Toll Brothers, Inc.

Good morning and welcome to the Toll Brothers Third Quarter Earnings Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal 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 Parrahouse, 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 availability of labor and materials, inflation, pandemic impacts, and many other factors beyond our control that could significantly affect future results. In our fiscal third quarter ended July 31st, we reported earnings of $2.35 per share, up 26% compared to the third quarter of 2021, and driven by continued gross margin expansion. Our third quarter adjusted gross margin was 27.9%. an improvement of 230 basis points compared to last year and 90 basis points better than guidance. SG&A expense was 10.3% of home building revenues, which was 20 basis points better than both our guidance and last year's third quarter. We delivered 2,414 homes in the quarter at an average price of approximately $935,000, generating $2.3 billion in home building revenues. Although we achieved record third-quarter revenues, net income and EPS, and our revenues were lower than anticipated due to fewer deliveries than projected, the shortfall resulted from the combined impact of unforeseen delays with municipal inspections, continued labor shortages, ongoing supply chain disruptions, and a softer demand environment. We missed our deliveries guidance by 336 homes. Most of these deliveries were concentrated in a handful of communities and markets. For example, in California, we had 200 homes that were completed at quarter end, but due to delays with city inspectors and with utility companies, we simply could not get the final inspections or the electricity needed to obtain certificates of occupancy. The change in the demand environment also impacted Q3 deliveries. The combination of fewer spec sales, outside lender delays, a modest uptick in cancellations, and customers taking more time to sell their existing homes all resulted in fewer deliveries. Due to these challenges, we are lowering our deliveries guidance. We now expect to deliver between 3,250 and 3,550 homes in our fourth quarter and between 10,000 and 10,300 homes for the full year. Our adjusted gross margin in the third quarter at 27.9% was 90 basis points better than projected primarily due to favorable mix and effective management of costs. We ended the quarter with a solid backlog of 10,725 homes worth $11.2 billion. We had a total of 190 cancellations in the third quarter, equal to just 1.6% of the 11,768 homes in backlog at the beginning of the quarter, and comparable to our cancellation rate of 1.2% in the first half of 2022. For context, since 2010, our average cancellation rate as a percentage of backlog has been 2.3%. And yes, we think looking at cancellations as a percentage of backlog is much better than as a percentage of current orders. We have not seen any change in cancellation rates in the first few weeks of August. We have consistently had the lowest cancellation rate in the industry for many decades. which speaks to the financial strength of our customers and our build-to-order model, where buyers personalize their homes and become emotionally invested. They make a nonrefundable down payment averaging $80,000, so they are also financially invested. As our low backlog cancellation rate in the third quarter attests, our buyers have remained committed to their new homes, even in this uncertain environment. Our backlog consists of homes sold in the very strong pricing environment of the past year, which puts us in a great position to continue to expand our gross margin in the fourth quarter and into fiscal year 2023. We project an adjusted gross margin of 29.2 percent for the fourth quarter, and we are reaffirming our full year guidance of 27.5 percent. Turning to market conditions. As our third quarter progressed, we saw a significant decline in demand as many prospective buyers stepped to the sidelines in the face of steep increases in mortgage rates, significantly higher home prices, a volatile stock market, and rising inflation. Buyer confidence was also impacted by the nonstop headlines about a softening housing market. and by a general sense of uncertainty regarding the future direction of the economy. All of these factors led to a market change in psychology, and buyers remained cautious through the summer months. As a result, our net signed contracts were down approximately 60% in units compared to last year's historically strong third quarter. On a dollar basis, signed contracts were down 44% year over year, As contracts in the third quarter benefited from price increases, we had steadily applied throughout the year. For most of the third quarter, we purposely did not chase buyers with incentives, as we felt demand was very inelastic. Buyers were on the sidelines. They were not looking for a better deal. On average, incentives in our third quarter contracts were approximately $16,000 per home, up only $5,000 from the average over the first half of 2022. In more recent weeks, we have seen signs of increased demand as sentiment appears to be improving and buyers are returning to the market. With higher quality traffic, we have also started to modestly increase incentives, which buyers are responding to. August sales included an average incentive of about $30,000. In the first three weeks of