Toll Brothers, Inc.

Good morning and welcome to the Toll Brothers third quarter fiscal year 2023 conference call. All participants will be in a 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 1 on your telephone keypad. To withdraw your question, please press star then 2. The company is planning to end the call at 9.30 when the market opens. During the Q&A session, 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, Betsy. Good morning. Welcome and thank you all for joining us. Before I begin, I ask you to read our 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, and many other factors beyond our control that could significantly affect future results. 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. We had another terrific quarter and are very pleased with our fiscal third quarter results. We beat our guidance for home sales revenues, adjusted gross margin, SG&A margin, and earnings. Our quarter end backlog of 7,295 homes and $7.9 billion is strong, and our cancellations remain very low. The market for new homes is solid, and we are well positioned with the right strategy in place to take advantage of it. As a result, we are raising our full year guidance for all of our core home building metrics including deliveries, adjusted gross margin, and SJ&A margin. We now project earnings of between $11.50 and $12 per diluted share in fiscal 2023, and a return on beginning equity of approximately 22%. In the quarter, we delivered 2,524 homes at an average price of $1,006,000, leading to record third quarter home sales revenues of $2.7 billion. Adjusted gross margin was 29.3%, or 140 basis points above last year's third quarter, and our SG&A expense was 8.6% of home sales revenues, 170 basis points better than last year. Our margins continue to benefit from cost controls and greater leverage from higher revenues. With a significant beat on our top line and improved margin performance, we delivered earnings per share of $3.73, a third quarter record. We signed 2,245 net contracts for $2.2 billion in our third quarter, up 77% in units and 30% in dollars compared to last year's third quarter when mortgage rates were much lower in the 5% to 6% range. On a per-community basis, we sold at a pace of 2.2 homes per month compared to 1.3 last year and 2.3 last quarter. Demand was stronger than normal in our third quarter compared to the second, with contracts down only 4% sequentially versus the long-term average of down 15%. Remember, the second quarter is historically stronger than the third since it is in the heart of the spring selling season. So running almost flat Q3 to Q2 is very encouraging, particularly with rates higher in Q3 than Q2. Demand was also solid across both geography and product lines in our third quarter, and we raised price by an average of $20,000. We saw particular strength in the mountain and south regions where we tend to have lower average prices. Due to this shift in mix and notwithstanding the price increase, our average sales price was flat compared to the second quarter. In terms of cadence, we saw a relatively steady number of deposits and contracts each month of the third quarter. Actually, June was our strongest month, when normally July is strongest. Often that is influenced by a sales event, and this year we ran a national sales event in June rather than July. As we start our fourth quarter, demand remains solid. August deposits are usually down 25 to 30% versus July, based on long-term historical trends, as summer winds down and kids return to school. So far in August, deposits are only down 11%, and both physical and web traffic is up slightly compared to July. While it is only three weeks, this is encouraging considering the increase in mortgage rates that has occurred during this period. We attribute the solid demand for new homes, at least in part, to the well-publicized shortage of existing homes for sale. Existing homeowners are clearly reluctant to give up their low-rate mortgages. And while rising rates remain a challenge for the overall industry, they further cement the lock-in effect that has kept resale inventory at historically low levels. This has become a tailwind for homebuilders, and especially the larger, well-capitalized builders who build at lower costs and are better positioned to take advantage of spec building and buying down mortgage rates. The supply, demand, and balance created by low resale inventory compounds the impact of the persistent underbuilding of homes over the past 15 years. Even before resale inventory dropped, there was a structural shortage of anywhere between 3 and 6 million homes in this country. In addition, demographic and migration trends continue to provide long-term support support for the industry with millennials forming families and buying their first home later in life when they have higher incomes and accumulated wealth. Baby boomers who are either retiring or planning for it are also moving as they adjust to their new lifestyles. There also appears to be an increase in generational wealth transfer with parents helping their kids buy homes. All of these factors combined have kept demand for new homes solid in the face of higher rates, and we are benefiting. Our strategy of increasing our supply of spec homes, which we implemented several quarters ago, has helped us meet demand while also helping to improve our cycle times. Our spec homes represented approximately 40% of our orders in the third quarter, and we expect that to continue in the near term. Specs were 28% of deliveries in the third quarter. We define a spec as any home without a buyer that has a foundation poured. We sell our specs at various stages of construction with a preference to sell before we finish the home as many of our buyers want to personalize their homes. In this way, our buyers are able to select their fixtures, appliances, flooring, and other finishing options while we benefit from a faster and more efficient construction schedule. At third quarter end, our backlog stood at $7.9 billion and 7,295 homes. Our cancellation rate as a percentage of backlog was 3.2% in the third quarter down from 3.9% in the second quarter. Our industry low cancellation rate is due to the significant upfront down payments our buyers make, as well as the emotional attachment they form as they personalize their homes with us. Our buyers also tend to be more affluent. In the third quarter, 25% of our buyers paid all cash, up from 23% in the second quarter, and our long-term average of 20%. Buyers who do take a mortgage make higher down payments, with an average LTV of 68% in this past quarter. We are also seeing modest improvements in our cycle times as supply chains and labor constraints continue to ease and as we increase production of spec homes. We expect cycle times to continue to improve as we move forward, which should further benefit our already strong cash flows. Turning to land, at the end of our fiscal third quarter, we owned or controlled 70,200 lots, half of which were controlled and the other half owned. Excluding the 7,295 lots committed to homebuyers in our backlog, our controlled land represents 56% of total lots. Our lot count is down nearly 15% year over year, which reflects our selective approach to buying land and our focus on ROE and capital efficiency. Still, this land position provides us with sufficient land needed for growth in fiscal year 2024 and beyond, and allows us to continue being selective and disciplined in our approach to buying land. Since the start of the third quarter, we've repurchased $163 million of our common stock, bringing our year-to-date repurchase to $265 million at an average price of $68. We have also paid $69 million in dividends year to date. We expect buybacks and dividends to remain an important part of our capital allocation priorities well into the future. As a reminder, we have planned for $400 million of share repurchases in fiscal 2023. Assuming we buy back an additional $144 million at the current price, In the fourth quarter, which would get us to the $400 million for the year, we will have bought back about 5% of our diluted share count at the beginning of the year. With that, I'll turn it over to Marty.

