corporate purposes. The Company believes that it will be able to fund its activities through a combination of existing cash resources, operating cash flow and existing sources of credit. INFLATION The long-term impact of inflation on the Company is manifested in increased land, land development, construction and overhead costs, as well as in increased sales prices. For several years prior to fiscal 1989, the Company was able to raise sales prices by amounts at least equal to its cost increases. From fiscal 1989 through February 1, 1991, however, sales prices either declined slightly or remained steady, and since then have risen only modestly. The Company generally contracts for land significantly before development and sales efforts begin. Accordingly, to the extent land acquisition costs are fixed, increases or decreases in the sales prices of homes may affect the Company's profits. Since the sales prices of homes are fixed at the time of sale and the Company generally sells its homes prior to commencement of construction, any inflation of costs in excess of those anticipated may result in lower gross margins. The Company generally attempts to minimize that effect by entering into fixed-price contracts with its subcontractors and material suppliers for specified periods of time, which generally do not exceed one year. Housing demand, in general, is adversely affected by increases in interest costs, as well as in housing costs. Interest rates, the length of time that land remains in inventory and the proportion of inventory that is financed affect the Company's interest costs. If the Company is unable to raise sales prices enough to compensate for higher costs, which had generally been the condition during prior years, or if mortgage interest rates increased significantly, affecting prospective buyers' ability to adequately finance a home purchase, the Company's 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 a new home. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Financial Statements as set forth in item 14(a)(1) and (2). ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this item with respect to executive officers of the Company is set forth in Part I. The information required by this item with respect to the Directors of the Company is incorporated by reference to the Company's Proxy Statement for the 1997 Annual Meeting of Shareholders. ITEM 11. EXECUTIVE COMPENSATION The information required by this item is incorporated by reference to the Company's Proxy Statement for the 1997 Annual Meeting of Shareholders. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item is incorporated by reference to the Company's Proxy Statement for the 1997 Annual Meeting of Shareholders. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is incorporated by reference to the Company's Proxy Statement for the 1997 Annual Meeting of Shareholders. STATEMENT ON FORWARD-LOOKING INFORMATION Certain information included herein and in other Company statements, reports and S.E.C. filings is forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995, including, but not limited to, statements concerning anticipated operating results, financial resources, growth and expansion. Such forward-looking information involves important risks and uncertainties that could significantly affect actual results and cause them to differ materially from expectations expressed therein. These risks and uncertainties include local, regional and national economic conditions, the effects of governmental regulation, the competitive environment in which the Company operates, fluctuations in interest rates, changes in home prices, the availability and cost of land for future growth, the availability of capital, the availability and cost of labor and materials, and weather conditions. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) Financial Statements and Financial Statement Schedule 1. Financial Statements Page Report of Independent Auditors F-1 Consolidated Statements of Income for the Years Ended October 31, 1996, 1995 and 1994 F-2 Consolidated Balance Sheets as of October 31, 1996 and 1995 F-3 Consolidated Statement of Shareholder's Equity for the Years Ended October 31, 1996, 1995 and 1994 F-4 Consolidated Statements of Cash Flows for the Years Ended October 31, 1996, 1995 and 1994 F-5 Notes to Consolidated Financial Statements F-6 - F-13 Summary Consolidated Quarterly Data F-14 2. Financial Statement Schedule Schedule II - Valuation and Qualifying Accounts for the Years Ended October 31, 1996, 1995 and 1994 F-15 Schedules not listed above have been omitted because they are either not applicable or the required information is included in the financial statements or notes thereto. 