Toll Brothers, Inc.

Good morning and welcome to the Toll Brothers first 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'd now like to turn the conference over to Douglas Yearley, CEO. Please go ahead.

Thank you, Jason. Good morning. Welcome and thank you for joining us. With me today are Marty Conner, Chief Financial Officer, Rob Parahouse, President and Chief Operating 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, interest rates, the impact of the pandemic, the availability of labor and material, inflation, and many other factors beyond our control that could significantly affect future results. I will begin by sharing some thoughts on current market conditions and sales, along with the challenges we are seeing on the production side and how we are addressing them. I will then turn it over to Marty to discuss the numbers and guidance in more detail. Our first quarter results were solid. Net income and earnings per share rose 57 percent and 63 percent respectively, and home sales revenues grew 20% in dollars and 9% in units compared to last year's first quarter. Our adjusted gross margin of 25.6% in the quarter was 270 basis points, better than last year's first quarter, and our SG&A expense as a percentage of home sales revenue improved 150 basis points over last year. At first quarter end, our backlog stood at a record $10.8 billion and 11,302 homes. Due to the strong demand we continue to see in the market and the good visibility that our backlog provides, we are reaffirming all of our full year guidance. We are pleased with our sales results in the first quarter as we saw broad strength across all of our buyer segments and geographies. We signed 2,929 net contracts for approximately $3 billion, up 2 percent in units and 19 percent in dollars over last year's extremely strong first quarter when orders were up 59 percent in units compared to fiscal Q1 of 2020. Our contracts per community at 8.8 for the quarter remained well above historical averages. This was our best first quarter sales ever. The average selling price of signed contracts in the quarter once again exceeded $1 million and was up approximately $149,000 compared to last year's first quarter. Favorable demand dynamics allowed us to continue raising prices in nearly all of our communities throughout the first quarter. While demand has remained strong, we continue to face challenges on the production side from supply chain disruptions labor shortages, and municipal delays. These challenges were compounded by additional pressure from the Omicron wave as it spread across the country, especially in January when it peaked. It is taking us approximately two months longer to deliver a home today versus one year ago. It's important to point out that these delayed deliveries are not lost. We continue to enjoy historically low cancellation rates and our contracts are supported by an average non-refundable down payment of $71,000. It is simply a timing issue. With demand and pricing as strong as they have been, and with construction schedules that continue to extend due to supply chain, labor, and similar issues, we believe the right strategy for us at this time is to limit sales and continue to focus on production. Over the past six weeks, we increased the number of communities on allocation from 25 percent to today over 50 percent. In many communities, we are using the traditional resale process of best and final sealed bid to maximize price. In addition, we are starting more specs in the second quarter than we typically would to replenish inventory sold last year. As a reminder, spec homes normally represent about 20% of our settlements. It is important to note that this increase in spec starts and purposefully metering sales should not impact the timing of future revenues, as we expect the spec homes started in Q2 to be sold later in the construction process and still be delivered in the first half of 2023. So we expect to start more homes than we sell in Q2, and we expect our sales pace in the second quarter to be similar to the 8.8 contracts per community that we booked in the first quarter. Our non-binding deposits in the first three weeks of February were consistent with the pace of the past nine months, which was approximately 325 deposits per week. We could have taken more deposits these past three weeks, but we chose not to in order to focus on production and manage build times. In order to further streamline our operations and mitigate potential production bottlenecks, we also continue to optimize the number of available floor plans and options we make available in a given community, offering buyers better choices by focusing on those that are most popular and more readily available. and we continue to work closely with our subcontractors and national suppliers so we can anticipate supply chain issues and labor delays and make any necessary adjustments. While we do not anticipate any meaningful improvement in supply chain and labor shortages in the near term, we are encouraged by the recent steep drop in COVID cases and the relaxing of many pandemic restrictions. Turning back to the demand side of the equation, The housing market and demand for our homes in particular is being propelled by strong demographics from both the millennial and boomer generations, the substantial imbalance between the tight supply of homes and continued pent-up demand, the wealth effect of rising existing home equity, migration trends, and the greater appreciation for home. We believe these long-term tailwinds will continue to support demand for our homes well into the future. We continue to see people move from states where home values, taxes, and cost of living are higher to less expensive regions. This dynamic is spurring demand in markets across the country, and particularly in the Sunbelt and Mountain states, where we have expanded in recent years. For these buyers, affordability is less of an issue. We have also not seen an impact on demand from the recent increase in mortgage rates. I remind you that our customers are generally better insulated from affordability concerns compared to buyers in the entry-level market. Our buyers tend to have higher incomes, and they benefited from multiple years of appreciation in their investment portfolios and their existing homes. They also understand that when they contract with us today, their interest rate will not lock until they are much closer to settlement. So we don't believe that demand for our homes is being pulled forward by buyers who are focused on beating a rise in rates. Also keep in mind that rates have no impact on monthly payments for about 15% to 20% of our customers who pay all cash, and that another approximately 30% of our buyers borrow at jumbo rates. which are currently five eighths of a point lower than conforming for our clients. And overall, our customers average less than 70% loan to value in their mortgages. In fact, we've analyzed our backlog and estimate that rates would have to increase to approximately five and one quarter percent before just 10% of our backlog would need to consider an arm, a higher down payment, or other alternative mortgage. This speaks to the credit worthiness and healthy balance sheets of our customers. As I mentioned earlier, we are reaffirming all of our guidance, including a return on beginning equity for fiscal 2022 of approximately 23%. We also expect to generate substantial cash flows in 2022. Our highest capital allocation priority continues to be investment in the growth of the business, including through disciplined and capital-efficient land buying. Of the approximately 86,500 lots we owned and controlled at January 31, 54% were optioned and 46% were owned, compared to 46% optioned one year ago. Our shift to more optioned lots is an important part of our capital efficiency strategy and our focus on returns. This lot position also provides us with all the land we need for our projected community count growth in fiscal year 2022 and beyond. We continue to expect approximately 10% community count growth by the end of fiscal 22 from the 340 communities we were operating at the end of fiscal 2021. We continue to use excess cash to further reduce leverage and return capital to shareholders. In the first quarter, we repaid $410 million of our senior notes. We also repurchased $185 million of our stock, which reduced our outstanding share count by approximately 2.5 percent, and we paid dividends of approximately $21 million. Our balance sheet remains strong. with ample liquidity, strong expected cash flow generation, and declining leverage. These factors, along with the positive fundamentals underlying our business, contributed to Moody's upgrading us to an investment grade credit rating last month. With that, I'll turn it over to Martin.

