Q2 2022 Toll Brothers Inc Earnings Call

May 25, 2022

[music].

Good morning, and welcome to the toll brothers second quarter earnings Conference call.

All participants will be in listen only mode should you need assistance. Please signal a conference specialist by pressing the star key followed by zero. After today's presentation there'll be an opportunity to ask questions to ask a question you May Press Star then one on your telephone keypad.

To withdraw your question. Please press Star then two.

The company is planning to end the call at 930, when the market opens during the Q&A. Please limit yourself to one question and one follow up. Please note. This event is being recorded I would now like to turn the conference over to Douglas yearly CEO . Please go ahead.

Thank you Jason.

Good morning.

Welcome and thank you for joining US with me today are Marty Connor Chief Financial Officer.

Rob powerhouse, President and Chief operating Officer.

Cooper senior VP of finance and Investor Relations.

Wendy Marlett, Chief marketing Officer, and Gregg Ziegler senior VP and treasurer.

Before I begin I ask you to read the statement on forward looking information in our earnings release of last night and on our website.

I caution you that many statements on this call are forward looking based on assumptions about the economy world events housing and financial markets interest rates the impact of the pandemic the availability of labor and materials inflation and many other factors beyond our control.

That could significantly affect future results.

We are very pleased with our second quarter performance as we met or exceeded our guidance on all key metrics.

We delivered a record 2000 and 407 homes in the second quarter at an average price of approximately $908000, resulting in record home sales revenue of $2 $2 billion.

This was an increase of 19% compared to last year's second quarter revenue.

Our teams did a great job delivering homes and what continues to be a very challenging production environment.

Adjusted gross margin of 26, 1% in the quarter improved 170 basis points compared to last year's second quarter.

And was 60 basis points better than guidance.

SG&A expense at 11, 1% of homebuilding revenues was.

It was 80 basis points better than both last year's second quarter and our guidance.

Driven by significant revenue growth and expanding margins.

We generated earnings per share of $1.85.

83% compared to last year.

The second quarter, and our backlog stood at a record 11 $7 billion and 11768 homes.

Based on the strong pricing and margin embedded in our backlog.

And with approximately half of our backlog scheduled for delivery in fiscal year 2023.

We expect our fiscal year 2023, adjusted gross margin to be better in fiscal year 2020 twos.

Sales in our second quarter, where our highest quarter ever as demand remains strong across all of our buyer segments and geographies.

We signed 2874 net contracts for.

For $3 $1 billion up one 2% in dollars over 'twenty 'twenty. One is extremely strong second quarter on orders were up 97% in dollars compared to Q2 of 2020.

Our quarterly sales pace was consistent with the eight eight contracts per community that we projected for Q2.

On our earnings call back in February .

While demand is still solid over the past month. It has moderated from the unprecedented pace of the past two years as buyers adapt the higher mortgage rates and other macroeconomic conditions.

The substantial rise in home prices.

Deep increase in mortgage rates since January <unk>.

Inflation concerns and stock market volatility.

Are all having an impact.

On buyer sentiment.

And we anticipate that some buyers may remain cautious.

Through the seasonally slower summer months.

As a.

[noise] Minder in the second quarter, we limited sales to catch up on construction.

We are continuing this strategy in the third quarter.

With the combination of restricting sales.

The normal summer slowdown.

And a more cautious buyer.

We expect our Q3 contracts to be lower than Q2.

Which is what normally occurred pre COVID-19.

Despite the recent moderation the housing market remains healthy.

Even over the past month, we have continued to raise prices in a limited number of communities and we are running successful best and final sealed bid processes and about 15% of our communities.

The many fundamental drivers that have supported the housing market in recent years remain firmly in place.

These include favorable demographics, with 150 million millennials and baby boomers experiencing life events that are driving home demand.

The supply and demand imbalance, resulting from over a decade of underproduction.

Tight resale inventories.

Migration trends driven by more flexibility in the workplace.

And then overall greater appreciation for homes.

And in particular new homes.

In addition, the for sale housing market is benefiting from an ongoing and significant increases in rents for single and multifamily dwellings.

We believe these trends will continue to support housing demand in the long term.

Turning specifically to our customers.

We believe they are generally better insulated.

From affordability concerns.

They tend to have higher incomes and network.

And many have benefited from significant price appreciation in their existing homes.

Approximately 20% of our customers paid all cash.

And those who do take a mortgage average approximately 70% loan to value.

Importantly, our buyers utilizing jumbo loans are benefiting from a rate that remains three quarters of a point lower than the conforming rate.

As our industry continues to be challenged by supply chain disruptions labor shortages and municipal delays.

We have revised our full year deliveries guidance.

We now expect full year deliveries to be between 11011 thousand $500.

A reduction of about 375 homes at the midpoint.

However, we have increased our average delivered price guidance.

$15000 per home to reflect the strong pricing in our backlog.

As a result, we expect full year 2022, homebuilding revenues of approximately $10 $1 billion at the midpoint of our guidance.

We're 20% growth.

Compared to fiscal year 2021.

We remain committed to our disciplined in capital efficient land acquisition strategy.

At the end of our fiscal second quarter, we owned or controlled 85800 lots.

Of which 53% were controlled.

And 47% were owned.

Nearly 12000 of these lots are already committed to homebuyers and our backlog.

Excluding these are controllable and represents 61%.

Our loss.

This land position much of which was contracted for pre pandemic.

<unk> us with sufficient land needed for.

For significant growth.

Well into the future.

Therefore.

We can be very selective as we evaluate new land deals.

And apply our more rigorous underwriting standards.

That incorporate higher gross margin and IRR thresholds.

Higher contingencies for land development and construction costs.

And more conservative assumptions related to sales paces.

We also remain focused on improving our return on equity in.

In the second quarter, we repurchased $106 $5 million of our common stock.

And another $16 million, so far in our third quarter.

Since the beginning of the fiscal year, we have repurchased about $308 million or four 6% of our year end share count.

We have also paid $44 million in dividends year to date, and we retired $410 million of long term debt in our first quarter.

In March our board approved an 18% increase in our quarterly dividend and just last week refreshed our share repurchase authorization to 20 million shares or nearly $900 million based on current prices.

These actions reflect our confidence in the business and our commitment to delivering returns to our shareholders.

With that I'll turn it over to Martin.

Thanks, Doug.

In our second quarter, we delivered 20, 407 homes and generated homebuilding revenues of $2 $2 billion.

Up 6% in units and 19% in dollars from one year ago.

The average selling price of our 2874 signed contracts in fiscal year 2022 second quarter.

There's 1 million to $75000.

Up nearly $200000 compared to last year's second quarter.

And up $53000 over Q1.

Our second quarter pretax income was $296 million compared to $170 million in the second quarter of fiscal 2021.

Net income was $221 million or $1 85 per share diluted compared to a $128 million and $1 one per share diluted one year ago.

Our second quarter adjusted gross margin was 26, 1% compared to 24, 4% in the second quarter of 2021.

And 60 basis points better than we had projected.

The improvement was due primarily to price, reflecting the strong demand environment.

Over the last year.

We continue to project an adjusted gross margin of approximately 27, 5% for the full year.

We expect the adjusted gross margin for our third quarter of fiscal year 2020 to be 27%.

Which implies an adjusted gross margin in excess of 29%.

Our fourth quarter.

As Doug mentioned, we believe our fiscal year 2023, adjusted gross margin will be even better than this year's.

This is due primarily to the composition of our backlog and the pricing power we've experienced over the past year.

Approximately half of our existing backlog of 11768 homes are projected to be delivered in fiscal year 2023.

And this backlog is solid.

Our cancellation rates have consistently been the lowest in the industry for many decades, which speaks to the financial strength of our customers.

And our build to order model.

It allows our buyers to personalize their homes, becoming emotionally invested in those homes.

They are also financially invested as they make a nonrefundable deposit averaging $75000.

Plus they benefit from any home price appreciation between contract signing and ultimate delivery.

Which has been significant.

As a result.

I had just 114 cancellations in our backlog of over 11000 homes in the second quarter.

We're about 1%.

We haven't seen any significant changes in mix.

Let me quickly address any concerns that rising mortgage rates may have on future cancellation rates.

First of all keep in mind that 20% of our buyers pay all cash.

Fluctuations in interest rates should have no impact on these buyers.

We have also pressured tested the balance of our backlog.

We estimate that if the 30 year conforming rate were to increase to 6%.

Less than 10% of our backlog.

Have to consider an arm <unk>.

Provide a higher down payment for additional source of income or consider other alternatives such as buying down rates with upfront points.

As our low cancellation rates in the second quarter and tests.

Our buyers have remained committed to their new homes, even with the rapid increase in interest rates.

And remember the homes in our older backlog, which we're contracted for when rates were lower.

I've enjoyed significant price appreciation.

Which means these buyers have greater motivation to close.

And we have less risk if they don't.

Turning back to our results.

SG&A as a percentage of revenue was 11, 1% in the second quarter.

Barrett to 11, 9% in Q2 of last year.

