Q3 2022 Toll Brothers Inc Earnings Call

August 24, 2022

[music].

Good morning, and welcome to the toll brothers third quarter earnings Conference call. All participants will be in listen only mode should you need assistance. Please signal 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.

And thank you for joining US with me today are Marty Connor Chief Financial Officer, Rob Powerhouse, President and Chief Operating Officer, Fred 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 from last night and on our website.

We 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 availability of labor and materials inflation in there.

That mix impact and many other factors beyond our control that could significantly affect future results.

In our fiscal third quarter ended July 31, we reported earnings of $2 35 per share up 26% compared to the third quarter of 2021 and driven by continued gross margin expansion.

Our third quarter adjusted gross margin was 27, 9% an improvement of 230 basis points compared to last year, and 90 basis points better than guidance.

SG&A expense was 10, 3% of homebuilding revenues, which was 20 basis points better than both our guidance and last year's third quarter.

We delivered 2414 homes in the quarter at an average price of approximately $935000 generating $2 $3 billion in homebuilding revenue.

We achieved record third quarter revenues net income and EPS and our revenues were lower than anticipated.

We anticipated due to fewer deliveries and projected the shortfall resulted from the combined impact of unforeseen delays with municipal inspections continued labor shortages ongoing supply chain disruptions and a softer demand environment.

We missed our deliveries guidance by 336 homes.

Most of these deliveries were concentrated in a handful of communities and markets.

For example, in California, We had 200 homes that were completed at quarter end.

But due to delays with city inspectors and with utility companies, we simply could not get the final inspections or the electricity needed to obtain certificates of occupancy.

The change in the demand environment also impacted Q3 deliveries the combination of fewer spec sales outside lender delays, a modest uptick in cancellations and customers taking more time to sell their existing homes all resulted in fewer deliveries.

Due to these challenges we are lowering our deliveries guidance, we now expect to deliver between 3250 and 3550 homes in our fourth quarter and between 10000 and 10300 homes for the full year.

Our adjusted gross margin in the third quarter at 27, 9%.

It was 90 basis points better than projected primarily due to favorable mix and effective management of costs.

We ended the quarter with a solid backlog of 10725 homes worth $11.2 billion.

We had a total of 190 cancellations in the third quarter.

Equally just one 6% of the 11768 homes in backlog at the beginning of the quarter and.

And comparable to our cancellation rate of one 2% in the first half of 2022.

For context since 2010, our average cancellation rate as a percentage of backlog has been two 3%.

And yes, we think looking at cancellations as a percentage of backlog is much better than as a percentage of current orders.

We have not seen any change in cancellation rates in the first few weeks of August .

We have consistently had the lowest cancellation rate in the industry for many decades, which speaks to the financial strength of our customers and our build to order model.

Are buyers personalize their homes can become emotionally invested.

They make a nonrefundable downpayment averaged $80000. So they are also financially invested.

As our low backlog cancellation rate in the third quarter attests. Our buyers have remained committed to their new homes, even in this uncertain environment.

Our backlog consists of homes sold and the very strong pricing environment of the past year.

Which puts us in a great position to continue to expand our gross margin in the fourth quarter and into fiscal year 2023, we've.

We project, an adjusted gross margin of 29, 2% for the fourth quarter.

And we are reaffirming our full year guidance of 27, 5%.

Turning to market conditions as our third quarter progressed, we saw a significant decline in demand as many prospective buyers step to the sidelines in the face of steep increases in mortgage rates significant Lee higher home prices.

A volatile stock market and rising inflation.

Buyer confidence was also impacted by the non stop headlines about a softening housing market and by a general sense of uncertainty regarding the future direction of the economy.

All of these factors led to a market change in psychology, and buyers remain cautious through the summer months.

As a result, our net signed contracts were down approximately 60% in units compared to last year's historically strong third quarter.

On a dollar basis sign contracts were down 44% year over year as contracts in the third quarter benefited from price increases we had steadily applied throughout the year.

For most of the third quarter, we purposely did not chase fires with incentives as we felt demand was very inelastic.

Buyers were on the sidelines they were not looking for a better deal.

On average incentives in our third quarter contracts were approximately $16000 per home up only $5000 from the average over the first half of 2022.

In more recent weeks, we have seen signs of increased demand as sentiment appears to be improving and buyers are returning to the market.

With higher quality traffic. We are also starting to modestly increase incentives, which fires are responding to.

August sales included an average incentives of about $30000.

In the first three weeks of August are average weekly nonbinding deposits were up 25% compared to July .

We have also seen digital leads and foot traffic to our model homes increase.

Our sales teams are reporting higher quality traffic.

And in several recently opened new communities, we are seeing great deposit activity.

Although we are only talking about a few weeks. These are encouraging signs and we are cautiously optimistic that the housing market is settling into a more normal seasonal cadence.

Despite the near term uncertainty, we believe that many fundamental draw fundamental drivers and it's.

Supporting the housing market in recent years remain firmly in place.

These include favorable demographics with more and more millennials, reaching their prime home buying years and baby boomers relocating as they embrace new lifestyles, the under supply of new homes over the past decade, which has led to a large deficit and tight supply of homes for sale migration trends driven by more work.

Place flexibility.

And the greater appreciation for home that Americans have embraced in the past few years.

We believe these long term secular trends will continue to support demand for homeownership well into the future.

In the current environment. We believe it is important is excuse me more important than ever to remain disciplined in capital efficient in our operations and our land acquisition strategy.

We are even more focused on controlling SG&A costs, and becoming more efficient as we manage head count and reduce SG&A expenditures.

We have also become more conservative in our underwriting of new land deals and we will continue to renegotiate or terminate.

Option land, if a project no longer meets our stricter underwriting standards.

At the end of the third quarter, we owned or controlled approximately 82100 lots.

<unk> 3700 fewer loss and at the end of the second quarter.

Proximately, 51% of these lots were option declined from 53% at second quarter end due in part to our terminating options of over 3000 lots in the quarter.

Longer term, we continue to target an overall mix of 60% optioned and 40% owned lots as a reminder, nearly 11000 of our total owned lots are committed to buyers in our backlog.

When you exclude these lots 59% of our land is controlled through options.

We also remain focused on our return on equity.

In the third quarter, we repurchased $92 million of our common stock.

At the beginning of the fiscal year, we have repurchased approximately $385 million or five 8%.

Our diluted share count at the end of fiscal year 2021.

We have also paid $67 million in dividends year to date, and we retired $410 million of long term debt in our first quarter.

We expect share repurchases to remain an important part of our capital allocation priorities for the foreseeable future. Additionally.

Additionally, we continue to employ capital efficient strategies and are led by.

Last week, we announced a new joint venture between our city living Division and sculptor real estate to develop two luxury condominium communities and the New York City market.

Including the latest addition to our promos square development in Jersey City.

Where we have sold 60 units at an average price of $1 $1 million.

Over the past three months.

We will act as the managing member and development lead overseeing approvals design construction and sales.

We hope to add future properties to this venture.

The structure of these transactions and our strategic partnership with a seasoned team at sculptor.

Demonstrate our commitment to maximizing the capital efficiency of our city living operation.

With that I'll turn it over to Marty.

Thanks, Doug.

Before we jump into the income statement.

Let me address the average sales price for a new signed contracts in the quarter.

The average selling price attributed to contract signed in fiscal year, 'twenty Twos third quarter was $1 3 million.

It's important to point out that this average contract value was skewed higher this quarter due to the lower number of contracts we signed.

Consistent with our normal practice our.

Our total contract value for the quarter.

Includes both the dollar value of new contracts signed in the quarter.

And the dollar value of option sales that occurred in the quarter on homes sold in prior quarters.

Remember, it's not unusual for our buyers to select finishing options a quarter or two after they signed the initial contract of sale.

And while this practice typically does not skew the quoted average sale price for new orders.

Did this quarter because of the much smaller denominator from fewer contracts in Q3 versus Q2 and Q1.

On a normalized basis, we estimate that the Q3 contracts.

Average selling price was closer to 115 million.

Which was still up approximately 7% compared to Q2.

This 7% increase was attributable to our pricing strategy throughout the previous year, including our decision not to incentivize through much of the third quarter and also by positive mix.

In our third quarter, we generated homebuilding revenues of $2 3 billion down 7% in units and up 1% in dollars from one year ago.

We also reported pre tax income of $366 million compared to $303 million in the third quarter of fiscal 'twenty one.

Net income was $273 5 million or $2 35 per share diluted.

Paired to $235 million and $1 87 per share diluted one year ago. The.

The increase in pretax and net income compared to last year was primarily driven by the significant year over year expansion in gross margin.

Our third quarter adjusted gross margin was 27, 9% compared to 25, 6% in the third quarter of 'twenty, one and 90 basis points better than projected.

As Doug mentioned.

The outperformance relative to our guide was due primarily to favorable mix and effective management of costs.

We expect adjusted gross margin to be 29, 2% in the fourth quarter and therefore, we continue to project 27, 5% gross margin for the full year.