Thanks, Doug. It was a great quarter. We grew earnings per share by 59% and net income by 52% over last year. Home building revenue of $2.7 billion was a third quarter record and increased 19% compared to one year ago. We delivered 2,524 homes in the quarter, up 5% year over year. With the outperformance in the third quarter, we are raising our full-year deliveries guidance. We now expect to deliver between 9,500 and 9,600 homes an increase of approximately 200 homes at the midpoint of our previous guidance. We are also increasing our guidance for full-year average delivered price to between $1,005,000 and $1,015,000. This translates to a home building revenue projection of approximately $9.65 billion at the midpoint for the full year. We signed 2,245 net contracts in the third quarter for $2.2 billion, up 77% in dollars and 30% in units over last year. The average price of contracts signed in the quarter was approximately $964,000, which was down 1.1% compared to our second quarter average price of $975,000. As Doug noted, we actually raised price by an average of $20,000 in the third quarter through base price increases and reduced incentives, which was offset by changes in mix. Turning back to the P&L, pre-tax income was $553 million compared to $366 million in the third quarter of fiscal 2022. Net income was $414.8 million, or $3.73 per share diluted, compared to $273.5 million and $2.35 per share diluted one year ago. Our third quarter adjusted gross margin was 29.3%, compared to 27.9% in the third quarter of 2022. and 160 basis points better than projected. The improvement was due primarily to better cost control and fixed cost leverage on higher-than-expected home sales revenues. We are raising our full-year adjusted gross margin guidance from 27.8% to 28.5%. This 28.5% is also what we expect in our fourth quarter. Note that our fourth quarter gross margin guidance includes the impact of homes that we sold a year ago in a softer sales environment. SG&A as a percentage of revenue was 8.6% in the third quarter compared to 10.3% in the third quarter of last year. And this is 170 basis points better than projected. In dollar terms, our SG&A expense was $4 million lower this quarter compared to the third quarter of fiscal year 22, despite over $400 million of additional home sales revenue and the impact of inflation. As we've pointed out before, we've been very focused on becoming more efficient, and we are now seeing the benefits flow through our results. We are projecting full-year SG&A costs to be approximately 9.4% of home sales revenues which represents a 60 basis point improvement from our prior guidance. For the fourth quarter of fiscal year 2023, we expect SG&A to be approximately 8.8% of home sales revenue. Third quarter JV, land sales, and other income was $39.4 million in the quarter, or $14.4 million above our guidance. We now expect our full-year joint venture land sales and other income to be approximately $105 million, down from the $125 million previously projected. This is due primarily to a challenge market for apartment building asset sales. Our new guidance assumes we close the sale of three stabilized apartment communities that we expect to sell in this fourth quarter. Our tax rate in the third quarter was 25%, 100 basis points better than our guidance. We expect our fourth quarter tax rate to be 26%, which would bring the full year rate to approximately 25.4%. We expect interest and cost of sales to be approximately 1.5% in the fourth quarter and for the full year as we continue to benefit from our reduced leverage. We expect community count to be approximately 375 by fiscal year end, with continued growth in fiscal year 2024. Our weighted average share count is expected to be approximately $111 million for the full year and $109.5 million for the fourth quarter. We reiterate our guidance for approximately $400 million of share repurchases this year, implying approximately $150 million of buybacks in the fourth quarter. Putting this all together, we expect to earn between $11.50 and $12 per share in fiscal year 2023. We expect to achieve a full-year return on beginning equity of approximately 22%. We expect to bring our book value to approximately $65 per share at year end. This would be the second year in a row we earned well over $1 billion, and this is in a period when mortgage rates doubled from slightly over 3% in November of 2021 to their current level around 7.5%. In addition, since 2020, we have generated an average of $1.1 billion of operating cash flow per year, and we expect 2023 to also exceed $1 billion. Turning to the balance sheet, we finished the quarter with a net debt-to-capital ratio of 20.5%, $1 billion in cash and cash equivalents, and $1.8 billion available under our $1.9 billion revolving bank credit facility, providing us with ample flexibility to both grow our business and return capital to stockholders. We also have no significant bank or senior debt maturities due until November 2025, which is fiscal year 26 for us. In recognition of our financial position, the solid demand for new homes, and strong fundamentals underpinning the market, as well as our favorable long-term prospects, Standard & Poor's upgraded our credit ratings to investment grade this quarter. We are now rated investment grade by all three major credit rating agencies. Now let me turn it back to Doug.

Thanks, Marty. Before I open it up for questions, I'd like to recognize the hard work and dedication of all of our great Toll Brothers employees. It is your passion for our business and commitment to our customers that will ensure our continued success. Betsy, 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 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 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 today comes from Raf Jadrosic of Bank of America. Please go ahead.

Hi, good morning. Thanks for taking my question. Good morning, Raf. Doug, I wanted to follow up on a comment you made earlier on the gross margin. You're saying the fourth quarter outlook for 28.5% includes the impact of homes that were sold last year in a softer sales environment. you have more visibility than other builders on the gross margin outlook. How do we think about how that goes going forward, just given that we saw at the beginning of the year the sales environment had definitely improved?

Sure.

So we'll get full guidance in December, as we always do, for 2024. And so we're not going to get ahead of ourselves right now. Marty's comment and our guidance, which is about 80 basis points lower than the 29.3 gross margin we achieved in Q3 for a 28.5 in Q4 was just a reminder that if you go back 12 to 15 months, the market had slowed dramatically. That's when, if you remember back in April of 22, is when rates went up dramatically. And late spring of 22 through the summer and fall, the market softened dramatically. we reminded everyone back then that we were not going to chase the bottom, and we didn't. And so an 80 basis point drop is pretty well range bound when you think about Q4 is going to represent a bit more of the sales that occurred back in that period of time, but again, it's only 80 basis points. Some of Some of the sales from that slower time will continue into the beginning of 24, but we're not going to get into the specific guidance until December on where the first quarter of 24 and the balance of the year comes out. But there is some shorter-term pressure, but the pressure is modest because we did not chase a bottom. Some of the other builders, as you know, had a pretty dramatic drop in margin from the sales that came through that period of time. And as you can see based on our guide for the next quarter, our impact is very minimal.

Thank you. That's very helpful. And then just we've seen an improvement on the backlog conversion over the last few quarters here. How do we think about additional opportunity going forward? Where are you versus your partners? what kind of historical average, and how do we think that could play out over the next few quarters?

Well, Rafe, I think we expect to see better backlog conversion because of reduced cycle times on the to-be-builts. As we are in a more stable supply chain environment, we've addressed some reductions in SKUs, and we're getting better at building the to-be-builts. But the big piece is going to come from more specs. Specs this quarter were 28% of deliveries. We're targeting 40% of sales. We achieved that this quarter. And so there will be 40% of deliveries, and they'll have a little bit less time in backlog, a lot less time in backlog than a 2B bill.

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

Hi, guys. Thanks for taking my questions. This is Andrew Ozzy on for Mike. I just wanted to get a sense of, you know, kind of regionally, market by market, where you're seeing that ability to push price a little bit better and where it's a little bit more stubborn. Thanks.

Sure. So, really pleased nationwide. And by the way, the $20,000 price increase we saw in Q3, I know the question will come up. It's about a $10,000 drop in incentive plus a $10,000 increase in the base price or the sales sheet price. The incentive was about $55,000 in Q2 when it went to $45,000 in Q3, and then the price went up by 10. That's on average. And it's not everywhere. Some areas are more. We still have some locations where we're still doing final and best sealed bid on select communities or select inventory. The best markets, and we mentioned the Mountain and the South had done the best this past quarter. Denver, very strong. Boise, Idaho is back in a big way after taking a pause. Southern California, very strong. Atlanta, New Jersey, and Pennsylvania, very strong. And then all of Florida, a bit softer where we're still feeling a little bit of pain. You know, Phoenix hasn't come back yet. It's better, but it hasn't come back as we look forward to it coming back at some point, but not yet. And then on that list, I'd also throw in Portland, Oregon, which is a very small market for us, but that has been a bit softer.

Thank you for that granularity. I appreciate it. I guess I wanted to ask about the sustainability. Obviously, this was a very nice SG&AB. Maybe if you can bucket out what was driving that and kind of the sustainability going forward.

Sure. So, you know, we talked now for over a year about a commitment and a drive to make Toll Brothers more efficient. And we're not done. But our headcount is down 11% and our business has grown. And there's also lower inside and outside commissions being paid on the sales side. But it is primarily overhead, and we will continue to look for opportunities to do more with less. I'm super proud of the steps we've taken. It will continue, and those are the main drivers of it.

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

Yeah, thanks very much, guys. Obviously, great results. Thanks for all your comments so far. I do think it might be worth sort of thinking about what might happen if you were to see a slowdown in demand. I appreciate that in August, what you shared with us certainly suggests you haven't seen that much of a negative impact from higher rates. But, you know, I think it's also fair to say we don't really know what's going to happen with rates in the in the next few months. And so hypothetically, if you did see buyer demand slow, do you look back upon the strategy that you pursued last year where you let orders slow significantly rather than get aggressive with incentives? Do you look back on that and say, we were vindicated that that was the right thing to do, And if demand slows in the months ahead, we should expect you to do a very similar thing that you did last year with respect to letting your order slow but holding the line on price.