Thanks, Doug. In our first quarter, we delivered 1,929 homes at an average price of approximately $875,000, generating home building revenues of $1.69 billion, which was up 9% in units and 20% in dollars from one year ago. Settlements came in 71 units below our expectation due to the supply chain disruptions, labor shortages, and municipal delays that Doug mentioned. We felt the greatest impact in January, the last month of our quarter, as the effects of the spread of Omicron were most acute. Fortunately, Omicron and the pandemic now seems to be waning. Our first quarter pre-tax and net income were $200.8 million and $151.9 million, respectively, both up approximately 57% compared to 127.4% and $96.5 million, respectively, in the first quarter of 2021. Earnings per share in the first quarter were $1.24 per share diluted, up 63 percent compared to the 76 cents per share diluted that we earned one year ago. The net income and earnings per share growth percentages were approximately triple our revenue growth percentage growth. Our first quarter adjusted gross margin was 25.6% compared to 22.9% in the first quarter of 2021. The 270 basis point improvement reflects the strong pricing environment over the last year. It also includes the impact of elevated lumber prices from last spring in this quarter's closings. We continue to project an adjusted gross margin of approximately 27.5% for the full year. We expect adjusted gross margin of 25.5% for the second quarter of fiscal year 22 as the impact of elevated lumber prices from last spring continues. This will be followed by a ramp up in our gross margin in the third quarter and a greater ramp in our fourth quarter. SG&A, as a percentage of revenue was 13.4% in the first quarter, compared to 14.9% in Q1 of last year, and 70 basis points better than projected. Joint venture, land sales, and other income met our guidance at approximately $30 million in the first quarter. Impairments and write-offs were $2.2 million in the quarter. Our tax rate in the quarter was 24.4% compared to guidance of 26%. Turning to future guidance, we are projecting fiscal year 2022 second quarter deliveries of 2,350 homes with an average price between $865,000 and $885,000. We are maintaining our full year delivery guidance of between 11,250 and 12,000 homes with an average price between $875,000 and $895,000. Deliveries will be back half-weighted and will be consistent with seasonal patterns. We expect interest and cost of sales to be approximately 2.1% in the second quarter. We project second quarter SG&A as a percentage of home sales revenues to be approximately 11.9%. For the full year, we continue to project SG&A as a percentage of home sales revenues to be approximately 10.5%. We expect community count to be approximately 330 at the end of the second quarter and 375 by fiscal year end. Other income, income from unconsolidated entities and land sales gross profit is expected to be approximately $5 million in the second quarter and $100 million for the full year. We project a tax rate of approximately 26% for the second quarter and 25.8% for the year. Our weighted average share count is expected to be $121.5 million for the full year and $122 million for the second quarter. Based on all these factors, We continue to project approximately $10 per share in full year earnings per share and a return on beginning equity of approximately 23%. Now let me hand it back to Doug.