This was 80 basis points better than we projected.

The improvement was driven primarily by revenue growth and lower sales and marketing spend.

Second quarter joint venture land sales and other income was $12 million exceeding our guidance of $5 million.

Due primarily to a gain from the bulk sale of home security monitoring incomes.

Impairments and write offs were $2 $2 million in the quarter, reflecting some cost on land deals that we are no longer pursuing.

Our tax rate in the quarter was 25, 4%.

We finished the quarter with a net debt to capital ratio of 33, 1%.

With $535 million in cash.

Equivalents and with $1 8 billion available under our $1 9 billion dollar revolving credit.

The facility.

This all provides us with ample flexibility to both grow.

And return capital to our shareholders.

At quarter end, our book value per share was $46 51.

Based on the midpoint of our guidance and supported by our solid backlog.

We expect this to be approximately $53 per share at fiscal year end.

Turning to guidance, we are projecting fiscal year 2022 third quarter deliveries of 2750 homes with an average price between 895009 hundred $15000.

As Doug mentioned continued supply chain and labor constraints and municipal delays are impacting production.

As a result, we have reduced our full year delivery guidance by approximately 375 homes.

Two between 11000 and 11500.

But based on the pricing in our backlog, we have increased our projected average delivered price to between 890009 hundred $10000 or <unk>.

$15000 increase from prior guidance.

We expect interest and cost of sales to be approximately 2% in the third quarter and for the full year as we continue to benefit from our reduced leverage.

We project third quarter SG&A as a percentage of home sales revenues to be approximately 10, 5%.

For the full year, we project SG&A as a percentage of home sales revenues to be approximately 10, 4%.

Modest 10 basis point improvement from our prior guidance.

We expect community count to be approximately 325 at the end of the third quarter and 370 by fiscal year end.

We've lowered our full year community count projection slightly due to municipal delays and supply chain disruptions impacting land development.

Other income income from unconsolidated entities and land sales gross profit is expected to be breakeven for the third quarter, but is now expected to be approximately $110 million for the full year.

An increase of $10 million over our prior guidance.

Our guidance for the fourth quarter is therefore $68 billion.

Primarily from the sale of certain apartment living assets.

We projected tax rate of approximately 26% for the third quarter and 25, 7% for the year.

The weighted average share count is expected to be 119 million shares for the full year and $117 5 million for the third quarter.

Based on all of these factors, we continue to project approximately $10 per share and full year earnings per share and a return on beginning equity of approximately 23%.

Now Doug back to you. Thank you Marty before I open it up for questions I would like to thank all of our total employees for their hard work this quarter.

Commitment to providing our customers an extraordinary home buying experience is.

He is key to our success.

Yes, Jason let me open it up to questions.

Thank you we will now begin the question and answer session. As a reminder, the company's planning to end the call at 930, when the market opens.

During the Q&A. Please limit yourself to one question and one follow up to ask a question you May Press Star then one on your Touchtone phone.

If youre using a speakerphone please pick up your handset before pressing the keys to withdraw your question. Please press Star then two.

At this time, we will pause momentarily to assemble our roster.

Our first question comes from John Lovallo from UBS. Please go ahead.

Good morning, guys and thank you for taking my questions.

Maybe a couple of higher level ones today.

The first one.

We're in the middle of probably the largest generational wealth transfer of 68 trillion.

From boomers to millennials and Gen X over the next 15 years, which is probably the greatest we've ever seen I'm. Just curious if you have any sense of.

How many of your buyers are receiving assistance on down payments and what kind of benefit that could be for the industry going forward.

Sure John .

<unk>.

As we told you in the past and it's pretty consistent this quarter about.

30% of our buyers are.

First time homebuyers now there.

Buying more expensive homes on what I'd call a traditional starter home as we've talked about it's our.

The three series BMW and I don't.

I can't give you that answer.

Im not sure whether our mortgage team Marty you can get that I'm not sure we know exactly where it comes from but I am with you I think I think mom and dad are helping out a lot.

I bought my first house of 27, and by Amazing father and mother.

Guaranteed my mortgage because I didn't have.

I was just getting out of law school so I.

I couldn't the mortgage company, maybe it was impressed by my diploma on the wall, but not by my income so.

That's absolutely happening and all have the team offline and see if we can put get you some more specifics on that.

Now our our buyer is as I said a bit more affluent even in that first home. So they probably have a little bit more saved up and so maybe they don't have to lean on that quite as much but.

I'm with you I think there is quite a bit of that that is happening.

Yes, Jonathan.

I think it also helps.

Buyers continue to qualify in a rising rate environment.

Either through a gift for mom and dad for higher down payments right.

<unk>.

I don't know that we have those stats, but we can we can try and pick.

Take them up.

Yeah. That's helpful. I mean, the National Association of Realtors said, it's about 25% of millennials that claimed that they receive.

So I think it's pretty powerful.

Next question is.

There is there a risk in your mind that the industries, it's just securing too much land on option and that could be sort of inflating prices.

And if demand does moderate at some point do you think that builders may not take some of these lots downwards pressure.

Downward pressure on land prices and I guess, along with that is is it fair to assume that if this did happen, but there's a pretty good cushion between.

Where we are and where impairments would occur.

Sure.

No I don't think the builders.

Too focused on optioning land.

Think driving return on equity.

The right way to run our companies.

I think whether it be land banking, whether it be joint ventures with other builders, whether it be terms with your underlying land seller that allows you to pay.

Hey over time I think.

All of that is very smart business does it have a modest impact on margin, yes, because if you are paying a land banker.

9%.

To carry land and feed it back to you when you need it.

Whereas you are paying a land seller.

Effectively an interest or a terms payment and not file all of his land our early now but by it over time.

Know that that can have a modest impact on the margin, but I think.

It is very smart business to trade that modest reduction in margin for less risk the ability if needed to pivot and move away from some land that you don't own outright, but you simply control.

And to drive that capital efficiency that ROE up so I.

I don't think the move towards row is.

And I think it's here to stay and I think it's here to stay through good cycles and bad cycles.

So I'm very comfortable with how toll brothers is approaching it.

I'm very impressed by how disciplined the industry has become over the last few years and how we're all vineland.

Yes, we would take you back to the John with respect to your question on.

Cushing for impairments.

We are not worried about impairments at this point.

Business is good.

We have $9 billion of inventory 6 billion of that is backlog.

$500 million as option contracts for land and the balances land.

And the land that we have right now is generating margins in the upper twenty's the low thirties.

Thanks, guys.

Our next question comes from Raffi, Chad Rossiter from Bank of America. Please go ahead.

Hi, Hi, good morning, Thanks for taking my questions.

So.

I'll give a little bit market Waqar, you sort of mentioned, how the priorities of capital allocation or maybe shifting a little bit.

How do you think about.

Buying land at sort of the current prices today compared to repurchasing your.

Your stock, which is now trading below the book value that you expect at the end of the year and then you also mentioned sort of having a higher.

Return hurdle for land underwriting can you just give a little bit more color on sort of where that's been in and what your expectation is going forward.

Sure.

We love our land position.

To have 85000, plus lots owned or controlled.

The business of selling call it 12000 homes, a year plus or minus.

Puts us in a I think enviable position I'm very proud of the pivot we've made to have more of that land optioned than owned.

We talked about all the time, we buy land at main and main even with the affordable luxury move.

Okay. So block off of main and main but it's still really good quality.

<unk>.

Because of that land, our land position because of how it is structured.

We are.

We have tightened our underwriting.

We expect to buy less land.

We have the land in place to show significant growth.

Over the next couple of years.

We're not ready to guide yet to 'twenty three community count, but I will tell you, it's going up and it's going up based on the land we have.

And it should be going up significantly.

And so.

We look at a combination of gross margin and IRR.

And.

About a year ago that combo was 50 about six months ago that combo with 55 and today that Commvault was north of 60.

And on top of that we have basically doubled the contingencies were putting on top of building costs and the contingencies were putting on top of land development.

And we're not underwriting off.

Yeah.

The Super Frothy Hot sales pace call. It a three months ago, we're being more conservative when we throw the sales pace assumptions.

And for when that land comes to market and we actually start selling homes. So.

Sorry for getting in the weeds, but you asked the questions and I'd like to get into the weeds and that's how it's moved and.

And has it slowed down land buying yes, it has as incentive message to the teams yes. It has as it freed up significant cash flow, yes. It will.

And we will use that to reduce debt to continue to give all of our shareholders a nice dividend.

And hopefully buyback well hopefully not because it's tucked goes up but have the opportunity to continue to.

Buyback our stock and that's the plan.

Rafi.

We heard from a few.

Folks that may be Mike mentioned of book value was.

Bit garbled, so I'll repeat it.

Our book value at the end of the quarter was $46 51.

We projected to be $53 per share at the end of the year.

Okay.

Great. Thank you that's really helpful.

The next question comes from Stephen Kim from Evercore ISI. Please go ahead.

Hey, guys, it's actually squeeze on pretrial could stand a little bit under the weather today.