Yes. I'm very proud of this management team's very thoughtful decisions around our strategy to not chase the bottom line. I think we ramped up our spec strategy at the right time. When building costs were beginning to come down, supply chain was easing. And so, yes, we are a margin-focused builder with an understanding, of course, that capital efficiency, ROE, buying land the right way, critically important to long-term success. But our houses are big. They're complicated. They have a lot of upgrades and features, and they take a while to build. And we're not giving them away. We're not going to chase the bottom. That doesn't mean we're going to have our head in the sand and not have more incentives in a soft market than we had in a good market. I mean, that's part of the conversation we've had around this modest drop in margin next quarter. But, yes, I think the strategy has worked, and we will continue with that strategy if your hypothetical was to prove true. Excellent.

Thanks so much for that. It was very clear. And then taking it a step further, can we talk a little bit more about capital allocation and Again, under this hypothetical scenario, which hopefully doesn't actually manifest. If we do enter a softer demand patch, you've been pretty good with capital allocation in terms of dividends and buybacks and so forth. Would you likely, though, shift even more capital to buybacks as opposed to investing in land, particularly since you have a lot more cash, actually, than you did last year? Absolutely. More broadly, with emerging long-only interest in the space, do you feel maybe the time is right to pursue a more asset-light strategy that might bring your year's supply of owned land down to like two years or less as we think about the longer-term positioning of the company strategy?

Yes. Our next debt maturity, as Marty said, is November of 2025, which is fiscal 26. We've been generating more than $1 billion of free cash flow for the last several years, three or four years. We have dropped our lot count by 15%, still being able with the land we control to to grow community last year, this year, next year, and beyond. Our land teams are very good at structuring land deals to be more capital efficient. We're doing joint ventures. We're relying upon land bankers. We're getting purchase money mortgages from land sellers. We're buying improved lots just in time. Can we get it down to two years owned? That's harder to do when you control Maine and Maine. That's all I'll say. We're moving in the direction of having less owned land, but I'm not going to agree that two years is possible only because our business model, where we buy land, is a bit different. Our land is very special, it's very unique, and not every deal lines up with somebody there to feed you finished lots. at the corner of Maine and Maine, in Greenwich, Connecticut, Princeton, New Jersey, Irvine, California. Radnor, Pennsylvania. Radnor, Pennsylvania. Take it home. But we are moving in that direction, and you will continue to see that effort as we go forward.

The next question comes from Joe Allersmeyer with Deutsche Bank. Please go ahead.

Hey, good morning, everybody. Congrats on the results. Thanks, Joe. I wanted to dig in on that point you made earlier about the higher down payments, lower loan to values. If you could maybe just hit on the psychology of this, whether you feel like your buyers are different in this regard, meaning, again, for those three out of four that are taking a mortgage, a 20% down payment may be a certain monthly payment, but are we sort of to infer that Even with rates at higher levels, there is sort of cash on this buyer's balance sheet that they're using to knowingly pull forward that cash outlay and just reduce their overall debt service.

Joe, for sure, and to put it in – I know I said it, but I'll remind everybody. Long-term, 20% of our clients were all cash. This quarter was 25%. And there's a good reason for it. I have the money. I'm wealthy. And I don't love a 7.5% rate, so I'll put more of my own money to work and less of the bank's money to work. Our LTV has gone from 70%, this is for those that do get a mortgage, to 68%. Same reason. I'm going to put a little bit more down. Our buyers are clearly wealthier. They have equity in their homes. Remember... The resale markets, it's very interesting, but good, solid, used homes, sorry, we like that term as new home builders, they sell, and they're selling quickly, and they're selling, in many cases, above asking price. What is sitting on the market is the old, tired inventory, which actually makes it even better for us because not only is the resale market really tight, of what's sitting on the resale market is lousy. We hope our buyers have some of the better homes that are moving faster, and therefore they may be getting a bit more equity out of their home than they had thought. So they're wealthier, they're getting a bit more equity out of the existing home, and they want to move. I talked about it on the last call. Buying a house for people besides Marty Conner, our CFO... is not a strict financial decision. It's a family decision. It's emotional. It's moving on with your life. It's getting the kids in the better school. It's moving down as an empty nester. It's buying a second home. And all of that wins. It trumps the straight financial calculation on the back of a napkin. And where do they go? They may start on a resale market. They can't find anything. We're really proud of what we do. We're really good at what we do. We have groupies. People want and aspire to get into the Toll Brothers house. We sell 10,000 a year, hope to sell 12,000, then 14, then 16. But in the scheme of the million-plus houses, new homes that are sold in this country in a year, We are a small fraction of it, and there are plenty of buyers still out there that are in the market even at 7.5%. And we're benefiting from that, and that's going to continue as our brand gets better and better.

Yeah, makes a ton of sense. I'm glad you sort of took it that direction because I think a lot of times folks are hearing the word tailwind. and maybe understanding it, at least on the existing home inventory point, to mean future headwind, right? And I'm just curious if you see it this way. It sounds like you don't. I don't want to put words in your mouth, but maybe if you could just, in your answer, sort of touch on what you see as the most likely scenario for existing home inventory rising and whether or not you think for toll, this actually would represent sort of a follow-on tailwind because it means more of your prospective buyers are shaken loose from those existing homes.

Yeah, I'm not suggesting that a 7.5% market is good for the industry. It has proven to be good for the new home builders because the wider the spread between the mortgage of the existing homeowner and today's new rate, the more lock-in effect is occurring. The resale market is tighter in a 7.5% rate environment than it was in a 6.5% because there's more people that are locking in. But all day long, I will take a 5.25% rate market that frees up more existing homeowners to want to move up into our homes. Of course I'll take that. And will there be a bit more competition on the resale market because it is freeing up? Yes. But there will be many more of those homeowners that want to move up where overall we will benefit and have even better results. We're just very pleased with how well we're doing considering how fast the rates have gone up, how they continue to go up, And our traffic is good, our web traffic is good, and our sales are good. And it's primarily driven by what I said. There are still buyers out there. They have very few options. They therefore find their way to us, and they fall in love, as we knew they would.

The next question comes from Mike Dahl with RBC Capital Markets. Please go ahead.

Morning.

Thanks for taking my questions. Um, like just to follow up on, um, kind of the LTV cash buyer dynamic. Um, one of the interesting things about this recent rise in rates is I think at various points over the last year, you know, the conventional 30 year had gone above seven, but you look at arms or jumbos or FHA VA, and they had kind of lived more in the like six, six and a half range. Now all rates have kind of surpassed seven. The spreads have all compressed. Can you just talk a little about, you know, have you seen that, like, as people are putting that little extra money down, are you seeing people shift, you know, out of jumbos into conventionals or any shifts in loan products? And part two is, you know, given there's not as much, you know, hypothetical arb between jumping around products today, have you started to lean back into your buy downs over the last month as rates have risen?

Mike, I'll take a shot at the first half of that in terms of what we have seen buyers do. Often when rates rise, we would see them gravitate to adjustable rates. And we haven't seen that because it hasn't been attractive. The spread between adjustable and fixed just has not been substantial enough to motivate somebody to go in that direction. We also just came through a period where jumbos were less expensive than conventionals. And so in 20, 21, 22, we saw buyers borrow more so that you could get to the lower jumbo rate. Right now, we're seeing the inverse of that. We are seeing them increase their down payments and reduce what they're borrowing so they can stay in conventional to a greater extent.

With respect to buy-downs and whether we've accelerated that lately, the answer is no. The buy-down program doesn't work for the build-to-order business because you can't buy down a rate that's 12, 14 months out. But it does work well... as a lead marketing headline for the spec inventory that can deliver over a four-month period of time. So we may advertise for a spec inventory that will take a 7.5% rate down to 5.5%. But the cost of that, and let's just say it's maybe $40,000 or $45,000, on the million-dollar home that Toll sells, it doesn't capture the buyer's attention as much as them deciding, well, can I use that $45,000 and buy finishes in the house or do something that is long-term? And I think the reason for that is they don't look at the 7.5% rate as a 30-year rate they're stuck with. They look at it as a shorter term timeframe where they're going to refi out of it when the rate comes down. And so why use my incentive to buy a rate down that I'm not going to have for a long period of time? That doesn't mean some don't take advantage of the buy down, but it's not like all of our spec inventory is being sold through the buy down program and that's where all the incentive is going. It's a marketing headline. It grabs attention. It starts conversation. Some take it, but more flip the dollar value of the buy-down into upgrades or features within the home.

