Toll Brothers, Inc.

Good morning and welcome to the Toll Brothers second quarter earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there 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. The company is planning to end the call at 9.30 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 Yearley, CEO. Please go ahead.

Thank you, Drew. Welcome and thank you for joining us. With me today are Marty Connor, Chief Financial Officer, Fred Cooper, Senior VP of Finance and Investor Relations, Wendy Marlette, Chief Marketing Officer, and Greg Ziegler, Senior VP and Treasurer. Before I begin, I ask you to read the statement on forward-looking information in our earnings release of last night and on our website. I caution you that many statements on this call are forward-looking based on assumptions about the economy, world events, housing and financial markets, the impact of the pandemic, interest rates, inflation, and many other factors beyond our control that could significantly affect future results. I'm very pleased with our second quarter results as we beat our guidance on nearly every metric. We delivered 2,271 homes for record second quarter home building revenue of $1.84 billion. Our adjusted gross margin of 24.4% increased 150 basis points year over year and was 100 basis points above our guidance. SG&A as a percentage of home building revenue was 11.9%, an improvement of 190 basis points year over year and 110 basis points better than guidance. Pre-tax income of $169.8 million and EPS of $1.01 per share increased 66% and 71% respectively compared to the prior year period. Contracts and backlog in both dollars and units were all-time records. Our backlog at quarter end was valued at $8.7 billion on 10,104 units, up 58% in dollars and 57% in units compared to last year. We signed 3,487 net new contracts for $3.1 billion in the quarter. On a year-over-year basis, our net signed contracts in the second quarter were up 85% in units and 97% in dollars. As a result of our excellent results in the quarter and based on the significant visibility our backlog provides, we are raising our full-year guidance on nearly all key metrics. We are increasing our full year 2021 projected home deliveries by 100 units to 10,300 at the midpoint. And we now project return on beginning equity of 14.5% for fiscal year 2021, representing a 570 basis point improvement over 2020. Our strong order growth coupled with significant and consistent price increases sets the stage for meaningful revenue earnings margin and ROE growth in fiscal year 2022. While we are not providing formal guidance for 2022 at this point, we believe our 2022 return on beginning equity is expected to exceed 20% and that our gross margin for 2022 will significantly exceed fiscal year 2021's gross margin. Demand remains very strong. We continue to raise prices in nearly all of our communities during the second quarter and into the start of our third quarter. We also continue to strategically moderate sales paces by limiting monthly lot releases to two to four lots per community. We have steadily expanded this allocation strategy to now cover about two-thirds of our communities. up from about one-third in January 2021. For communities that are on allocation, we raise prices as we release lots to a priority list of high-interest buyers or through a competitive sealed bid process. This allows us to maximize price and therefore margins and align our sales pace to a manageable level of production. We are very pleased with the effectiveness of this strategy. For the three weeks ended May 23, non-binding reservation deposits were up 19% over the comparable period last year. The market did not dictate this 19% deposit growth. We did. We will continue to evaluate the number of communities on allocation to balance profitability and growth. We believe the housing market is positioned for sustained strength driven by the long-term supply-demand imbalance resulting from the past decade of underproduction of new homes, low interest rates, a tight resale market, favorable demographics, especially as millennials enter their home-buying years, migration from higher-cost metropolitan markets into attractive, more affordable markets enabled by the remote work trend. and the greater overall appreciation of one's home that has emerged over the past year and an improving economy. All of these tailwinds should be here for some time and sustain the strong housing market. Whole Brothers customers specifically are also benefiting from the strong stock market and rising existing home prices. Our buyers who have a home to sell are confident they can sell it quickly and at an appreciated value. We are seeing an increase in demand in markets like Boise, Reno, Vegas, Austin, Phoenix, Denver, and all of Florida from buyers who are migrating out of higher cost coastal markets. These relocating buyers are not experiencing affordability issues as we raise prices. The shift to more permanent work from home arrangements means our customers increasingly want to personalize their homes to fit their evolving lifestyles. The design choices we offer is a distinct competitive advantage. This quarter, our buyers added on average $162,000, or approximately 24% of the base price, in lot premiums, options, and upgrades. This is up from our long-term average of about 21%. These features and upgrades are generally accretive gross margin. While the strength in the housing market has been well documented, so too have cost increases for materials such as lumber and copper. To date, we have been able to more than offset these cost pressures with