Can you tell us how youre affordable luxury product is performing relative to your true luxury product for instance, we understand that the typical toll buyers pretty insulated from northern nights, if you kind of highlight.

Highlight it.

But youre affordable luxury community are they seeing a bigger change in demand metrics than your traditional communities given the rate like.

50% of your total movies.

Not restricting sales.

The ratio for the affordable luxury ultimately and how do you think about the cycle times between those two.

Sure so.

I'm going to answer your question in relation to the comments, we've made about the last month, because I think that's what you're really asking.

<unk>.

As we said the market is still good demand is still good.

However, we have noticed in the last month as we expected with all that's going on with rates and with home prices being up and with inflation concerns and and with the stock market all over the place and with.

What's going on in Europe , We did expect that we would see.

Some caution.

From buyers and.

As to your specific question affordable luxury is performing.

A little bit.

Worse than that in the luxury and the.

Active adult.

Would've also expected that as you come down in price.

The monthly payment becomes more important.

And.

Therefore, you I think you are more.

Concerned about affordability.

That doesn't mean that market has rolled over by any means but if I look to Boise, Idaho is an example, where homes are less expensive or I look too.

Probably now.

A third to a half of our Phoenix operation.

Which is less expensive those two areas are good examples of where.

That side of the business the affordable luxury has not performed as well and Thats, what we expected.

South Carolina is also an example, where in Myrtle Beach, where in Greenville and.

We're in Charleston, those are all lower priced markets for us and they have similarly been a bit slower over the last month and the rest of our business. So.

It's common sense for the reasons I just gave and we are we are seeing it.

And our results.

Okay, and I'm, sorry, you asked.

The cycle time.

Yes.

A couple of months shorter to build the less expensive homes.

Are there easier simpler they are less upgrades.

So a couple of months or less.

Okay.

Understandable. Thank you very much for that.

Your commentary suggests <unk> order trends will be down double digits is this due to restricting sales in the quarter or are you.

Factoring in some softening demand as well into that outlook.

All 10 year down nearly 40 bps in the last three weeks.

If it continues to.

Move down over the next couple of months could there be an upside.

Those orders.

Yes, it's really hard.

To talk through the summer.

When we're just now seen in the last month.

Some signs of caution.

Hum.

From buyers.

So I think the answer is it's a combination now we went back and looked at the 10 year period of time before Covid.

Our third quarter on average was down about 15%.

Our second quarter sales.

And that that's not that market softened in those 10 years went may head that seasonality.

May June and July are tend to be slower sales months in normal times.

Because your kids graduate you've got weddings, you open up the summer House and off you go.

And we didn't see that in the last two years because of Covid.

We didn't have seasonal patterns.

It feels like one three weeks in one month and that that is occurring.

But the answer as to why.

I boldly said I believe Q3 will be lower than Q2 is.

And looking back at those 10 years before Covid.

The return of seasonality.

We are still on allocation. So we are managing.

Our sales as we get caught up with production.

And.

Some buyer sentiment.

We are feeling so it's really a combination of all of those.

But.

It'll be very hard to predict.

I think I think buyers are some buyers now demand is still so strong that it outweighs supply and we still have many markets that are really good that's where we've tended to still allocate sales limit sales. We also have 15% of our communities that are going through the.

Best and final sealed bid process.

We are still achieving higher winning bids that are minimum.

Data amount.

But theres no question that I think there are some buyers that are taking a more measured approach.

And Thats.

Think thats what were.

Yeah.

That's what we're up against.

We are using.

The opportunity here to control sales.

Limit sales.

It's not because of demand, we're not saying, okay. We're going to we're going to slow sales out here because we are feeling less demand, it's all about catching up with production.

And when you have a community that is.

It is still quoting a 14 month delivery.

Even six months ago buyers were saying I, just don't want to wait that long.

If we can get that back to normal 910 months.

I think we're going to have which is what we're striving to do and that's the purpose eliminate sales we're going to have a much better indication.

Sort of out of that buyer sentiment is it that they just don't want to wait 14 months.

Or are they just being more cautious because of all these.

Other.

Affordability and macro issues that we're facing at the moment.

Yes, thank you very much.

Youre welcome. Thank you good question.

The next question comes from Susan Mcclary from Goldman Sachs. Please go ahead.

Good morning, everyone. This is actually Charles per run for Susan today. Thanks for taking my question.

Obviously, you gain a ton of price in the quarter with average order price up 23% year over year in Q I recognize that you should continue to support results in 2023, given your backlog.

But for those houses that <unk> been selling over the past months have you seen any change in your ability to push price and get higher ASB to offset inflationary pressure that you've seen.

Yes, so for the last year and a half we've been running approximately.

5% price increase per quarter.

That's not exactly every quarter, but that's what it averages out to.

Part of that is this.

Best and final offer process, where we let the client decide how much they are willing to pay and they bid against each other and drive the price up even higher.

But a lot of it is our own increases to our pricing.

We do not expect it to continue at that pace.

We still have some pricing power.

We are still raising prices today and a limited number of locations as I've mentioned several times now we still have the best and final offer.

<unk> bid process going at 15% of our communities.

But we don't expect at the moment.

Particularly as we head into the summer and we talked about seasonality.

We don't expect to continue that cadence of 5% price increase a quarter I will say, we have no incentives out there.

We're not contemplating incentives.

There are not communities out there that are feeling the need to incentivize to drive sales. So that's why I've said.

In my comments in the release last night that were still in a good market.

But I do not expect that 5% per quarter to continue.

With respect to whether we are offsetting cost increases through our pricing.

We have more than exceeded cost increases through our pricing over the last 18 months.

Hence the increase in margin and the increase in guidance on margin.

23.

We'll have to see how it plays out through the summer as to how much pricing power we have.

While costs are going up we do feel like we have good controls over those costs I've mentioned that we have increased our contingencies and.

And thats not just for the land buying I mentioned, but we've increased our contingencies on our open communities.

And are still comfortable with our ability to drive that gross margin higher.

So I think we will have to.

Wait and see what develops over the let's call. It the next three months.

To know how that pricing power.

Will relate to cost pressures.

That's very good color. Thanks, very much for this and I guess as a follow up can you provide an update on your community ground growth outlook. If we see slower demand I understand that you expect 2023 community count to be up year over year, but if we were to expect like I say slower demand going forward.

Is there any way for you to flex that community count opening to maybe protect your sales space and how does this change your outlook.

If you were to see moderate demand trends going forward.

We can always flex our community openings.

The only time, we could disappear if we're up against some permit that's about to expire and we have to get the roads in or we lose the years of hard work in gaining entitlements, but that's very rare.

Permits have a pretty long shelf life, and we don't feel that pressure so.

We're not going to move forward it put roads in and build beautiful model homes and open for sale if we haven't.

Studied in great detail the current market conditions, the financial metrics of that community with cost and pricing.

And then of course, we make the decision to go or not go so.

Right now there is there is none of that being contemplated.

We have the land we have a pretty good idea as to when we gain entitlements and when we're ready to open.

Much of this land two thirds of this land that we control was put under contract.

Either in the early days of Covid are more likely pre COVID-19 before land prices went up and.

So.

We're sitting on terrific margins and a lot of this land that is positioned to be opened in new communities.

Later in 'twenty two 'twenty three.

There's always the ability to pivot if market conditions suggests that we should.

I think in the short term.

A slowing of sales would actually lead to community count growth, because we would have fewer sellouts than we currently project.

But it probably will not in the short term change what we plan to open.

That's very good color. Thanks for the time guys.

The next question comes from Deepa Raghavan from Wells Fargo Securities. Please go ahead.

Hi, Good morning, everyone. Thanks for taking my question I'll start off with a broader one.

Are you able to provide any data points on profit.

At this point in time, or even others well known.

Tim.

No.

April .

Also you mentioned that 15%.

Options are still on what was that a quarter before.

I'm sorry.

Didn't understand the second part of the question I got traffic, we will get to that 15% was what.

The field options.

You mentioned, what was that a quarter before.

Oh, Thank you final <unk> best and final sale. Thank you.

When you pull that up and with respect to traffic.

There has been a modest slowing of foot traffic and web traffic.

Through the month of May.

Which we didn't see in the prior to amaze, but is consistent with the more seasonal patterns that we've talked about pre COVID-19.

It's nothing that alarms us, but it is we're keeping an eye on it.

And so that both web and foot traffic.

Is down on a typical seasonal basis, we are encouraged that what we call web leads.

Which are those people that.

Spend time on our website and then either make their way to our sales office by foot or send in.

E mail request through the website seek.

Seeking more information our definition of leads as a percentage of traffic that becomes a lead is holding up.

But the amount of traffic.

Is down as I mentioned on the on the on.

The consistency subtle pattern.

In terms of best and final offers at the end of the first quarter. It was in the neighborhood of 25% to 30% of our communities.

And now it's at that 15%.

Thank you Marty.

Yes.

That's helpful. Thanks, My follow up is on the guide the implied guide for Q4.

Within that full year guide pulled back in terms of closing units.

