Toll Brothers, Inc. (NYSE:TOL) Q1 2024 Earnings Call Transcript

Toll Brothers, Inc. (NYSE:TOL) Q1 2024 Earnings Call Transcript February 21, 2024

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Operator: Good morning, everyone and welcome to the Toll Brothers First Quarter Fiscal Year 2024 Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] 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 also note today’s event is being recorded. And at this time I’d like to turn the floor over to Douglas Yearley, CEO. Please go ahead, sir.

Douglas Yearley: Thank you, Jamie. 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 Parahus, President and Chief Operating Officer; Fred Cooper, Senior VP of Finance and Investor Relations; Wendy Marlett, Chief Marketing Officer; and Gregg Ziegler, Senior VP and Treasurer.

I’m very pleased with our strong first quarter results. We beat our guidance across the board and saw another quarter of solid sales with contracts, up 40% in units and 42% in dollars compared to last year. In addition, since the start of the spring selling season in mid-January, we have seen a meaningful uptick in demand that has continued through this past weekend. In our first quarter, we delivered 1,927 homes at an average price of approximately $1 million, generating record first quarter home sales of $1.93 billion, up 10.4% in dollars, compared to the first quarter of fiscal 2023. Our adjusted gross margin was 28.9%, 90 basis points better than guidance and 140 basis points better than last year’s first quarter. The outperformance versus our guidance was due to mix, driven by earlier than expected deliveries in certain of our higher margin Pacific and Mid-Atlantic communities and fewer than expected deliveries in lower margin mountain communities.

SG&A expense at 11.9% of home sales revenues was 20 basis points better than last year’s first quarter and 50 basis points better than guidance. In addition to greater fixed cost leverage from higher revenues, we continued to benefit from cost reduction initiatives we’ve taken over the past several years. We continue to look for ways to operate more efficiently. Pre-tax income was $311.2 million and earnings per share were $2.25 diluted, up 23% and 32% respectively, compared to last year’s first quarter. With the outperformance in our first quarter and a strong start to the spring selling season, we are raising our full-year guidance across all of our key home building metrics. At the midpoint of our guidance, we now expect full-year deliveries of 10,250 homes, an adjusted gross margin of 28% and an SG&A margin of 9.8%.

In addition, earlier this month we sold a parcel of land to a commercial developer for net cash proceeds of $180.7 million, which will result in a pre-tax land sale gain of approximately $175 million in our second quarter. We are raising our full-year joint venture and other income guidance from $125 million to $260 million. Factoring in both the increase in our home building guidance and the impact of this land sale, we now expect to earn between $13.25 and $13.75 per diluted share in fiscal 2024, up from the $12 to $12.50 we guided to last quarter. We now also expect a return on beginning equity to be approximately 21% in fiscal 2024, which would be our third year in a row above 20%. Turning to market conditions. Demand in the first quarter was solid.

We signed 2,042 net contracts at an average price of $1.11 million up 40% in units and 42% in total dollars compared to the first quarter of 2023. Demand in our first quarter steadily improved as the quarter progressed, following the normal seasonal pattern. December was stronger than November and January was significantly stronger than December. Based on both deposit and agreement activity, our January was better than normal seasonality. The strong demand has continued through the first three weeks of February. From a geographic standpoint, demand was broadly distributed across our footprint. We saw particular strength in our Pacific region, including all of California and Seattle and also in Las Vegas, all of Texas, Denver and from Atlanta up through Boston, Demand was solid across all product types as well, with affordable luxury accounting for 45% of our units and 34% of dollars, luxury 36% and 49% and Active Adult 19% and 17%.

Another indicator of healthy demand was our deposit-to-agreement conversion ratio, which at 76% in the first quarter was significantly higher than our five-year average of 67%. We are pleased that we have been able to continue taking advantage of healthy demand while managing our incentives. While mortgage rate buy downs are heavily marketed and offered nationwide, very few of our buyers use incentive dollars to buy down their rates. The vast majority of our customers can qualify for a market rate mortgage without buy down, and they prefer to use any incentive offered on design studio upgrades or to reduce their closing costs. Additionally, consistent with the past several quarters, approximately 25% of our buyers paid all cash in the first quarter and the LTVs for buyers who took a mortgage dropped to approximately 67%, 200 basis points lower than our average over the prior four quarters.