Thanks, Marty. This month, Fortune Magazine named us the number one world's most admired home building company. This is the seventh time we have received this high honor. I would like to thank all of our Toll Brothers team members for achieving this tremendous recognition. They continue to demonstrate their dedication to our brand and our customers. And for that, I am very proud and very grateful. As Toll Brothers enters its 55th year in business, I'm excited about the current market and the long-term prospects for our company. Now let me turn it over to Jason for questions.

Thank you. We'll now begin the question and answer session. As a reminder, 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. To ask a question, you may press star, then 1 on your touchtone phone. If you're 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'll pause momentarily to assemble our roster. Our first question comes from Anthony Pettinari from Citi. Please go ahead.

Hi, this is Asher Sonnen on for Anthony. Thanks for taking my question. I guess my question is, the last time we saw rates rise, you know, in the 2018 timeframe, your sales pace did, you know, slow down meaningfully. So, I'm just wondering, what were maybe some of the early warning signs, you know, in 2018-2019 timeframe, you know, that were showing a demand hike? then maybe we should be looking for around now. And then I know you haven't seen any impact on demand yet, but have any of those warning sign metrics started to weaken for you at all?

Very good question. The warning signs are web traffic, foot traffic, and right now web traffic and foot traffic is up significantly.

Okay, thanks. As a follow-up, I just want to say, you know, Thinking about your sales pace in 2021, you sold maybe a little over three homes per community per month in the quarter, similar to that. And then I think for Q2, you expect to do the same. So I'm just wondering, looking out for the rest of the year and then maybe even beyond that, is that sales pace sustainable, maybe like a new normal? Or should we think about that 10% growth in community count coming more maybe at the cost of a little bit more of a normalization in sales pace?

So right now we're selling at about a pace of 37 homes per community per year, and we're settling at a pace of about 35 homes per community because of everything that all the builders have talked about and what we talked about in our prepared comments earlier. We can and we will get the settlement pace higher as supply chain labor issues improve over, you know, I think it's going to be the later part of this year. As I talked about, you know, we're going to be focused on more starts this quarter. There's about six, we're about 600 spec or what we call quick move-in homes behind because so many of those were sold over the last year and a half through the heat of the market. And we are committed to get many more homes started in this second quarter. And that's why we put over 50% of our community's on allocation. And so longer term, we are very comfortable being in the high 30s in both a sales cadence and a delivery cadence. And so community count will certainly contribute to our growth, but there are opportunities as supply chain labor settles down for us to, we believe, both sell and deliver more homes.

Okay, that's very helpful. Thanks. I'll turn it over.

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

Yeah, thanks very much, guys. Really great info regarding, you know, the buyers and all the factors you ran through about demand not being pulled forward. So thanks for that. One of the things that I wanted to, that our model spitting out that I thought was interesting is we have your net debt based on what we see here easily moving back down into the low 20s. I guess my question was, in your outlook for return on equity, about 23%, can you give us a sense for what kind of range of net debt to cap you're expecting at the end of the year? In addition, you've talked about specs here a little bit more. You're one of the few builders that doesn't actually give us a detailed breakdown of the number of homes you have under construction at any point in time. I was wondering if you could give us that number, what it was this quarter and what it was in the year-ago period.