The estimated gross margin of homes in our backlog is high reflecting the strong and improving price environment, then held through most of our third quarter.

With 10725 homes in backlog and approximately 3400 deliveries projected for our fourth quarter at our midpoint.

We have more than 7000 homes in backlog that will form the foundation of our deliveries in fiscal year 2023.

The estimated gross margin that is embedded in these deliveries.

Then our projected full year 2022 margin.

SG&A as a percentage of revenue in our third quarter was 10, 3% compared to 10, 5% in Q3 of last year, and 20 basis points better than projected despite lower than projected revenue.

This was primarily due to lower than anticipated selling and marketing expenses.

Third quarter joint venture land sales and other income was $13 2 million exceeding our breakeven guidance, mostly due to gains on land sold into joint ventures that we had originally projected.

Would occur later in the year.

We had previously expected to sell several of our stabilized apartment living and student housing properties in our fourth quarter, which were projected to generate approximately $50 million and income from unconsolidated entities.

However, we are pushing these sales into fiscal year 2023, when we expect to see better pricing from buyers.

As a result, we are lowering our 2022 full year joint venture land sale and other income to $60 million.

Overall, our total investment in the apartment living at the end of our fiscal third quarter was $565 million.

It consisted of $133 million in 18 properties that were either stabilized or in lease up.

We believe we have unrealized gains of approximately $400 million.

In addition to the $133 million, we had $289 million invested in 23 properties that are currently in joint venture and under construction.

And another $143 million in land and projects 28 in total that are 100% on our balance sheet with slated for future development and joint ventures.

This pipeline should allow us to produce a consistent series of gains from our apartment sales in future years.

We expect the earnings from these gains on apartment sales will continue to be a nice complement to our core homebuilding business.

Turning back to our results impairments and write offs were $6 2 million in the quarter.

Primarily reflecting some due diligence cost or loss deposits on land that we are no longer pursuing because it doesn't meet our stricter underwriting standards.

Our tax rate in the third quarter was 25, 3% 70 basis points better than projected.

We now projected tax rate of approximately 24, 8% for the fourth quarter and 25% for the full year.

This is a slight improvement over our prior guidance as we now expect approximately $10 million in section 45 L. Energy tax credits that were reinstated in the recently signed inflation reduction.

We finished the quarter with a net debt to capital ratio of 34, 3%.

We had $316 $5 million in cash and equivalents and $1 8 billion available under our $1 9 billion revolving bank credit facility.

Which doesn't mature for over four years.

This provides us with ample flexibility to both grow and return capital to our shareholders.

At quarter end, our book value per share was $48 74.

We expect this to be approximately $52 50.

At fiscal year end.

Let me cover the additional items in our guidance that we have not already touched on.

Based on the strong pricing in our backlog, we expect our fourth quarter average delivered price.

To be between 935000.

And $955000.

We have increased the full year average to $920000 at the midpoint.

We expect interest and cost of sales to be approximately 1.8.

8% of home sales revenues in the fourth quarter and for the full year, representing a 40 basis point decline compared to full year 2021.

This decline is primarily due to the retirement of higher interest rate debt over the past few years, which has also decreased leverage.

We expect to further reduce interest in cost of sales in fiscal year 2023.

We project SG&A as a percentage of home sale revenues to be approximately eight 7% and our fourth quarter and 10, 5% for the full year.

Our weighted average share count is expected to be $118 5 million for the full year.

We expect community count to be approximately 350 at fiscal year end.

We've lowered this community count projection due to the impact of entitlement delays and supply chain disruptions impacting land development and our strategy to essentially defer the opening of some communities until 2023.

Over the past two years.

We were able to open communities earlier than normal without models and auto sales trailers or even offsite due to frenzy buyer demand we.

We do not see that continuing into the near future and we will shift back to our normal practice of opening communities with finished model homes and sales centers that are fully complete.

Importantly.

We own or control sufficient land for a significant increase in community count in fiscal year 2023.

Now, let me turn it back to Doug Thank you Marni.

I want to take this opportunity to thank our incredible toll brothers team members, who continue to work tirelessly on behalf of our clients in these unprecedented times.

It is their dedication and passion for our business and make us all so excited for the future.

Jason now, let's open it up for questions.

Well now begin the question and answer session and 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.

That's a question you May press Star then one on your Touchtone phone 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'll pause momentarily to assemble our roster.

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

Hey, guys. Good morning, Thanks for taking the questions and all the color I appreciate it.

So I guess first question just on the delivery guidance.

You reduced it by about 1000 homes for the year.

Curious, if you're able to give a rough split how much of that is kind of the supply chain challenges.

Challenges you guys referenced just in terms of Hey, these homes are not going to get delivered or completed before year end like we previously thought versus how much of that is maybe just more of a conservative view on demand for you guys had been building more specs and I assume there had been some assumption that you would sell and deliver some of those homes before year end how.

How much of the reduction is just conservatism around not having those homes sold and delivered in time for yearend.

Okay.

Good question, Yeah, our model is about 80% build to order 20% spec.

And so the reduced guidance.

<unk> is probably Alan around 10% to 15% due to less spec sales that will sell and deliver.

What I call in the same quarter or in a short period of time since that's not.

The primary part of our business model and so the balance of let's call it 85% to 90%.

Is primarily I would say two thirds of that balance is being driven by supply chain.

We've recently in the industry has recently run into these incredible problems with getting Transformers from utility companies. So we can get houses fired up with electricity that are completed and getting electric meters that you put on the outside of the house.

Things that this is a new one for us, but it can be significant as I mentioned with the issues in California.

And then the balance of a third I'd say is a combination.

<unk> township issues with the inability to get inspections and to get certificates of occupancy and then some buyer delays right theres more mortgage issues. We have today is the mortgage rates are a bit higher.

And there may be some more time for qualification.

There could be a longer timeframe because buyers.

Now find it a bit harder to sell their existing home and then we've had this modest increase in cancellations, which we have certainly budgeted and I said that August can cans are not up.

Historically, our cans are still low.

But you know.

They have moved up a little bit so when you combine all of it.

Very little is due to the.

The sell and deliver spec strategy since that's not our primary business and more of it is just that bucket of items I, just described which really goes to primarily production and municipality related production issues and utility company production issues.

But that's the bulk of it.

Got it now that that's really helpful. Thanks for walking through all that.

Secondly on the incentive environment I think.

Appreciate your comments there just in terms of the <unk>.

Elasticity of demand through the quarter. So it was the easiest way to think about the incentives that you're offering in August 30000, So thats.

Roughly double from where you were before pretty modest overall.

About a one 5% I guess.

In terms of I guess, the potential margin impact when you were talking about your margin in backlog and kind of the expectation for improvement in 'twenty three recognizing that these incentives are on new orders today, what are the conversations like in terms of your buyers in backlog or are they coming to you expecting a similar incentive are ya.

Prepare to offer that type of incentive to a buyer to keep them in backlog and ultimately how aggressive are you willing to get on the incentive front.

Before kind of just taken a backseat in letting that letting other builders compete in that area. Because traditionally you have not been very aggressive there.

Sure, so I'm going to give a little bit of a longer answer here because I know it's on everybody's mind.

Our Q2 incentive was $11000 and what's on our $1 1 million house.

Let's call it 1%.

May it was 12.

June It was 15000 July it was 22000 in August it was 30 at.

At $30000 on a $1 1 million dollar house, we're still below 3% incentive which historically through good times is a very low incentive when you sell a million one house even in a great market you tend to give the buyer.

10, 15, 20, $30000 suspended our design studio would've finished their basement or help them closing costs. It's just it's a normal incentive and we're still in that range.

We saw early on in May and June and I talked about it a bit on the may call that we expected a slow summer, we think buyers with not only the rise in home prices, but you know the doubling of mortgage rates.

All of the chatter about inflation. The headlines we are starting to hit about a softening market. We knew they were headed to the sidelines. They were going to take the summer off and we were not going to chase those buyers down with incentives we have $11 billion in backlog, we're going to focus on that backlog and it just wasn't smart business.

For us with our business model to do that we didn't have finished spec inventory that we had to move out and we made the business decision I think correctly to not chase Sapphire down. It was an elastic they were on the sidelines they were not coming in asking what is this week's deal.

They werent negotiating.

From the fourth of July forward, we started seeing some.

Signs of better traffic, we survey our 350 sales teams around the country every week.

Im involved in calls on for hours every Monday, and we started hearing.

The traffic is better.

The they're interested they're back they've absorbed the new market summer is moving on they are starting to think through their plans and so we felt demand was getting a bit more elastic meaning that buyers were interested they knew it was more of a buyer's market than it had been.

But they were at the negotiating table interested in buying and so we moved the incentive up modestly and we've seen.

Some pretty good results from that does that mean, we're done with Incentivising. It's community by community. We will continue to react to what we hear from the sales teams.

And I think as summer is winding down we're going to continue to see better traffic higher quality traffic, but we recognize it is certainly more of a buyers market and we will act accordingly, so I'm not suggesting that the 30000 of August is I'm not calling the bottom here.