So for the 75% of our buyers who took a mortgage, on average, they put down 33%. All of these factors highlight the financial strength of our more affluent customers. During the quarter, we once again benefited from our strategy of increasing our supply of spec homes, which represented approximately 50% of orders and 40% of deliveries in the first quarter. As we have discussed before, we sell our specs at various stages of construction from foundation to finished home. This allows many of our spec buyers the opportunity to visit our design studios and personalize their homes with finishes that match their tastes. So choice a pillar of Toll Brothers is still part of our spec strategy. This benefits our margins as design studio upgrades, tend to be highly accretive.

We are also pleased that our cancellation rate in the first quarter remained consistent with recent quarters at 2.9% of beginning backlog. Our low cancellation rate speaks to the financial strength of our buyers, as well as the sizable deposits they make and how emotionally invested they become as they personalize their new Toll Brothers home. We continue to expect community count growth to help drive results in fiscal 2024 and beyond. In the first quarter, we were operating from 377 communities, two more than we guided to last quarter. and we remain on target to reach our year-end guidance of approximately 410 communities, which would be an approximate 10% increase from fiscal year-end 2023. Importantly, we control sufficient land for community cap growth beyond 2024.

At first quarter end, we controlled approximately 70,400 lots, 49% of which were optioned. This land position allows us to be highly selective and disciplined as we assess new land opportunities. We believe we have a competitive advantage acquiring land at the corner of Main and Main, where very few of the big well-capitalized publics and privates play. Our main competition for this land tends to be the smaller local and regional builders who are not as well capitalized. Our balance sheet is very healthy with ample liquidity, low net debt and no significant near-term debt maturities. We also continue to expect strong cash flow generation from operations this year. In addition, as I mentioned earlier, we received $181 million in cash from a land sale at the start of our second quarter.

As a result, we are increasing the amount we are budgeting for fiscal 2024 share repurchases from $400 million to $500 million. Longer term, we continue to expect buybacks and dividends to remain an important part of our capital allocation priorities. With that, I will turn it over to Marty.

Marty Connor: Thanks, Doug. We are very pleased with our first quarter results. We grew both our top and bottom lines and operated more efficiently compared to last year. First quarter net income was $239.6 million or $2.25 per share diluted, up 25% and 32%, respectively, compared to $191.5 million and $1.70 per share diluted a year ago. Our net income and earnings per share were both first quarter records. We delivered 1,927 homes, and generated homebuilding revenues of $1.93 billion. The average price of homes delivered in the quarter was $1.3 billion. We signed 2,042 net agreements for $2.06 billion in that first quarter, up 40% in units and 42% in dollars, compared to the first quarter of fiscal year 2023. The average price of contracts signed in the quarter was approximately $1.11 million, this was up 1.6% year-over-year and 2.3% on a sequential basis.

Our first quarter adjusted gross margin was 28.9%, up 140 basis points compared to 27.5% in the first quarter of 2023. As Doug mentioned, Q1 gross margin exceeded our guidance due primarily to more deliveries in our higher-margin Pacific and Mid-Atlantic regions and less-than-expected deliveries in our lower-margin Mountain region. We expect the inverse to be true in our second quarter, and this is reflected in our second quarter adjusted gross margin guidance of 27.6%. Overall, we have increased our full year adjusted gross margin 10 basis points to 28.0%. Write-offs in our home sales gross margin totaled $1.5 million in the quarter and were all associated with predevelopment costs on deals we are no longer pursuing. SG&A as a percentage of homebuilding revenue was 11.9% in the first quarter, compared to 12.1% in the same quarter one year ago.

Note that our SG&A expense in that first quarter includes $14 million of accelerated employee stock-based comp expense that only hits in the first quarter. The year-over-year 20 basis point reduction in SG&A margin reflects leverage from increased revenues as well as benefits from tighter cost controls in the face of inflation. Joint venture, land sales and other income was $8.6 million during the first quarter compared to $16.8 million in the first quarter of fiscal year ’23 and compared to our guidance of $10 million loss. We exceeded our guidance due primarily to better-than-expected results in our mortgage unit and higher-than-projected interest income. Our tax rate in the first quarter was 23% or about 300 basis points lower than guidance due to the accounting benefit of stock compensation deductions, which we do not expect to repeat at the same level for the rest of the year.