Steven, with respect to the debt question, I think you're directionally accurate. I think we're interested in operating in the low to mid 20s, but the timing of land opportunities or builder acquisition opportunities can always impact that from quarter to quarter or from year end to year end. We're encouraged by the fact that our plans have been shared with Moody's, and they moved us up to investment grade, and so we feel very comfortable operating in those levels with the liquidity we have, the cash generation we foresee, and the growth opportunities we have on balance sheet or in process. With respect to your second question, which is the number of starts, I don't know that we have that with us this morning. As Doug mentioned, a lot of our starts in the second quarter will be to replenish our depleted spec inventory. So we expect to start in the second quarter in the neighborhood of 3,400 to 3,600 units. Right.

And Stephen, in the first quarter, we did start about as many homes as we sold. But last year, you know, when we were selling a bit more homes than we were starting. And that, again, is one of the main reasons that we have increased allocations for the moment. We are going to replenish the spec count. And so this quarter, as Marty said, we will be starting more homes than we sell. But those homes will, in fact, they should have a shorter construction cycle time because at least in the early stages of the home, we don't have a client and we're able to move faster, but they will, we believe, deliver in the same timeframe as if they had been sold. And if this market continues, we are hopeful that maybe there's even more margin in those houses because they're sold a bit later in the cycle time.

Yeah, no doubt. One of the interesting things that these times like this brings is the higher margin on specs. Second question I had for you relates to the fact that you're trading pretty darn close to your book value, which, you know, as I've thought about that, one of the things that we've analyzed is how much of your land that you own, how many of the lot you own, likely reflect pre-pandemic pricing. The analysis that we've run, suggest that basically, you know, easily all of it could theoretically have been, have had prices that were negotiated pre-pandemic. But there's two assumptions in there. I was wondering if you could comment on those. One is that your land values rise more significantly even than the rate of home price appreciation, that land values rise, you know, I've heard, you know, 2x or whatever of home price appreciation. I wanted to sort of check that. The second thing is you have options, and my understanding is that some of those options have some form of escalator, but the escalator usually is sort of capped out, right? So when you have this period where land values have risen radically since, you know, the last two years, your escalators don't, you know, move up at the same rate. So you really do have an embedded arbitrage on anything that you had as an option at the time of the pandemic. Are those two assumptions roughly correct?

It's a very, very complicated answer, and I don't want to bog down, but let me start with the land that we own that was contracted for pre-pandemic. That number is 77% of the land we own was tied up pre-pandemic. With respect to the deal structures, most of our deals have what we call kickers, no kickers. So we pay for the land. We may not pay all up front. With our obsession with capital efficiency, we may be paying over time. There may be an interest rate associated with paying over time. Certainly with a land banker, there's an interest rate associated with taking that land down later, but most of our deals don't have a kicker, which means a land seller is participating on the back end with our success. However, there are some deals that do have a kicker, where they are either having a revenue share on the back end based on a small percentage of the price the home ultimately sells for, or in a very, very, very limited case, there may be a profit participation where they have to get into our books and understand how we calculate profit, and we have some arm wrestling over accounting, and they actually get to participate on the profit side. So one is revenue, which is a percentage of the home price itself, and the other would be a share of the profit made. But those are the exceptions. Most cases do not have that. But to your point, when they do have a revenue or profit participation, we have the outsized component of that. So we are benefiting far more than our seller as our prices or our profitability goes up.

Yeah, makes sense. Thanks very much, guys.

You're very welcome.

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

Hey, guys. Good morning. Thanks for taking my questions. Doug, I'd love to follow up, I think, on a comment you made to a prior question about the supply chain. And I think you kind of made a hopeful comment that as the year goes on, maybe things will at least stabilize or maybe even improve a bit. And I'm just curious your thoughts because you guys seem to be following a similar playbook that a lot of the industry is right now in terms of limiting sales, ramping spec starts. Obviously, community count is going to be growing a lot. So I guess... where I struggle a little bit is, and I'd love to hear your thoughts are why would the supply chain stabilize if the industry is all kind of trying to ramp up the volume of specs over the next three months, six months, community counts going to be growing double digits for just about everybody over the next nine months. What is the catalyst that would actually cause the supply chain to, to stabilize or even improve?