Is that all.

Is that portion that's unsold yet.

And I ask because.

Please ask your backlog Delaware in 2023.

Means in a roughly 6K in Delaware in the second half, but you're guiding to seven coal closings as well I'm sure. It's an approximation there, but just curious is there a portion that is still on.

Sold.

Within the Q4 guide.

Yes, there are.

500 to 1000 units that we would expect to sell and settle between the end of.

Q2, and the end of Q4.

And that will come from homes under construction or our spec inventory and Thats a normal amount.

And actually we could probably.

Sell more but again, we're trying to build our spec count back up to more normal levels.

Got it that's what I thought I appreciate the color thanks, very much and good luck.

Thank you.

Alright, I have one quick clarification. Thank you Wendy more left.

Our amazing Chief marketing officer, when I said, there are no when I think I said that we're very strongly incentives.

What I wanted to I want to clarify is when we sell millions of $2 million houses even in the greatest market. We've ever seen we may give the customer.

Five or $10000 towards upgrades.

To make them feel good.

And that's in place that's been in place, we're not increasing any incentives anywhere.

I just want to thank you Wendy I want to make sure that that is clarified.

Our next question comes from Alan Ratner from Zelman and Associates. Please go ahead.

Hey, guys. Good morning, Thanks for taking the questions.

Our first question, Doug I think you just touched on this briefly but the.

The spec strategy last quarter I think you noted you were starting more specs trying to replenish the inventory. There I think you just kind of highlighted that that remains the strategy today, but can you just talk a little bit about where you are from a spec count perspective across the company under construction completed presumably you don't have much if any but.

Are you kind of back at the levels, where you want to be or are you still kind of ramping the spec activity. How are you thinking about that given your comments about the slight moderation in demand as well.

Sure, Yes, it's a great question so yes.

Don't be alarmed we're not a spec builder we built this company on.

On build to order.

We know what $1 million the client is very discriminating.

Very important pulmonary.

Home and their life is not their first one generally and they wanted to they wanted to design. It their way we think the right mix is 80% build to order 20% spec.

And even on the spec in many cases, we open that for sale when the client can still go to our design studio and pick their finishes.

So it's rarely finished spec inventory for the same reason at that price point.

The buyer wants to pick their kitchen cabinets and countertops or flooring.

And so through Covid.

We got so hot we sold for many homes, we put our attention on our backlog.

We were unable to keep up with mixing specs into production and we felt far behind that 80, 20 balance and so as we mentioned on the last call.

Because we had some very long quoted delivery times that some of our communities.

A walk in you want your build to order home and we tell you I'm very sorry, but its going to take 15 months we've.

We made the right decision strategic decision to put those types of communities on allocation limit sales, but still start.

More unsold homes, so we could get back to the 80 20 mix. So it shouldn't hurt revenue down the road because we'd have those homes completed at the same time, we just might not have the sale today and so we.

We started more homes in Q2 that we sold.

And I think we'll do the same thing in Q3.

But we're not caught up we're not we're not close to 20%.

Im not sure we get to 20%.

If the market shows signs of softening.

We will be more careful.

We understand the business, we are not interested in sitting on <unk>.

Completed spec inventory in a tough market.

Historically spec homes or incentivize more than build to order through Covid. We know that wasn't the case, if you held at home longer.

And you rolled out the price appreciation.

That's back would have a higher margin than our build to order, but thats unusual historically in this industry.

Typically build to order drove higher margin and I'm, not saying, we're heading back into that yet I don't know, but we will.

I'll start more but we will I don't think be able to approach that 20% and thats. The cap we are not looking to go beyond that.

Got it and the key point there just my takeaway from what you. Just said is in spite of what Youre seeing in terms of slight moderation in demand that hasnt impacted your.

Willingness or aggressiveness to start more homes and you're selling you still think that the demand is going to be strong enough. As you bring these homes to market to absorb it at strong prices and strong margins.

Yeah.

We do and then with respect to you and I think you asked a little bit Alan about.

How much do we have at different stages.

Right now.

We have about a thousand units.

So call that a little bit less than 10%.

Our annual sales.

That are <unk>.

At or beyond Foundation.

And that was what will feed into the deepest comment about how much of your full year is sold.

Marty gave a range of 500 to 1000 specs.

I think the exact number guys. We think is about 600 I just heard Q3 and Q4 for Q3 and Q4.

There are about 600 more sales we need to deliver in Q3 and Q4.

We have a thousand.

Columns that are at or beyond foundation. So we're in very good shape.

But we are we're being thoughtful and every week, we study where we should be starting homes, what the market conditions are in that locale as to whether we should continue to start specs.

I mean, you know we've always been very conservative when it comes to spec building.

I'd like to get back towards 20% if the market continues to be good.

But we.

We can easily pivot on that and we're not going to pivot up anything that pivot is down.

Alright, I appreciate the comments there Doug and if I can just add one more.

The 23 margin guide to be up obviously, that's a reflection of that 50% of your backlog that's in there presumably at margins similar or better than what you're expecting in the fourth quarter of this year.

Doug you've made this comment the last several quarters that the home youre selling today is the highest gross margin in the company history and I'm. Just curious is that still true today or has that maybe been a little bit more mixed given the fact that you are dialing back the price increases and what youre seeing in the market.

Yes.

I chatted about that a few questions back.

With 5% price increase per quarter for the last 18 months.

We have been more than offsetting cost increases I do not anticipate.

Continuing to achieve 5% price increase per quarter.

With with what we've seen in the last month and what we've been discussing so it's hard to say yet whether.

We will have enough pricing power to offset cost increases.

The market does slow do costs come down we have a nice tailwind with lumber coming down that I think will benefit us in at least the second half of 'twenty. Three so it's very hard to say, Alan but certainly with what feels like a bit less pricing power today.

Can't sit here and confidently tell you as I did the last few quarters that the next homes sold.

We will be at a higher margin I think it will be at a similar margin at the moment I'm very happy with the margin, but we're just going to have to see how this.

Demand plays out.

It makes sense alright appreciate the thoughts guys.

Thanks take care.

The next question comes from Buck Horne from Raymond James. Please go ahead.

Hey, Thanks, Good morning, guys congrats on the quarter.

I'll start with a kind of a question that probably difficult to answer, but what I get a lot.

The market.

Correct prices for your stock in the group I mean, the markets anticipating some sort of housing cataclysm almost similar to 2008 style meltdown.

My question is kind of you know.

What would it take from here.

If you're trying to.

Helping portfolio manager understand the downside in terms of what kind of home price declines would have to take place or margin erosion.

To drive some sort of land impairments cycle from here, what kind of scenario.

What does it take.

From here to get to that point.

But I guess, there's a couple of points.

I'll go through our $9 billion of inventory.

As I did earlier 6 billion of that inventory is backlog homes.

So I think there's very little risk associated with those we haven't seen cancellation rates they have 25%.

Low 30 margins in them.

And they're not in our books book value, yet we talked about.

And then getting into our book value by the end of the year, but then there is further book value appreciation, we would expect in the next year as the balance of those backlog homes deliver.

Secondly, I talked about another $2 $5 billion of owned land.

That's in our inventory, we feel very good about the underwriting of those those also projected roughly 25% to 30% gross margins. So we'd have to see significant cost growth or.

Sure.

Price drops and we are not seeing that at this point and then the last piece is the $500 million.

Option deposits are sunk costs, we have on deals that are in our option plan portfolio.

And.

Again, thats not a big number to control 46000 lots.

There may be some occasions in there where we choose not to proceed with the deal as we saw in the first quarter, but here in the first.

In the second quarter, and the first and second quarter, we wrote off $4 million of costs.

Associated with those.

The underwriting of those deals didn't work for various reasons as part of our diligence exercise. So we didn't get approval. So we didn't get approved under the underwriting it may just be that certain deals fizzle out.

Approvals didn't come through maybe.

Construction costs for land development were more substantial than we thought and the seller wasn't willing to renegotiate so.

We are not worried about impairments.

Great No. That's helpful. I appreciate the color there.

My last question is just kind of switching.

Switching gears to the rental side of the business I'm just wondering.

With the rise in rates here, you're obviously multifamily rents are continuing to go up really really strong single family rental as well.

Do you anticipate growing your capital investments or the mix of capital into the rental side of the business or how do you think about the.

The optionality of growing the JV partnership on the <unk> side or anything related to the rental side.

Yeah, we love the business, it's performing very well.

Our joint venture with EQM <unk> is fantastic.

The teams are working really well in QR has it.

He is a great partner, there is more and more opportunities for us too.

This co developed with them and then they take us out at stabilization.

As we've mentioned, we're now committed to sell all of the apartment buildings at stabilization to produce earnings that become more predictable.

For all of you.

And we see that business growing but we're not.

Not having to put more investment into it because we're turning assets quickly as we get more and more assets and they sell a stabilization.

That money can be recycled on the <unk> side, we have a $25 million investment in a joint venture with.