We ended the first quarter with over $2.5 billion of liquidity, including approximately $755 million of cash and $1.8 billion of availability under our revolving bank credit facility. Our facility has four years until maturity. Our net debt-to-capital ratio was 21.4% at first quarter end, down from 27.5%, one year ago. We have no significant maturities of our long-term debt until fiscal 2026 when $350 million of notes come due in November of 2025. Our community count at quarter end was 377 compared to our guide of 375. Looking forward, our guidance is subject to the usual caveats regarding such forward-looking information. We are projecting fiscal 2024 second quarter deliveries of approximately 2,400 to 2,500 homes, with an average delivered price of between $1 million and $1.1 million.

For fiscal year 2024, we are increasing our projected deliveries to be between 10,000 and 10,500 homes with an average price between $940,000 and $960,000. As I noted earlier, we expect adjusted gross margin to be 27.6% in the second quarter and 28% for the full-year, 10 basis points better than our previous full-year guidance. We expect interest in cost of sales to be approximately 1.3% in the second quarter and for the full year. This is also a 10 basis point improvement from our earlier guide. We project second quarter SG&A as a percentage of home sales revenues to be approximately 9.7%. For the full year, we expect it to be 9.8%, another improvement of 10 basis points compared to our previous guidance. Other income, income from unconsolidated entities and land sales gross profit in the second quarter is expected to be approximately $180 million, which reflects the impact of the commercial land sale Doug mentioned.

We now expect it to be $260 million for the full-year, which is up significantly from our prior guide of $125 million. Aside from the land sale, much of this full-year other income is projected from sales of our interests in certain stabilized apartment communities developed by Toll Brothers Apartment Living in joint venture with various partners. We project the second quarter tax rate to be approximately 25.8% and the full year rate to be approximately 25.5%. That’s 50 basis points of improvement, compared to our prior full-year guidance. Our weighted average share count is expected to be approximately $106 million for the second quarter and $105 million for the full-year. This assumes we repurchased approximately $166 million of common stock per quarter for the remainder of the year, to reach the $500 million guide, Doug referred to earlier.

As Doug mentioned, with our updated guidance and the Q2 land sale gain we now expect to earn between $13.25 and $13.75 per diluted share in fiscal 2024. This would result in a full-year return on beginning equity of approximately 21% and would put our year-end book value per share at approximately $77 per share. Now let me turn it back to Doug.

Douglas Yearley: Thank you, Marty. Before I open it up for questions, I’d like to thank our Toll Brothers’ employees for another great quarter. I’m so proud of their dedication, hard work and commitment to each other and our customers. Their talent and constant focus on our business is the driver of our long-term success. Jamie, with that, let’s open it up to questions.

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Q&A Session

Operator: Ladies and gentlemen, at this time, we’ll begin the question-and-answer session. [Operator Instructions] As a reminder, the company is planning to end the call at 9:30 when the market opens. [Operator Instructions] Our first question today comes from Jessie Letterman from Zelman & Associates. Please go ahead with your question.

Ivy Zelman: Hey guys. It’s actually Ivy, but thank you. First, I just want to say congratulations. It’s a great quarter and really excited about your strategic initiatives of driving returns higher with the land sale expected in ’24, just thinking about other opportunities to generate cash flow to maybe do some continued buybacks or other ways to drive returns higher. But it’s really been quite a tremendous improvement in just overall management, working capital and returns and love to see continued improvement. And wondering how strategically you can do so.

Douglas Yearley: Thank you, Ivy. Yes, the land sale was — I shouldn’t say never, but I think it was a one-off. We had a unique piece of property in Northern Virginia that we were processing for approvals to build homes on, and a data center operator came along and made us an offer that we couldn’t refuse. There could be something like that out there, one never knows. But we will continue to always look for opportunities to be more capital efficient, to drive gross margin, to grow this company. And that’s beyond just core homebuilding where we get bigger in the markets we’re in, and we have lots of opportunities to do that because as everyone knows, at our price point, we tend to have a fairly small market share in many of our markets.