Yeah, it's a great question. And I just want to start by explaining that, you know, we haven't modeled for any improvement. The guidance we've given, in fact, we've increased our contingencies and our building costs recently to be more careful. So all the guidance we're providing and the way we're running this business is assuming that there will continue to be significant stress and there will continue to be significant pricing pressure. With that said, and returning to my comment I made a few minutes ago, I'm just looking at the world today. You know, my January, 9 million Americans called in sick. You know, that's off the chart, off the chart to the normal, I don't know, 2 or 3 million pre-COVID. I think the prior peak to that was a year ago when it was 6 million. January was a really, really tough month. We felt we couldn't get building inspections because the inspector was home. We couldn't get COs because the town clerk who processes the CO was home. Our employees were home. Truck drivers were home. You know, I saw it in my kids' school. We saw it in our personal lives with friends and family. And that is changing dramatically. You know, masks came off my kids last week going to school. You know, there's a lot that's changing rapidly that just gives me some optimism that things will be more normal. The L.A. Long Beach port, you don't have 100 freighters sitting in the harbor. You don't have thousands of containers sitting on the dock. You know, I've heard the big suppliers are now beginning to talk about You know, some improvement they're seeing in their opportunities to run their factories full speed, to get the truckers to transport. And so, Alan, that was the extent of it. I mean, I agree with you. You know, the builders are growing. There's a lot of action out there. The market continues to be really strong. And so, of course, that's the other side of the equation. But I am hopeful that and cautiously optimistic, using an old term, that as this year progresses, we're going to see a bit of a more normal, although still somewhat stressed, production environment.

I think to follow on to that a little, Alan, we are offering product that we know is available. We are choosing product in these spec homes that we are building that we know is available. And we are narrowing to the most popular items what is offered in our design studios. And that actually marries with what the manufacturers are producing. They've narrowed how much they produce to drive efficiency.

Got it. Appreciate the comments there, guys. I know it's a tough environment to predict here, so it's helpful to hear how you're thinking about it. Second question, you know, would love to just dig in a little bit in terms of the mix of your business. You know, I think one of the areas that, you know, perhaps there was some optimism on, you know, in terms of navigating some of the extending cycle times was the growth in affordable luxury and the growth in newer markets where perhaps cycle times historically have not been quite as extended as the coasts. So I'm curious, if I look at your average price growth, it's been very strong, kind of consistent with the broader industry. So it doesn't seem like there's really been much of a mix towards more affordable product or kind of more affordable markets. Your cycle times obviously have not yet stabilized. So should I interpret that, that you're actually just seeing incrementally stronger demand from the luxury higher end price point, or is that not the correct interpretation and There's something else going on underneath the surface there.

No, you know, we're committed to the affordable luxury business. We're committed to these new markets that tend, as you point out, tend to be a bit lower priced. There's a lot less city living in 22. There's almost no city living deliveries in 22 because of timing of buildings and our intentional decision to slow that business down as COVID hit. and the move out of city living has ramped into active adults, age-restricted primarily, but we're raising prices everywhere. So don't read into this million dollar plus sales price of the last two quarters to suggest that it's coastal, it's very expensive places. You know, we entered Boise four years ago selling houses at three and a quarter, and our average house in Boise now is 650, guys, plus or minus. And I can tell that kind of story to many markets around the country. I guess there's a bit of a new definition to affordable. And many of these markets are seeing equal or higher percentage increase in sales price to some coastal regions. And then when you mix it all together, the price is coming out over a million. We like the mix. Much of the land we're buying continues to be in these new lower-priced markets where we will be able to offer more affordable homes. But as I said, those homes are going up just as fast or faster than other areas. So it's no change in strategy. It's just prices going up everywhere.

All right. Appreciate the thoughts. Thanks a lot.

You're very welcome. Thank you.