August, our average weekly non-binding deposits were up 25% compared to July. We have also seen digital leads and foot traffic to our model homes increase. Our sales teams are reporting higher quality traffic, and in several recently opened new communities, we have seen great deposit activity. Although we are only talking about a few weeks, these are encouraging signs, and we are cautiously optimistic that the housing market is settling into a more normal seasonal cadence. Despite the near-term uncertainty, we believe the many fundamental drivers that have supported the housing market in recent years remain firmly in place. These include favorable demographics, with more and more millennials reaching their prime home-buying years, at baby boomers relocating as they embrace new lifestyles, the undersupply of new homes over the past decade, which has led to a large deficit and tight supply of homes for sale, migration trends driven by more workplace flexibility, and the greater appreciation for home that Americans have embraced in the past few years. We believe these long-term secular trends will continue to support demand for home ownership well into the future. In the current environment, we believe it is more important than ever to remain disciplined and capital efficient in our operations and our land acquisition strategy. We are even more focused on controlling SG&A costs and becoming more efficient as we manage headcount and reduce SG&A expenditures. We have also become more conservative in our underwriting of new land deals and will continue to renegotiate or terminate option land if a project no longer meets our stricter underwriting standards. At the end of the third quarter, we owned or controlled approximately 82,100 lots, 3,700 fewer lots than at the end of the second quarter. Approximately 51% of these lots were optioned a decline from 53% at second quarter end due in part to our terminating options of over 3,000 lots in the quarter. Longer term, we continue to target an overall mix of 60% optioned and 40% owned lots. As a reminder, nearly 11,000 of our total owned lots are committed to buyers in our back lot. When you exclude these lots, 59% of our land is controlled through options. We also remain focused on our return on equity. In the third quarter, we repurchased $92 million of our common stock. Since the beginning of the fiscal year, we have repurchased approximately $385 million, or 5.8% of our diluted share count at the end of fiscal year 2021. We have also paid $67 million in dividends year-to-date, and we retired $410 million of long-term debt in our first quarter. We expect share repurchases to remain an important part of our capital allocation priorities for the foreseeable future. Additionally, we continue to employ capital-efficient strategies in our land buy. Last week, we announced a new joint venture between our City Living Division and Sculptor Real Estate to develop two luxury condominium communities in the New York City market, including the latest addition to our Provost Square development in Jersey City, where we have sold 60 units at an average price of $1.1 million over the past three months. We will act as a managing member and development lead, overseeing approvals, design, construction, and sales. We hope to add future properties to this venture. The structure of these transactions and our strategic partnership with the seasoned team at Sculptor demonstrate our commitment to maximizing the capital efficiency of our city living operation. With that, I'll turn it over to Marty.

Thanks, Doug. Before we jump into the income statement, let me address the average sales price for our new signed contracts in the quarter. The average selling price attributed to contracts signed in fiscal year 22's third quarter was $1.3 million. It's important to point out that this average contract value was skewed higher this quarter due to the lower number of contracts we signed. Consistent with our normal practice, our total contract value for the quarter includes both the dollar value of new contracts signed in the quarter and the dollar value of option sales that occur in the quarter on homes sold in prior quarters. Remember, it's not unusual for our buyers to select finishing options a quarter or two after they sign the initial contract of sale. And while this practice typically does not skew the quoted average sale price for new orders, It did this quarter because of the much smaller denominator from fewer contracts in Q3 versus Q2 and Q1. On a normalized basis, we estimate that the Q3 contract's average selling price was closer to $1.15 million, which was still up approximately 7% compared to Q2. This 7% increase was attributable to our pricing strategy throughout the previous year, including our decision not to incentivize through much of the third quarter and also by positive mix. In our third quarter, we generated home building revenues of $2.3 billion, down 7% in units and up 1% in dollars from one year ago. we also reported pre-tax income of $366 million compared to $303 million in the third quarter of fiscal 21. Net income was $273.5 million, or $2.35 per share diluted, compared to $235 million and $1.87 per share diluted one year ago. The increase in pre-tax and net income compared to last year primarily driven by the significant year-over-year expansion in gross margin. Our third