3. Exhibits required to be filed by Item 601 of Regulation S-K: 3.1 Certificate of Incorporation, as amended, is hereby incorporated by reference to Exhibit 3.1 of the Registrant's Form 10-K for the fiscal year ended October 31, 1989. 3.2 Amendment to the Certificate of Incorporation dated March 11, 1993, is hereby incorporated by reference to Exhibit 3.1 of Registrant's Form 10-Q for the quarter ended January 31, 1993. 3.3 By-laws, as amended, are hereby incorporated by reference to Exhibit 3.2 of the Registrant's Form 10-K for the fiscal year ended October 31, 1989. 4.1 Specimen Stock Certificate is hereby incorporated by reference to Exhibit 4.1 of the Registrant's Form 10-K for the fiscal year ended October 31, 1991. 4.2 Indenture dated as of March 15, 1992, between Toll Corp., as issuer, the Registrant, as guarantor, NBD Bank, National Association, as Trustee, including Form of Guarantee, is hereby incorporated by reference to Exhibit 4 of Toll Corp.'s Registration Statement on Form S-3 filed with the Securities and Exchange Commission on March 11, 1992, File No. 33-45704. Exhibit Number Description 4.3 Indenture dated as of March 15, 1993, among Toll Corp., as issuer, the Registrant, as guarantor, and NBD Bank, National Association, as Trustee, including Form of Guarantee, is hereby incorporated by reference to Exhibit 4.1 of Toll Corp.'s Registration Statement on Form S-3 filed with the Securities and Exchange Commission, March 10, 1993, File No. 33-58350. 4.4 Indenture dated as of January 15, 1994 between Toll Corp., as issuer, the Registrant, as guarantor, Security Trust Company, N.A., as Trustee, including Form of Guarantee, is incorporated by reference to Exhibit 4.1 of Toll Corp.'s Registration Statement on Form S-3 filed with the Securities and Exchange Commission on January 23, 1995, File No. 33-51775. 4.5 Indenture dated as of November 12, 1996 between Toll Corp., as issuer, the Registrant, as guarantor, NBD Bank, a Michigan banking corporation, as Trustee, including form of guarantee, is hereby incorporated by reference to Exhibit 4.1 of the Registrant's Form 8-K dated November 6, 1996 filed with the Securities and Exchange Commission. 10.1 Revolving credit agreement, dated as of November 1, 1993 as amended through May 8, 1996, among First Huntingdon Finance Corp., the Registrant, PNC Bank, National Association, CoreStates Bank, N.A., The First National Bank of Chicago, NationsBank National Association, Bank Hapoalim B.M., Kleinwort Benson Limited, Mellon Bank, The Fuji Bank, Limited, Credit Lyonnais, New York Branch, Banque Paribas, Krieditbank N.V., Comerica Bank, Bayerische Vereinsbank AG, New York Branch, The Industrial Bank of Japan Trust Company, The Sanwa Bank Limited and PNC Bank, National Association, as Agent. 10.2 Toll Brothers, Inc. Amended and Restated Stock Option Plan (1986), as amended and restated by the Registrant's Board of Directors on February 24, 1992 and adopted by its shareholders on April 6, 1992, is hereby incorporated by reference to Exhibit 19(a) of the Registrant's Form 10-Q for the quarterly period ended April 30, 1992. 10.3 Toll Brothers, Inc. Amended and Restated Stock Purchase Plan is hereby incorporated by reference to Exhibit 4 of the Registrant's Registration Statement on Form S-8 filed with the Securities and Exchange Commission on August 4, 1987, File No. 33-16250. 10.4 Toll Brothers, Inc. Key Executives and Non-Employee Directors Stock Option Plan (1993) is hereby incorporated by reference to Exhibit 10.1 of the Registrant's Form 8K filed with the Securities and Exchange Commission on May 25, 1994. 10.5 Amendment to the Toll Brothers, Inc. Key Executives and Non-Employee Directors Stock Option Plan (1993) is hereby incorporated by reference to Exhibit 10.2 of the Registrant's's Quarterly Report on Form 10-Q for the quarter ended April 30, 1995. Exhibit Number Description 10.6 Toll Brothers, Inc. Cash Bonus Plan is hereby incorporated by reference to Exhibit 10.2 of the Registrant's Form 8-K filed with the Securities and Exchange Commission on May 25, 1994. 10.7 Amendment to the Toll Brothers, Inc. Cash Bonus Plan adopted by the Board of Directors subject to shareholder approval. 10.8 Toll Brothers, Inc. Stock Option and Incentive Stock Plan (1995) is hereby incorporated by reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended April 30, 1995. 10.9 Amendment to the Toll Brothers, Inc. Stock Option and Incentive Stock Plan (1995) adopted by the Board of Directors on May 29, 1996 subject to shareholder approval. 