We don't know what lies ahead, but we certainly do feel better and we will act accordingly, but we're not going to chase the incentives to a big number and we don't think we need to do that with our business model with respect to the backlog, which was another one of your questions No. We do not negotiate with the backlog.

We have about $80000 in downpayment do not underestimate.

The emotional connection our client has to the home 80% of our buyers are custom designing the home out of the gate. It isn't there a lot. It is their architecture is there structural changes and then they go to our design studio and they spend another 100000 $200000 on all of the.

<unk> finishes they have become emotionally attached it is a move up family primarily this is about lifestyle changes for them. The kids are moving into a new school. This is the dream house and historically.

We have not seen can rates anything close to the industry for all of those reasons.

And so right now the rates are low.

We do not negotiate with the backlog we work with them if they need a little bit more time because of a house to sell if we need to help them with different mortgage programs.

There's lots of different things, we can do to help.

Our backlog right now is secure.

<unk>.

We are not.

Going back and negotiating with that backlog they are committed for the most part and moving forward.

Sorry for the long answer, but I know, it's on everyone's mind and I appreciate that thanks again.

The next question comes from Michael Rehaut from J P. Morgan. Please go ahead.

Great. Thanks, Good morning, and thanks for taking my questions.

Alright.

First.

Good morning, Doug.

First just wanted to hit on it.

See if I could get a little more clarity on the.

A statistic around average weekly deposits for the first three weeks of August up 25%.

July .

Very helpful number and obviously.

Around the narrative of the improvement that youre starting to see.

Just curious for context.

If we could kind of get that number on a year over year basis in other words August 1st three weeks average weekly deposits versus.

First three weeks or roughly let's say August of 'twenty one.

As well as what the year over year.

Was for July .

Sure. So so yes, and again, it's only three weeks I'm not in a while I would say, we're cautiously optimistic I'm going to you know.

The disclaimer here is we're talking about three weeks, it's a short window of time, but we are encouraged that deposits are up about 25% over July when you look year over year.

The three weeks of this July are down about 45% to the three <unk>.

Since the August my apology. Thank you Marnie to three weeks of this August are down about 45% to the same three weeks of last August in terms of cadence.

We talk about the same contracts in each month.

May June July this year, which was about 420 agreements or orders per.

Per month.

Now when you look at last year July was elevated significantly.

Over last 2021 May and June , but this year it was more or less.

And so if you consider the deposits being up 25% and you just do the normal math on conversion ratios. It would be fair to say if for the next.

Weak or so until this month is over.

That 420 sales that we saw.

In July would be about $500. If you do that math and I'm not going to guess at all as to what.

September and October may hold.

That I think we are encouraged by what we see and we've certainly loosened the strings as I just mentioned to Alan.

Of the incentives and we're getting out of the summer doldrums.

So.

Again have that cautious optimism as to where we're headed does.

Does that answer your questions.

Yeah.

Alright.

Second part of that was what was July down year over year.

You may not have that in front of you.

I guess the second question I had was just kind of drilling into.

The comments around gross margins.

Last couple of calls you talked about an expectation for fiscal 'twenty three gross margins to be up over fiscal 'twenty two.

I'm not sure if I heard it slightly different but.

This call so far what you've said is.

Yeah.

Gross margins in backlog are above what you expect for the overall fiscal 'twenty two and you expect expansion into fiscal 'twenty. Three I was wondering if you still feel what your level of confidence is that as you look at overall fiscal 'twenty three.

That might still be up over fiscal 'twenty two.

Sure So on your first.

I do have the answer to your July .

So July 22 deposits were.

We're down 56% over July 2021 deposits and.

In July 2022 agreements were down 66% against July 2021 agreements.

With respect to 2020 threes gross margin.

I think.

Marty laid it out and really good detail, which is.

We have over 7000 homes in backlog.

That we project will deliver in 2023.

And that's just taken the math the total backlog, what we think will deliver in this fourth quarter and the balance of it or almost in almost the entire balance of it is.

Projected to deliver next year that of course is not our full year deliveries because we still have homes, we can sell.

In the fourth quarter and even into early 2023 that will still deliver by October 31 of 23 and that includes build the orders and that of course <unk>.

<unk>.

Many of those 20% spec homes that I talked about which is part of our strategy.

Is that bucket.

That I cant and I am not prepared right now on this call.

Give any guidance on.

We usually do that and does that in December that is still our intention, but our point was simply that a significant portion of 2020 three's deliveries are in backlog with very high margins.

And so that part of the year is pretty well baked.

But as for the balance that needs to be sold.

We will have to see how the market evolves and we'll give more updates in December .

Alright.

Perfect. Thanks, so much I appreciate it.

Youre very welcome.

The next question comes from Dan Oppenheim from Credit Suisse. Please go ahead.

Thanks, very much I was wondering in terms of the timing of community openings, you talked about delaying some openings to have them fully set.

Given that some of the new communities when they come online kind of strong orders does that impact what you would think about in terms of overall order trends for the fourth quarter of the year.

Okay.

Dan.

We're pretty well.

Split with new community openings quarter by quarter.

If we see the market.

Improving or if we have a specific location, where we have a lot of pent up demand.

We may go back to the Covid style.

And out of the back of a station wagon on a farm field.

But that is not our intention right now this company has always White club every opening we are the Ritz Carlton we don't open until.

Everything is perfect.

And that's how we like to launch.

When you get into a hot market when you have a lot of pent up demand.

If we can get roads in and get houses built right, which is the other part of it we don't want to be opening if we can't pull permits and start construction, but if all of that falls together in certain locations. There will certainly be exceptions to our older and now.

Our current strategy.

Get the entrants in get the flowers planted get the model home perfect.

And off we go but in terms of the cadence go ahead martie.

And we.

We opened 20% to 25 communities in each of the first three quarters of this year and we project to open 35 to 40 in the fourth quarter of this year now while that number is down compared to what we had previously thought it is still up significantly over the first three quarters. So we do expect <unk>.

Boost in the fourth quarter from new community openings compared to the most recent quarters and then next year.

As we mentioned in our prepared comments.

We are in a great position in that we have the land controlled for significant community count growth next year.

And so we will open those communities.

When when and for the reasons I have described.

But again, it'll it'll be somewhat market dependent I am very encouraged.

Based on this the openings that we continue to have in those that we've had over the last month.

We have had significant success at the initial launch.

With a lot of pent up demand and in some cases, we've sold 510 15 20 homes in the first couple of weeks of a new launch.

So the buyers are out there and if you have the right offerings and the right locations.

We are seeing success as I mentioned 60 sales and three months in New York City.

At $1 $1 million.

New York didn't get soft as other markets.

Excuse me it wasn't as hot as other markets over the last couple of years.

As people.

Left the cities and so there wasn't quite the sticker shock in the community has continues to be very successful with hundreds of qualified buyers on our list that we're just working through to.

To continue to sell there so.

There are certainly bright spots around the country with new openings, which we're encouraged by.

Great. Thanks, and then just a quick follow up you had mentioned the expectation of book value at year end I was wondering how youre thinking about allocating capital.

Given the discount to book.

Book sort of relative to this environment towards sort of reassessing sort of putting them more into land and such.

Well, Dan we've demonstrated.

Our commitment to returning shareholder capital to shareholders through the dividends that we paid this year as well as the buybacks and we've done that.

As we've grown the company.

We would continue to look at balancing.

Buybacks will pay the dividends.

And we will continue to pursue new land deals.

Many of those land purchases are from old land contracts and they still work it is increasingly difficult for new land deals to meet our underwriting standards.

So so the balance will continue to.

To exist.

We will see what the opportunity set is and what the cash flows.

Great. Thank you.

The next question comes from John Lovallo from UBS. Please go ahead.

Hey, guys. Good morning. This is actually Spencer Kaufman on for John Thank you for the questions.

And then just piggybacking off of some of the comments from the last question can you just talk about what you're seeing across your various markets, which markets are more challenged say, which markets are behaving better than most.

And are you seeing any difference in buyer activity between your affordable luxury product in your more traditional homes.

Sure so.

<unk>.

The move up.

And the.

Active adult have performed better than affordable luxury.

And I think thats, because the buyers are wealthier and.

Mortgage rates arent quite as important to them, it's not a monthly payment affordability issue as you move up in price. So we've seen that.

In the past in times like this and it's proving to be the case again.

The best markets for Us right now.

Our home turf here in Philadelphia.

New Jersey, Southern California, I mentioned, New York City Atlanta Denver.

Dallas.

The southeast coast of Florida.

Rollins.

The weakest markets, which happens every cycle are those that were the highest.

When the price goes up a lot.

Those markets tend to take a little longer to adjust and that would include Phoenix.

Phoenix Austin, Texas.

Boise, Idaho, and Reno and.

I think again, it's just an adjustment that's occurring because of the.