Yeah, that's interesting. Thanks. And maybe that's also a point of differentiation for your wealthier buyer. Yeah.

The second question... Right, because it's not a straight affordability issue where they have to have the 4.5% rate to get approved. It's more discretionary as to where do they want to spend the incentive.

Okay. Second question, and maybe, Marty, this is just a technicality or a clarification on the earnings guide. $1,150 at the low end. If I bridge your You know, if I bridge your operating metrics and account for the year-to-date charges, I think you'd get to a number that's still maybe 30 cents, give or take, north of that. So is that really just hedging for, you know, you're saying your guides, including the three buildings that you anticipate to close, is it as simple as you're hedging in case those don't close in the fourth quarter, or is there something else in the core operating metrics where you think there could be some give or take?

Well, I think we're trying to get to some rounded numbers. $11.50 to $12 is pretty rounded. I think there's some caution in there if something doesn't go according to plan. We don't project any impairments. We don't expect any, but there may be some. And so it's as simple as that, Mike. I think you're reading much more into it than you should.

That's helpful. Thanks.

You're welcome.

The next question comes from Ken Zener with Seaport Research. Please go ahead.

Good morning, everybody. Good morning, Ken. How are you? I'm doing well.

Appreciate all your comments. I wonder if you could quantify, you know, you've mentioned base pricing. Could you give us a sense, you know, this quarter, last quarter versus a longer-term trend? What's your kind of base price and how much of options traditionally been a percent of your sales? And the reason I'm asking that is, you know, obviously with this liquidity from your buyers, options historically have a higher margin profile. So I'm trying to sense, you know, if you're seeing greater share of options and what the impact is historically on your gross margins. So you can give us some context. Is that my first question?

Sure. Long-term average upgrades, and that includes the lot premium, is 21%.

Q3, it was 27%.

That's counterintuitive, right? With rates going up, you think maybe people are moving towards smaller homes, more affordable homes, not the case. And that goes right to the wealth of our client and how we do it. This is their dream move, and if they can afford it, they're going to reach. And so I'm not telling you that trend is going to continue. I don't know, but those are the numbers. 21% long-term average upgrades, Q3 27%. And yes, the margin coming out of our design studios, where we send the client to pick all their beautiful finishes, is higher than the company's gross margin.

And the lot premium is 100% gross margin.

And the lot premium is... What is the... Well, I guess, following up on that, what is the split between you know land and the physical upgrades if you would and then the second question i really want to address is you talked about 2200 um you know pre-sale units last quarter i don't know if you guys are updating us on inventory units yet um that would be useful but could you maybe talk about where we are in terms of those pre-sale starts as well as that land upgrade mix if you could thank you

Greg or... So I think we have approximately 2,400 specs under construction compared to the 2,200 you mentioned. And we have around 400 at CO or beyond. Compared to approximately... Compared to 350? Yes, last quarter. Last quarter. In terms of a breakdown of the option premium versus things in the house... What do we got there? You say it.

Yeah, sure. Yeah, Ken. So the base house prices, you know, for the quarter was call it, you know, high eights, $870,000. So the lot premium this quarter, again, at 100% gross margin was almost $60,000. And then the option upgrades were around $175,000. Now that will include both the design studio and the structural options. Thanks.

The next question comes from Alex Barron with Housing Research Center. Please go ahead.

Thanks, everybody.

I was hoping we could focus a little bit on your ASP trends, especially in orders. I'm guessing July's order a year ago was a bit distorted, maybe by cancellations, maybe not. Maybe you can clarify that. But, you know, clearly the trend has gone from the $1.1 million towards $960,000. I'm just trying to understand that better. Is that due to more specs that are lower priced? Are you guys building smaller homes? Is it, you know, a more intentional thing that's going to continue or do you feel like the prices are here to stay at that level of the orders this quarter? Just, you know, some better understanding would be helpful.

It's really a function of mix, Alex. I think, you know, we talked about the success we've had in the mountain region and in the south where our prices are generally lower than they are in California or in the north. And so as the business has shifted to those geographies and as we've increased the affordable luxury market line as a percentage of total, the average price mathematically comes down. It is not a function of building house type A this year at 4,000 square feet and last year it was 4,200 square feet. It's really just a function of the mix shift from a geography perspective as well as a market segment perspective.

Okay, so LL being equal, you don't necessarily see these trends taking the price further down necessarily, or possibly yes?

I think they could modestly go lower, but again, it can be very lumpy quarter to quarter based on what is delivering. We are now north of 40% affordable luxury, and I think we've said we're comfortable with affordable luxury getting as high as half of our business. And we also have to be careful how we define affordable luxury now because it's gone up fairly dramatically in price through the COVID years. And it's a very gray area. We don't market it to the public as affordable luxury. It's just an internal term to help us with how we prepare for marketing and how fancy we decorate the model homes and build the entrance features. And also, I think it helps the street in understanding this move we made in price. But we're close to where I think we want to be long-term in terms of the mix between the affordable luxury, the true luxury, the empty nester move down, et cetera. So there could be some modest drop in price, but I think you've seen most of it already.

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

Good morning, guys. Thank you for taking my question. I guess the first one is, that seasonality has certainly been a little bit tricky over the past few quarters, and you guys did better than normal seasonality in the most recent quarter. Just curious how you're thinking about absorption as we move into the fourth quarter, given what you're seeing out there in the market today.

It feels right now, John, like it's trending very similar to Q3. I think our comments around the three weeks of August helped explain that, You know, we're running at a pace right now of about 24 homes sold per year per community. Last year was 25 homes sold per year per community, so it's relatively flat, and that's, you know, that's what we're projecting here. The 2010 to 2019 timeframe, again, pre-COVID, we tracked at about 22 sales per community per year. So we're, you know, modestly call it 10% or so above that. But that's what we anticipate for the fourth quarter.

Okay, that's helpful. And then you guys mentioned cycle times improving. Just wondering if you could help us kind of quantify, you know, where they are today maybe versus last quarter, maybe pre-COVID. And then, you know, how much of that improvement is, you know, getting better on the to-be-built side versus just, you know, offering more spec?

So cycle times are coming down slowly. We're picking up a couple of weeks. For the next home sold, the range is about 10 to 11 months. I think the exact number, I think it's 315 days is what we project when you average out the entire company. That's obviously down dramatically from the COVID years, and it's similar to what we saw pre-COVID, but we are more efficient. There's no question. We've changed our operating model in the field, and we're enjoying those efficiencies. The spec build as a larger percentage of our business is certainly helping because we can get the house started without the customer making all the selections. We can build the house without the customer visiting every Sunday afternoon and coming back at us with their own little punch list. And the houses are less complicated because we're not loading them up as much as some of our clients do when they run through the design studios. So that is certainly helping. We have less SKUs. We have optimized all of our plans. We have less homes that we offer. And all of that is contributing. And I do feel like it's just the beginning, particularly with almost half our business being affordable luxury, which means smaller, simpler homes, and this operations focus on becoming a better production builder, there's still room to go. But I am encouraged that we're down a few weeks and it's trending in an even better direction.