10.10 Stock Redemption Agreement between the Registrant and Robert I. Toll, dated October 28, 1995, is hereby incorporated by reference to Exhibit 10.7 of the Registrants Form 10-K for the Fiscal Year ended October 31, 1995. 10.11 Stock Redemption Agreement between the Registrant and Bruce E. Toll, dated October 28, 1995, is hereby incorporated by reference to Exhibit 10.8 of the Registrants Form 10-K for the Fiscal Year ended October 31, 1995. 10.12 Agreement between the Registrant and Joel H. Rassman, dated June 30, 1988, is hereby incorporated by reference to Exhibit 10.8 of Toll Corp.'s Registration Statement on Form S-1 filed with the Securities and Exchange Commission on September 9, 1988, File No. 33-23162. 10.13 Agreement regarding sharing of office expenses, dated May 29, 1986, among Robert Toll, Bruce Toll and the Registrant, is hereby incorporated by reference to Exhibit 10.8 of the Registrant's Registration Statement on Form S-1 filed with the Securities and Exchange Commission on July 8, 1986, File No. 33-6066. 11 Statement regarding computation of Per Share Earnings. 22 Subsidiaries of the Registrant. 24 Consent of Independent Auditors. 27 Financial Data Schedule (b) Reports on Form 8-K No reports on Form 8-K have been filed during the last quarter of the period covered by this report. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the Township of Lower Moreland, Commonwealth of Pennsylvania on December 12, 1996. TOLL BROTHERS, INC. By: /s/ Robert I. Toll ------------------------- Robert I. Toll Chairman of the Board and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Signature Title Date /s/ Robert I. Toll Chairman of the Board December 12, 1996 Robert I. Toll of Directors and Chief Executive Officer (Principal Executive Officer) /s/ Bruce E. Toll President, Chief Operating December 12, 1996 Bruce E. Toll Officer, Secretary and Director /s/ Zvi Barzilay Executive Vice President December 12, 1996 Zvi Barzilay and Director /s/ Joel H. Rassman Senior Vice President, December 12, 1996 Joel H. Rassman Treasurer, Chief Financial Officer and Director (Principal Financial Officer) /s/ Joseph R. Sicree Vice President and December 12, 1996 Joseph R. Sicree Chief Accounting Officer (Principal Accounting Officer) /s/ Robert S. Blank Director December 12, 1996 Robert S. Blank /s/ Richard J. Braemer Director December 12, 1996 Richard J. Braemer /s/ Roger S. Hillas Director December 12, 1996 Roger S. Hillas /s/ Carl B. Marbach Director December 12, 1996 Carl B. Marbach /s/ Paul E. Shapiro Director December 12, 1996 Paul E. Shapiro REPORT OF INDEPENDENT AUDITORS The Board of Directors and Shareholders Toll Brothers, Inc. We have audited the accompanying consolidated balance sheets of Toll Brothers, Inc. and subsidiaries at October 31, 1996 and 1995, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended October 31, 1996. Our audits also included the financial statement schedule listed in the Index at item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Toll Brothers, Inc. and subsidiaries at October 31, 1996 and 1995, and the consolidated results of their operations and their cash flows for each of the three years in the period ended October 31, 1996, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ Ernst & Young LLP Philadelphia, Pennsylvania December 10, 1996 CONSOLIDATED STATEMENTS OF INCOME (Amounts in thousands, except per share data) Year Ended October 31 1996 1995 1994 Revenues: Housing sales $759,303 $643,017 $501,822 Interest and other 1,404 3,322 2,242 -------- -------- -------- 760,707 646,339 504,064 -------- -------- -------- Costs and expenses: Land and housing construction 580,990 485,009 380,240 Selling, general and administrative 69,735 59,684 48,789 Interest 24,189 22,207 18,195 -------- -------- -------- 674,914 566,900 447,224 -------- -------- -------- Income before incomd taxes 85,793 79,439 56,840 Income taxes 32,049 29,507 20,663 -------- -------- -------- Net income $ 53,744 $ 49,932 $ 36,177 ======== ======== ======== Earnings per share Primary $ 1.56 $ 1.47 $ 1.08 Fully-diluted $ 1.50 $ 1.41 $ 1.05 Weighted average number of shares Primary 34,492 33,909 33,626 ======== ======== ======== Fully-diluted 36,891 36,651 35,664 ======== ======== ======== See accompanying notes. CONSOLIDATED BALANCE SHEETS (Amounts in thousands, except share amounts) October 31 1996 1995 ASSETS Cash and cash equivalents $ 22,891 $ 27,772 Inventory 772,471 623,830 Property, construction and office equipment, net 12,948 11,898 Receivables, prepaid expenses and other assets 26,783 25,017 Mortgage notes receivable 2,833 3,940 -------- -------- $837,926 $692,457 