The prices being higher and the affordability those locations also tend to be a little bit lower priced for us in many cases, and so I think they probably fell a little bit more into that affordable luxury groups that I mentioned.

There.

As rates have gone up.

There's a bit more.

Pressure.

Okay. That's helpful. Appreciate the color.

Maybe can you just talk a little bit as to what would need to happen in order for you guys to see widespread impairments.

Okay.

I'm, sorry, I didn't.

Oh, Yes, I think.

Things would have to go a lot worse than theyre going right now for widespread impairments.

Kind of reiterate the breakdown of our inventory that I gave last quarter. It hasnt moved too much we have about $9 $4 billion of inventory.

Six and a quarter $1 billion of that is construction in progress associated with our backlog. So there shouldn't be much concern at all about that backlog, but backlog has upper <unk> gross margin to it.

We're seeing very low cancellation rates.

So theres not too much to that.

<unk> two $5 billion of our inventory is owned land that also has strong margins associated with it and around $450 million of our inventory is land deposits and about $80 million of that is refundable and those are for.

Pieces of land that we have not acquired.

That we have under option.

So with a close to 30% gross margin.

And a 20% operating margin from home sales, we'd have to see dramatic reductions in price for impairments to be of concern and as you have that dramatic reduction in volume or price Youre also going to have reductions in costs. So it would.

Have to be much more significant than a 25% or 30% decline in price.

The trigger.

Any impairments and those impairments would be.

Associated with those smaller buckets of inventory land and.

And deposits not so much associated with our homes under construction in backlog.

Thanks Marty.

The next question comes from Matthew Bouley from Barclays. Please go ahead.

Hey, good morning, everyone. Thanks for taking the questions and for all the detail.

Another question on Asps and pricing.

Pricing power in light of all these communities you've got coming online.

I appreciate that detail you gave around the order asps in Q3, so that's helpful. But as we think about these future community openings.

How should we think about sort of the opening price points and margins on that is that an area, where you might flex a little bit given current market conditions. Thank you.

Again, it's very very specific to the location and the interest.

We hope not to flex, we like a 30% gross margin, but if we have to flex.

We will.

But that decision is made very locally.

But we are very confident and comfortable with the underwriting we have in place now for these new openings that continue to show significant outsized gross margins.

So again as we go through a pricing analysis before every community opens and that analysis is based on detailed market comps.

The number of VIP buyers, we have that are interested in buying and we do a full analysis and make decisions on where to open and of course, we have a keen eye on what those returns are when we do that.

But right now I'm very comfortable that.

The communities, we have slated to open over the next year.

We will all performed well.

Got it. Thank you for that and then just second one on I guess sales pace in underwritings, presumably if the sales pace.

This level is maybe a little bit less than what you had.

Sort of underwrote to.

In the past I guess the question is kind of how do you balance the.

Were you one inventory turns to get.

Or to be.

Versus just that potential pressure on on returns or as the result of all that simply just reducing your.

Acquisition of bones labs, like how do you kind of balance those points. Thank you.

Well.

As we've been talking about for a few years, it's not just profit margin, it's also capital efficiency and ROE.

So we are absolutely balancing.

Price with pace.

Fact that we had a very slow quarter.

It does not mean that our heads in the sand and we're not going to sell because we're trying to maintain a margin. We recognize there is a balance and the reason we didn't have sales as well as what I described that in May June and into the early summer.

Buyers were on the sidelines and we didn't think it was about price unless you wanted to.

Really dropped the price to go grab those few buyers that might have been out there as that is changing.

I think we will do a good job of balancing the incentives necessary to drive and absorption that will still have an eye on Roe and being capital efficient so.

We recognize the.

The need and as part of our strategy to focus on driving strong margins, but also being capital efficient and having good returns.

With respect to the land.

Our underwriting has gotten even tighter I talked on the last call that we are now up to 60% combined gross margin and what we call internally IRR. So if you had a 30 gross margin you needed 30 IRR.

That's now 65.

And on top of it being 65, we are building in today's sales paces and today's pricing.

So that's a bit of a double whammy, because sales paces down a bit and price with more incentives is down a bit and on top of that you've layered in.

Higher threshold that you have to hit so.

We're going to continue to be disciplined and by the way when we exit due diligence, we're doing that new analysis and deciding whether we want to go forward and we're going back to land sellers to renegotiate and if they don't come around and we will drop deals the.

The only reason our option lots went up modestly this excuse me went down modestly this quarter, because we dropped 3000 option lots because they no longer pencils with our tighter underwriting and the quarter before that we dropped a couple of thousand lots for the same reason so.

I'm very happy with the discipline, we're bringing to land buying we have a great land portfolio that allows us to grow community count significantly next year and we will continue operating this way into the future.

Great. Thanks for all the detail.

You're very welcome. Thank you.

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

Thank you good morning, everyone.

Good morning. My first my first question is can you just talk a little bit about the supply chain and Bill times and as we are seeing the market shift how you're thinking about the forward trajectory for the construction cycles as we go into the back half of this year and then into next year.

Sure So right now our <unk>.

Cycle time from agreement is about 13 months on average 380 days, that's not pure construction because the front end and it takes a while for the client to pick their finishes their options and for us to get a building permit.

So the actual build cycle time is.

You know not that full 380, affordable luxuries about 60 days less than that because the houses are smaller and a bit simpler.

It is up.

It continues decline right now the stress I mentioned is on.

Things, we took for granted like transformer boxes.

You guys have all seen those green.

Boxes in the front yard of houses that generally handle about four to six homes.

On a street you have to put a transformer down which gets the electricity to those four to six houses and utility companies have apparently.

Run out of them at the moment or are having a hard time finding them and this is just the whack a mole.

Issues that the industry is dealing with.

<unk> finished trades right now our houses are a bit more complicated when you get beyond toll brothers hotel right. When you get beyond drywall with toll brothers home.

A lot more that goes into those finish it with tile and millwork.

Cabinets and things like that and on the finish and right now we're feeling a bit of pressure.

With the late with trades, and so I think thats pushed out.

You look at dry wall to delivery, we've added a couple of weeks from.

From what we used to have so.

That's the latest issue that we are addressing.

There are some encouraging signs that I have for next year.

When it comes to supply chain, we are on the phone regularly with our biggest suppliers and I'm hearing some encouraging words in that regard, but we're not building that into any of the projections, we're making internally or to you.

Okay. That's helpful and then following up.

We're standing netback is only about 20% of the business, but can you talk about.

Where you are in terms of the spec inventory and how youre thinking about adding to that as we go forward.

Yes, we are.

In really good shape right now.

With spec.

We have about 1800.

What we define as spec which means the homes.

Have a footing.

Which is a foundation in the ground.

Suspect doesn't mean, it's finished.

Internally. It means we have started at home we have poured concrete we are putting in place for a home that has not yet sold.

And sometimes we will sell that house at frame.

Now you can get it in five months instead of getting it in 13 months and sometimes we will hold that house until finishes.

So we are in very good shape now not every one of those specs. Its footing is moving forward right now.

We are making some decisions to move houses forward on.

On a full cadence and we're making decisions in other locations to sit and wait to see where the market goes.

Behind those 1800, we have many houses that have permits in place and in some municipalities that can be a couple of months.

To get a permit so so we will decide when that permit.

It gets ago, which means we're going to move forward with footings and build the apps, but.

Last year, our spec inventory was depleted because the market was so hot we were selling.

Very rapidly and I'm very happy now to have the 1800 at footing or beyond with more permit behind that because now we can pull levers.

In certain locations based on market conditions as to when and how quickly we move forward with us.

But overall the strategy. We think is the right one at our price point to be 80% build to order, which is what most people want with toll brothers, but then 20% of our houses that are available in a quicker turn time that many of these specs you are allowed to have finishes.

Because we'll put the house on the market, let's say a dry wall season still pick your kitchen cabinets countertops or flooring.

Which our clients want.

Okay. That's very helpful color. Thank you.

We have time for one last question from Mike Dahl from RBC capital markets. Please go ahead.

Thanks for squeezing me in last minute.

Mike just a quick.

Doug on the.

Just going back to the deposits.

And the orders in August .

When you make that comment.

Got it.

All else equal tracking to about 500 orders.

In August if you just look at deposit trends.

Have the conversion rates from the cloud contract.

<unk> been trending the last couple of months and what does that comment kind of imply for conversion in order to hit let's say a 500 order number.

Sure. So we're trending at about 70%.

Of our deposits convert to agreement.

And it's consistent with what we.

We've had over the over.

Over the last.

A couple of quarters in fact.

Just Greg Gregg Ziegler, just sent me a piece of paper that says our five year average conversion ratio was 71%.

We're right on that.

Now last month last quarter last year.

Okay. That's very helpful. And then my follow up just given.

Given what you articulated around the build cycle or the ordered a closed cycle. What are you finding it is there.

The right balance of incentives figure by right now and I don't mean magnitude, but I mean kind of quiet because it's easy to see where if there is something thats quicker close that financing incentives.

Visibility on kind of the <unk>.