price increases, and our gross margin projections for this year and next reflect our confidence in our ability to continue managing costs. At corner end, we owned or optioned approximately 74,500 lots. Our strong land position provides a firm foundation for outsized growth over the next several years. And we are currently benefiting from the significant percentage of our land that was put under control at pre-pandemic prices. Notwithstanding our 85% order growth this quarter, we met our Q2 guidance of 320 communities at quarter end. And while we project community cap to drop to 310 at the end of our third quarter, Due simply to the timing of certain community sellouts and openings, we continue to project 340 communities at fiscal year end. We also reaffirm our guidance for 10% community count growth in fiscal 22, and this guidance is based solely on the land that we already control today. Our strategic expansion into new markets and products, especially the affordable luxury niche, has positioned us well for growth. We now operate in over 50 markets in 24 states with communities in both high growth and high barrier to entry markets. We offer the widest variety of homes in the industry, appealing to growing families and affluent customers with our luxury move-up homes, as well as to millennials and first-time buyers with our expanding affordable luxury business, and for baby boomers, our active adult communities. This product and market expansion has helped fuel the increase in our backlog to record levels. For example, in the 12 months ended April 30, 2021, nearly 16% of contracts were from markets where we had no presence five years ago. This is up from approximately 6% in the comparable period last year. First-time homebuyers who are primary buyers in our affordable luxury market accounted for 30% of our deliveries this quarter compared to 25% one year ago. We have also seen our active adult segment strengthen with the rollout of vaccines. Orders in our active adult segment were up 135% compared to the second quarter of last year. With our increased focus on capital efficiency, a record backlog and expanding gross margins, We are projecting ROE growth this year and next. With fiscal year 2022, ROE expected to exceed 20%. We believe this growth is sustainable due to actions we have taken in many aspects of our business. This starts with the structural and permanent changes we have made to how we acquire and develop land. As we have discussed over the past 18 months, we have totally revamped our land underwriting standards to require higher risk-adjusted returns. We have also increased the amount of land that we acquire through more capital-efficient structures like land banks, joint ventures, seller financing, and other strategies that allow us to option more land. At second quarter end, the percentage of lots that we optioned versus owned grew to 49% from 46% at the end of the first quarter and 40% one year ago. Since we have just about met our previously announced 50-50 target, we are now updating our target to 60% optioned land and 40% owned. Our focus on ROE also includes our expansion into more affordable luxury homes, which can be built more quickly and efficiently on less expensive land. We are improving ROE by returning capital to shareholders through share repurchases and dividends. Since fiscal 2016, we have bought back approximately one-third of the outstanding shares at an average price of $37.20. And in April, we increased our quarterly dividend by 55% to 17 cents per share. These actions reflect our confidence in the sustainability of our substantial cash flows moving forward. We project approximately $750 million in cash generated from operating activities this year. Our highest priority for capital allocation continues to be investment in the growth of our business, whether through disciplined land buying or strategic home builder acquisitions, followed by returning capital to shareholders and reducing our leverage. As we enter the second half of our fiscal year, which historically has been when we generate the majority of our excess cash flow, we expect to be more programmatic in our stock repurchases. We are also committed to improving the capital efficiency and earnings consistency of our city living and apartment living businesses. With respect to our city living urban condo business, we are very pleased with the renewed demand coming out of New York City. where we signed 44 contracts in our second quarter, including 27 at 77 Charlton in West Soho, up from 33 total for all of the city living business in the first quarter of 2021. Going forward, we intend to develop most of our city living buildings off balance sheet in joint ventures with project level financing. We expect this to significantly reduce the amount of capital committed to the city living business and improve return on equity. Our apartment living platform is performing very well. We recorded a $10.7 million gain on sale this quarter and expect more through the balance of the year. But we recognize that this business can also be an inconsistent contributor to earnings and thus ROE. As we have mentioned before, we are monetizing some of our land in this business through joint venture formations. And going forward, we intend to defer closing on any new land for the apartment business until third-party equity and debt capital is committed. Additionally, we are likely to increase the number of projects that we sell at stabilization versus holding longer term. These new strategies should make earnings more consistent and improve ROAs. Now let me turn it over to Marty.