And as we expand our price points coming down in price, we have great opportunities in our 60 markets that we’re in to get bigger. We have the widest variety of product and the widest range of price of any of the builders. And so we think that gives us the greatest opportunity for core growth within home building. Outside of that, we’ll continue to focus on the apartment business. We’ll continue to focus on other opportunities to generate positive cash flow. And as you can see, as you know, we’re committed to return capital to shareholders. We’re taking the vast majority of the proceeds from the data center sale to increase our buyback. We are committed long-term to the dividend. We are committed to continue to grow that dividend. And so I’m just really pleased with where we are.

The initiatives to come down in affordable luxury price points is now well on its way with 40% plus of our sales and our closings now in what we call the affordable luxury business model. We’ve also committed to a greater spec strategy, and that is really working well of 50% of our sales in the first quarter were spec, 40% of our deliveries were spec. The market is very much in place with the tight resale market. to gravitate towards Toll spec, particularly since, as I explained, much of that spec still allows us to offer choice where they can go to the design studio and pick finishes. And spec is not just affordable luxury. It’s not just the lower priced, lower margin communities. We are building spec across all of our price points, all of our product lines.

And so — you gave me a general question, I gave you a general answer.

Ivy Zelman: No, no. That’s really helpful. I think one thing that you’ve also done is a significant debt reduction, which the balance sheet is the best position it’s ever been in. So I think that you’re probably — my guess would be at a debt to capital level that you’re comfortable with. So — are there opportunities for bolt-on acquisitions, given that privates are really disadvantaged for many reasons, not to mention cost of capital. Or is it more likely that you’ll continue to grow organically and focus on share buyback to be capital efficient and generate higher returns?

Douglas Yearley: Yes, thank you. We’re always in the conversation on M&A. We’ve acquired 15 builders in 30 years. We’re very selective. I’m very happy with our geographic footprint. So I can’t tell you that there’s five or 10 markets out there that we really want to get into where you use M&A most often to enter a new market. But there are a few markets we’re looking at that are new, and there’s many opportunities for bolt-on M&A to get bigger and diversify the offering in an existing market. About five of our 15 acquisitions were in existing markets. So those opportunities still exist. You’re right, the M&A market has heated up a lot, and we are certainly studying opportunities. But I think you’re going to see more with capital return to shareholders with Toll, and you’re going to see new M&A.

Ivy Zelman: Great. Well, good luck, guys. Thank you.

Douglas Yearley: Thanks, Ivy.

Operator: Our next question comes from Sam Reid from Wells Fargo. Please go ahead with your question.

Sam Reid: Awesome. Thanks so much, guys, and congrats on the quarter. I wanted to touch on the updated delivery guide for ’24. It clearly shows you’re seeing some momentum in the spring, but my question is kind of help us gauge the level of conservatism that might be embedded in that outlook? And what would we need to see specifically in March and April for you to be comfortable to take that number up again?

Douglas Yearley: Marty, do you want to go with that?

Marty Connor: That’s a tough question to answer the level of conservatism. I think, Sam, it’s safe to say there’s no difference in the construct of our guidance right now than there traditionally has been. I think, obviously, if we see a really strong March and April, particularly with our spec strategy, that could result in additional deliveries beyond the guide that we’ve given. But we’re very comfortable with the guidance we’ve given. And we’ll update it in three more months.

Douglas Yearley: And remember, on the build-to-order side of our business, which is 50% to 60% of our operation, these houses are big. These houses are complicated. They have upgrades because we send everybody through our design studio and let them design their house to their lifestyle. And so they take some time to build. So we’re now 3.5 months into fiscal ’24, and there aren’t all that many communities remaining where the next sale of a build-to-order home can be delivered by the end of October. There are still some communities that can do that. But with every passing week, there are less and less. And we do have a lot of specs in process that are certainly going to be completed, sold and delivered by year-end. But I think as the year progresses, our guidance becomes even more definitive because of the build-to-order nature of our business.

Sam Reid: No, that’s helpful. And maybe to drill down a little bit more on that kind of spec build-to-order dynamic here. So on your gross margin guide for second quarter, can you give us a sense as to what the spread between your spec deliveries and your build-to-order deliveries might be between those two buyer groups? And is there any inclination that, that could potentially narrow going forward? Thanks.