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities Loans payable $132,109 $ 59,057 Subordinated notes 208,415 221,226 Customer deposits on sales contracts 43,387 36,194 Accounts payable 42,423 31,640 Accrued expenses 58,211 46,771 Collateralized mortgage obligations payable 2,816 3,912 Income taxes payable 35,888 36,998 -------- -------- Total liabilities 523,249 435,798 -------- -------- Shareholders' equity Preferred stock, none issued Common stock, 33,918,606 and 33,638,026 shares issued at October 31, 1996 and 1995, respectively 339 336 Additional paid-in capital 43,018 38,747 Retained earnings 271,320 217,576 -------- -------- Total shareholders' equity 314,677 256,659 -------- -------- $837,926 $692,457 ======== ======== See accompanying notes. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (Amounts in thousands) Additional Common Stock Paid-In Retained Shares Amount Capital Earnings Total Balance, November 1, 1993 33,319 $333 $35,206 $131,467 $167,006 Net income 36,177 36,177 Exercise of stock options 101 1 954 955 Employee stock plan purchases 3 38 38 ------- ------ ------- -------- -------- Balance, October 31, 1994 33,423 334 36,198 167,644 204,176 Net income 49,932 49,932 Exercise of stock options 213 2 2,525 2,527 Employee stock plan purchases 2 24 24 ------- ------ ------- -------- -------- Balance, October 31, 1995 33,638 336 38,747 217,576 256,659 Net income 53,744 53,744 Exercise of stock options 276 3 4,196 4,199 Employee stock plan purchases 5 75 75 ------- ------ ------- -------- -------- Balance, October 31, 1996 33,919 $ 339 $43,018 $271,320 $314,677 ======= ====== ======= ======== ======== See accompanying notes. CONSOLIDATED STATEMENTS OF CASH FLOWS (Amounts in thousands) Year Ended October 31 1996 1995 1994 Cash flows from operating activities: Net income 53,744 $ 49,932 $ 36,177 Adjustments to reconcile net income to net cash used in operating activities: Depreciation and amortization 3,306 2,943 2,687 Loss (gain) from repurchase of subordinated debt 540 (355) (616) Deferred tax provision (benefit) 877 (476) (361) Net realizable value provisions 1,000 3,800 4,300 Changes in operating assets and liabilities: Increase in inventory (138,059)(118,720)(104,482) Increase in receivables, prepaid expenses and other assets (2,783) (3,345) (1,481) Increase in customer deposits on sales contracts 7,193 6,123 7,622 Increase in accounts payable and accrued expenses 22,223 8,625 22,594 (Decrease) increase in income taxes payable (1,805) 4,957 4,046 -------- ------- -------- Net cash used in operating activities (53,764) (46,516)(29,514) -------- ------- -------- Cash flows from investing activities: Sale (purchase) of marketable securities 3,674 (1,691) Purchase of property and equipment, net (3,596) (2,452) (2,968) Principal repayments of mortgage notes receivable 1,107 684 5,308 ------- ------- ------- Net cash (used in) provided by investing activities (2,489) 1,906 649 Cash flows from financing activities: ------- ------- ------- Proceeds from loans payable 173,028 160,000 23,493 Principal payments of loans payable (111,738)(121,159)(35,900) Net proceeds from issuance of subordinated debt 55,541 Repurchase of subordinated debt (13,096) (6,256) (3,290) Principal payments of collateralized mortgage obligations payable (1,096) (780) (6,152) Proceeds from stock options exercised and employee stock plan purchases 4,274 2,551 870 ------- ------- ------ Net cash provided by financing activities 51,372 34,356 34,562 ------- ------- ------ Net (decrease) increase in cash and cash equivalents (4,881)(10,254) 5,697 Cash and cash equivalents, beginning of year 27,772 38,026 32,329 ------- ------- ------- Cash and cash equivalents, end of year $22,891 $27,772 $38,026 ======= ======= ======= Supplemental disclosures of cash flow information Interest paid, net of amount capitalized $ 8,612 $ 7,587 $ 6,762 ======= ======= ======= Income taxes paid $32,116 $24,547 $16,977 ======= ======= ======= Supplemental disclosures of noncash activities Residential inventories acquired through seller financing $11,582 $ 2,563 $ 5,000 ======= ======= ======= Income tax benefit relating to exercise of employee stock options $ 861 $ 478 $ 124 ======= ======= ======= See accompanying notes. Notes to Consolidated Financial Statements 1. Significant accounting policies Basis of presentation The accompanying 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. Use of estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Income recognition The Company is engaged in the development, construction and sale of residential housing. Revenues and cost of sales are recorded at the time each home sale is closed