Thanks, Doug. Good morning, everyone. We had a terrific quarter. Our business continues to fire on all cylinders, especially our production teams out in the field. We delivered 2,271 homes at an average price of approximately $809,000. generating record second quarter home building revenue of $1.84 billion. Deliveries were up 18% in units and 21% in dollars compared to one year ago. Our second quarter pre-tax income was $169.8 million compared to $102.1 million in the second quarter of 2020. Net income was $127.9 million, or $1.01 per share diluted, compared to $75.7 million and 59 cents per share diluted one year ago. It's important to note that our second quarter pre-tax and net income included a $34.2 million pre-tax charge, or 20 cents per share after tax, related to the early redemption of debt. Without this one-time charge, earnings per share would have been $1.21. Second quarter adjusted gross margin was 24.4% compared to 22.9% in fiscal year 2020 second quarter, and 100 basis points better than projected. The outperformance was due primarily to pricing power, higher margin option sales, favorable mix, operational efficiencies, and cost controls. Looking forward, we are now projecting adjusted gross margin for full year 2021 of 24.6%, up 30 basis points from prior guidance. Despite recent increases in material and labor costs led by lumber prices, we are confident in our adjusted gross margin projection for the second half of fiscal year 2021 and our ability to further expand it in fiscal year 2022. With new home demand far outstripping supply, we have been able to push prices, which has more than offset cost increases. We are intensely focused on our construction budgets and managing building costs. Before we build any of our homes, we have contracts in place for substantially all of our components and trades, and we develop conservative budgets that include a significant contingency on top of our contracted costs. When input costs rise and our trades request price increases, our first priority is to protect the margin of the homes in our backlog, where sales prices have already been set, and to postpone negotiating those cost increases to the next home sold. We have generally been successful with this strategy due to our strong relationships with our trades and our operating scale. I would also point out that our expansion into affordable luxury has made us a better, more efficient builder at all price points. The efficiency required to compete at lower price points has driven us to optimize the designs of our homes and adopt more streamlined construction processes. We've taken these practices and lessons learned to all of our product lines, which has made us a leaner, more efficient, production-focused builder Importantly, as we have optimized our plans and refined choice for our customers, we have improved their customer experience. In addition, we have been fine-tuning our strategy related to our spec homes. On average, 15 to 20% of our deliveries each year are built on spec. Our strategy is now to delay selling these homes until we reach at least 50% completion, allowing us to maximize the price at which we sell these homes. All of these factors give us confidence in the gross margin in our backlog and our projections for the remainder of this year and into next. Turning back to our second quarter results, as Doug mentioned, SG&A as a percentage of revenue in the quarter was 11.9% of revenues. 190 basis point improvement over the prior year period and 110 basis points better than our guidance. We attribute this primarily to leverage resulting from higher revenue, the continuing impact of the cost savings initiatives taken in 2020, reductions in advertising spend, and our relentless focus on controlling overhead. Joint venture, land sales, and other income was $21.5 million in the second quarter, compared to $16 million in the same quarter last year and our projection of $7 million. Better than expected performance here was due to the sale of an apartment building in suburban Atlanta that had been projected for our third quarter. In addition, our mortgage and title operations were more profitable than projected. Our balance sheet remains strong. We ended our second quarter with approximately $2.5 billion of liquidity, including $715 million of cash, and $1.79 billion available under our $1.9 billion revolving bank credit facility. In the second quarter, we invested approximately $430 million in land and acquisition and development. We also redeemed $250 million of our 5.58% notes due in 2024 in the quarter, which resulted in the $34 million charge I noted earlier. In total, in the first half of fiscal year 21, we retired approximately $440 million of debt and have reduced our debt to capital ratio at quarter end to 42.2% on a gross basis and 35.6% on a net basis, compared to 43.8% and 35.8% respectively at the end of the first quarter of fiscal year 2021. We continue to target a net debt to capital ratio in the high 20% range by fiscal year end. We also continue to project approximately $750 million in cash generation from operating activities in fiscal year 21. As Doug noted, we will continue to use our cash to invest in the growth of our business with excess cash returned to shareholders and used to further reduce our financial leverage, including repaying $410 million of our 5.875% public notes that are due in February 22, when they become callable at PAR in mid-November 21. As we look forward to the second half of fiscal 21, we are increasing our guidance for nearly all key metrics. We now expect full-year deliveries of between 10,200 and 10,400 units, with approximately 2,675 to be delivered in the third quarter. Our third quarter deliveries guidance reflects the slow COVID-impacted sales environment from mid-March to the end of May in 2020. We estimate an average delivered price for the full year of between $805,000 and $825,000 per home. This is up $15,000 at the midpoint compared to previous guidance. Average delivered price for the third quarter is expected to be between $820,000 and $840,000. As I mentioned earlier, we project adjusted gross margin of 24.6% for the full fiscal year, up from our previous projection of 24.3%. We expect adjusted gross margin to be approximately 24.8% in the third quarter, which implies a fourth quarter margin of 25.4%. We expect our gross margin to grow further from Q4 in fiscal year 2022. As Doug said, we have increased our projected return on beginning equity for fiscal year 21 by 570 basis points to 14.5%, and we expect it to exceed 20% in fiscal year 22. We expect full-year interest and cost of sales to be approximately 2.4%, which is also what we expect in the third quarter, versus 2.5% in fiscal 2020. Excuse me. As a result of the debt reductions I discussed earlier, we expect this interest expense to continue to decline in fiscal 2022 and beyond. We expect SG&A as a percentage of revenue to be approximately 11.8% for the full year and 11.6% in the third quarter. In addition to revenue leverage and the ongoing benefit of past cost-saving actions, we expect the benefit from lower sales commissions that we are now paying to outside brokers. We expect community accounts to be $310 at the end of our third quarter and $340 at fiscal year-end, with an additional 10% growth in community accounts by fiscal year-end 2022. Our full-year guide for other income, income from unconsolidated entities, and land sales gross margin is now $110 million for the full year, up $30 million from our prior guidance, with approximately $20 million projected for the third quarter. The increase is primarily due to greater profitability in our mortgage and title operations, along with gains we are projecting from the sale of an additional apartment living project this year. Now, let me turn the call back to Doug.

