托爾兄弟 (TOL) 2016 Q4 法說會逐字稿

Good morning and welcome to the Toll Brothers fourth-quarter earnings conference call.

(Operator Instructions)

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, Gary.

Welcome and thank you for joining us.

I am Doug Yearley, CEO.

With me today are Bob Toll, Executive Chairman; Rick Hartman, President and COO; Marty Connor, Chief Financial Officer; Fred Cooper, Senior VP of Finance and Investor Relations; Joe Sicree, Chief Accounting Officer; Kira Sterling, Chief Marketing Officer; Mike Snyder, Chief Planning Officer; Don Salmon, President of TBI Mortgage Company; and Gregg Ziegler, Senior Vice President and Treasurer.

Before I begin, I ask you to read the statement on forward-looking information in today's release and on our website.

I caution you that many statements on this call are forward-looking statements based on assumptions about the economy, world events, housing and financial markets, and many other factors beyond our control that could significantly affect future results.

Those listening on the web can email questions to rtoll@tollbrothersinc.com.

We completed FY16's fourth quarter on October 31.

Fourth-quarter net income was $114.4 million, or $0.67 per share diluted, compared to $147.2 million, or $0.80 per share diluted, in FY15's fourth quarter.

FY16's fourth-quarter pretax income was $168.2 million, compared to $217.5 million in FY15's fourth quarter.

Impacting FY16's fourth-quarter pretax income reported in cost of sales were $2.5 million of inventory impairments and a $121.2 million warranty charge primarily related to older stucco homes in the Mid-Atlantic region.

FY15's fourth-quarter pretax income included a $4.4 million of inventory impairments and a comparable $14.7 million warranty charge.

Adjusting for these items, FY16's fourth-quarter adjusted pretax income was $291.8 million, compared to $236.7 million in FY15's fourth quarter, a 23% increase over last year.

Revenues of $1.86 billion and homebuilding deliveries of 2,224 units rose 29% in dollars and 22% in units compared to FY15's fourth-quarter totals.

The average price of homes delivered was $834,000 compared to $790,000 in FY15's fourth quarter.

Net signed contracts of $1.47 billion and 1,728 units rose 17% in dollars and 20% in units compared to FY15's fourth quarter.

The average price of net signed contracts was $848,000 compared to $872,000 in last year's fourth quarter.

FY16's fourth quarter was our ninth consecutive quarter of year-over-year growth in total net contract units and dollars.

For the first five weeks of FY17 beginning November 1, 2016, non-binding reservation deposits were up 10% in units compared to the same period in FY16.

Including the inherited outstanding Coleman Home deposits, the increase was 14%.

As the only national homebuilding company focused on the luxury market, we continue to benefit from healthy demand, limited competition in many markets, superior land positions, a financially strong buyer base, and a highly recognizable brand.

These strategic advantages and a solid financial foundation have propelled us to more than triple our revenues and increase net income ninefold in the past five years.

Based on these initiatives, we believe we are well positioned to continue to grow in a vibrant luxury new home market.

While there has been some debate about softness in the luxury housing market, we continue to produce impressive results by serving what we believe is the demographic sweet spot in the luxury market.

We are not focused on super luxury.

With an average delivered home price of approximately $850,000 companywide in FY16 and $690,000 in markets other than New York City and California, our product lines are affordable to many households in the US.

The value of our brand, our demographically targeted product lines, and our well located communities all helped drive this year's results.

We achieved double-digit growth in EPS, revenues, contracts, and backlog in FY16.

As household formations increase, we continue to pursue growth initiatives to amplify the value of the Toll Brothers brand.

Through our dual pronged strategy of expanding and diversifying our geographic footprint and broadening our platform of residential product lines, we reach affluent buyers across the demographic spectrum, from millennials to baby boomers and everyone in between.

Our for-sale products include luxury move up, empty nester, active adult, second home, and urban high-rise condominiums.

We also build rental apartment communities.

Toll Brothers Apartment Living took a major step forward this year.

In total, Toll Brothers apartment and student living has projects completed, in construction, or under development totaling over 10,000 units.

We believe we are creating significant shareholder value for the Company through Toll Brothers Apartment Living.

With the millennial generation now entering their 30s and forming families, we are starting to benefit from the desire for homeownership from the affluent leading edge of this huge demographic wave.

In FY16, approximately 22% of our settlements included one primary buyer 35 years of age or under.

We currently are courting these customers with our core suburban homes, urban condos, and rental apartment properties.

We are also introducing a new product line, TSelect by Toll Brothers, which incorporates the elegance and style of a higher end Toll Brothers home but with slightly fewer structural options, a quicker delivery time, and a slightly lower price.

Now let me turn it over to Marty.

Thanks, Doug.

Please note that a reconciliation of the non-GAAP measures referenced during today's discussion to their most recently comparable GAAP measures can be found in the back of today's press release.

Our growth in revenues, contracts, deliveries, and earnings per share in FY16 reflect the benefit of our diverse geographic and product mix.

We project continued growth in these financial metrics in FY17.