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

Hi, good morning, everyone. Thanks for taking my question. A pretty broad one for me. If your 2022 is more or less locked in at this time, just given your backlog, visibility, etc., what's driving that wide range in guide? Is that Are you waiting for spring selling season or, you know, the supply chain, still the governor to the high end, low end? Any thoughts there?

Yeah, go ahead, Marty.

So I think our guide for deliveries is a width of 725 units, right? 11, 250 to 12,000 with roughly 10,000 of those to go. I think that's a prudent guide in this operating environment.

Sorry, 10,000 to go. I misunderstood. Sorry.

Well, we delivered 1,929 in the first quarter.

Got it. 10,000 to go to deliver. Got it. Yeah. I think that the reason for that range, it's not sales. You know, we're selling in 2023. And, you know, we're very, you know, I said last quarter that the next home sold by us in December had the highest margin we've seen in this cycle. I can repeat that comment now three months later that the next home sold today has the highest margin we've seen in this quarter because we continue to raise prices more than costs are going up. But that's a 23 comment. As to 22, it's supply chain. We missed deliveries in the first quarter. We've given you guidance in the second quarter on deliveries. Obviously, we have a lot to do in the second half. If we hit our delivery guidance in Q2, 63 percent of our full-year deliveries to hit the midpoint of guidance would occur in the second half. Our 10-year average for second-half deliveries is right at 60 percent. And we've studied the construction status of the backlog, and it is further along than it has been historically. So we are comfortable that we can get to that 63% for those reasons. But we think it's prudent right now to keep that 750 unit window because of the environment we're building in. There are some quick move-in spec homes that will still need to be sold. But with the market conditions, I think that's a very, very low risk of impacting you know, the ultimate delivery number. I think that conservatism right now is simply based upon the production environment we're living in.

Thanks for that. That's helpful, Collar. Another broad one for me. You addressed a little bit in your prepared remarks, Doug. There is a bare narrative out there that luxury builders are a little bit more price elastic, and the first move down usually happens in that portfolio resulting in luxury builders perhaps losing buyers to other categories as the buyers trade down in this high interest rate environment. How would you address that?

We disagree. I think our buyers are much more financially sound. I went through the numbers on their credit worthiness. I went through the numbers on the average LTV is 70%. Yes, a luxury home is a discretionary buy. We understand that. But when we look at prior cycles, you know, we've been the darling of the industry at times when rates have gone up because the buyers can still afford our homes. It is not a monthly payment decision. Our buyers don't think, maybe except in Detroit where they lease a lot of automobiles, they don't think about monthly payment. They think about moving up in their lives. They think about getting that larger home as the kids hit middle school, buying that second home, moving down as boomers into that luxury community, and they have the bread. They have the ability. They can afford it. They don't max out the mortgage. 50% of our buyers are more, you know, today are move up. And the percentage that have a home to sell is 70%. And look at the equity that's been generated in those existing homes for 70% of our client that allows them to move up. So that little ticking rate up, you know, 25, 50, 75, even 100 basis points, Historically, we're not 100% immune, but we have been in a better place than the start our home business where it comes straight down to monthly payment and affordability.

All right, that's great. Thanks very much. I'll pass it on.

You're very welcome.

Thank you.

The next question comes from Truman Patterson from Wolf Research. Please go ahead.

hey good morning everyone thanks for taking my questions first hey first just wanted to hop back to us you know one of the questions on the early warning signs and as a portion of your orders your cancellation your cancellation rate ticked up about a point year-over-year just seeing if you had any more clarity from the field is this just simply cancellations in the normal course of business Or are you beginning to see the higher mortgage rates impact some buyer's ability to qualify for the mortgage?

Truman, I think the cancellation rate is low by our historical standards. I'm looking back at the last 10 years, and 6% looks like our long-term average. It was extra low last year. It's ticked up a little bit this year. A lot of that tick up is a function of how large the backlog is right now. If you look at cancellations as a percentage of backlog rather than as a percentage of current quarter sales, they've hardly moved it at all. And we are not seeing an early warning sign, if you will, in cancellations. So I think that's a bit of a red herring as it relates to having gone from high threes to high fours as a percentage of new contracts. It's 1.4% of backlog. It was 1.3% of backlog a year ago.