Thank you, Marty. To wrap it up, We continue to believe that with our strong land position, our plans to grow community count this year and next, and the wide variety of homes that we offer in 24 states and 50 markets, we are very well positioned to capitalize on the extraordinary demand we are seeing in the housing market. And with the structural changes we have made and continue to make in how we operate, including our relentless focus on capital efficiency, returns, and internal operating efficiencies, we believe that our results will continue to improve in both the short and long term. Before I open it up to questions, I want to remind all of you of our upcoming Virtual Analyst and Investor Day that we will be hosting next Wednesday, June 2nd, starting at 11 a.m. Eastern Time. We will showcase many of our team members, products, and our communities and you will become much more familiar with our operations and our culture and we hope you will come to understand what makes Toll Brothers such a special company and how much we have evolved in the past decade. I'm really looking forward to it and I hope you'll be able to join us on Wednesday. I'd also like to encourage you to take a look at our recently released ESG report, which is now available on our website. This is our first report and it includes important information regarding the many initiatives we have taken with respect to ESG. And finally, I'd like to thank all of our Toll employees for their contributions to our great results this quarter. We couldn't have achieved these results without your hard work, dedication, and commitment to providing our customers an experience unmatched in the home building industry. With that, Drew, let's open it up for questions.

We will now begin the question and answer session. As a reminder, 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. To ask a question, you may press star then 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble our roster. The first question comes from Mike Dahl with RBC Capital Markets. Please go ahead.

Hi, this is Chris Calata. I'm from Mike. Thanks for taking our questions. My first question is just on the assumptions behind the greater than 20% ROE expectation for 22%. Obviously, the strength in sales and margins are driving much of that improvement, but are you assuming any benefit at all on buybacks or benefits from balance sheet repositioning?

I think there is modest benefit assumed from that. The big drivers of that expansion in ROE are revenue growth and gross margin.

Understood.

And I know you guys said you didn't want to provide 22 guidance, but I know last quarter you guys spoke to expecting gross margins above 25% in the first half of the year. Given the strength and the exit rates expected this year, any update you'd be willing to provide on what you're expecting specifically for the first half on gross margins?

I think in the prepared remarks I mentioned that are relevant, The math leads you to 25.4% as the gross margin for our fourth quarter, and we expect it to be higher than that in 2022.

And I'll refer you, Chris, back to my comment in my prepared remarks when I said our gross margin for 2022, and I'm reading, will significantly exceed 2021.

Understood. Fair enough. Thanks for taking my question.

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

Thanks, guys. I appreciate all the color. Exciting times out there and a lot of changes in terms of the way builders are pricing given the scarcity of supply. You all have obviously got a lot of experience with selling scarcity to your customer base. But the auctions and the sealed bids that we've kind of been hearing about, as well as some builders putting in escalators for potential increases in costs, one of the things that I've gotten from builders when they talk about those strategies is that they are concerned about the customer service blowback that implementing some of these things may generate. I've got my own views on that, but I would be curious if you could explain how you think about any potentially negative ramifications from changing, you know, altering the way in which you price versus, you know, the past. And then specifically with respect to escalators, cost escalators in your sales contracts, Is that something that you guys actually are doing or would consider doing or not?

Great question, Steve. I look forward to the days when we are able to sell everybody who wants a home one of our beautiful homes, but that is not today's market. And there's precedent set, of course, in the resale market when things are hot. For the five of you who have made an offer, By tomorrow night at 5 o'clock, we need your final invest in an envelope. And so that occurs in the housing market. We have, as I mentioned, have now gone on allocation in two-thirds of our communities because of just significant, significant demand that far exceeds our ability to sell or our desire to sell, frankly, because we want to manage our growth, you know, with 58% up in backlog. And our construction teams are doing a fantastic job out there, but it is time to start taking price and managing operations, managing demand, and managing growth. And so what we have done in our communities that are on allocation is basically two things. Some communities have been taking a list. And by the way, the people on that list have been pre-qualified for a mortgage and they're ready to go. And if we've given people a number on the list, you know, Mr. and Mrs. Smith, there's 20 on the list and you're number seven. And at the pace we're going, we think we're going to get to you in the month of July or whatever it may be. That's one way. And then every couple of weeks when we offer a couple of lots, we raise the price. We may raise it $50,000. It just depends on the community. The way we've now migrated, not in all cases but in many, is those people on the list that are number 7, 12, 20, 32 say, what the heck? You've taken my destiny out of my hands. You've taken the opportunity for me to buy a home away because you're not going to get to me for so long. How about the resale market? Give me the chance like they do to give you a sealed envelope with a number. And we actually have seen more people accepting of that because they can control their destiny than the people that are further down on that list, and we may not get to them for a while. It's a balancing act, and I'd say it's probably right now 50-50 between working off of a VIP list in a particular order and going to final and best sealed bid. Now you may ask, with 80% of your business being sold, to be built. How do you do that? It's easy when you have a spec house. You just put the house on the market, give a base price, and tell them to give you an envelope. We figured it out. If we're going to open up two or three lots on a weekend, we have our price sheet of the base price of all of the homes that you can buy from us. We have the price of the structural upgrades. And of course, we have a design studio where you can go and buy your finishes. So we bid the lot premium. We tell the clients two lots are opening up this Saturday. The minimum lot premium is $25,000. And put in your price for the lot premium, and if you win, you can then still have all the choice and the special sauce of Toll Brothers because you can then pick your home off of our price sheet at our base price, and you can then go through your upgrade program. And so that's how we're doing it. I am confident we are treating the client well. We are communicating with the client, and it's working, and it's maximizing price, and it's controlling growth as we want to. As to your question about escalators, no. We are not adding escalator provisions to our contracts. Sorry for the long answer, but I know it's an important question, and I wanted to give a detailed answer for you.