A substantial wall Street partner and BB living we'd like the <unk> business. We will continue to co invest in that venture. There may also be some opportunities outside of that venture on some smaller assets that toll brothers zones, where we sell.

Some homes.

<unk> added the gate.

<unk> operators that tends to be our lower priced locations I know a lot of the other builders are doing that.

And we do have some carve outs with the BV deal that allows us to.

To do that so we like both the traditional multifamily the SSR business, we're going to continue to invest in it.

But we're going to show earnings out of it.

By selling everything at stabilization.

Great. Thanks, guys.

Thank you.

This concludes our question and answer session I would like to turn the conference back over to management for any closing remarks.

Jason Thank you very much thanks, everyone.

Hope you have a wonderful summer take care.

Conference has now concluded. Thank you for attending today's presentation you may now disconnect.

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Okay.

Good morning, and welcome to the toll brothers second quarter earnings Conference call.

All participants will be in listen only mode should you need assistance. Please signal a conference specialist by pressing the star key followed by zero.

After today's presentation there'll be an opportunity to ask questions to ask a question you May Press Star then one on your telephone keypad.

To withdraw your question. Please press Star then two.

Thank you Jason.

Good morning.

Welcome and thank you for joining US with me today are Marty Connor Chief Financial Officer.

Rob powerhouse, President and Chief operating Officer.

Cooper senior VP of finance and Investor Relations.

Wendy Marlett, Chief marketing Officer, and Gregg Ziegler senior VP and treasurer.

Before I begin I ask you to read the statement on forward looking information in our earnings release of last night and on our website.

That could significantly affect future results.

We are very pleased with our second quarter performance as we met or exceeded our guidance on all key metrics.

We delivered a record 2407 homes in the second quarter at an average price of approximately $908000, resulting in record home sales revenue of $2 2 billion.

This was an increase of 19% compared to last year's second quarter revenue.

Our teams did a great job delivering homes and what continues to be a very challenging production environment.

Adjusted gross margin of 26, 1% in the quarter improved to 170 basis points.

Impaired to last year's second quarter.

And was 60 basis points better than guidance.

SG&A expense at 11, 1% of homebuilding revenues was.

It was 80 basis points better than both last year's second quarter and our guidance.

Driven by significant revenue growth and expanding margins.

We generated earnings per share of $1 85.

Of 83% compared to last year.

At second quarter end, our backlog stood at a record 11 $7 billion and 11 seven.

768 homes.

Based on the strong pricing and margin embedded in our backlog.

And with approximately half of our backlog scheduled for delivery in fiscal year 2023.

We expect our fiscal year 2023, adjusted gross margin to be better in fiscal year 2020 twos.

Sales in our second quarter, where our highest quarter ever as demand remains strong across all of our buyer segments and geographies.

We signed 2874 net contracts.

For $3 1 billion up one 2% in dollars over 2021 extremely strong second quarter on orders were up 97% in dollars compared to Q2 of 2020.

Our quarterly sales pace was consistent with the eight eight contracts per community that we projected for Q2.

On our earnings call back in February .

While demand is still solid over the past month. It has moderated from the unprecedented pace of the past two years as buyers adapt to higher mortgage rates and other macroeconomic conditions.

The substantial rise in home prices.

Deep increase in mortgage rates since January <unk>.

Inflation concerns and stock market volatility are all having an impact.

On buyer sentiment.

And we anticipate that some buyers may remain cautious.

For the seasonally slower summer months.

As a reminder, in the second quarter, we limited sales to catch up on construction.

We are continuing this strategy in the third quarter.

With the combination of restricting sales.

The normal summer slowdown.

And a more cautious buyer.

We expect our Q3 contracts to be lower than Q2.

Which is what normally occurred.

Got it.

Despite the recent moderation the housing market remains healthy.

Even over the past month, we have continued to raise prices in a limited number of communities and we are running successful best and final sealed bid processes and about 15% of our communities.

There are many fundamental drivers that have supported the housing market in recent years remain firmly in place.

These include favorable demographics, with 150 million millennials and baby boomers.

Spearing seen life events that are driving home demand.

The supply and demand imbalance, resulting from over a decade of underproduction.

Tight resale inventories.

Migration trends driven by more flexibility in the workplace.

And then overall greater appreciation for homes.

And in particular new homes.

In addition to <unk>.

For sale housing market is benefiting from an ongoing and significant increases in rents for single and multifamily dwellings.

We believe these trends will continue to support housing demand in the long term.

Turning specifically to our customers.

We believe they are generally better insulated.

From affordability concerns.

They tend to have higher incomes and network.

And many have benefited from significant price appreciation in their existing homes.

Approximately 20% of our customers paid all cash and those who do take a mortgage average approximately 70% loan to value.

Importantly, our buyers utilizing jumbo loans are benefiting from a rate that remains three quarters of a point lower than the conforming rate.

As our industry continues to be challenged by supply chain disruptions labor shortages and municipal delays.

We have revised our full year deliveries guidance.

We now expect full year deliveries to be between 11011 thousand $500 a reduction of about 375 homes with at the midpoint.

However, we have increased our average delivered price guidance by $15000 per home to reflect the strong pricing in our backlog.

As a result, we expect full year 2022, homebuilding revenues of approximately $10 $1 billion at the midpoint of our guidance.

We're 20% growth.

Compared to fiscal year 2021.

We remain committed to our disciplined and capital efficient land acquisition strategy.

At the end of our fiscal second quarter, we owned or controlled 85800 lots of which 53% were controlled.

And 47% were owned.

Nearly 12000 of these lots are already committed to homebuyers and our backlog.

Excluding these are controllable and represents 61%.

Of lots.

This land position much of which was contracted for pre pandemic provides.

<unk> provides us with sufficient land needed.

Our significant growth.

Well into the future.

Therefore.

We can be very selective as we evaluate new land deals.

And apply our more rigorous underwriting standards that.

That incorporate higher gross margin and IRR thresholds.

Higher contingencies for land development and construction costs.

And more conservative assumptions related to sales paces.

We also remain focused on improving our return on equity in.

In the second quarter, we repurchased $106 $5 million of our common stock at.

And another $16 million, so far in our third quarter.

Since the beginning of the fiscal year, we have repurchased about $308 million or four 6% of.

Of our year end share count.

We have also paid $44 million in dividends year to date, and we retired $410 million.

<unk> of long term debt in our first quarter.

These actions reflect our confidence in the business and our commitment to delivering returns to our shareholders.

With that I'll turn it over to Martin.

Thanks, Doug.

In our second quarter, we delivered 20, 407 homes and generated homebuilding revenues of $2 2 billion.

Up 6% in units and 19% in dollars from one year ago.

The average selling price of our 2874 signed contracts in fiscal year 2022 second quarter.

Was $1 million $75000.

Up nearly $200000 compared to last year's second quarter.

And up $53000 over Q1.

Our second quarter pretax income was $296 million compared to $170 million in the second quarter of fiscal 2021.

Net income was $221 million or $1 85 per share diluted compared to a $128 million and $1 one per share diluted one year ago.

Our second quarter adjusted gross margin was 26, 1% compared to 24, 4% in the second quarter of 2021 and.

And 60 basis points better than we had projected.

The improvement was due primarily to price, reflecting the strong demand environment.

Over the last year.

Sure.

We continue to project an adjusted gross margin of approximately 27, 5% for the full year.

We expect the adjusted gross margin for our third quarter of fiscal year 2022 to be 27%.

Which implies an adjusted gross margin in excess of 29%.

Our fourth quarter.

As Doug mentioned, we believe our fiscal year 2023, adjusted gross margin will be even better than this year's.

This is due primarily to the composition of our backlog and the pricing power we've experienced over the past year.

Approximately half of our existing backlog of 11768 homes are projected to be delivered in fiscal year 2023.

And this backlog is solid.

Our cancellation rates have consistently been the lowest in the industry for many decades, which speaks to the financial strength of our customers and our build to order model, which allows our buyers to personalize their homes, becoming emotionally invested in those homes.

They are also financially invested as they make a nonrefundable deposit averaging $75000.

Thus they benefit from any home price appreciation between contract signing and ultimate delivery.

Which has been significant.

As a result.

I have just 114 cancellations in our backlog of over 11000 homes in the second quarter.

We're about 1%.

We haven't seen any significant changes in may.

Let me quickly address any concerns that rising mortgage rates.

They have on future cancellation rates.

First of all keep in mind that 20% of our buyers pay all cash.

Fluctuations in interest rates should have no impact on these buyers.

We are also pressured tested the balance of our backlog.

We estimate that if the 30 year conforming rate were to increase to 6%.

Less than 10% of our backlog would have to consider an arm.

Provide a higher down payment for additional source of income or consider other alternatives such as buying down rates with upfront points.

As our low cancellation rates in the second quarter and tests are.

Our buyers have remained committed to their new homes, even with the rapid increase in interest rates.

And remember the homes in our older backlog, which we're contracted for when rates were lower.

I have enjoyed significant price appreciation.

Which means these buyers have greater motivation to close.

And we have less risk if they don't.