Our net results were impacted by the significant warranty charge, but despite this our full-year earnings per share grew 10.7%.

With our strong backlog and a lower share count, as well as significant projected contributions from our joint ventures and other income lines, we expect earnings per share in 2017 to grow significantly.

To complement this growth in earnings per share, we have also undertaken a number of initiatives to improve our return on equity, including slightly increasing our leverage, buying back stock, utilizing lower rate variable borrowings, and forming capital and risk efficient joint ventures.

We repurchased $392.8 million, or 13.7 million shares, of stock during FY16, and an additional 550,000 shares for $15 million during the start of FY17.

We expect our FY17 average share count to be approximately 170.5 million shares, down from the 176 million share average for FY16.

In May of 2016, we expanded our bank revolving credit facility to $1.295 billion and 20 banks, and in August of 2016 we extended to five years our $500 million floating rate bank term loan.

We now have nearly $1.8 billion of long-term credit facilities with 21 banks at an average interest cost below LIBOR plus 150.

We had approximately $750 million borrowed on these facilities at fiscal year end.

That was $500 million on our term loan and approximately $250 million on our line.

Based on closings and commitments in place, by December 31, 2016 we will have raised approximately $1 billion of joint venture debt and equity for transactions since the start of FY16.

These involve three types of properties: our larger, more capital intensive New York City high-rise condominium projects, all of our urban and suburban rental projects, and a number of our larger, longer-term master-planned communities.

These financings, which encompass both project specific construction and permanent loans and project specific third-party equity investments, enable us to reduce our equity commitment, generate fees and performance-based promotes, and increase our return on investment.

We are looking at more of these joint venture structures as a tool to improve return on equity.

Our recently acquired Coleman Homes division in Boise, Idaho involves lower cost land and higher inventory turns, albeit at a generally lower gross margin.

This should translate into a stronger return on equity than our core business.

In FY17, we expect Coleman to deliver approximately 300 homes at an average delivered price of $300,000 to $325,000.

We expect the combination of purchase accounting and lower gross margins from our Coleman Homes acquisition to reduce our overall adjusted gross margin by 30 to 40 basis points in FY17.

We also expect changes in our mix of product deliveries throughout the country to negatively impact adjusted gross margins in 2017 by 25 to 35 basis points.

Therefore, our full-year FY17 adjusted gross margin is expected to be between 24.8% and 25.3% of FY17 revenues.

Our first-quarter gross margin -- adjusted gross margin in FY17, will be the quarter most impacted by purchase accounting and mix.

We expect adjusted gross margin to be approximately 23.4% in the first quarter with approximately 75 basis point improvements expected each quarter thereafter through the end of the year.

We expect FY17 first quarter deliveries of between 1,000 and 1,250 units, which with an average price of between $750,000 and $780,000, and full FY17 deliveries of between 6,500 and 7,500 units with an average price of between $775,000 and $825,000.

SG&A as a percentage of full FY17 revenues is projected to be approximately 10.6% of revenues, and first-quarter SG&A will be approximately 15.2% of first-quarter revenues.

The Company's full FY17 other income and income from unconsolidated entities is now expected to be between $160 million and $200 million, with approximately $50 million in our first quarter.

Our fourth-quarter tax rate benefited from a net $9 million state tax reserve release resulting from a settlement.

We estimate that our effective tax rate for 2017 will be approximately 36.2%.

With our existing backlog, strong sales trends, and expected growth in revenues, we expect to deliver one of the highest adjusted gross margins in the industry in FY17, while improving our return on equity to above 12% and growing earnings per share significantly.

Now let me turn it back over to Doug.

Thanks, Marty.

Stucco-related issues are an industrywide problem.

Increasing this reserve is intended to set aside sufficient funds to stand behind our communities, get the repairs completed on these older homes, and move forward.

Our customers buy homes from us because of our 50 years in business and our reputation of standing behind the homes we build.

Importantly, we discontinued the use of stucco in our Mid-Atlantic and north regions several years ago.

We are seeing positive demand trends in many regions.

California, where we build primarily in the coastal suburbs of San Francisco, Los Angeles, and San Diego, remained our largest housing market.

With a multi-year land position and desirable coastal locations, we see this as a dynamic region for us for years to come.

We also enjoyed strong demand in our other Western markets of suburban Seattle, Phoenix, Reno, Las Vegas, and Denver as well as in Dallas, Jacksonville, and Orlando, Northern Virginia, Philadelphia, and New Jersey.

With the goal of augmenting our footprint in the western United States, we expanded into the Boise, Idaho market with the acquisition of Coleman Homes.

Announced just after our fiscal year end, Boise complements our significant presence in California and our other western markets which accounted for over 45% in dollars and 30% in units of signed contracts in FY16.

As we have said previously, demand at our New York City project is not as strong as it was several years ago when the market was on fire.

In FY16's fourth quarter, we commenced deliveries at two joint ventures, Pierhouse at Brooklyn Bridge Park and the Sutton on Manhattan's east side.

Also in early November, we launched sales at a project just north of Gramercy Park in Manhattan.