and title and possession have been transferred to the buyer. Closing normally occurs shortly after construction is substantially completed. Cash and cash equivalents Liquid investments with original maturities of three months or less are classified as cash equivalents. The carrying value of these investments approximates fair market value. Property, construction and office equipment Property, construction and office equipment are recorded at cost and are stated net of accumulated depreciation of $16,159,000 and $14,079,000 at October 31, 1996 and 1995, respectively. Depreciation is recorded by using the straight- line method over the estimated useful lives of the assets. Inventories Inventories are stated at the lower of cost or estimated net realizable value. In addition to direct land acquisition, land development and housing construction costs, costs include interest, real estate taxes and direct overhead costs related to development and construction, which are capitalized to inventories during the period beginning with the commencement of development and ending with the completion of construction. Land, land development and related costs are amortized to cost of homes closed based upon the total number of homes to be constructed in each community. Housing construction and related costs are charged to cost of homes closed under the specific identification method. The Company capitalizes project marketing costs and charges them against income as homes are closed. In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" ("FAS 121"). The new rules establish standards for the recognition and measurement of impairment losses on long-lived assets. The Company will adopt FAS 121 in the first quarter of fiscal 1997 and does not believe that it will have a material effect on its financial position or results of operations Income taxes Income taxes are provided using the liability method prescribed by Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes". This Statement requires a liability approach for measuring deferred taxes based on temporary differences between the financial statement and tax bases of assets and liabilities existing at each balance sheet date using enacted tax rates for years in which taxes are expected to be paid or recovered. Earnings per share The computation of primary and fully-diluted earnings per share is based on the weighted average number of shares of common stock and common stock equivalents outstanding. In addition, the computation of fully-diluted earnings per share assumes the conversion of the Company's 4 3/4% Convertible Senior Subordinated Notes due 2004 at $21.75 per share for the period that the notes were outstanding, although the closing price of the Company's common stock on the New York Stock Exchange on October 31, 1996 was $17.125 per share. Acquisition In August 1995, the Company acquired certain assets of Geoffrey H. Edmunds & Associates, a privately owned luxury homebuilder located in Scottsdale, Arizona. The Company, through this acquisition, obtained ownership or control of 773 lots in the Scottsdale area. The acquisition took place in phases with the merger of the Edmunds organization completed in April 1996. The acquisition price was not material to the financial position of the Company. 2. Inventory Inventory consists of the following(amounts in thousands): October 31 1996 1995 Land and land development costs $204,527 $182,790 Construction in progress 491,552 377,456 Sample homes 40,017 32,448 Land deposits and costs of future development 16,243 13,555 Loan assets acquired for future development 4,106 5,157 Deferred marketing and financing costs 16,026 12,424 -------- -------- $772,471 $623,830 ======== ======== Construction in progress includes the cost of homes under construction, land and land development costs and the carrying costs of lots that have been substantially improved. Loan assets acquired for future development represent loans secured by liens on real property purchased from various banks. If the Company acquires title to the property, the cost of the loan asset is reclassified to land and land development costs. For the years ended October 31, 1996, 1995 and 1994, the Company provided for inventory writedowns to net realizable value and the expensing of costs which it believed not to be recoverable of $4,611,000, $5,366,000 and $6,957,000, respectively. Interest capitalized in inventories is charged to interest expense when the related inventories are closed. Interest incurred, capitalized and expensed for the three years ended October 31, 1996 is as follows(amounts in thousands): 1996 1995 1994 Interest