Turning back to our results.

SG&A as a percentage of revenue was 11, 1% in the second quarter.

Baird to 11, 9% in Q2 of last year.

And this was 80 basis points better than we projected.

The improvement was driven primarily by revenue growth and lower sales and marketing spend.

Second quarter joint venture land sales and other income was $12 million exceeding our guidance of $5 million.

Due primarily to a gain from the bulk sale of home security monitoring incomes.

Impairments and write offs were $2 $2 million in the quarter, reflecting sunk cost on land deals that we are no longer pursuing.

Our tax rate in the quarter was 25, 4%.

We finished the quarter with a net debt to capital ratio of 33, 1%.

$535 million in cash and equivalents and with $1 8 billion available under our $1 9 billion revolving credit facility.

This all provides us with ample flexibility to both grow.

And return capital to our shareholders.

At quarter end, our book value per share was $46 51.

Based on the midpoint of our guidance and supported by our solid backlog.

We expect this to be approximately $53 per share at fiscal year end.

Turning to guidance, we are projecting fiscal year 2022 third quarter deliveries of 27 to 150 homes with an average.

Between 895 and.

At $915000.

As Doug mentioned continued supply chain and labor constraints and municipal delays are impacting production.

As a result, we have reduced our full year delivery guidance by approximately 375 homes.

Two between 11000 and 11500.

But based on the pricing in our backlog.

<unk> increased our projected average delivered price.

Between 890009 hundred $10000 $15000 increase from prior guidance.

We expect interest and cost of sales to be approximately 2% in the third quarter and for the full year as we continue to benefit from our reduced leverage.

We project third quarter SG&A as a percentage of home sales revenues to be approximately 10, 5%.

For the full year, we project SG&A as a percentage of home sales revenues to be approximately 10, 4% a modest 10 basis point improvement from our prior guidance.

We expect community count to be approximately 325 at the end of the third quarter and 370 by fiscal year end.

We've lowered our full year community count projection slightly due to municipal delays and supply chain disruptions impacting land development.

Other income income from unconsolidated entities and land sales gross profit is expected to be breakeven for the third quarter, but is now expected to be approximately $110 million for the full year.

An increase of $10 million over our prior guidance.

Our guidance for the fourth quarter is therefore $68 million.

<unk> from the sale of certain apartment living assets.

We projected tax rate of approximately 26% for the third quarter and 25, 7% for the year.

The weighted average share count is expected to be 119 million shares for the full year and $117 5 million for the third quarter.

Based on all of these factors, we continue to project approximately $10 per share and full year earnings per share and a return on beginning equity of approximately 23%.

Now Doug back to you.

Good morning, before I open it up for questions I'd like to thank all of our toll employees for their hard work this quarter.

Commitment to providing our customers an extraordinary home buying experience is.

As key to our success.

Jason Let me open it up to questions.

Thank you we will now begin the question and answer session. As a reminder, the company's planning to end the call at 930, when the market opens.

During the Q&A. Please limit yourself to one question and one follow up to ask a question you May Press Star then one on your Touchtone phone.

If youre using a speakerphone please pick up your handset before pressing the keys to withdraw your question. Please press Star then two.

At this time, we will pause momentarily to assemble our roster.

Our first question comes from John Lovallo from UBS. Please go ahead.

Good morning, guys and thank you for taking my questions.

Maybe a couple of higher level ones today.

First one was more.

We're in the middle of probably the largest generational wealth transfer of 68 trillion.

From boomers to millennials and Gen X over the next 15 years, which is probably the greatest we've ever seen I'm. Just curious if you have any sense of.

How many of your buyers are receiving assistance on down payments and what kind of benefit that could be for the industry going forward.

Sure John .

<unk>.

As we told you in the past and it's pretty consistent this quarter about.

30% of our buyers are.

First time homebuyers.

They are buying more expensive homes on what I'd call a traditional start around as we've talked about it's our.

And three series BMW and I don't.

I can't give you that answer.

I'm not sure whether our mortgage team Marty you can get that I'm not sure we know exactly where it comes from but I am with you I think I think mom and dad are helping out a lot.

I bought my first house of 27 in my Amazing father and mother.

Guaranteed my mortgage because I didn't have.

I was just getting out of law school, so I couldnt. The mortgage company, maybe was impressed by my diploma on the wall, but not by my income so.

That's absolutely happening and all have the team offline and see if we can put.

Get you some more specifics on that.

Now our our buyer is as I said a bit more affluent even in that first home. So they probably have a little bit more.

Saved up and so maybe they don't have to lean on that quite as much but.

I'm with you I think there is quite a bit of that that is happening.

Yes, Jonathan.

I think it also helps.

<unk> continued to qualify in a rising rate environment.

Either through a gift for mom and dad for higher down payment right.

Which I don't know that we have those stats, but we can we can try and see them up.

Yeah. That's helpful. I mean, the National Association of Realtors said, it's about 25% of millennials that claimed that they receive assistance. So I mean, I think it's pretty powerful.

Our next question is.

There is there a risk in your mind that the industry is just securing too much land on option and that could be sort of inflating prices.

And if demand does moderate at some point do you think that builders may not take some of these lots downward pressure.

Downward pressure on land prices and I guess, along with that is it fair to assume that if this did happen, but there is a pretty good cushion between.

Where we are and where impairments would occur.

Sure.

No I don't think the builders.

Our.

Two focused on optioning land.

Think driving return on equity.

The right way to run our companies.

I think whether it be land banking, whether it be joint ventures with other builders, whether it be terms with your underlying land seller that allows you to pay over time I think all of that is very smart business does it have a modest impact on margin, yes, because if you are paying a land back.

<unk>.

9%.

To carry land and feed it back to you when you need it or if you are paying a land seller.

Effectively an interest or a terms payment.

File all of his land or <unk> land now, but by it over time.

That can have a modest impact on the margin, but I think it is very smart business to trade that modest reduction in margin for less risk.

Ability if needed to pivot.

And move away from some land that you don't own outright Bayou simply control and to drive that capital efficiency that ROE up so.

I don't think the move towards row.

I think it's here to stay and I think it's here to stay through good cycles and bad cycles.

So I'm very comfortable with how toll brothers is approaching it.

I am very impressed by how disciplined the industry has become over the last few years and how we're all vineland.

<unk>.

Yes.

Thanks, you guys did John with respect to your question on <unk>.

Cushing for impairments.

We are not worried about impairments at this point.

Business is good.

We have $9 billion of inventory $6 billion of that is backlog.

$500 million option contracts for land and the balances land.

And the land that we have right now is generating margins in the upper <unk> to low thirty's.

Thanks, guys.

Our next question comes from Raffi chatter offsets from Bank of America. Please go ahead.

Hi, Hi, good morning, Thanks for taking my questions.

Hum.

Can you give a little bit market Waqar, you sort of mentioned, how the priorities of capital allocation.

Shifting a little bit.

How do you think about buying.

Buying land at sort of the current prices today compared to repurchasing your.

Your stock, which is now trading below the book value that you expect at the end of the year and then you also mentioned sort of having a higher.

Return hurdle for land underwriting can you just give a little bit more color on sort of where that's been in and what your expectation is going forward.

Sure.

We love our land position.

To have 85000, plus lots owned or controlled.

The business that selling call it 12000 homes, a year plus or minus.

Puts us in I think enviable position I'm very proud of the pivot we've made to have more of that land optioned than owned.

We talk about all time, we buy land in Maine, and Maine, even with the affordable luxury move.

Okay. So block off of main and main but it's still really good quality.

<unk>.

Because of that land, our land position because of how it is structured.

We are.

We have tightened our underwriting.

We expect to buy less land.

We have the land in place to show significant growth.

Over the next couple of years.

We're not ready to guide yet to 'twenty three community count, but I will tell you, it's going up and it's going up based on the land we have.

And it should be going up significantly.

And so.

We look at a combination of gross margin and IRR.

And.

About a year ago that combo was 50 about six months ago that combo was 55 and today that Commvault was north of 60.

And on top of that we have basically doubled the contingencies were putting on top of building costs and the contingencies were putting on top of land development.

And we're not underwriting off.

Yes.

The Super Frothy Hot sales pace call. It a three months ago, we're being more conservative when we throw the sales pace assumptions.

In for when that land comes to market and we actually start selling homes. So.

Sorry for getting in the weeds, but you asked the questions and I'd like to get into the weeds and that's how it's moved.

And has it slowed down land buying yes. It has sent a message to the teams yes. It has as it freed up significant cash flow, yes, it will and we will use that to reduce debt to continue to give all of our shareholders a nice dividend.

And hopefully buyback hopefully not because it goes up but have the opportunity to continue to.

Buyback our stock and that's the plan.

Rafi.

We heard from a few.

Folks that may be Mike mentioned of book value was.

Bid garbled, so I'll repeat it.

Our book value at the end of the quarter was $46 51.

We projected to be $53 per share at the end of the year.

Great. Thank you that's really helpful.

The next question comes from Stephen Kim from Evercore ISI. Please go ahead.