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

Thank you, Betsy. Thank you, everyone. We appreciate all your great questions and all of your interest. We're always here, as you know, to answer any additional questions offline. I hope everyone had a wonderful summer. Tough to believe it's over. And we'll see you through the fall and back on a call in December. So thanks again. Take care.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect. Thank you. you Thank you. Thank you. Thank you. Good morning and welcome to the Toll Brothers third quarter fiscal year 2023 conference call. All participants will be in a 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 session, 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, Betsy. Good morning. Welcome and thank you all for joining us. Before I begin, I ask you to read our 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, and many other factors beyond our control that could significantly affect future results. With me today are Marty Connor, 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. We had another terrific quarter and are very pleased with our fiscal third quarter results. We beat our guidance for home sales revenues, adjusted gross margin, SG&A margin, and earnings. Our quarter end backlog of 7,295 homes and $7.9 billion is strong, and our cancellations remain very low. The market for new homes is solid, and we are well positioned with the right strategy in place to take advantage of it. As a result, we are raising our full year guidance for all of our core home building metrics including deliveries, adjusted gross margin, and SJ&A margin. We now project earnings of between $11.50 and $12 per diluted share in fiscal 2023, and a return on beginning equity of approximately 22%. In the quarter, we delivered 2,524 homes at an average price of $1,006,000, leading to record third quarter home sales revenues of $2.7 billion. Adjusted gross margin was 29.3%, or 140 basis points above last year's third quarter, and our SG&A expense was 8.6% of home sales revenues, 170 basis points better than last year. Our margins continue to benefit from cost controls and greater leverage from higher revenues. With a significant beat on our top line and improved margin performance, we delivered earnings per share of $3.73, a third quarter record. We signed 2,245 net contracts for $2.2 billion in our third quarter, up 77% in units and 30% in dollars compared to last year's third quarter when mortgage rates were much lower in the 5% to 6% range. On a per community basis, we sold at a pace of 2.2 homes per month compared to 1.3 last year and 2.3 last quarter. Demand was stronger than normal in our third quarter compared to the second, with contracts down only 4% sequentially versus the long-term average of down 15%. Remember, the second quarter is historically stronger than the third since it is in the heart of the spring selling season. So running almost flat Q3 to Q2 is very encouraging, particularly with rates higher in Q3 than Q2. Demand was also solid across both geography and product lines in our third quarter, and we raised price by an average of $20,000. We saw particular strength in the Mountain and South regions, where we tend to have lower average prices. Due to this shift in mix and notwithstanding the price increase, our average sales price was flat compared to the second quarter. In terms of cadence, we saw a relatively steady number of deposits and contracts each month of the third quarter. Actually, June was our strongest month, when normally July is strongest. Often that is influenced by a sales event, and this year we ran a national sales event in June rather than July. As we start our fourth quarter, demand remains solid. August deposits are usually down 25 to 30% versus July, based on long-term historical trends, as summer winds down and kids return to school. So far in August, deposits are only down 11%, and both physical and web traffic is up slightly compared to July. While it is only three weeks, this is encouraging considering the increase in mortgage rates that has occurred during this period. We attribute the solid demand for new homes, at least in part, to the well-publicized shortage of existing homes for sale. Existing homeowners are clearly reluctant to give up their low-rate mortgages. And while rising rates remain a challenge for the overall industry, they further cement the lock-in effect that has kept resale inventory at historically low levels. This has become a tailwind for home builders, and especially the larger, well-capitalized builders who build at lower costs and are better positioned to take advantage of spec building and buying down mortgage rates. The supply-demand imbalance created by low resale inventory compounds the impact of the persistent underbuilding of homes over the past 15 years. Even before resale inventory dropped, there was a structural shortage of anywhere between 3 and 6 million homes in this country. In addition, demographic and migration trends continue to provide long-term support support for the industry with millennials forming families and buying their first home later in life when they have higher incomes and accumulated wealth. 80 boomers who are either retiring or planning for it are also moving as they adjust to their new lifestyles. There also appears to be an increase in generational wealth transfer with parents helping their kids buy homes. All of these factors combined have kept demand for new homes solid in the face of higher rates, and we are benefiting. Our strategy of increasing our supply of spec homes, which we implemented several quarters ago, has helped us meet demand while also helping to improve our cycle times. Our spec homes represented approximately 40% of our orders in the third quarter and we expect that to continue in the near term. Specs were 28% of deliveries in the third quarter. We define a spec as any home without a buyer that has a foundation poured. We sell our specs at various stages of construction with a preference to sell before we finish the home, as many of our buyers want to personalize their home. In this way, our buyers are able to select their fixtures, appliances, flooring, and other finishing options while we benefit from a faster and more efficient construction schedule. At third quarter end, our backlog stood at $7.9 billion and 7,295 homes. Our cancellation rate as a percentage of backlog was 3.2% in the third quarter, down from 3.9% in the second quarter. Our industry low cancellation rate is due to the significant upfront down payments our buyers make, as well as the emotional attachment they form as they personalize their homes with us. Our buyers also tend to be more affluent. In the third quarter, 25% of our buyers paid all cash, up from 23% in the second quarter, and our long-term average of 20%. Buyers who do take a mortgage make higher down payments, with an average LTV of 68% in this past quarter. We are also seeing modest improvements in our cycle times as supply chains and labor constraints continue to ease, and as we increase production of spec homes. We expect cycle times to continue to improve as we move forward, which should further benefit our already strong cash flows. Turning to land, at the end of our fiscal third quarter, we owned or controlled 70,200 lots, half of which were controlled and the other half owned. Excluding the 7,295 lots committed to homebuyers in our backlog, our controlled land represents 56% of total lots. Our lot count is down nearly 15% year over year, which reflects our selective approach to buying land and our focus on ROE and capital efficiency. This land position provides us with sufficient land needed for growth in fiscal year 2024 and beyond, and allows us to continue being selective and disciplined in our approach to buying land. Since the start of the third quarter, we've repurchased $163 million of our common stock, bringing our year-to-date repurchase of to $265 million at an average price of $68. We have also paid $69 million in dividends year-to-date. We expect buybacks and dividends to remain an important part of our capital allocation priorities well into the future. As a reminder, we have planned for $400 million of share repurchases in fiscal 2023. Assuming we buy back an additional $144 million at the current price in the fourth quarter, which would get us to the $400 million for the year, we will have bought back about 5% of our diluted share count at the beginning of the year. With that, I'll turn it over to Marty.