Yeah, that's great. Really appreciate that, Doug. The second question relates to margins, and particularly what I'm talking about is not margins in the third quarter, but really what the margin opportunity is as you look forward, assuming that the current environment doesn't dissipate very rapidly for whatever reason. When I look back in history and I look at, let's say, the 2003 to 2005 period, which is probably the most analogous time, to today in terms of pricing obviously the bone structure was much worse back then than it is today but you know pricing back then in the industry was call it you know got the fifteen percent we're now running twenty five percent year-over-year in the in the retail market so we're running much hotter than we were even then in that period of time your gross margins went about six hundred and seventy basis points i think people may have forgotten that uh... and I know that there are some things that would work against you from achieving something like that over the next couple of years. The ones that come to mind are your increasing affordable luxury focus, as well as the material cost inflation that you're fighting against, but probably still incurring to some degree, and possibly a change in your land investment, just sort of trying to go to where more just in time. So as we think about what you saw during that period of time in terms of pricing and the margin impacts, and you assess these three things that I laid out that are sort of drags to your margin, can you dimensionalize some of those for us and help us understand how significant some of these headwinds theoretically might be to margin expansion versus the opportunity from pricing?

Sure. Let's start with land. Yes, as you can tell by our prepared comments and what we've been talking about lately, we are structurally changing how we buy land. We are very, very focused on ROE. I know it's shining through and we're proud of it and it will continue and it's permanent. Right now, those 70,000 plus lots that we control, and I mentioned it, most of those lots were controlled, were put under contract pre-pandemic. before prices ran. So we're in a really good position where we can be selective in how we grow the land bank. And I think that is not maybe the headwind you suggested as much as it would appear for that reason. Affordable luxury, which is a growing part of our business and we thought would be lower margin than our luxury business, is not. Because of the strength of that market, because of the 70 million-plus millennials coming out, the affordable luxury margins are right there with our core luxury business. Our move to the south, our move to the mountain states has helped, has been a tailwind to margin, because those are growth areas in this country. We've had pricing power, and while one would think, you know, you go to Tampa, you go to Jacksonville, you go to Atlanta, You know, you're going to have a little margin compression, not the case because of the strength of those markets and how this country is migrating. And the Pacific, California, Oregon, and Seattle, there's 40 million people in California. They're not all leaving. We are seeing tremendous growth, 80% plus, well, 85% order growth, Q2 coming out of California with significant pricing power. So I'm not going to comment historically on what happened to gross margins. Thank you for being with us for that length of time. I remember those good old days. But we are certainly feeling strong tailwinds. I'm not going to speculate on where lumber goes, but Marty talked at length about how we are fully budgeted with contingencies for the building costs that have been rising. We also push back with our trades. You know, if a plumber wants a price increase, it's not fair that he asks for it on a house and backlog. We sold that house to that client with that plumber's contract in place, and he will honor that contract for that price. If we need to talk about an increase on the next home sold that we can then properly budget for, that may be a fair conversation. But we fight hard to protect that backlog, and it's working.

That makes a lot of sense. Thanks, Doug. By the way, I misspoke. It was 670 on the operating margin, not the gross. That's what I meant. But thanks for the fulsome answer. Really appreciate it.

You're very welcome. Thanks, Steve.

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

Hi. Thanks. Good morning, everyone, and congrats on the results. Hi, Mike. Hi. So, you know... My first question, I guess, I found it really interesting around the relocating buyers in different states, how that helps with consumers accepting price increases, perhaps coming from higher cost states to lower cost states or coastal to inland. I was curious if you track any of those stats, you know, for example, out-of-state buyers in Florida or, you know, some of your, you know, inner, you know, Western markets relative to California and how that might have changed, has changed over the last year or two?