Cost of blocky, and buying down the rate that could be affected but.

With your long cycle, what's making the most sense.

Yes.

Alright, so mortgage buy down.

Would be number one.

We have programs that allow our clients to get the mortgage rate under five.

Now that may not apply to long term.

We can't lock us up five for 13 months.

But there are opportunities as they ask us closer to delivery.

We.

Have that opportunity closing costs.

Always helped people, we recently ran a kitchen and bath.

Weekend, where there were upgrades.

Your kitchen, and your master bathroom, which is that's where people want to put the money you can get second and third level.

Cabinets countertops appliances.

And that's always very effective we moved the incentives around regularly this weekend, it's a finished basement.

Next weekend, it's $25000 credit at our beautiful design studio when you do go through finishes so theres not one thing but.

Today's market where rates are on everybody's mind, that's generally where the incentive starts.

But we do have 20% cash fires right. So there's an example, right away, but we're going to give them money at the design studio, where we're going to we're going to lower them into the kitchen and Bath.

Sales event. So it's constantly moving on purpose, we do not touch the price sheet.

And we try to the local teams have the authority to try to adapt their incentive that they've been given to what they think will be most effective for their clients.

Okay. Thanks, Bob Apple.

You're very welcome. Thank you.

Okay, Jason I think.

Time is up.

And.

Thanks, everyone that Jason Thank you and thanks, everyone.

For your interest and your support.

Always here to answer any questions you may have offline and have a wonderful end of summer take care.

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

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

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

After todays presentation, there will 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, Fred Cooper Senior VP of Finance and Investor Relations, Wendy Marlett, Chief Marketing Officer, and Gregg Ziegler senior VP and <unk>.

<unk>.

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.

We 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 availability of labor and materials inflation and that mix impact and many other factors beyond our control that could significantly affect future results.

In our fiscal third quarter ended July 31, we reported earnings of $2 35 per share up 26% compared to the third quarter of 2021 and driven by continued gross margin expansion.

Our third quarter adjusted gross margin was 27, 9% an improvement of 230 basis points compared to last year, and 90 basis points better than guidance.

SG&A expense was 10, 3% of homebuilding revenues, which was 20 basis points better than both our guidance and last year's third quarter.

We delivered 2414 homes in the quarter at an average price of approximately $935000 generating $2 3 billion and homebuilding revenues.

Although we achieved record third quarter revenues net income and EPS and our revenues were lower than <unk>.

We anticipated due to fewer deliveries than projected.

The shortfall resulted from the combined impact of unforeseen delays with municipal inspections continued labor shortages ongoing supply chain disruptions and a softer demand environment.

We missed our deliveries guidance by 336 homes.

Most of these deliveries were concentrated in a handful of communities and markets.

For example, in California, We had 200 homes that were completed at quarter end.

But due to delays with city inspectors and with utility companies, we simply could not get the final inspections or the electricity needed to obtain certificates of occupancy.

The change in the demand environment also impacted Q3 deliveries the combination of fewer spec sales outside lender delays.

Modest uptick in cancellations and customers, taking more time to sell their existing homes all resulted in fewer deliveries.

Due to these challenges we are lowering our deliveries guidance, we now expect to deliver between 3250 and 3550 homes in our fourth quarter and between 10000.

And 10300 homes for the full year.

Our adjusted gross margin in the third quarter at 27, 9%.

It was 90 basis points better than projected primarily due to favorable mix and effective management of costs.

We ended the quarter with a solid backlog of 10725 homes with 11 2 billion.

We had a total of 190 cancellations in the third quarter equal to just one 6% of the 11768 homes in backlog at the beginning of the quarter.

And comparable to our cancellation rate of one 2% in the first half of 2022.

For context since 2010, our average cancellation rate as a percentage of backlog has been two 3%.

And yes, we think looking at cancellations as a percentage of backlog is much better than as a percentage of current orders.

We have not seen any change in cancellation rates in the first few weeks of August .

We have consistently had the lowest cancellation rate in the industry for many decades, which speaks to the financial strength of our customers and our build to order model.

Our buyers personalize their homes and become emotionally invested.

They make a nonrefundable downpayment, averaging $80000. So they are also financially invested.

As our low backlog cancellation rate in the third quarter attests. Our buyers have remained committed to their new homes, even in this uncertain environment.

Our backlog consists of homes sold and the very strong pricing environment of the past year.

Which puts us in a great position to continue to expand our gross margin in the fourth quarter and into fiscal year 2023.

We project an adjusted gross margin of 29, 2% for the fourth quarter and we are reaffirming our full year guidance of 27, 5%.

A volatile stock market and rising inflation.

Buyer confidence was also impacted by the non stop headlines about a softening housing market and by a general sense of uncertainty regarding the future direction of the economy.

All of these factors led to a market change in psychology, and buyers remain cautious through the summer months.

As a result, our net signed contracts were down approximately 60% in units.

<unk> to last year's historically strong third quarter.

On a dollar basis sign contracts were down 44% year over year as contracts in the third quarter benefited from price increases we have steadily applied throughout the year.

For most of the third quarter, we purposely did not chase fires with incentives as we felt demand was very inelastic buyer.

Buyers were on the sidelines they were not looking for a better deal.

On average incentives in our third quarter contracts were approximately $16000 per home.

Up only $5000 from the average over the first half of 2022.

In more recent weeks, we have seen signs of increased demand as sentiment appears to be improving and buyers are returning to the market.

With higher quality traffic. We are also starting to modestly increase incentives, which buyers are responding to.

August sales included an average incentives of about $30000.

And the first three weeks of August are average weekly nonbinding deposits were up 25% compared to July .

We are also seeing digital leads and foot traffic to our model homes increase.

Our sales teams are reporting higher quality traffic.

And in several recently opened new communities, we are seeing great deposit activity.

Although we are only talking about a few weeks. These are encouraging signs and we are cautiously optimistic that the housing market is settling into a more normal seasonal cadence.

Despite the near term uncertainty, we believe that many fundamental draw fundamental drivers and it supported the housing market in recent years remain firmly in place.

These include favorable demographics with more and more millennials, reaching their prime home buying years at baby boomers relocating as they embrace new lifestyles.

Under supply of new homes over the past decade, which has led to a large deficit and tight supply of homes for sale.

Gration trends driven by more workplace flexibility.

And the greater appreciation for home that Americans have embraced in the past few years.

We believe these long term secular trends will continue to support demand.

For home ownership well into the future.

In the current environment. We believe it is important is excuse me more important than ever to remain disciplined in capital efficient in our operations and our land acquisition strategy.

We are even more focused on controlling SG&A costs, and becoming more efficient as we manage head count and reduced SG&A expenditures.

We have also become more conservative in our underwriting of new land deals and we will continue to renegotiate or terminate option land if a project no longer meets our stricter underwriting standards.

At the end of the third quarter, we owned or controlled approximately 82100 lots.

<unk> 3700 fewer loss and at the end of the second quarter.

<unk>, 51% of these lots were option declined from 53% at second quarter end due in part to our terminating options of over 3000 lots in the quarter.

Longer term, we continue to target an overall mix of 60% optioned and 40% owned lots.

As a reminder, nearly 11000 of our total owned lots are committed to buyers in our backlog.

When you exclude these lots.

59% of our land is controlled through options.

We also remain focused on our return on equity.

In the third quarter, we repurchased $92 million of our common stock.

Since the beginning of the fiscal year, we have repurchased approximately $385 million or five 8%.

Our diluted share count at the end of fiscal year 2021.

We have also paid $67 million in dividends year to date, and we retired $410 million of long term debt in our first quarter.

We expect share repurchases to remain an important part of our capital allocation priorities for the foreseeable future.

Additionally, we continue to employ capital efficient strategies and our land buying.

Last week, we announced the new joint venture between our city living Division and sculptor real estate to develop two luxury condominium communities and the New York City market.

Including the latest addition to our promos square development in Jersey City.

We have sold 60 units at an average price of $1 $1 million.

Over the past three months.

We will act as the managing member and development lead overseeing approvals design construction and sales.

We hope to add future properties to this venture.

The structure of these transactions and our strategic partnership with a seasoned team at sculptor demonstrate our commitment to maximizing the capital efficiency of our city living operation.

With that I'll turn it over to Marty.

Thanks, Doug.

Before we jump into the income statement let.

Let me address the average sales price for a new signed contracts in the quarter.

The average selling price attributed to contract signed in fiscal year 'twenty Twos third quarter was $1 3 million. It's important to point out that this average contract value was skewed higher this quarter due to the lower number of contracts we signed.

Consistent with our normal practice.

Our total contract value for the quarter.

Includes both the dollar value of new contracts signed in the quarter.

And the dollar value of option sales that occurred in the quarter on homes sold in prior quarters.

Remember, it's not unusual for our buyers to select finishing options a quarter or two after they signed the initial contract of sale.

And while this practice typically does not skew the quoted average sale price for new orders.

It did this quarter because of the much smaller denominator from fewer contracts in Q3 versus Q2 and Q1.