Perfect. Thank you.

And in a rising price environment, cancellations are an opportunity for us right now because we get to sell the home at a higher price.

Okay, so cancellations are still beneficial for the gross margin. Okay.

That's not a strategy.

That is not a strategy. Fair enough. And then second question on rate locks. Are you seeing consumers, you know, beginning to use rate locks more frequently? Are they using longer rate locks? And if so, how should we think about the cost associated to toll and where it might impact the income statement?

Yeah, we have not yet seen an extended period of time rate locks be asked for by our customers. They can lock a mortgage generally in a normal course within 60 to 90 days of closing, and we are seeing them take advantage of that opportunity.

And I want to reiterate, 80% of the homes that we're selling are build to order. That's tolls, that's our special sauce at our price point. And those homes today will take nine to 14 months to deliver based on where they're located, how much backlog, and production issues. And so the commentary I hear that there's this pull forward of demand because buyers are trying to grab a rate today before it goes up. It's just not the case. Our buyers are not able to lock on our homes until 60, maybe 90 days before that home delivers. And we are seeing tremendous demand and tremendous pricing power in the last month as rates have risen. and buyers know that they are not running in to lock a lower rate when they buy a home from Toll Brothers.

Yeah, it's interesting when you say that. If you actually look at the data historically, you're exactly correct that it kind of dispels the pull-forward narrative. So thanks for taking my questions. I appreciate it.

You're welcome. Thank you, Truman.

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

Good morning, guys, and thank you for taking my questions as well. The first one is I'm curious how many communities you're implementing that best and final sealed bid in. And, you know, along those lines, how do customers tend to react to that process? And, you know, do you risk pushing some buyers away that maybe chose to purchase a new home? You know, does this sort of avoid this process?

So about 90 of our 350. call it 30 plus or minus communities are currently using the best and final offer program. That may not be for every lot. Sometimes we do it for special home sites where we know we have outside demand. I know on my last call I gave some great detail on how that process works and how you can do it in a bill to order environment because we're not generally bidding a finished spec home, although we'll also do that. If you recall, we do it through the lot premium, and then if you are successful in bidding up the lot premium, you can then pick your house and go through the process of customizing the home to your lifestyle. Buyers, it's how you manage the process, and sales has been really well-trained in how they manage the process. If there are 30 people that want a home site, those that are 25, 26, 27 on the list are pretty happy we're running this process because at least they have an opportunity. Not everybody is happy. Just like not everybody is happy on a resale when it goes to final invest. But that is the environment that we are in at the moment. Buyers are used to it through the resale market. We now have a really cool app where you can bid through a toll app that makes it totally transparent. And so I think we've done a really good job of explaining it. It's a bit of the new normal in the industry. But yes, is everybody happy with it? No. People want to walk in and buy a house off a price sheet. But that's not the environment we're working in at the moment. And I'm proud of how we're handling it. I think most buyers are understanding of it.

Yeah, that makes a lot of sense. And then maybe going back to Steve's question from before, just about where the stock is trading today. I'm curious how this impacts your capital allocation decisions. I mean, if you guys are as confident as you sound in the sustainability of the cycle, which we would agree with, I mean, wouldn't your stock be a great investment right now and even more a positive signal to the market?

Well, we bought $185 million worth of stock back at $61, guys. So I think that gives you the answer. Okay.

Thanks, guys. The next question comes from Alex Barron from Housing Research Center. Please go ahead.

Yeah, thank you, gentlemen, and great job. I wanted to focus on the trend and the gross margins this year. Clearly, In the first half, you guys are in the mid-25%, and in the back half, it looks like you'll be in the high 20% range. So I know you're probably not going to give us 2023 guidance, but I'm more curious to see how you guys see margins unfolding as we move into next year. Is it more likely to stay at the higher level or trend back towards kind of where margins are currently?

Yeah, Alex, I mentioned earlier that The next home sold by Toll Brothers has the highest margin we've seen in this cycle, so I think that bodes very well for 2023.