Sure. We do track it, you know, as best we can. And In those markets that are seeing more and more of the Northeasterners and the Californians, and that's not the only migration, right? But those are the two big ones. You've got the Boston to Washington, D.C. corridor that's moving south or moving west. And you've got the Californians who are moving east somewhere. They don't know where to go west. We're at about 40% of our sales in those accepting markets are people coming from what I just mentioned. Now, you know, there's some markets that are 50%, 60%, and there's others that may be lower, but that's call it about almost half, right? Just shy of half of the buyers are coming from out-of-state markets. And the phenomenon is fascinating. We've never seen migration like this. It obviously caught wind early in the pandemic when people thought they would be working in their sweatpants from their kitchen table forever. But it's continuing as people now realize that, well, maybe I'm not at my kitchen table every day of the week. But Austin, Texas, the pricing in Austin, which is The pricing power of Austin, which is number one in the country, is driven by Californians, plain and simple. The pricing power of Boise, Idaho, of Reno, of Phoenix, of Vegas, of Florida. We're in Charleston. We're in Greenville, South Carolina, Atlanta, Raleigh, Charlotte. It's the obvious markets. Denver. I mean, this can go on and on. I need to cut it off here. they're moving from areas that are very expensive. The homes are expensive, the taxes are high, and it's giving us more power to raise the price without affordability issues being apparent. You know, the traffic is holding up. Yes, a year ago, could the Californian have gotten one of our homes in Boise for $400,000? And is it now $600? Yes, but it's a million-dollar house they're trading out of in California, or maybe it's a million-two now, and it was a million a year ago. And their monthly payment is so much less because of the tax structure. So we're very happy, and we're benefiting from these migration patterns from expensive to less expensive.

That's helpful, Doug, and it's a really fascinating pattern that I think is accelerated, as you're pointing out. I guess, secondly, I just wanted to shift a little bit to ROE and the goal that you have set for 2022. You mentioned earlier, Marty, that the big ROE drivers or improvement drivers would be revenues and gross margin. You also mentioned earlier at some point in the talk that in your prepared remarks that, you know, you're going to become more programmatic on your stock repurchases. Just wanted to get a sense, if possible, what you mean by programmatic. I mean, I think at points, you know, the stock repurchases over the prior couple of years have been, you know, somewhat sizable, you know, one quarter, then more modest prior and subsequent quarters. You know, should we be thinking about maybe one or two million shares per quarter here? Something on that type of a run rate or, you know, any type of, you know, rough annual spend, any type of directional guidance would be helpful.

Sure. Mike, we are focused on return on equity and shareholder value now more than ever before. And The rough magnitude you outlined of a million to two million shares is probably a good entry point, particularly as we look at, I'll say, quarters other than the first or second when we are generally using more cash in operations. And conversely, Q3 and Q4 is when we generate a lot more cash. So we're going to maintain some flexibility. We've been opportunistic in the past. We're going to be more programmatic in the future.

Great. Thanks very much. You're very welcome, Mike.

The next question comes from Alan Ratner with Zellman & Associates. Please go ahead.

Hey, guys. Good morning. Thanks for taking my questions. Doug, first I'd love to maybe just expand a little bit on the out-of-state buyer topic. So very interesting, the data you gave there. First, I'm curious, I might have missed it, but the 40-50% number you gave kind of where that's running at today, what was that pre-COVID? And I guess the follow-on to that would be, I'm sure it's a little bit difficult to look at this on a weekly or monthly basis, but now that offices are starting to open back up in the Northeast and schools are not going to be remote in the fall, have you heard any chatter about that trend slowing any bit on the margin more recently?

So, Alan, your first question, about 30% pre-COVID in Florida, some of these markets I mentioned earlier, that have been for some time accepting out-of-staters because of, back then it was more, it was lifestyle in Florida, but places like Austin would have been tremendous job growth. So let's call it 30 to just shy of 50 is probably the move from pre-COVID to today. And you would think that we would see less migration for the reasons today, than nine months ago for the reason you just described, and we are not. And I don't have a great answer as to why that is. I think people, for example, and I'm of the age where you start thinking about where's the retirement home gonna be, and I just know so many people that are doing that earlier, and they're doing that while they're still working. because they want to set it up at 55 instead of at 63. And they know they don't have to be on Wall Street every day of every month. And they can figure out it's going to be a week in Florida. I'll fly back for the next week. But I'm going to begin to set up the next phase of my life. So I think part of that is why this continues to sustain itself even as people go back to work. I know our company. while we are going, we believe we are better when we are together, and that's become a tagline of Toll Brothers as we begin to come back together, we, of course, will be flexible. We're not going to be able to hire people and retain people unless we show some level of flexibility. And so I think people recognize that in most companies. And therefore, I think this migration pattern to live where you want and not where you're tethered is continuing.

I also think, Alan, you're seeing more companies move their operations to lower cost of operations areas. You know, the migration of corporate headquarters to Texas is well documented. And I think you're also seeing companies, while they may not move the headquarters, they see where the people are going and they'll move a back office or a support function to that area so people can be in an office, if not the headquarters office as part of their workday.