On a normalized basis, we estimate that the Q3 contracts average selling price was closer to 115 million.

Which was still up approximately 7% compared to Q2.

This 7% increase was attributable to our pricing strategy throughout the previous year <unk>.

Including our decision not to incentivize through much of the third quarter and also by positive mix.

In our third quarter, we generated homebuilding revenues of $2 3 billion down.

Down 7% in units and up 1% in dollars from one year ago.

We also reported pretax income of $366 million compared.

Compared to $303 million in.

In the third quarter of fiscal 'twenty one.

Net income was $273 5 million or $2 35 per share diluted compared to $235 million and $1 87 per share diluted one year ago.

The increase in pretax and net income compared to last year was primarily driven by the significant year over year expansion in gross margin.

Our third quarter adjusted gross margin was 27, 9% compared to 25, 6% in the third quarter of 2001, and 90 basis points better than projected.

As Doug mentioned.

The outperformance relative to our guide was due primarily to favorable mix and effective management of costs.

We expect adjusted gross margin to be 29, 2% in the fourth quarter and therefore, we continue to project 27, 5% gross margin for the full year.

The estimated gross margin of homes in our backlog is high reflecting the strong and improving price environment, then held through most of our third quarter.

With 10725 homes in backlog and approximately 3400 deliveries projected for our fourth quarter at our midpoint.

We have more than 7000 homes in backlog that will form the foundation of our deliveries in fiscal year 2023.

The estimated gross margin that is embedded in these deliveries.

Then our projected full year 2022 margin.

SG&A as a percentage of revenue in our third quarter was 10, 3% compared to 10, 5% in Q3 of last year, and 20 basis points better than projected despite lower than projected revenue.

This was primarily due to lower than anticipated selling and marketing expenses.

Third quarter joint venture land sales and other income was $13 2 million.

Exceeding our breakeven guidance, mostly due to gains on land sold into joint ventures that we had originally projected.

Would occur later in the year.

However, we are pushing these sales into fiscal year 2023, when we expect to see better pricing from buyers.

As a result, we are lowering our 2022 full year joint venture land sales and other income to $60 million.

Overall, our total investment in the apartment living at the end of our fiscal third quarter was $565 million and consisted.

<unk> of $133 million in 18 properties that were either stabilized or in lease up.

We believe we have unrealized gains of approximately $400 million.

In addition to the $133 million, we had $289 million invested in 23 properties that are currently in joint venture and under construction.

And another $143 million in land and projects 28 in total that are 100% on our balance sheet with slated for future development and joint ventures.

This pipeline should allow us to produce a consistent series of gains from apartment sales in future years.

We expect the earnings from these gains on apartment sales will continue to be a nice complement to our core homebuilding business.

Turning back to our results.

Impairments and write offs were $6 2 million in the quarter.

Merrily, reflecting some due diligence cost or loss deposits on land that we are no longer pursuing because it doesn't meet our stricter underwriting standards.

Our tax rate in the third quarter was 25, 3% 70 basis points better than projected.

We now projected tax rate of approximately 24, 8% for the fourth quarter and 25% for the full year.

This is a slight improvement over our prior guidance as we now expect approximately $10 million in section 45 L. Energy tax credits that were reinstated in the recently signed inflation reduction.

We finished the quarter with a net debt to capital ratio of 34, 3%.

We had $316 5 million in cash and equivalents and $1 8 billion available.

Under our $1 9 billion revolving bank credit facility, which doesn't mature for over four years.

This provides us with ample flexibility to both grow and return capital to our shareholders.

At quarter end, our book value per share was $48 74.

We expect this to be approximately $52 50.

At fiscal year end.

Let me cover the additional items in our guidance that we have not already touched on.

Based on the strong pricing in our backlog, we expect our fourth quarter average delivered price.

To be between 935000.

$955000.

We have increased the full year average to $920000 at the midpoint.

We expect interest and cost of sales to be approximately one eight.

8% of home sales revenues in the fourth quarter and for the full year, representing a 40 basis point decline compared to full year 2021.

This decline is primarily due to the retirement of higher interest rate debt over the past few years, which has also decreased leverage.

We expect to further reduce interest in cost of sales in fiscal year 2023.

We project SG&A as a percentage of home sale revenues to be approximately eight 7% and our fourth quarter and 10, 5% for the full year.

Our weighted average share count is expected to be $118 5 million for the full year.

We expect community count to be approximately 350 at fiscal year end.

We've lowered this community count projection due to the impact of entitlement delays and supply chain disruptions impacting land development.

And our strategy to essentially defer the opening of some communities until 2023.

Over the past two years, we were able to open communities earlier than normal without models and out of sales trailers or even off site due to frenzy buyer demand we.

We do not see that continuing into the near future and we will shift back to our normal practice of opening communities with finished model homes and sales centers that are fully complete.

Importantly.

We own or control sufficient land for a significant increase in community count in fiscal year 2023.

Now, let me turn it back to Doug Thank you Marni.

I want to take this opportunity to thank our incredible toll brothers team members, who continue to work tirelessly on behalf of our clients in these unprecedented times.

It is their dedication and passion for our business.

Make us all so excited for the future.

Jason now, let's open it up for questions.

We will now begin the question and answer session and 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 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 Alan Ratner from Zelman and Associates. Please go ahead.

Hey, guys. Good morning, Thanks for taking the questions and all the color I appreciate it.

So I guess first question is just on the.

Delivery guidance.

You reduced it by about 1000 homes for the year.

I'm curious are you able to give a rough split how much of that is kind of the supply chain.

<unk> you guys referenced just in terms of Hey. These these homes are not going to get delivered or completed before year end like we previously thought versus how much of that is maybe just more of a conservative view on demand for you guys had been building more specs and I assume there had been some assumption that you would sell and deliver some of those homes before year end.

How much of the reduction is just conservatism around not having those homes sold and delivered in time for yearend.

Okay.

Good question.

Our model is about 80% build to order 20% spec.

And so the reduced guidance.

Is probably Alan around 10% to 15% due to less spec sales that will sell and deliver.

What I call in the same quarter or in a short period of time since that's not.

The primary part of our business model and so the balance level, let's call it 85% to 90%.

Is primarily I would say two thirds of that balance is being driven by supply chain.

Things that this is a new one for us, but it can be significant as I mentioned with the issues in California.

And then the balance of a third I'd say is a combination.

There may be some more time for qualification.

There could be a longer timeframe because buyers.

Now find it a bit harder to sell their existing home and then we've had this modest increase in cancellations, which we have certainly budgeted and I said that August cans cans are not up.

Historically, our cans are still low.

But.

They have moved up a little bit so when you combine all of it.

Very little is due to the.

But that's the bulk of it.

Got it that's really helpful. Thanks for walking through all that.

Secondly on the incentive environment I think.

Appreciate your comments there just in terms of B E.

Elasticity of demand through the quarter. So it's the easiest way to think about the incentives that you're offering in August 30000, So thats.

Roughly double from where you were before pretty modest overall.

About one 5% I guess.

I guess the potential margin impact.

You were talking about your margin in backlog and kind of the expectation for improvement in 'twenty three recognizing that these incentives are on new orders today, what are the conversations like in terms of your buyers in backlog or are they coming to you expecting a similar incentive are you prepared to offer that type of incentive to a buyer to keep them in.

Backlog and ultimately how aggressive are you willing to get on the incentive front.

Before kind of just taken a backseat in letting letting other builders compete in that area because traditionally have not been very aggressive there.

Sure, so I'm going to give a little bit of a longer answer here because I know it's on everybody's mind.

Our Q2 incentive was $11000 and what's on our $1 $1 million a house.

Let's call it 1%.

May it was 12000.

June It was 15000 July it was 22000 in August it was 30 at.

At $30000 on a $1 1 million dollar house, we're still below 3% incentive which historically through good times is a very low incentive when you sell a million one house, even in a great market you tend to get the buyer.

10, 15, 20, $30000 suspended our design studio.

Their basement or help them closing costs, it's just.

It's a normal incentive and we're still in that range.

We saw early on in May and June .

And I talked about it a bit on the may call that we expected a slow summer, we think buyers with not only the rise in home prices, but you know the.

The doubling of mortgage rates.

All of the chatter about inflation. The headlines we are starting to hit about a softening market. We knew they were heading to the sidelines. They were going to take the summer off and we were not going to chase those buyers down with incentives we have $11 billion in backlog, we're going to focus on that backlog and it just wasn't smart business.

For us with our business model to do that we didn't have finished spec inventory that we had to move out and we made the business decision I think correctly to not chase Sapphire down it was an elastic they were on the sidelines they were not coming in asking.

What is this week's deal.

They werent negotiating.

From the fourth of July forward, we started seeing signs of better traffic. We survey our 350 sales teams around the country every week.

I'm involved in calls on for hours every Monday, and we started hearing.

The traffic is better.

But they were at the negotiating table interested in buying and so we moved the incentive up modestly and we've seen some.