Douglas Yearley: Yes, it’s a great question. It has narrowed. Let me give a little historical for the last few quarters. In Q4 of ’23, our spec gross margin was 26.3%. In Q1 of ’24, this past quarter, that jumped to 27.9%. And as you know, the gross margin for the company for the first quarter was 28.9%. So in the first quarter, specs ran exactly 100 basis points below the full gross margin for the quarter. Now some of those specs came out of the West, the Pacific region, California and were more expensive and had a higher embedded gross margin in them, but we are definitely encouraged by the increase in spec gross margin over time here, and we think that will continue. So in terms of the second quarter guide, I think it’s probably fair that, that 100 basis point difference is about where we’ll be.

Marty Connor: Yes, I think so. It might be a little wider than that because back less from the Pacific it. But again, it depends to a certain extent on how strong the spring is, what we do with pricing as we progress.

Douglas Yearley: Please understand our business strategy and our business modeling is for the spec business to have a lower gross margin. We expect that the houses tend to — the specs tend to be built on the more average lot that doesn’t have the high lot premium. We save that very high lot premium for the build-to-order business where that client will spend a lot more money in the design studio. We also — while we upgrade the spec homes, we don’t take them, in some cases, to the level that the client will, in a build-to-order purchase. So — and we also know that some of the spec inventory does make its way all the way to the end where it’s a completed home that is unsold. And when that does happen, we know we may have to incentivize a bit more to move it because it’s standing finished inventory that can deliver.

So our strategy has always been, as we got into the spec business that there would be a lower gross margin, but we’re very pleased with how close it has been to the overall company’s margin.

Operator: Our next question comes from Stephen Kim from Evercore ISI. Please go ahead with your question.

Stephen Kim: Yes, thanks very much guys. Appreciate all the color. And I just wanted to zoom the lens out a little bit and try to get a sense for maybe if 2024 is a year where we can see some of the dust settle on rates and some of the volatility subside. If we could focus a little bit more on what your longer-term targets are and how you seek to operate the business. Let’s start with the with what you just were talking about with an increased spec mix, I would assume that, that would allow you to run at a higher level of absorptions or sales per community. I think that you’ve talked in the past about something in the 24%, 25% per year range. I was curious as to whether or not if this spec strategy is something that’s going to be a going forward kind of a thing.

We might see that more approach something like 30 a year, how you sort of feel about that. And also whether we might see your backlog turnover ratio also sort of remain or move higher, let’s say, into the 40s on backlog turns. I’m not talking about the next quarter, I’m not even talking this year, I’m just talking about in general going forward.

Douglas Yearley: Great question, Stephen. You’re spot on. We delivered 27 homes per community in 2023, and we expect to be at 27 to 28 homes per community in 2024.

Marty Connor: In ’23, we did 23 to 24.

Stephen Kim: Yes.

Marty Connor: In ’24, we’re doing 27.

Douglas Yearley: Did I not say that?

Marty Connor: I think you said 23 twice. Sorry, you said 27 twice.

Douglas Yearley: My apologies. 24 per community in 2023 and 27 to 28 per community in 2024. And that is in part the spec strategy — it’s in part cycle time coming down, but it’s primarily the new strategy we have of building more and more spec. We think that can improve as we head into ’25 and beyond, and we are certainly planning for that. You talk about 30 per year. Yes. That’s out there. That’s a goal that’s achievable. With the spec strategy, we’re nimble, we’re flexible. We follow the market. And right now, there is a very, very strong market for our spec homes that can be delivered faster, particularly those homes that we may put on the market at frame that still allows the client the opportunity to get the design studio and fix the finishes to suit their lifestyle.

So it’s been a big move for the company to go from less than 10% spec to now the 40% to 50% range. We are committed to it. And it’s going to be another reason why we think we can increase community absorptions. And that’s where we’re certainly headed. The existing homes, the resales on the market are still historically tight even with a modest drop in rates that has not freed up the resale market. There is still a lock-in effect. And let’s not forget, even as rates do come down, which I think they will, and that market begins to modestly loosen up. The average resale home is now 45-years old. There is a flight to new that is not just because of unavailable inventory due to the lock-in effect, but because of the quality of that resale inventory, and that will continue even as rates come down and the resale market unlocks.