I got it. I appreciate those thoughts. Second, I'd love to drill in a little bit more on the shift in your spec strategy, because I think this is going to be something that's really interesting to track over the next few quarters. So I know you're not a big spec builder to begin with, but even kind of delaying, you know, the sales of some of those homes, I would imagine, you know, at some point later this year, you're going to have more specs coming to the market that are closer to completion. And I think the shift has probably been even more dramatic from some other builders. I mean, some builders that are primarily built-to-order builders have completely shifted their sales strategies and are effectively building up spec homes, and we'll release those later in the year. And in addition, you guys are talking about 10% community count growth between now and the end of the year, and other builders are as well. So I'd love to hear your confidence and your thoughts about What the pricing power will be later this year when it seems like as this shift in sales strategy unfolds and you have more inventory coming to the market, recognizing that there's a ton of demand today, but do you think the pricing power will still be as strong as it is today once all of these new communities and specs ultimately get listed for sale?

Yeah. You're not going to see what you describe as a larger number of finished specs coming to market later in the year. We actually have 1,500 specs, and we define a spec. Actually, we hate that word around here. It's a QMI, quick move-in. We had 1,500 QMIs last year, and that's defined as framing has begun, and we have 1,000 today. So because of how hot the market is, You know, we are actually undersupplied at the moment, but we are catching up because we are forcing and requiring all divisions to build QMIs into their backlog every month. And so I think it will be fairly consistent, and I'm not worried about all of a sudden a lot of, you know, finished homes come to the market and, oh, boy, I hope the market's still in good shape. That's I think it's formulaic, I think it's progressive, and I think it's fairly consistent in the number that we're starting, the number that we're selling. We just, you know, we would sell, we'd sell a spec at frame, but not today, because to sell a spec at frame, the market is so hot. Somebody that truly wanted a new home, custom designed, Well, if all they can get is a house at frame where they can't do the custom design of the structural changes, they can only go to the design studio for the finishes, they're going to grab it. And we would rather have those people, you know, wait their turn to buy the new home and save that spec home until it is beyond drywall. Obviously, we know every single cost at that point without any issue. I mean, I already gave the story of how we push back on the plumber that wants a price increase on backlog, but If a house gets beyond drywall, you know, we're in fantastic shape when it comes to cost. But more importantly, we're riding an appreciating market, and we will make more money, drive more margin, improve ROE by selling that house a bit later at a higher price. And that strategy has been in place now for a while. We're just a bit more obsessed about it, and it's mandatory now that you have to hold us back until that point.

Understood. Thanks a lot. You're welcome. Thank you.

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

Hey, good morning, everyone. Great quarter. Hey, thanks. Doug, can you talk about your luxury strength versus actuarials. You mentioned some of that, but also some of the trends you're witnessing there. Just talk about how your actuarial category, for example, which is pretty strong, how do you think that trend this year and next few years, and curious how that could benefit your margins or your balance sheet?

Sure. So when I break down the 85% order growth in Q2, Affordable luxury was up 103%. Luxury was up 48%. Age-targeted empty nester, the baby boomer crowd, was up 135%. And the smaller city living operation was up 171%. So affordable luxury will be the fastest-growing part of Toll Brothers as we focus more and more on the 400 to 650 price point for the 35-year-old millennial population. And you're going to see that grow fastest. And as I mentioned earlier, the gross margin out of that business is now matching our traditional luxury business. So we're very, very pleased with that. We knew it would have higher ROEs because the land is less expensive and we turn houses faster because they're smaller. We're just obviously delighted that the gross margin has been higher than we had thought. Going forward, we're not giving up on luxury. And as those millennials age more and more, they're going to be buying their second and third home. It's not that far away when, you know, we've got the 42-year-old millennial who is ready to move up. And so, you know, we worked hard on this brand. And I hope you all join us next Wednesday because I am sure, based on how hard we're working here you are going to be blown away by some of the product videos and photography and presentations by our management team and just how we do it. And so affordable luxury will be the number one grower. Obviously, age-targeted empty nester with that boomer crowd is doing better and better because they're on the sidelines for a long time through COVID.

It may be in the next quarter or two the strongest performing segments. Because of the low base from a year ago.

Correct. Great. But, you know, I know we talk about it, but we do have the widest offering in the industry. You can buy a $300,000 house from Toll Brothers and you can buy a $5 million house. And that wide offering and the wider geography with all these new markets we've mentioned is what gives us such great confidence and excitement about the outsized growth that we can achieve.

Got it. I'm definitely looking forward to your Investor Day presentation. My follow-up question is on pricing mostly, a little bit two-part. What are your thoughts on keeping price when commodities start to moderate? That's one part of it. Second part of the pricing question is right now you're capping your orders per community. When do you expect to be caught up? You know, I'd appreciate if you have any thoughts on when you expect to be caught up. You know your lock positions. You know what you're taking right now, your intake. So you should probably have an idea, you know, when you expect to be caught up. So once you get to that equilibrium level, which enables you to lift cap, would pricing then still – Will pricing start to get competitive? Would you start to think about probably lowering price, especially when that commodity starts to moderate? I mean, a couple of points there, but I appreciate any time.