Hey, guys, it's actually squeeze on trying to expand a little bit under the weather today.

Affordable luxury.

Are they seeing a bigger change in demand metrics than your traditional community given the rate like.

50% of your total knees.

Not restricting sales.

The ratio for the affordable luxury ultimately and how do you think about the cycle times between those two.

Sure so.

I'm going to answer your question in relation to the comments, we've made about the last month, because I think that's what you're really asking.

<unk>.

As we said the market is still good demand is still good.

What's gone on in Europe , We did expect that we would see.

Some caution.

From buyers and.

As to your specific question affordable luxury is performing.

A little bit.

Worse than that in the luxury and the.

Active adult.

Would have also expected that as you come down in price.

The monthly payment becomes more important.

And.

Therefore, you're I think you're more.

Concerned about affordability.

It doesn't mean that market has rolled over by any means but if I look to Boise, Idaho is an example, where homes are less expensive.

Or I look too.

Probably now.

A third to a half of our Phoenix operation.

Which is less expensive those two areas are good examples of where.

That side of the business the affordable luxury has not performed as well and Thats, what we expected.

South Carolina is also an example, where in Myrtle beach or in Greenville.

And were in Charleston.

These are all lower priced markets for us and they have similarly benefit slower over the last month and the rest of our business. So.

It's common sense for the reasons I just gave and we are we are seeing it in.

In our results.

Okay.

Sorry.

The USA and cycle time, yes.

It's a couple of months shorter to build the less expensive homes, they're smaller they're easier simpler they are less upgrades.

A couple of months left.

Okay.

Well, thank you very much for that.

And your commentary suggests <unk> order trends will be down double digits is this due to restricting sales in the quarter or are you factoring in some softening demand as well into that outlook.

10 year down nearly 40 bps in the last three weeks.

If it continues to move down over the next couple of months could there be an upside to those orders.

Yes, it's really hard.

To talk through the summer.

When we're just now seen in the last month.

Some signs of caution.

From buyers.

So I think the answer is it's a combination now we went back and looked at the 10 year period of time before Covid.

Our third quarter on average was down about 15% from our second quarter sales.

And that that's not that market softened in those 10 years when may hit that seasonality.

May June and July .

<unk> tend to be slower sales months in normal times.

Because your kids graduate you've got weddings, you opened up the summer house.

Off you go.

And we didn't see that the last two years because of Covid.

We didn't have seasonal patterns.

It feels like one three weeks in one month and that that is occurring.

But the answer as to why.

I boldly said I believe Q3 will be lower than Q2.

And looking back at those 10 years before Covid.

The return of seasonality.

We are still on allocation. So we are managing.

Our sales as we get caught up with production.

And.

Some buyer sentiment.

We are feeling so it's really a combination of all of those.

But it'll be very hard to predict.

I think I think buyers are some buyers now demand is still so strong that it outweighs supply and we still have many markets that are really good.

It's where we've tended to still allocate sales limit sales. We also have 15% of our communities that are going through the best and final sealed bid process.

We are still achieving higher winning bids than our minimum.

Date amount.

But theres no question that I think there are some buyers that are taking a more measured approach.

And Thats.

I think thats what were.

That's what we're up against.

We are using.

The opportunity here to control sales.

To limit sales.

It's not because of demand, we're not saying, okay. We're going to we're going to slow sales out here because we are feeling less demand, it's all about catching up with production.

And when you have a community that.

It's still quoting a 14 month delivery.

Even six months ago buyers were saying I, just don't want to wait that long.

If we can get that back to normal 910 months.

I think we're going to have which is what we're striving to do and that's the purpose eliminate sales we're going to have a much better indication.

Sort of as that buyer sentiment is it that they just don't want to wait 14 months.

Or are they just being more cautious because of all of these.

Other.

Affordability and macro issues that we're facing at the moment.

Yes, thank you very much.

Youre welcome. Thank you good question.

The next question comes from Susan Mcclary from Goldman Sachs. Please go ahead.

Good morning, everyone. This is actually Charles per run for Susan today. Thanks for taking my question.

Obviously, you gain a ton of price in the quarter with average oil price of 23% year over year in Q I recognize that you should continue to support results in 2023, given your backlog.

But for those houses that <unk> been selling over the past months have you seen any change in your ability to push price and get higher ASB to offset inflationary pressure that you've seen.

Yes, so for the last year and a half we've been running at approximately.

5% price increase per quarter.

It's not exact to every quarter, but that's what it averages out to.

Part of that is this is the best and final offer process, where we let the client decide how much they are willing to pay in a.

The bid against each other and drive the price up even higher.

But a lot of it is our own increases to our pricing.

We do not expect it to continue at that pace.

We still have some pricing power.

We are still raising prices today and a limited number of locations as I've mentioned several times now we still have the best and final offer.

Seal bid process going to 15% of our communities.

But we don't expect at the moment.

Particularly as we head into the summer and we talked about seasonality.

We don't expect to continue that cadence of 5% price increase a quarter I will say, we have no incentives out there we're not contemplating incentives.

There are not communities out there that are feeling the need to incentivize to drive sales. So that's why I've said.

In my comments in the release last night that we are still in a good market.

But I do not expect that 5% per quarter to continue.

With respect to whether we are offsetting cost increases through our pricing.

We have more than exceeded cost increases through our pricing over the last 18 months.

Hence the increase in margin and the increase in guidance on margin in 'twenty three.

We will have to see how it plays out through the summer as to how much pricing power we have.

While costs are going up we do feel like we have good controls over those costs I've mentioned that we have increased our contingencies and.

And that's not just for the land buying I mentioned, but we have increased our contingencies on our open communities.

And are still comfortable with our ability to drive that gross margin higher.

So I think we will have to.

Wait and see what develops over the let's call. It the next three months.

To know how that pricing power.

Will relate to cost pressures.

Is there any way for you to flex that community count opening to maybe protect your sales space and how does this change your outlook.

If you were to see moderate demand trends going forward.

We can always flex our community openings.

The only time, we could dissipate if we're up against some permit that's about to expire and we have to get the roads in or we lose the years of hard work in gaining entitlements, but that's very rare.

Permits have a pretty long shelf life, and we don't feel that pressure so.

We're not going to move forward it put roads in and build beautiful model homes and open for sale if we haven't.

Studied in great detail the current market conditions, the financial metrics of that community with cost and pricing.

And then of course, we make the decision to go or not go so.

Right now there is there is none of that being contemplated.

We have the land we have.

Pretty good idea as to when we gain entitlements and when we're ready to open.

Much of this land two thirds of this land that we control was put under contract.

Either in the early days of Covid are more likely pre COVID-19 before land prices went up.

And so.

We're sitting on terrific margins and a lot of this land that is positioned to be opened in new communities and later in 'twenty two we're in 'twenty three.

But there's always the ability to pivot if market conditions suggests that we should.

I think in the short term.

A slowing of sales would actually lead to community count growth because we have fewer sellouts than we currently project.

Probably we will not in the short term change what we plan to open.

That's very good color. Thanks for the time guys.

The next question comes from Deepa Raghavan from Wells Fargo Securities. Please go ahead.

Yes.

Hi, Good morning, everyone. Thanks for taking my question I'll start off with a broader one.

Are you able to provide any data points on profit.

At this point in time, or even others well known.

Tim.

No.

<unk>.

Also you mentioned that 15%.

That's still on while there is that a quarter before.

I'm sorry.

I understand the second part of the question I got traffic will get to that 15% was what.

The field options.

You mentioned, what was that a quarter before.

Thank you.

Final <unk> best and final sealed thank you.

Guys, when you pull that up and with respect to traffic.

There has been a modest slowing of foot traffic and web traffic.

Through the month of May.

Which we didn't see in the prior to amaze, but is consistent with the more seasonal patterns that we've talked about pre COVID-19.

It's nothing that alarms us, but it is we're keeping an eye on it.

And so that both web and foot traffic.

Is down on a typical seasonal basis, we are encouraged that what we call web leads.

Which are those people that.

Spend time on our website and then.

Either make their way to our sales office.

Foot or send in an email request through the website.

Seeking more information our definition of leads as a percentage of traffic that becomes a lead is holding up.

But the amount of traffic.

<unk> is down as I mentioned.

On the consistency subtle pattern.

In terms of best and final offers at the end of the first quarter. It was in the neighborhood of 25% to 30% of our communities.

And now it's at that 15%.

Thank you Marty.

So that's.

That's helpful. Thanks, My follow up is on the guide the implied guide for Q4.

Within that full year guide pullback in terms of closing units.

Is that all.

Is that a portion thats unsold yet and ask.

Because.

SaaS backlog, Delaware in 2023.

Means in a roughly 6K, Delaware in the second half, but you're guiding to seven coal closings as well I'm sure. It's an approximation there, but just curious is there a portion that is still on.

Sold.

Within the Q4 guide.

Yes, there is.

There are.

500 to 1000 units that we would expect to sell and settle between the end of.

Q2, and the end of Q4.