Some pretty good results from that does that mean, we're done with Incentivising. It's community by community. We will continue to react to what we hear from the sales teams and I think as summer is winding down we're going to continue to see better traffic.

Higher quality traffic, but we recognize it is certainly more of a buyers market and we will act accordingly, so I'm not suggesting that the 30000 of August is not calling the bottom here.

<unk> $80000 in downpayment do not underestimate.

The emotional connection our client has to the home 80% of our buyers are accustomed designing the home out of the gate. It isn't there a lot. It is their architecture is there structural changes and then they go to our design studio and they spend another 100000 $200000 on all of the.

Finishes they have become emotionally attached it is a move up family primarily this is about lifestyle changes for them. The kids are moving into a new school. This is the dream house and historically.

We have not seen can rates anything close to the industry for all of those reasons and so right now the rates are low.

We do not negotiate with the backlog we work with them if they need a little bit more time because of a house to sell if we need to help them with different mortgage programs.

There's lots of different things, we can do to help.

Our backlog right now is secure.

And.

We are not.

Going back and negotiating with that backlog they are committed for the most part and moving forward.

Sorry for the long answer, but I know, it's on everyone's mind.

I appreciate that thanks again.

The next question comes from Michael Rehaut from Jpmorgan. Please go ahead.

Great. Thanks, Good morning, and thanks for taking my questions.

Alright.

First.

Good morning, Doug.

First just wanted to hit on.

See if I could get a little more clarity on the statistic.

Statistic around average weekly deposits for the first three weeks of August up 25%.

From July very helpful number and obviously.

Around the narrative of the <unk>.

Proving that youre starting to see I was just curious for context.

If we could kind of get that number on a year over year basis in other words August 1st three weeks average weekly deposits versus.

First three weeks or roughly let's say August of 'twenty one.

As well as what the year over year.

Was for July .

Sure. So so yes, and again, it's only three weeks I'm not in a while I would say, we're cautiously optimistic I am going to now.

The disclaimer here you were talking about three weeks, it's a short window of time, but we are encouraged that deposits are up about 25% over July when you look year over year.

The three weeks of this July are down about 45% to the three August excuse me August my apology. Thank you Marni. The three weeks of this August are down about 45% to two the same three weeks of last August in terms of cadence.

We took about the same contracts in each month of May June July this year.

Which was about 420 agreements or orders.

Per month.

Now when you look at last year July was elevated significantly.

Over last 2021 May and June but this year it was more level.

And so if you consider the deposits being up 25% and you just do the normal math on conversion ratios it would be fair to say for the next.

Weak or so until this month is over.

That 420 sales that we saw.

In July would be about $500, if you do that math.

And I'm not going to guess at all as to what.

September and October may hold except that I think we are encouraged by what we see and we've certainly loosened the strings as I just mentioned to Alan.

In terms of the incentives and we're getting out of the summer doldrums.

So we're.

Again have that cautious optimism as to where we're headed does.

Does that answer your questions.

Yeah.

Alright.

Second part of that was what was July down year over year.

You may not have that in front of you.

I guess the second question I had was just kind of drilling into the.

The comments around gross margins.

Last couple of calls you talked about an expectation for fiscal 'twenty three gross margins to.

To be up over fiscal 'twenty two.

I'm not sure if I heard it slightly different but.

This call so far what you've said is.

Yeah.

It might still be up over fiscal 'twenty to.

Sure. So on your first I do have the answer to your July .

So July 22 deposits were down 56% over July 2021 deposits.

In July 2022 agreements were down 66% against July 2021 agreements.

With respect to 2020 Three's gross margin.

I think.

Marty laid it out and really good detail, which is.

We have over 7000 homes in backlog.

That we project will deliver in 2023.

And that's just taken the mass of the total backlog, what we think will deliver in this fourth quarter and the balance of it or almost in almost the entire balance of it is.

Projected to deliver next year that of course is not our full year deliveries because we still have homes, we can sell.

In the fourth quarter and even into early 2023 that will still deliver by October 31 of 23 and that includes build the orders and that of course <unk>.

<unk>.

Many of those 20% spec homes that I talked about which is part of our strategy.

It is that bucket.

That I cant and I am not prepared right now on this call.

Give any guidance on.

We usually do that and does that in December that is still our intention, but our point was simply that a significant portion of 2020 three's deliver.

Deliveries are in backlog with very high margins.

And so that part of the year is pretty well baked.

But as for the balance that needs to be sold.

We'll have to see how the market evolves and we'll give more updates in December .

Alright perfect.

Perfect. Thanks, so much I appreciate it.

Youre very welcome.

The next question comes from Dan Oppenheim from Credit Suisse. Please go ahead.

Thanks, very much I was wondering in terms of the timing of community openings, you talked about delaying some openings to them fully set.

Given that some of the new communities when they come online kind of strong orders does that impact what you would think about in terms of overall order trends for the fourth quarter of the year.

Yes.

Dan.

Pretty well.

Split with new community openings quarter by quarter.

If we see the market.

Improving or if we have a specific location, where we have a lot of pent up demand.

We may go back to the Covid style.

Open out of the back of a station wagon on a farm field.

But that is not our intention right now this company has always White club every opening we are the Ritz Carlton we don't open until.

Everything is perfect.

And that's how we like to launch.

But when you get into a hot market. When you have a lot of pent up demand.

Current strategy of get the entrants in get the flowers planted get the model home perfect and off we go but in terms of the cadence go ahead martie.

And we we opened 20% to 25 communities in each of the first three quarters of this year and we project to open 35 to 40 in the fourth quarter of this year now while that number is down compared to what we had previously thought it is still up significantly over the first three quarters. So.

We do expect a boost in the fourth quarter from new community openings compared to the most recent quarters and then next year.

As we mentioned in our prepared comments.

We are in a great position in that we have the land controlled for significant community count growth next year.

And so we will open those communities.

When when and for the reasons I have described.

But again, it'll it'll be somewhat market dependent I am very encouraged.

Based on this the openings that we continue to have in those that we've had over the last month.

We have had significant success at the initial launch.

With a lot of pent up demand and in some cases, we've sold 510 15 20 homes in the first couple of weeks of a new launch.

So the buyers are out there and if you have the right offerings and the right locations.

We are seeing success I mentioned 60 sales and three months in New York City.

At $1 $1 million.

New York didn't get soft as other markets.

Excuse me it wasn't as hot as other markets over the last couple of years.

As people.

Left the cities and so there wasn't quite the sticker shock in the community has continues to be very successful with hundreds of qualified buyers on our list that we're just working through to.

To continue to sell there so.

There are certainly bright spots around the country with new openings, which we're encouraged by.

Great. Thanks, and then just a quick follow up you had mentioned the expectation of book value at year end, just wondering how youre thinking about allocating capital.

Given the discount to book.

Book sort of relative to this environment towards a re.

Reassessing sort of putting them more into land and such.

Well, Dan we've demonstrated.

Our commitment to returning shareholder capital to shareholders through the dividends that we paid this year as well as the buybacks when we've done that as.

As we've grown the company.

I think we would continue to look at balancing.

Buybacks will pay the dividends.

And we will continue to pursue new land deals.

Many of those land purchases are from old land contracts and they still work it is increasingly difficult for new land deals to meet our underwriting standards.

So the balance will.

Continue to exist.

Sure.

We will see what the opportunity set is and what the cash flows.

Great. Thank you.

The next question comes from John Lovallo from UBS. Please go ahead.

Hey, guys. Good morning. This is actually Spencer Kaufman on for John . Thank you for the questions. Maybe just piggybacking off of some of the comments from the last question can you just talk about what you're seeing across your various markets, which markets are more challenged say, which markets are behaving better than most.

And are you seeing any difference in buyer activity between your affordable luxury product in your more traditional forms.

Sure so.

The move up.

And the.

Active adult have performed better than affordable luxury.

And I think thats, because the buyers are wealthier and.

Sure.

Mortgage rates arent quite as important to them, it's not a monthly payment affordability issue as you move up in price. So we've seen that.

In the past in times like this and it's proving to be the case again.

The best markets for Us right now.

Our our home turf here in Philadelphia.

New Jersey, Southern California, I mentioned, New York City Atlanta Denver.

Dallas.

The southeast coast of Florida.

Royalties.

The weakest markets, which happens every cycle are those that were the highest.

Because when the price goes up a lot.

Those markets tend to take a little longer to adjust and that would include.

Phoenix Austin, Texas.

Boise, Idaho and Reno.

<unk>.

I think again, it's just an adjustment that's occurring because of the.

Where.

As rates have gone up there's a bit more.

Pressure.

Okay. That's helpful. Appreciate the color.

And maybe can you just talk a little bit as to what would need to happen in order for you guys to see widespread impairments.

Okay.

Im sorry, I didnt impairment micro environment.

Yes, I think.

Things would have to go a lot worse than they are going right now for widespread impairments.

Kind of reiterate.

The breakdown of our inventory that I gave last quarter. It hasnt moved too much we have about $9 $4 billion of inventory.