Sure. So we have never based the price of our homes on the cost to build them. That's not the business model of Toll Brothers, and I don't believe it's the business model of many builders out there. We do detailed market comps. on how much can we sell the home for? What will the market bear? What are the other new home communities by other builders selling for? What is the resale market selling for? Our business, we will drive this price as high as the client will pay. If costs moderate and we still have the demand at the levels we have today, no, we're not stopping our strategy of allocation. We're not stopping... Our price increases are our sealed bid process. It is completely based upon market demand and market pricing. With respect to when we get caught up, yeah, obviously we're moderating sales right now, as we have discussed. The beauty is at the moment we control how much we sell. So we have the levers in place to decide, hey, let's open five this weekend. Right now it's all internal and we can make those decisions and as this backlog up 57% starts coming down a bit and we have a little bit less pressure on production where the next home sold can be delivered, not in 13 months or not in 12 months, but in 10 months, then you'll start seeing more and more of our communities open up As I said, the way I'd like them to be where we can sell everybody a house. But the pricing decisions will not be based on anything but the level of demand and the market comps.

And, Deepa, our allocation decisions are community by community right now, and coming off allocation will be community by community as well, not overall company evaluation.

Right.

And the last question or today will be the Truman Patterson with wolf research. Please go ahead.

Hey, good morning guys. And, uh, thanks for taking my questions. I appreciate it. So first I feel like I might be, uh, beating this to death a little bit, but look, and clearly lumber costs are big topic at conversation. It sounds like you all have a lot of confidence in your gross margins going out to 2022. As of today, spot lumber costs as of May, labor, et cetera, et cetera, you all have more than enough pricing in hand today to offset all of your costs at today's levels. And then given all of these bidding processes that you all have been talking about, excluding makeshift to the affordable, what do you think core pricing was up in the quarter or year over year?

I think the best way that we look at the pricing versus cost equation, which is where I think you're going, Truman, is to overly simplify this. If we have an $800,000 home we're selling, we have a 25% gross margin, and we have around 25% of the costs that are associated with the land and improvements. And so those have been paid for previously. So... It's a two-for-one kind of equation. A 2% cost increase can be offset with a 1% price increase when you're looking at those cost increases from a labor and materials perspective.

Okay.

Yeah, I got that. On the core pricing, Quarter over quarter, year over year, do you all have that metric?

You say price? Is it cost or sales price? Sales price, yeah.

Yeah, the sales price. Okay. Okay. All right. And on the affordable luxury, I know it's moved to 30% of your sales. Is this rolled out nationwide? Are there any new metros? Is there any additional expansion, and where do you think you could ultimately take that to? Doug, you made a comment, I believe in the prepared remarks, about the streamlined construction process and possibly bringing these techniques to your other product segments. Could you just elaborate a little bit on that?

Sure. Affordable luxury is now rolled out nationwide. That doesn't mean every single one of our 50 markets has it, but it is in place around the country. We have markets that are primarily all affordable luxury, Jacksonville, Boise, as two obvious examples. We have other divisions that sell $2 million houses and they also have a significant affordable luxury business, example, Phoenix. And you'll continue to see new markets that may be lower priced. One example, we're going to announce shortly that we're going to be reentering San Antonio. Well, San Antonio is primarily an affordable luxury market throughout, as Jacksonville is. But there's going to be other markets that we will enter. that will be both luxury and affordable, and you will see more and more affordable luxury in the existing footprint. With respect to cycle time, our cycle time came down again from the first quarter to the second quarter by about 10 days. That was a combination of our operations teams clicking, and we have restructured how we operate in the field and more affordable luxury, but by its nature, we turn those houses faster. So the things we are learning on the affordable luxury side, Marty talked a bit about optimizing our plans, and we're going to talk more about this next Wednesday. We're not changing the buyer experience. We're not pulling the opportunity of choice, the opportunity to upgrade your home out. We're just optimizing the plans. We're making them more efficient. We're making them better. Better can also be less expensive. Better can also mean you can build faster. And that's what optimization is all about. So even though we're hot and we're busy, we are actually building houses faster than we ever have. And it's a combination of all those things I just mentioned.

Perfect. Thank you guys for the time and good luck in the upcoming quarter. Thank you, Truman.

Just a reminder, the market is opening. So this concludes our question and answer session. I would like to turn the conference back over to Doug Yearley for any closing remarks.

Drew, I thank you. Thanks, everyone, for your interest and support. I'm sorry that we didn't get to every question, but next Wednesday there will be plenty of opportunity during our three-hour Analyst and Investor Day for Q&A. We have built Q&A in throughout the day, and I'm really, as I said, excited to share next Wednesday with all of you I'm so proud of this company and just so proud of what we're going to be able to show you next week about how we operate and, most importantly, the people within this company that do all the work. So I hope you can join us, and thanks again. Have a great balance of the week and weekend, and we'll see you next week. Thanks.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.