quarter adjusted gross margin was 27.9% compared to 25.6% in the third quarter of 21, and 90 basis points better than projected. As Doug mentioned, the outperformance relative to our guide was due primarily to favorable mix and effective management of costs. We expect adjusted gross margin to be 29.2% in the fourth quarter, and therefore, we continue to project 27.5% gross margin for the full year. The estimated gross margin of homes in our backlog is high, reflecting the strong and improving price environment that held through most of our third quarter. With 10,725 homes in backlog, and approximately 3,400 deliveries projected for our fourth quarter at our midpoint, we have more than 7,000 homes in backlog that will form the foundation of our deliveries in fiscal year 2023. The estimated gross margin that is embedded in these deliveries is better than our projected full year 2022 margin. SG&A, as a percentage of revenue in our third quarter, was 10.3%, compared to 10.5% in Q3 of last year, and 20 basis points better than projected, despite lower than projected revenue. This was primarily due to lower than anticipated selling and marketing expenses. Third quarter joint venture land sales and other income was $13.2 million, exceeding our break-even guidance, mostly due to gains on land sold into joint ventures that we had originally projected would occur later in the year. We had previously expected to sell several of our stabilized apartment living and student housing properties in our fourth quarter, which were projected to generate approximately $50 million in income from unconsolidated entities. However, we are pushing these sales into fiscal year 2023 when we expect from buyers. As a result, we are lowering our 2022 full-year joint venture, land sale, and other income to $60 million. Overall, our total investment in apartment living at the end of our fiscal third quarter was $565 million. It consisted of $133 million in 18 properties that were either stabilized or in lease of. where we believe we have unrealized gains of approximately $400 million. In addition to the $133 million, we have $289 million invested in 23 properties that are currently in joint venture and under construction, and another $143 million in land and projects, 28 in total, that are 100% on our balance sheet but slated for future development in joint venture. This pipeline should allow us to produce a consistent series of gains from apartment sales in future years. We expect the earnings from these gains on apartment sales will continue to be a nice complement to our core home building business. Turning back to our results, impairments and write-offs were $6.2 million in the quarter. primarily reflecting sunk due diligence costs or lost deposits on land that we are no longer pursuing because it doesn't meet our stricter underwriting standards. Our tax rate in the third quarter was 25.3%, 70 basis points better than projected. We now project a tax rate of approximately 24.8% for the fourth quarter and 25% for the full year. This is a slight improvement over our prior guide, as we now expect approximately $10 million in Section 45L energy tax credits that were reinstated in the recently signed Inflation Reduction Act. We finished the quarter with a net debt-to-capital ratio of 34.3%. We had $316.5 million in cash-in equivalents and $1.8 billion available under our $1.9 billion revolving bank credit facility. which doesn't mature for over four years. This provides us with ample flexibility to both grow and return capital to our shareholders. At quarter end, our book value per share was $48.74. We expect this to be approximately $52.50 at fiscal year end. Let me cover the additional items in our guidance that we have not already touched on. Based on the strong pricing in our backlog, we expect our fourth quarter average delivered price to be between $935,000 and $955,000. We have increased the full year average to $920,000 at the midpoint. We expect interest and cost of sales to be approximately 1.8% of home sales revenues in the fourth quarter and for the full year. representing a 40 basis point decline compared to full year 2021. This decline is primarily due to the retirement of higher interest rate debt over the past few years, which has also decreased leverage. We expect to further reduce interest and cost of sales in fiscal year 2023. We project SG&A, as a percentage of home sale revenues to be approximately 8.7% in our fourth quarter and 10.5% for the full year. Our weighted average share count is expected to be 118.5 million for the full year. We expect community count to be approximately 350 at fiscal year end. We've lowered this community count projection due to the impact of entitlement delays and supply chain disruptions impacting land development, and our strategy to intentionally defer the opening of some communities until 2023. Over the past two years, we were able to open communities earlier than normal without models and out-of-sale trailers or even off-site due to frenzied buyer demand. We do not see that continuing into the near future, and we will shift back to our normal practice of opening communities with finished model homes and sales centers that are fully complete. Importantly, we own or control sufficient land for a significant increase in community count in fiscal year 2023. Now let me turn it back to Doug.