Thanks, Doug. It was a great quarter. We grew earnings per share by 59% and net income by 52% over last year. Home building revenue of $2.7 billion was a third quarter record and increased 19% compared to one year ago. We delivered 2,524 homes in the quarter, up 5% year over year. With the outperformance in the third quarter we are raising our full-year deliveries guidance. We now expect to deliver between 9,500 and 9,600 homes, an increase of approximately 200 homes at the midpoint of our previous guidance. We are also increasing our guidance for full-year average delivered price to between $1,005,000 and $1,015,000. This translates to a home building revenue projection of approximately $9.65 billion at the midpoint for the full year. We signed 2,245 net contracts in the third quarter for $2.2 billion, up 77% in dollars and 30% in units over last year. The average price of contracts signed in the quarter was approximately $964,000, which was down 1.1% compared to our second quarter average price of $975,000. As Doug noted, we actually raised price by an average of $20,000 in the third quarter through base price increases and reduced incentives, which was offset by changes in mix. Turning back to the P&L, pre-tax income was $553 million compared to $366 million in the third quarter of fiscal 2022. Net income was $414.8 million, or $3.73 per share diluted, compared to $273.5 million and $2.35 per share diluted one year ago. Our third quarter adjusted gross margin was 29.3%, compared to 27.9% in the third quarter of 2022, and 160 basis points better than projected. The improvement was due primarily to better cost control and fixed cost leverage on higher than expected home sales revenues. We are raising our full year adjusted gross margin guidance from 27.8% 28.5%. This 28.5% is also what we expect in our fourth quarter. Note that our fourth quarter gross margin guidance includes the impact of homes that we sold a year ago in a softer sales environment. SG&A as a percentage of revenue was 8.6% in the third quarter compared to 10.3% in the third quarter of last year. and this is 170 basis points better than projected. In dollar terms, our SG&A expense was $4 million lower this quarter compared to the third quarter of fiscal year 22, despite over $400 million of additional home sales revenue and the impact of inflation. As we've pointed out before, we've been very focused on becoming more efficient and we are now seeing the benefits flow through our results. We are projecting full-year SG&A costs to be approximately 9.4% of home sales revenues, which represents a 60 basis point improvement from our prior guidance. For the fourth quarter of fiscal year 2023, we expect SG&A to be approximately 8.8% of home sales revenues. Third quarter JV, land sales, and other income was $39.4 million in the quarter, or $14.4 million above our guidance. We now expect our full year joint venture land sales and other income to be approximately $105 million, down from the $125 million previously projected. This is due primarily to a challenged market for apartment building asset sales. Our new guidance assumes we close the sale of three stabilized apartment communities that we expect to sell in this fourth quarter. Our tax rate in the third quarter was 25%, 100 basis points better than our guidance. We expect our fourth quarter tax rate to be 26%, which would bring the full year rate to approximately 25.4%. We expect interest in cost of sales be approximately 1.5% in the fourth quarter and for the full year as we continue to benefit from our reduced leverage. We expect community count to be approximately 375 by fiscal year end, with continued growth in fiscal year 2024. Our weighted average share count is expected to be approximately $111 million for the full year and $109.5 million for the fourth quarter. We reiterate our guidance for approximately $400 million of share repurchases this year, implying approximately $150 million of buybacks in the fourth quarter. Putting this all together, we expect to earn between $11.50 and $12 per share in fiscal year 2023. We expect to achieve a full-year return on beginning equity of approximately 22%, We expect to bring our book value to approximately $65 per share at year end. This would be the second year in a row we earned well over $1 billion. And this is in a period when mortgage rates doubled from slightly over 3% in November of 2021 to their current level around 7.5%. In addition, since 2020, we have generated an average of $1.1 billion of operating cash flow per year. and we expect 2023 to also exceed $1 billion. Turning to the balance sheet, we finished the quarter with a net debt-to-capital ratio of 20.5%, $1 billion in cash and cash equivalents, and $1.8 billion available under our $1.9 billion revolving bank credit facility, providing us with ample flexibility to both grow our business and return capital to stockholders. We also have no significant bank or senior debt maturities due until November 2025, which is fiscal year 26 for us. In recognition of our financial position, the solid demand for new homes, and strong fundamentals underpinning the market, as well as our favorable long-term prospects, Standard & Poor's upgraded our credit ratings to investment grade this quarter. We are now rated investment grade by all three major credit rating agencies. Now let me turn it back to Doug.

Thanks, Marty. Before I open it up for questions, I'd like to recognize the hard work and dedication of all of our great Toll Brothers employees. It is your passion for our business and commitment to our customers that will ensure our continued success. Betsy, 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 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 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 today comes from Raf Jadrosic of Bank of America. Please go ahead.

Raf Jadrosic Hi. Good morning. Thanks for taking my question. Doug, I wanted to follow up on a comment you made earlier on the gross margin. You're saying the fourth quarter outlook for 28.5% includes the impact of homes that were sold last year in a softer sales environment. You have more visibility than other builders on the gross margin outlook. How do we think about how that goes going forward, just given that we saw at the beginning of the year the sales environment definitely improved?

Sure.

So we'll get full guidance in December, as we always do, for 2024 outlook. and so we're not going to get ahead of ourselves right now. Marty's comment and our guidance, which is about 80 basis points lower than the 29.3 gross margin we achieved in Q3 for a 28.5 in Q4, was just a reminder that if you go back 12 to 15 months, the market had slowed dramatically. That's when, if you remember, back in April of 22, is when rates went up dramatically, and late spring of 22 through the summer and fall, you know, the market softened dramatically. We reminded everyone back then that we were not going to chase the bottom, and we didn't. And so an 80 basis point drop, you know, is pretty well range bound when you think about Q4 is going to represent you know, a bit more of the sales that occurred back in that period of time, but it's, again, it's only 80 basis points. You know, some of the sales from that slower time will continue into the beginning of 24, but we're not going to get into the specific guidance until December on where, you know, the first quarter of 24 and the balance of the year, you know, comes out. But But there is some shorter-term pressure, but the pressure is modest because, you know, we did not chase a bottom. Some of the other builders, as you know, had a pretty dramatic drop in margin from the sales that came through that period of time. And as you can see based on our guide for the next quarter, our impact is very minimal.

Thank you. That's very helpful. And then just we've seen an improvement on the backlog conversion over the last few quarters here. How do we think about additional opportunity going forward? Where are you versus your kind of historical average, and how do we think that could play out over the next few quarters?

Well, Rafe, I think we expect to see better backlog conversion Because of reduced cycle times on the to-be-builts, as we are in a more stable supply chain environment, we've addressed some reductions in SKUs, and we're getting better at building the to-be-builts. But the big piece is going to come from more specs. Specs this quarter were 28% of deliveries. We're targeting 40% of sales. We achieved that this quarter. And so there'll be 40% of deliveries and they'll have a little bit less time in backlog, a lot less time in backlog than a 2B bill.

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

Hi, guys. Thanks for taking my questions. This is Andrew Ozion for Mike. I just wanted to get a sense of you know, kind of regionally, market by market, where you're seeing that ability to push price a little bit better and where it's a little bit more stubborn. Thanks.

Sure. So, really pleased nationwide. And by the way, the $20,000 price increase we saw in Q3, I know the question will come up, it's about a $10,000 drop in incentive plus a $10,000 increase in the base price or the sales sheet price. The incentive was about $55,000 in Q2 when it went to $45,000 in Q3, and then the price went up by 10. That's on average. And it's not everywhere. Some areas are more. We still have some locations where we're still doing final and best sealed bid, on select communities or select inventory. The best markets, and we mentioned the Mountain and the South had done the best this past quarter. Denver, very strong. Boise, Idaho is back in a big way after taking a pause. Southern California, very strong. Atlanta. New Jersey and Pennsylvania, very strong, and then all of Florida. A bit softer, where we're still feeling a little bit of pain. You know, Phoenix hasn't come back yet. It's better, but it hasn't come back as we look forward to it coming back at some point, but not yet. And then on that list, I'd also throw in Portland, Oregon, which is a very small market for us. but that has been a bit softer.

Thank you for that granularity. I appreciate it. I guess I wanted to ask about the sustainability. Obviously, this was a very nice SG&AB. Maybe if you can bucket out what was driving that and kind of the sustainability going forward.

Sure. So, you know, we talked now for over a year about a commitment and a drive to make Toll Brothers more efficient. And we're not done. But our headcount is down 11%, and our business has grown. And there's also lower inside and outside commissions being paid on the sales side. But it is primarily overhead. And we will continue to look for opportunities to do more with less. I'm super proud of the steps we've taken. It will continue. And those are the main drivers of it.

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

Yeah, thanks very much, guys. Obviously, great results. Thanks for all your comments so far. I do think it might be worth sort of thinking about what might happen if you were to see a slowdown in demand. I appreciate that in August what you shared with us certainly suggests you haven't seen that much of a negative impact from higher rates. But I think it's also fair to say we don't really know what's going to happen with rates in the next few months. And so hypothetically, if you did see buyer demand slow, Do you look back upon the strategy that you pursued last year where you let orders slow significantly rather than get aggressive with incentives? Do you look back on that and say, we were vindicated that that was the right thing to do, and if demand slows in the months ahead, we should expect you to do a very similar thing that you did last year with respect to letting your orders slow but holding the line on price?