Got it. Okay, great. And then my other question has to do with expectations on orders. You guys obviously only had one negative growth quarter in October and then went back to positive this quarter. It gets related to that in your comment about 50% of your buyers, I think you said, are move-up. I'm curious, what percentage of the buyers are you guys seeing that are moving across state lines? And what percentage of your buyers are first-time buyers? I'm trying to get a sense of your mix and what's really driving the strength here.

Sure. And just to clarify, because we are now restricting sales significantly focusing on production and getting specs started Q2, as I think we made very clear, will also be a quarter where sales will be down. 40% of our sales are to those moving to a different market, to migration.

Got it. And what percentage are first-time guys?

30%, our first time on virus.

Okay, thanks and best of luck.

Thank you very much.

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

Thank you. Good morning, everyone. My first question is, you know, you made the comment, Doug, that the web traffic remains high and that you haven't really seen any changes in that. But just wondering if you could give us any more details in terms of what you are seeing online. Are people looking at different products? Is there any change in options that they're keeping an eye on? Are they spending more or less time? Any details around what you're seeing there?

Sure. We have about 9 million visitors to our website per quarter. And our foot traffic, as I mentioned, is also up, even though they all can't buy because of allocations, but they're still coming out. I'm very proud of our website. We have an amazing web team. We better have the best website in the industry being America's luxury home builder, I think we do. We track the amount of time they spend on the website, the stickiness, right? You get on a website and how long do you want it? That's a big one. We also have online sales consultants now that represent every single community in every market where they engage with clients through web texting, through phone calls, You know, not only before communities opened to set up the grand opening, but even as communities are open and selling, and we call them online concierge service. And they're very, very engaged now with the web visitors. It's very easy to see how you can click the button and, you know, start the chat with the online concierge, and they set it up. They tee up that client for the sales manager at the local community, The one thing we like to see is when they click on the directions page, because that means that they're thinking about getting in their car and running out to the community. But the opportunity to look at videos now, to do walkthroughs of homes, to do some design of your home, custom design, to fiddle with colors and products, all of that is available. I'm not going to bog down on the percentages they spend on each different page, but we track it very closely. We also change the experience. So different pictures come up, different pages come up, and we see what the client seems to like. And when you have 9 million visitors a quarter, you get some pretty good trends that allow us to figure out the most efficient, most optimal web experience. And so our website is very fluid and constantly changing. Does that help?

Yes, but I guess, you know, are you seeing any changes in the stickiness to the website or what they're looking at? Anything that's been different in the last couple of weeks as we've seen rates rise relative to where we were, you know, a couple months ago or a couple quarters ago? Or has it been consistent?

It's been consistent. Yeah, I don't think I'm not... I'm not aware of anything in the last month or two that has changed the buyer experience on the website. We track web leads where they start on the web and ultimately go to agreement, which in today's world, I think I'd be shocked if there's a buyer that hasn't at least spent a little bit of time on our website. Susan, I don't think anything's changed recently.

um for because rates have gone up or for any other reason okay okay that's helpful and then my next question is just around you know when we think about where the business is today holistically you focused a lot on growing the affordable luxury piece in the last several years when you think about the business going into a rising rate environment with the affordable luxury piece of it today which you didn't have in the past how do you think about the the mix shift that we could see the potential to sort of grow the luxury versus the affordable luxury pieces of things and any changes there that could be coming?

Yeah, I'm very happy with the progress we've made over the last three years in widening the price point, the product offering, and of course the geographies. We're not done. There will be more affordable luxury in the mix. Right now it's about and I think it could probably get up to maybe 45%, maybe 50% over a bit of a longer term. But we're not giving up on luxury. There's still a lot of opportunity at the higher price points for us, and we're seeing that success. But as I look longer term at that mix, we're beginning to approach what I think is optimal but we're not quite there, but we've come a long way. I'd say we're probably 80% on our way towards the long-term strategic mix that we want. By the way, when I say 40%, that's on the dollar value, so the actual number of homes would be higher since those homes are less expensive.

Gotcha. Okay, thank you very much for all that color, and good luck.

Thank you, Susan.

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

Thank you, Jason. Thanks, everyone. We really appreciate your interest and support. And happy spring. It's on its way. Almost March 1. Take care. Thanks.

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