capitalized, beginning of year $43,142 $39,835 $38,270 Interest incurred 27,695 25,780 21,701 Interest expensed (24,189) (22,207) (18,195) Write-off to cost and expenses (457) (266) (1,941) Interest capitalized, ------- ------- ------- end of year $46,191 $43,142 $39,835 ======= ======= ======= 3. Loans payable and subordinated notes Loans payable consists of the following(amounts in thousands): October 31, 1996 1995 Revolving credit facility borrowing $50,000 $52,000 Term loan due July 2001 68,000 Other 14,109 7,057 -------- ------- $132,109 $59,057 ======== ======= The Company has a $250,000,000 unsecured revolving credit facility with fifteen banks which extends through June 2000. The facility reduces by 50% in June 1999 unless extended as provided for by the agreement. Interest is payable on short-term borrowing at 1.10% above the Eurodollar rate or at other specified variable rates as selected by the Company from time to time. The Company fixed the interest rate on $50,000,000 of borrowing at 7.54% until June 2000. As of October 31, 1996, letters of credit and obligations under escrow agreements of $26,127,000, were outstanding. The agreement contains various covenants, including financial covenants related to consolidated shareholders' equity, indebtedness and inventory. The agreement requires that the Company maintain a minimum consolidated shareholders' equity which restricts the payment of cash dividends and the repurchase of Company stock to approximately $73,678,000 as of October 31, 1996. In July 1996, the Company borrowed $68,000,000 from eight banks for a period of five years at a fixed interest rate of 7.91%. The agreement contains the same financial covenants as the Company's revolving credit facility. The carrying value of the loans payable approximates the estimated fair market value Subordinated notes consists of the following(amounts in thousands): October 31, 1996 1995 > 10 1/2% Senior Subordinated Notes, due March 15,2002 $ 87,800 $ 94,500 9 1/2% Senior Subordinated Notes, due March 15,2003 69,960 73,960 4 3/4% Convertible Senior Subordinated Notes, due January 15, 2004 50,999 53,199 Bond discount (344) (433) -------- -------- $208,415 $221,226 ======== ======== The 10 1/2% notes are subordinated to all senior indebtedness of the Company. These notes are redeemable in whole or in part, at the option of the Company on or after March 15, 1997 at various prices. The indenture restricts certain payments by the Company including cash dividends and the repurchase of Company stock. The 9 1/2% notes are subordinated to all senior indebtedness of the Company. The notes are redeemable in whole or in part, at the option of the Company on or after March 15, 1998 at various prices. The indenture restricts certain payments by the Company including cash dividends and the repurchase of Company stock. The 4 3/4% convertible notes are subordinated to all senior indebtedness of the Company. The notes are convertible into shares of common stock of the Company at the option of the noteholders at any time prior to maturity at a conversion price of $21.75 per share. The notes are redeemable, in whole or in part, at the option of the Company on or after January 15, 1997 at various prices. In November 1996, the Company issued $100,000,000 of 8 3/4% senior subordinated notes due in 2006. The notes, redeemable in whole or in part, at the option of the Company on or after November 15, 2001 at various prices, are subordinated to all senior indebtedness of the Company and have the same restrictions as to the payment of dividends and the repurchase of Company stock as the 9 1/2% notes. During fiscal 1996, 1995 and 1994, the Company repurchased $12,900,000, $6,801,000 and $4,040,000, respectively, of the various issues of notes in open market purchases. The gains and losses from the repurchases were immaterial and included in other income. As of October 31, 1996, the aggregate fair market value of all the outstanding subordinated notes, based upon their quoted market prices, was approximately $214,574,000. The annual aggregate maturities of the Company's loans and notes during the next five fiscal years are: 1997 - $8,941,000; 1998 -$ 2,944,000; 1999 - $353,000; 2000 - $51,871,000 and 2001 - $68,000,000. 