And that will come from homes under construction or our spec inventory and Thats a normal amount.

And actually we could probably see.

Sell more but again, we are trying to build our spec count back up to more normal levels.

Got it that's what I thought I appreciate the color thanks, very much and good luck.

Thank you.

Alright, I have one quick clarification. Thank you Wendy <unk> last.

Our amazing Chief marketing officer.

There are no and I think I said that we're very strongly incentives.

But.

What I wanted to I want to clarify is when we sell a million dollars and $2 million houses even in the greatest market. We've ever seen we may give the customer.

Five or $10000 towards upgrades.

To make them feel good.

And that's in place that's been in place, we're not increasing any incentives anywhere.

I just want to thank you Wendy I want to make sure that that is clarified.

Our next question comes from Alan Ratner from Zelman and Associates. Please go ahead.

Hey, guys. Good morning, Thanks for taking the questions.

First question, Doug I think you just touched on this briefly but the.

The spec strategy last quarter I think you noted that you were starting more specs trying to replenish the inventory. There I think you just kind of highlighted that that remains the strategy today, but can you just talk a little bit about where you are from a spec count perspective across the company under construction completed presumably you don't have much if any but.

Are you kind of back at the levels, where you want to be or are you still kind of ramping the spec activity. How are you thinking about that given your comments about the slight moderation.

Ration in demand as well.

Yes, it's a great question. So yes don't don't be alarmed we're not a spec builder we built this company on.

On build to order, we know what $1 million. The client is very discriminating very important home in their life. It's not their first one generally and they want it they want to design it their way.

We think the right mix is 80% build to order.

<unk> percent spec and.

And even on the spec in many cases, we open that for sale when the client can still go to our design studio and pick their finishes.

It's rarely finished spec inventory for the same reason at that price point.

<unk> wants to take their kitchen cabinets and countertops or flooring.

And so through Covid.

We got so hot we sold for many homes, we put our attention on our backlog.

We're unable to keep up with mixing specs into production and we felt far behind that 80, 20 balance and so as we mentioned on the last call.

Because we had some very long quoted delivery times that some of our communities.

You walk in you want your build to order home and we tell you I'm very sorry, but its going to take 15 months we.

We made the right decision strategic decision to put those types of communities on allocation limit sales, but still start.

Salt and I think we'll do the same thing in Q3.

But we're not caught up we're not we're not close to 20%.

I'm not sure we get to 20%.

If the market shows signs of softening.

We will be more careful.

We understand the business, we are not interested sitting on <unk>.

Completed spec inventory in a tough market.

Historically spec homes or incentivize more than build to order through Covid, we know that wasn't the case.

Held at home longer.

And you rolled out the price appreciation.

That's back would have a higher margin than our build to order, but thats unusual historically in this industry.

Typically build to order drove higher margin and I'm, not saying, we're heading back into that yet I don't know, but we will.

Start more but we will I don't think be able to approach that 20% and thats. The cap we are not looking to go beyond that.

Got it and the key point there just my takeaway from what you. Just said is in spite of what Youre seeing in terms of slight moderation in demand that hasnt impacted your.

We do and then with respect to you I think you asked a little bit Alan about.

How much do we have at different stages.

Right now.

We have about a thousand units.

So call that a little bit less than 10%.

Our annual sales.

That are <unk>.

At or beyond Foundation.

And that is what will feed into the deepest comment about how much of your full year is sold Marty gave a range of 500 to 1000 specs.

I think the exact number guys. We think is about 600 I just heard Q3 and Q4 for Q3 and Q4.

We're about 600 more sales we need to deliver in Q3 and Q4, but we have a thousand spec.

Spec homes that are at or beyond foundation. So we're in very good shape.

But we are we're being thoughtful on every week, we study where we should be starting homes, what the market conditions are in that locale as to whether we should continue to start specs.

Yes, I mean, you know we've always been very conservative when it comes to spec building.

Like to get back towards 20% if the market continues to be good.

But we.

We can easily pivot on that and we're not going to pick it up if anything the pivot is down.

Alright, I appreciate the comments there Doug and if I can just add one more.

The 23 margin guide to be up obviously, that's a reflection of that.

50% of your backlog that's in there, presumably at margins similar or better than what you're expecting in the fourth quarter of this year.

Doug you've made this comment the last several quarters that the home youre selling today is the highest gross margin in the company history and I'm. Just curious is that still true today or has that maybe been a little bit more mixed given the fact that you are dialing back of price increases and what youre seeing in the market.

Yes.

I chatted about that a few questions back.

With 5% price increase per quarter for the last 18 months.

We have been more than offsetting cost increases I do not anticipate.

Continuing to achieve 5% price increase per quarter.

With.

What we've seen in the last month and what we've been discussing so it's hard to say yet whether.

We will have enough pricing power to offset cost increases.

The market does slow do costs come down.

We have a nice tailwind with lumber coming down that I think will benefit us in at least the second half of 'twenty. Three so it's very hard to say, Alan but certainly with what feels like a bit less pricing power today.

Can't sit here and confidently tell you as I did the last few quarters that the next homes sold.

We will be at a higher margin I think it will be at a similar margin at the moment I'm very happy with the margin, but we're just going to have to see how this <unk>.

<unk> plays out.

It makes sense alright, I appreciate the thoughts guys.

Thanks take care.

The next question comes from Buck Horne from Raymond James. Please go ahead.

Hey, Thanks, Good morning, guys congrats on the quarter.

That was kind of a question that probably difficult to answer, but what I get a lot.

The market at current prices.

Prices for your stock in the group I mean, the markets anticipating some sort of housing cataclysm almost similar to 2008 style meltdown.

The question is kind of.

What would it take from here.

If you try to.

<unk> portfolio manager understanding downside in terms of what kind of home price declines would have to take place or margin erosion.

It drive some sort of land impairment cycle from here, what kind of scenario.

What does it take.

From here to get to that point.

But I guess, there's a couple of points.

I will go through our $9 billion of inventory.

As I did earlier 6 billion of that inventory is backlog homes.

So I think there's very little risk associated with those we haven't seen cancellation rates. They have 25 to 30 low 30 margins in them.

And they're not in our book.

Book value, yet we've talked about.

Getting into our book value by the end of the year, but then there is further book value appreciation, we would expect in the next year as the balance of those backlog homes deliver.

Secondly, I talked about another $2 $5 billion of owned land.

That's in our inventory, we feel very good about the underwriting of those those also projected roughly 25% to 30% gross margins. So we'd have to see significant <unk>.

Cost growth.

Sure.

Rice drops and we are not seeing that at this point and then the last piece is the $500 million of.

Option deposits are sunk costs, we have on deals that are in our optioned land portfolio and.

Again, that's not a big number to control 46000 lots.

There may be some occasions in there where we choose not to proceed with the deal as we saw in the first quarter, but here in the first and the second quarter or the first and second quarter, we wrote off $4 million of costs associated with those as the underwriting of those deals didn't work for various reasons as part of our diligence exercises. So we didn't get approval.

So I don't we Didnt get approved under the underwriting it may just be that certain deals fizzle out approvals didn't come through maybe.

Construction costs for land development, where more substantial than we thought and the seller wasn't willing to renegotiate so well.

We are not worried about impairments.

Great. That's helpful. I appreciate the color there.

My last question is just kind of switching.

Switching gears to the rental side of the business I'm just wondering.

With the rise in rates here, you're obviously multifamily rents are continuing to go up really really strong single family rental as well.

Do you anticipate growing your capital investments or the mix of capital into the rental side of the business or how do you think about the.

The optionality of growing the JV partnership on the <unk> side or anything related to the rental side.

Yes, we love the business, it's performing very well.

Our joint venture with EQ are is fantastic.

The teams are working really well EUR has it is.

He's a great partner, there is more and more opportunities for us too.

Co developed with them and then they take us out at stabilization as.

As we've mentioned, we're now committed to sell all of the apartment buildings at stabilization to produce earnings that become more predictable.

For all of you.

And we see that business growing but we're not.

We're not having to put more investment into it because we are turning assets quickly as we get more and more assets and they sell at stabilization.

That money can be recycled on the <unk> side, we have a $25 million investment in a joint venture with.

The substantial wall Street partner and BB living we'd like the FSFR business.

We will continue to co invest in that venture. There may also be some opportunities outside of that venture on some smaller assets that toll brothers zones, where we sell.

Some homes.

Out of the gate.

<unk> operators that tends to be our lower priced locations I know a lot of the other builders are doing that.

And we do have some carve outs with the BV deal that allows us.

To do that so.

We like both the traditional multifamily the SSR business, we're going to continue to invest in it.

But we're going to show earnings out of it.

By selling everything at stabilization.

Great. Thanks, guys.

Thank you.

This concludes our question and answer session I would like to turn the conference back over to management for any closing remarks, Jason.

Jason Thank you very much thanks, everyone.

I hope you have a wonderful summer take care.

Conference has now concluded. Thank you for attending today's presentation you may now disconnect.

Q2 2022 Toll Brothers Inc Earnings Call

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