Six and a quarter $1 billion of that is construction in progress associated with our backlog. So there shouldnt be much concern at all about that backlog the backlog has upper twenty's gross margin to it.

Pursuing very low cancellation rates.

So theres not too much to that.

<unk> two $5 billion of.

Our inventory is owned land that also has strong margins associated with it and around $450 million of our inventory is land deposits and about $80 million of that is refundable and those are four.

Pieces of land that we have not acquired.

We have under option so.

So with a close to 30% gross margin.

To be much more significant than a 25% to 30% decline in price.

The trigger.

Any impairments.

And those impairments would be.

Associated with those smaller buckets of inventory land and.

<unk>.

In deposits not so much associated with our homes under construction of backlog.

Thanks Marty.

The next question comes from Matthew Bouley from Barclays. Please go ahead.

Hey, good morning, everyone. Thanks for taking the questions and for all the detail.

The question on Asps and pricing.

Pricing power in light of all these communities you've got coming online.

I appreciate that detail you gave around the order asps in Q3, so thats helpful. But as we think about these future community openings.

How should we think about sort of the opening price points and margins on that is that an area, where you might flex a little bit given current market conditions. Thank you.

Again, it's very very specific to the location and the interest.

We hope not to flex, we like a 30% gross margin, but if we have to flex.

We will.

But that decision is made very locally.

But we are very confident and comfortable with the underwriting we have in place now for these new openings that.

That continued to show significant outsized gross margins.

So again it will.

We go through a pricing analysis before every community opens and that analysis is based on detailed market comps.

Number of VIP buyers, we have that are interested in buying and we do a full analysis and make decisions on where to open and of course, we have a keen eye on what those returns are when we do that but right now I'm very comfortable that.

The communities, we have slated to open over the next year.

All performed well.

Got it thank you for that and then.

The second one I guess sales pace in underwritings, presumably if the sales pace.

This level is maybe a little bit less than what you had.

Sort of underwrote to.

In the past.

I guess the question is kind of how do you balance.

Were you one inventory turns to get.

Or to be.

Versus just that potential pressure on returns or as the result of all that simply just reducing your.

Acquisition of <unk> labs, like how do you kind of balance those points. Thank you.

Well as.

We've been talking about for a few years, it's not just profit margin, it's also capital efficiency and ROE.

So we are absolutely balancing.

Price with pace.

Fact that we had a very slow quarter.

In May June and into the early summer that buyers were on the sidelines and we didn't think it was about price unless you wanted to.

Really dropped the price to go grab those few buyers that might have been out there as that is changing.

I think we will do a good job of balancing the incentives necessary to drive and absorption that will still have an eye on Roe and being capital efficient so.

We recognize the.

The need and as part of our strategy to focus on driving strong margins, but also being capital efficient and having good returns.

With respect to the land.

Our underwriting has gotten even tighter I talked on the last call that we are now up to 60% combined gross margin and what we call internally IRR. So if you had a 30 gross margin you needed 30 IRR.

That's now 65.

And on top of it being 65, we are building in today's sales paces and today's pricing.

So that's a bit of a double whammy, because sales paces down a bit and price with more incentives is down a bit and on top of that you've layered in.

Higher thresholds that you have to hit so.

I'm very happy with the discipline, we are bringing to land buying we have a great land portfolio that allows us to grow community count significantly next year and we will continue operating this way into the future.

Great. Thanks for all the detail.

You're very welcome. Thank you.

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

Thank you good morning, everyone.

Good morning.

My first question is can you just talk a little bit about the supply chain and Bill times and as we are seeing the market shift how you're thinking about the forward trajectory for the construction cycles as we go into the back half of this year and then into next year.

Sure So right now our <unk>.

Cycle time from agreement is about 13 months on average 380 days Thats.

That's not pure construction because the front end.

It takes a while for the client to pick their finishes their options and for us to get a building permit.

So the actual build cycle time is.

Not that full 380, affordable luxuries about 60 days less than that because the houses are smaller and a bit simpler.

It is up.

It continues decline right now the stress I mentioned is on.

Things, we took for granted like transformer boxes.

You guys have all seen those green.

Boxes in the front yard of houses that generally handle about four to six homes.

On a street you have to put a transformer down which gets the electricity to those four to 6000 utility companies have apparently.

Run out of them at the moment or are having a hard time finding them and this is just the whack a mole.

Issues that the industry is dealing with.

<unk> finished trades right now our houses are a bit more complicated when you get beyond toll brothers October when you get beyond drywall with toll brothers home.

A lot more that goes into those finishes with tile and millwork.

Cabinets and things like that and on the finish and right now we're feeling a bit of pressure.

With the late with trades, and so I think thats pushed out.

You look at dry wall to delivery, we've added a couple of weeks from.

From what we used to have so.

That's the latest issue that we are addressing.

There are some encouraging signs that I have for next year.

Okay. That's helpful and then following up.

We're standing next that is only about 20% of the business, but can you talk about.

Where you are in terms of the spec inventory and how youre thinking about adding to that as we go forward.

Yes, we are.

In really good shape right now.

With spec.

We have about 1800.

What we define as spec which means the homes.

Have a footing.

Which is a foundation in the ground.

Suspect doesn't mean, it's finished.

Internally. It means we have started at home we have poured concrete we are putting in place for home that has not yet sold and sometimes we will sell that house and frame.

Because now you can get it in five months instead of getting it in 13 months and sometimes we will hold that house until finishes.

So we are in very good shape now not every one of those specs. Its footing is moving forward right now we are making some decisions to move houses forward.

On a full cadence and we're making decisions in other locations to sit and wait to see where the market goes.

Behind those 1800, we have many houses that have permits in place and in some municipalities that can be a couple of months.

To get a permit so so we will decide when that permit.

It gets ago, which means we're going to move forward with footings and build the apps, but.

Last year, our spec inventory was depleted because the market was so hot we were selling.

Very rapidly and I'm very happy now to have the 1800 at footing or beyond with more permit behind that because now we can pull levers.

In certain locations based on market conditions.

As to when and how quickly we move forward with this.

But overall the strategy. We think is the right one at our price point to be 80% build to order, which is what most people want with toll brothers, but then 20% our houses that are available in a quicker turn time that many of these specs you are allowed to have finishes.

Because we'll put the house on the market, let's say a dry wall. So you can still pick your kitchen cabinets countertops or flooring.

Which our clients want.

Okay. That's very helpful color. Thank you.

We have time for one last question that is from Mike Dahl from RBC capital markets. Please go ahead.

Thanks for squeezing me in last minute.

Sure Mike.

Doug on the just going back to the deposits.

And the orders in August .

When you when you make that comment.

All else equal and tracking to about 500 orders.

In August if you just look at deposit trends, how have the conversion rates from the cloud contract.

<unk> been trending the last couple of months and what does that comment kind of imply for conversion in order to hit let's say a 500 order number in August .

Sure. So we're trending at about 70%.

Of our deposits convert to agreement.

And it's consistent with what we.

We've had over the over.

Over the last.

A couple of quarters in fact.

Just Greg Gregg Ziegler, just sent me a piece of paper that says our five year average conversion ratio was 71%.

We're right on that.

Now last month last quarter last year.

Okay. That's very helpful and then my follow up.

Given what you articulated around the build cycle or the ordered a closed cycle.

What are you finding it is the right balance of incentives for buyer right now and I don't mean magnitude, but I mean.

Alright, because it's easy to see where if theres something thats quicker close financing incentives had been.

Ability on kind of cost of blocky and buying down the rate that could be affected but.

With your long cycle, what's making the most sense for you or your buyers.

So mortgage buy down.

Would be number one.

We have programs that allow our clients to get the mortgage rate under five.

Now that may not apply to long term.

We can't lock a sub five for 13 months.

But there are opportunities as the haskett closer to delivery.

<unk>.

We have that opportunity closing costs.

Always helped people, we recently ran a kitchen and bath.

We can where there were upgrades to your to your kitchen and your master bathroom, which is that's where people want to put the money you can get second and third level.

Cabinets countertops appliances.

And that's always very effective we moved the incentives around regularly this weekend, it's a finished basement.

Net next weekend, it's $25000 credit at our beautiful design studio when do you do you go through finishes so theres not one thing, but in today's market where rates are on everybody's mind, that's generally where the incentive starts.

But we do have 20% cash buyers right. So there's an example, right away we're going to give them money at the design studio, where we're going to we're going to lower them into the kitchen and Bath.

Sales event. So it's constantly moving on purpose, we do not touch the price sheet.

And we try to the local teams have the authority to try to adapt their incentive that they've been given to what they think will be most effective for their clients.

Okay. Thanks, Bob Apple.

You're very welcome. Thank you.

Okay, Jason I think.

Time is up.

And.

Thanks, everyone that Jason Thank you and thanks, everyone.

For your interest and your support we're always here to answer any questions. You may have offline and have a wonderful end of summer take care.

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

Q3 2022 Toll Brothers Inc Earnings Call

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