4. Shareholders' equity The Company's authorized capital stock consists of 40,000,000 shares of Common Stock, $.01 par value per share, and 1,000,000 shares of Preferred Stock, $.01 par value per share. The Company's Certificate of Incorporation, as amended, authorizes the Board of Directors to increase the number of authorized shares of Common Stock to 60,000,000 shares and the number of shares of authorized Preferred Stock to 15,000,000 shares. Stock option plans The Company's three stock option plans for employees, officers and non-employee directors provide for the granting of incentive stock options and nonstatutory options with a term of up to ten years at a price not less than the market price of the stock at the date of grant. The Company's Stock Option and Incentive Stock Plan (1995) provides for automatic increases each January 1 in the number of shares available for grant by 2% of the number of shares outstanding (including treasury shares). The 1995 Plan restricts the number of options that may be granted in a calendar year to the lesser of the number of shares available for grant or 2,500,000 shares. The following summarizes stock option activity for the three plans during the three years ended October 31, 1996: Number Option Price of Shares Per Share Outstanding, November 1, 1993 1,031,750 $ 3.25 - $15.13 Granted 729,200 15.81 - 19.00 Exercised (106,425) 3.25 - 12.75 Cancelled (41,400) 10.75 - 15.88 Outstanding, October 31, 1994 1,613,125 $ 3.25 - $19.00 Granted 1,022,200 9.94 - 11.00 Exercised (212,775) 3.25 - 15.88 Cancelled (80,350) 9.94 - 15.88 Outstanding, October 31, 1995 2,342,200 $ 3.25 - $19.00 Granted 843,450 17.31 - 20.25 Exercised (276,000) 3.25 - 15.88 Cancelled (37,825) 9.94 - 20.25 Outstanding October 31, 1996 2,871,825 $ 3.25 - $20.25 Exercisable, October 31, 1996 1,751,800 $ 3.25 - $19.00 Options available for grant at October 31, 1996, 1995 and 1994 under all the plans were 2,899,000, 3,260,000, and 2,537,000, respectively. Bonus Award Shares Under the terms of the Company's Cash Bonus Plan covering the Chairman of the Board and Chief Operating Officer (the "Executives"), each Executive is entitled to receive cash bonus awards based upon the pretax earnings and shareholders' equity of the Company. In May 1996, the Board of Directors and the Executives agreed, subject to shareholder approval, that any bonus payable under the plan for each of the three fiscal years ended October 31, 1998 shall be made (except for specified conditions) in shares of the Company's common stock using the value of the stock as of the date of the agreement ($17.125 per share). On October 31, 1996, the closing price of the Company's common stock on the New York Stock Exchange was $17.125. The shares will be allocated from the Company's Stock Option and Incentive Stock Plan (1995). The Executives will receive 66,975 shares each for their 1996 bonus award if the shareholders approve the amendments to the Cash Bonus Plan and the Stock Option and Incentive Stock Plan (1995). Employee stock purchase plan The Company's Employee Stock Purchase Plan enables substantially all employees to purchase the Company's common stock for 95% of the market price of the stock on specified offering dates. The plan, which terminates in December 2001, provides that 100,000 shares be reserved for purchase. As of October 31, 1996, a total of 65,780 shares were available for issuance. The following summarizes stock purchases under this plan during the three years ended October 31, 1996: Number of Price Shares Range 1994 3,124 $10.81 - $17.10 1995 1,942 9.62 - 17.81 1996 4,580 15.68 - 21.73 Redemption of Common Stock In order to help provide for an orderly market in the Company's common stock in the event of the death of either Robert I. Toll or Bruce E. Toll (the "Tolls"), or both of them, the Company and the Tolls have entered into agreements in which the Company has agreed to purchase from the estate of each of the Tolls $10,000,000 of the Company's common stock (or a lesser amount under certain circumstances) at a price equal to the greater of fair market value (as defined) or book value (as defined). Further, the Tolls have agreed to allow the Company to purchase $10,000,000 of life insurance on each of their lives. In addition, the Tolls granted the Company an option to purchase up to an additional $30,000,000 (or a lesser amount under certain circumstances) of common stock from each of their estates. The agreements expire in October 2005. 