Yes. I'm very proud of this management team's very thoughtful decisions around our strategy to not chase the bottom. I think we ramped up our spec strategy at the right time when building costs were beginning to come down, supply chain was easing. And so, yes, we are a margin-focused builder with an understanding, of course, that capital efficiency, ROE, buying land the right way is critically important to long-term success. But our houses are big. They're complicated. They have a lot of upgrades and features, and they take a while to build. And

We're not giving them away.

We're not going to chase the bottom. That doesn't mean we're going to have our head in the sand and not have more incentives in a soft market than we had in a good market. I mean, that's part of the conversation we've had around this modest drop in margin next quarter. But, yes, I think the strategy has worked. And we will continue with that strategy if your hypothetical was to prove true. Excellent.

Thanks so much for that. It was very clear. And then taking it a step further, can we talk a little bit more about capital allocation, again, under this hypothetical scenario, which hopefully doesn't actually manifest? If we do enter a softer demand patch, you've been pretty good with capital allocation in terms of dividends and buybacks and so forth. Would you likely, though, shift even more capital to buybacks as opposed to investing in land, particularly since you have a lot more cash, actually, than you did last year? And more broadly, with emerging long-only interest in the space, do you feel maybe the time is right to pursue a more asset-light strategy that might bring your year's supply of as we think about the longer-term positioning of the company strategy?

Yes. Our next debt maturity, as Marty said, is November of 2025, which is fiscal 26. We've been generating more than $1 billion of free cash flow for the last several years, three or four years. We have dropped our lot count by 15%. Still being able with the land we control to grow community count last year, this year, next year, and beyond. Our land teams are very good at structuring land deals to be more capital efficient. We're doing joint ventures. We're relying upon land bankers. We're getting purchase money mortgages from land sellers. We're buying improved lots just in time. Can we get it down to two years owned? That's harder to do when you control Maine and Maine. That's all I'll say. We're moving in the direction of having less owned land, but I'm not going to agree that two years is possible only because our business model where we buy land is a bit different. Our land is very special. It's very unique, and not every deal lines up with somebody there to feed you finished lots at the corner of Maine and Maine in Greenwich, Connecticut, Princeton, New Jersey, Irvine, California. Radnor, Pennsylvania. Radnor, Pennsylvania. Take it home. But we are moving in that direction, and you will continue to see that effort as we go forward.

The next question comes from Joe Allersmeyer with Deutsche Bank. Please go ahead.

Hey, good morning, everybody. Congrats on the results. Thanks, Joe. I wanted to dig in on that point you made earlier about the higher down payments, lower loan-to-values. If you could maybe just hit on the psychology of this, whether you feel like your buyers are different in this regard or Meaning, again, for those three out of four that are taking a mortgage, a 20% down payment may be a certain monthly payment, but are we sort of to infer that even with rates at higher levels, there is sort of cash on this buyer's balance sheet that they're using to knowingly pull forward that cash outlay and just reduce their overall debt service?

Joe, for sure, and to put it in, I know I said it, but I'll remind everybody, long-term 20% of our clients were all cash. This quarter was 25%. And there's a good reason for it. I have the money. I'm wealthy. And I don't love a 7.5% rate, so I'll put more of my own money to work and less of the bank's money to work. Our LTV has gone from 70%, this is for those that do get a mortgage, to 68%. Same reason. I'm going to put a little bit more down. Our buyers are clearly wealthier. They have equity in their homes. Remember, the resale markets, it's very interesting, but good, solid, used homes, sorry, we like that term as new home builders, they sell, and they're selling quickly, and they're selling, in many cases, above asking price. What is sitting on the market is the old tired inventory, which actually makes it even better for us because not only is the resale market really tight, but the quality of what's sitting on the resale market is lousy. We hope our buyers have some of the better homes that are moving faster, and therefore they may be getting a bit more equity out of their home than they had thought. So they're wealthier, they're getting a bit more equity out of the existing home, And they want to move. I talked about it on the last call. Buying a house for people besides Marty Conner, our CFO, is not a strict financial decision. It's a family decision. It's emotional. It's moving all of your life. It's getting the kids in the better school. It's moving down as an empty nester. It's buying a second home. And all of that wins. It trumps It trumps the straight financial calculation on a back of a napkin. And where do they go? They may start on a resale market. They can't find anything. We're really proud of what we do. We're really good at what we do. We have groupies. People want and aspire to get into the Toll Brothers house. We sell 10,000 a year, hope to sell 12,000, then 14, then 16. But in a scheme... Of the million-plus houses, new homes that are sold in this country in a year, we are a small fraction of it, and there are plenty of buyers still out there that are in the market even at 7.5%. And we're benefiting from that, and that's going to continue as our brand gets better and better.

Yeah, it makes a ton of sense. I'm glad you sort of took it that direction because I think a lot of times folks are hearing the word tailwind and maybe understanding it, at least on the existing home inventory point, to mean future headwind, right? And I'm just curious if you see it this way. It sounds like you don't. I don't want to put words in your mouth, but maybe if you could just, in your answer, sort of touch on what you see as the most likely scenario for existing home inventory rising and whether or not you think for toll this actually would represent sort of a follow-on tailwind because it means more of your prospective buyers are shaken loose from those existing homes. Thanks.

Yeah, I'm not suggesting that a 7.5% market is good for the industry. It has proven to be good for the new home builders because the wider the spread between mortgage buyers of the existing homeowner and today's new rate, the more lock-in effect is occurring. So the resale market is tighter in a 7.5% rate environment than it was in a 6.5% because there's more people that are locking in. But all day long, I will take a 5.25 rate market that frees up more existing homeowners to want to move up into our homes, of course I'll take that. And will there be a bit more competition on the resale market because it is freeing up? Yes. But there will be many more of those homeowners that want to move up where overall we will benefit and have even better results. We're just very pleased with how well we're doing, considering how fast the rates have gone up, how they continue to go up, and our traffic is good, our web traffic is good, and our sales are good. And it's primarily driven by what I said. There are still buyers out there. They have very few options. They therefore find their way to us, and they fall in love, as we knew they would.

The next question comes from Mike Dahl with RBC Capital Markets. Please go ahead.

Morning.

Thanks for taking my questions. Just to follow up on kind of the LCV cash buyer dynamic, one of the interesting things about this recent rise in rates is I think at various points over the last year, you know, the conventional 30-year had gone above seven, but you look at arms or jumbos or FHA, VA, and they had kind of lived more in the like six, six and a half range. Now all rates have kind of surpassed seven. The spreads have all compressed. Can you just talk a little about, you know, have you seen that like as people are putting that little extra money down, are you seeing people shift, you know, out of, out of jumbos into conventionals or any shifts in loan rates? products and part two is, you know, given there's not as much, you know, hypothetical arb between jumping around products today, you know, have you started to lean back into your buy downs over the last month as rates have risen?

Mike, I'll take a shot at the first half of that in terms of what we have seen buyers do. Often when rates rise, we would see them gravitate to adjustable rates. And we haven't seen that because it hasn't been attractive. The spread between adjustable and fixed just has not been substantial enough to motivate somebody to go in that direction. We also just came through a period where jumbos were less expensive than conventionals. And so in 20, 21, 22, we saw buyers borrow more so that you get to the lower jumbo rate. Right now, we're seeing the inverse of that. We are seeing them increase their down payments and reduce what they're borrowing so they can stay in conventional to a greater extent.

With respect to buy-downs and whether we've accelerated that lately, the answer is no. The buy-down program doesn't... work for the build to order business because you can't buy down a rate that's 12, 14 months out. But it does work well as a lead marketing headline for the spec inventory that can deliver over a four month period of time. So we may advertise for a spec inventory that will take a 7.5% rate down to 5.5%. But the cost of that, and let's just say it's maybe $40,000 or $45,000 on the million-dollar home that Toll sells, it doesn't capture the buyer's attention as much as them deciding that, well, can I use that $45,000 and buy finishes in the house or do something that is long-term? And I think the reason for that is they don't look at the 7.5% rate as a 30-year rate they're stuck with. They look at it as a shorter-term timeframe where they're going to refi out of it when the rate comes down. And so why use my incentive to buy a rate down that I'm not going to have for a long period of time? That doesn't mean some don't take advantage of the buy-down, but it's not like all of our spec inventory is being sold through the buy-down program, and that's where all the incentive is going. It's a marketing headline. It grabs attention. It starts conversation. Some take it, but more flip the dollar value of the buy-down into into upgrades or features within the home.