5. Income taxes The provision for income taxes includes federal and state taxes. Substantially all of the difference between the effective tax rate (37.4%, 37.1% and 36.4% for 1996, 1995 and 1994, respectively) used in these provisions and the statutory federal tax rate of 35% was due to state taxes, net of federal tax benefit, and in 1994, the recalculation of the deferred tax balances due to an increase in the federal statutory rate, a decrease in the estimated state tax rate, and the effect of nontaxable income generated from short-term investments. The provisions for income taxes for the three years ended October 31, 1996 were as follows (amounts in thousands): 1996 1995 1994 Federal $29,013 $27,586 $19,020 State 3,036 1,921 1,643 $32,049 $29,507 $20,663 Current $31,172 $29,983 $21,024 Deferred 877 (476) (361) $32,049 $29,507 $20,663 The components of income taxes payable as of October 31, 1996 and 1995 were (amounts in thousands): 1996 1995 Current $21,999 $23,986 Deferred 13,889 13,012 ------- ------- $35,888 $36,998 ======= ======= The components of net deferred taxes payable as of October 31, 1996 and 1995 were (amounts in thousands): 1996 1995 Deferred tax liabilities Capitalized interest $16,203 $16,776 Deferred expenses 4,434 2,955 Other 314 225 ------- ------- Total 20,951 19,956 ------- ------- Deferred tax assets Net realizable value reserves 3,640 3,699 Inventory valuation differences 1,556 1,780 Accrued expenses deductible when paid 522 791 Other 1,344 674 ------- ------- Total 7,062 6,944 ------- ------- Net deferred tax liability $13,889 $13,012 ======= ======= 6. Employee retirement plan The Company maintains a salary deferral savings plan covering substantially all employees. The plan provides for Company contributions totaling 2% of all eligible compensation, plus 2% of eligible compensation above the social security wage base, plus matching contributions of up to 2% of eligible compensation of employees electing to contribute via salary deferrals. Company contributions with respect to the plan totaled $1,061,000, $851,000 and $770,000, for the years ended October 31, 1996, 1995 and 1994, respectively. 7. Commitments and contingencies As of October 31, 1996, the Company had agreements to purchase land and improved home sites for future development with purchase prices aggregating approximately $193,733,000 of which $9,802,000 had been paid or deposited. Purchase of the properties is contingent upon satisfaction of certain requirements by the Company and the sellers. As of October 31, 1996, the Company had agreements of sale outstanding to deliver 1,367 homes with an aggregate sales value of approximately $526,194,000. As of that date, the Company has arranged through a number of outside mortgage lenders to provide approximately $174,000,000 of mortgages related to those sales agreements. In August 1996, the Company entered into an agreement with two banks to borrow $50,000,000 in March 1997, at a fixed interest rate of 7.82% for a period of five years. The agreement contains covenants similar to the Company's revolving credit facility. The Company is involved in various claims and litigation arising in the ordinary course of business. The Company believes that the disposition of these matters will not have a material effect on the business or on the financial condition of the Company. Summary Consolidated Quarterly Financial Data (Unaudited) (Amounts in thousands, except per share data) Three Months Ended Oct. 31 July 31 April 30 Jan. 31 FISCAL 1996: Revenues $260,351 $212,778 $145,508 $142,070 Income before income taxes $ 35,216 $ 24,609 $ 12,753 $ 13,215 Net income $ 22,085 $ 15,413 $ 7,978 $ 8,268 Earnings per share Primary $ .64 $ .45 $ .23 $ .24 Fully-diluted $ .61 $ .43 $ .23 $ .23 Weighted average number of shares outstanding Primary 34,479 34,435 34,506 34,547 Fully-diluted 36,833 36,780 36,929 37,023 FISCAL 1995: Revenues $199,606 $186,928 $137,488 $122,317 Income before income taxes $ 27,151 $ 24,360 $ 15,081 $ 12,847 Net income $ 16,986 $ 15,242 $ 9,445 $ 8,259 Earnings per share Primary $ .49 $ .45 $ .28 $ .25 Fully-diluted $ .47 $ .43 $ .27 $ .24 Weighted average number of shares outstanding Primary 34,326 34,074 33,707 33,527 Fully-diluted 36,774 36,605 36,153 36,009 TOLL BROTHERS, INC. AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS (Amounts in thousands) Additions Balance at Charged to Charged to Balance Beginning Costs and Other at End Description of Period Expenses Accounts Deductions of Period (A) Net realizable value reserves for inventory of land and land development costs: Year ended October 31, 1994: Delaware $1,000 $1,000 Massachusetts $2,759 300 $1,393 1,666 New Jersey 3,056 3,000 367 5,689 Pennsylvania 1,247 1,247 Total $7,062 $4,300 $3,007 $8,355 Year ended October 31, 1995: Delaware $1,000 $ 320 $ 680 Massachusetts 1,666 $1,000 270 2,396 New Jersey 5,689 2,800 1,131 7,358 Total $8,355 $3,800 $1,721 $10,434 Year ended October 31, 1996: Delaware $ 680 $ 183 $ 497 Massachusetts 2,396 1,698 698 New Jersey 7,358 $1,000 150 8,208 Total $10,434 $1,000 $2,031 $9,403 (A) Represents amount of reserves utilized, which is recorded at the time that affected homes are closed.