Yeah, that's interesting. Thanks. And maybe that's also a point of differentiation for your wealthier buyer.

The second question... Right, because it's not a straight affordability issue where they have to have the 4.5% rate to get approved. It's more discretionary as to where do they want to spend the incentive.

Yeah, yeah, yeah. Okay. Second question, and maybe, Marty, this is just a technicality or a clarification on the earnings guide. You know, $1,150 at the low end, if I bridge your operating metrics and account for the year-to-date charges, I think you'd get to a number that's still maybe $0.30, give or take, north of that. So is that really just hedging for, you know, you're saying your guides including the three buildings that you anticipate to close? Is it as simple as you're hedging in case those don't close in the fourth quarter? Or is there something else in the core operating metrics where you think there could be some give or take?

Well, I think we're trying to get to some rounded numbers. $1,150 to $12 is pretty rounded. I think there's some caution in there if something doesn't go according to plan. We don't project any impairments. We don't expect any, but there may be some. And so it's as simple as that, Mike. I think you're reading much more into it than you should.

That's helpful. Thanks.

You're welcome.

The next question comes from Ken Ziener with Seaport Research. Please go ahead.

Good morning, everybody. Good morning, Ken. How are you? I'm doing well.

Appreciate all your comments. I wonder if you could quantify, you know, you've mentioned base pricing. Could you give us a sense, you know, this quarter, last quarter versus a longer term trend? What's your kind of base price and how much of options traditionally been a percent of your sales? And the reason I'm asking that is you know, obviously with this liquidity from your buyers, options historically have a higher margin profile. So I'm trying to sense, you know, if you're seeing greater share of options and what the impact is historically on your gross margins. If you could give us some context, is that my first question?

Sure. Long-term average upgrades, and that includes a lot of premiums, It was 21%. Q3, it was 27%. That's counterintuitive, right? With rates going up, you think maybe people are moving towards smaller homes, more affordable homes. Not the case. And that goes right to the wealth of our client and how we do it. You know, this is their dream move, and if they can afford it, they're going to reach. And so I'm not telling you that trend is going to continue. I don't know. But those are the numbers. 21% long-term average upgrades, Q3 27%. And, yes, the margin coming out of our design studios, where we send the client to pick all their beautiful finishes, is higher than the company's gross margins.

And the lot premium is 100% gross margin.

And the lot premium is correct.

What is the, you know, the, well, I guess, so following up on that, what is the split between, you know, land and the physical upgrades, if you would? And then the second question I really want to address is you talked about 2,200, you know, presale units last quarter. I don't know if you guys are updating us on inventory units yet. That would be useful. But could you maybe talk about where we are in terms of those pre-sale starts as well as that land upgrade mix, if you could?

Thank you. So I think we have approximately 2,400 specs under construction compared to the 2,200 you mentioned. And we have around 400 at CO or beyond compared to 350? Yes, last quarter. Last quarter. In terms of a breakdown of the option premium versus things in the house, what do we got there? You say it. Yeah, sure.

You don't want to go back, right? Yeah, Ken. So the base house prices, you know, for the quarter was, call it, you know, high, $870,000. So the lot premium is, This quarter, again, at 100% gross margin, was almost $60,000, and then the option upgrades were around $175,000. Now, that will include both the design studio and the structural options. Thanks.

The next question comes from Alex Barron with Housing Research Center. Please go ahead.

Thanks, everybody.

I was hoping we could focus a little bit on your ASP trends, especially in orders. I'm guessing July's quarter a year ago was a bit distorted, maybe by cancellations, maybe not. Maybe you can clarify that. But, you know, clearly the trend has gone from the $1.1 million towards $960,000. I'm just Trying to understand that better, is that due to more specs that are lower priced? Are you guys building smaller homes? Is it, you know, a more intentional thing that's going to continue or do you feel like the prices are here to stay at that level of the orders this quarter? Just, you know, some better understanding would be helpful.

It's really a function of mix. Alex, I think, you know, we talked about the success we've had in the mountain region and in the south where our prices are generally lower than they are in California or in the north. And so as the business has shifted to those geographies and as we've increased the affordable luxury line as a percentage of total, the average price mathematically comes down. It is not a function of building house type A this year at 4,000 square feet and last year it was 4,200 square feet. It's really just a function of the mix shift from a geography perspective as well as a market segment perspective.

Okay, so all else being equal, you don't necessarily see these trends taking the price further down necessarily or possibly yes.

I think they could modestly go lower. But again, it can be very lumpy quarter to quarter based on what is delivering. We are now north of 40% affordable luxury. And I think we've said we're comfortable with affordable luxury getting as high as half of our business. And we also have to be careful how we define affordable luxury now because it's gone up fairly dramatically in price through the COVID years. And it's a very gray area. We don't market it to the public as affordable luxury. It's just an internal term to help us with how we prepare for marketing, how fancy we decorate the model homes and build the entrance features And also, I think it helps the street in understanding this move we made in price. But we're close to where I think we want to be long term in terms of the mix between the affordable luxury, the true luxury, the empty nester move down, et cetera. So there could be some modest drop in price, but I think you've seen most of it already.

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

Good morning, guys. Thank you for taking my question. I guess the first one is that seasonality has certainly been a little bit tricky over the past few quarters, and you guys did better than normal seasonality in the most recent quarter. Just curious how you're thinking about absorption as we move into the fourth quarter, given what you're seeing out there in the market today.

Yeah, it feels right now, John, like it's trending very similar to Q3. I think our comments around the three weeks of August helped explain that. You know, we're running at a pace right now of about 24 homes sold per year per community. Last year was 25 homes sold. per year per community, so it's relatively flat, and that's what we're projecting. The 2010 to 2019 timeframe, again, pre-COVID, we tracked at about 22 sales per community per year, so we're modestly call it 10% or so above that, but that's what we anticipate for the fourth quarter.

Okay, that's helpful. And then you guys mentioned cycle times improving. Just wondering if you could help us kind of quantify where they are today maybe versus last quarter, maybe pre-COVID, and then how much of that improvement is getting better on the to-be-built side versus just offering more spec?

So cycle times are coming down slowly. We're picking up a couple of weeks. For the next home sold, the range is about 10 to 11 months. I think the exact number, I think it's 315 days is what we project when you average out the entire company. That's obviously down dramatically from the COVID years. And it's, you know, it's similar to what we saw pre-COVID, but we are more efficient. There's no question. We changed our operating model in the field, and we're enjoying those efficiencies. The spec build as a larger percentage of our business is certainly helping because we can get the house started without the customer making all the selections. We can build the house without the customer visiting every Sunday afternoon, and... and coming back at us with their own little punch list. And the houses are less complicated because we're not loading them up as much as some of our clients do when they run through the design studios. So that is certainly helping. We have less skews. We have optimized all of our plans. We have less homes that we offer. And all of that is contributing. And I do feel like it's just the beginning, particularly with almost half our business being affordable luxury, which means smaller, simpler homes, and this operations focus on becoming a better production builder, there's still room to go. But I am encouraged that we're down a few weeks and it's trending in an even better direction.

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

Thank you, Betsy. Thank you, everyone. We appreciate all your great questions and all of your interest. We're always here, as you know, to answer any additional questions offline. I hope everyone had a wonderful summer. Tough to believe it's over. And we'll see you through the fall and back on a call in December. So thanks again. Take care.

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