We are not focused on the super luxury in New York City.

Rather, we have focused on price points in the $2,000 to $2,500 per square foot range and projects of 150 units and less.

City Living gross margins still lead the Company.

We did sign 40 contracts in our fourth quarter, even though we faced limited inventory at a number of our nearly sold-out projects.

We have been encouraged by the 20 deposits we have taken in the past five weeks since our new fiscal year began.

We delivered 41% gross margins on $240 million of revenues from wholly-owned City Living projects in FY16.

We are projecting revenue growth of approximately 70% from wholly-owned City Living projects in FY17 at on average 37% gross margins.

As we have explained before, due to the risk associated with this business, we underwrite City Living to a mid-30%s gross margin compared to the mid-20%s for our suburban communities.

Even with the current softer New York City market, we still have good margins embedded in what we believe is well bought land acquired several years ago.

With our solid fourth-quarter operating performance, double-digit increase in year-end backlog, and positive demand trends to jumpstart our new fiscal year, we are excited about FY17.

Through the first five weeks of FY17, our non-binding reservation deposits in units, a precursor to signed contracts and eventually to home deliveries, were up 10% compared to FY16 same period.

With this strong start, our great brand, high-quality land positions, diversified product lines, and strong buyer profile, we believe FY17 will be another year of solid growth in revenues and profits.

Now let me turn it over to Bob.

Thanks, Doug.

Recent data highlights the recovery of home prices to pre-recession levels.

This should translate into more equity for homeowners looking to move up.

We were encouraged by surveys that indicate most millennials still believe homeownership is a goal to aspire to.

In Monday's Wall Street Journal, the ULI study highlighted that suburbs are outstripping cities in population growth.

More than 90% of our business is transacted in suburbs.

Yesterday housing expert John Burns released a report stating that luxury home sales have increased.

Sales priced above $600,000 had risen in 37 of the 43 counties he had studied, and that home sales above $600,000 exceeded sales in the prior 12 months.

These are positive data points.

With the employment picture and the stock market on positive trajectories, interest rates still extremely attractive, significant pent-up demand, and a dearth of supply in many markets we believe the new home market will remain on its current course of steady growth.

In FY16 we marked our 30th year as a public company on the New York Stock Exchange.

This is an impressive milestone in our three-decade evolution from a local suburban Philadelphia builder to a nationally diversified homebuilding corporation with a uniquely recognized brand.

In June 2017, we will celebrate the 50th year since our formation back in 1967 when we sold our first home for $17,990.

I am so proud of where our Company is today.

Now, with a much more diversified array of product offerings, a team of dedicated associates, a solid land position, and a growing customer base, we look forward to a bright future for Toll Brothers, our shareholders, and our associates.

Now, let me turn it back to you, Doug.

Thank you, Bob.

Gary, we are ready for questions.

(Operator Instructions)

Stephen Kim, Evercore ISI.

Hello.

It's actually Trey on for Steve.

Thanks for taking my questions.

My pleasure.

First thing I wanted to talk about is your traditional homebuilding business saw a really strong -- orders up in the south, up 35% year on year.

I am wondering what drove that such large growth, and is that something that is showing evidence of a mix shift away from California that is resulting in that margin and lower price that you are alluding to?

Trey, the growth throughout the South was really across our major markets.

We saw significant order growth in Florida.

It went from 64 sales a year ago to 116.

We saw about 15% growth in North Carolina over that time, and Texas also had moderate growth.

It was really across all of our major southern markets.

Got you.

Secondly, on this new T Select product that you mentioned, where are you going to try and introduce this product first?

Do you already have it on the ground, and what has been the response so far?

So T Select will be launched officially in January in Texas, in Houston.

We have three or four communities that will be following.

We already do something like T Select in places like Jacksonville, and the Boise operation which we just acquired is more of a T Select line, which means great Toll Brothers experience, great homes, smaller, less upgrades, quicker turn.

And we have that business already, but we are now launching it officially in markets we are already in to distinguish T Select from the larger Toll Brothers brand.

Again, beginning in Houston, but then from there you will see it growing.

While we don't have specific T Select experience, we have the same basic experience at a number of our existing markets where we do sell at a lower price point, faster turn, less upgrades and it has been very successful.

We are looking forward to the launch early next year and continue to look for new opportunities to expand it.

All right.

Thanks, Doug.

I appreciate it.

My pleasure.

Thank you.

John Lovallo, Bank of America Merrill Lynch.

Thanks for taking my call.

First question here is on the California conversion rate was a lot stronger than we were looking at, I think around 58%.

I guess the question is was there some pull forward in deliveries in the quarter that might be negatively impacting the first quarter of 2017 and deliveries and also potentially the ASP?

The answer to that is no.

There is no pull forward.

Going forward in California, we have a whole bunch of openings coming.

You will see in Southern Cal continued revenue and order growth because we are open and in action in many locations and doing really well.

In Southern Cal, excuse me, in Northern Cal you're going to see early in the year some flattening or negative orders simply because of timing of new communities.

We have seven communities opening in Northern Cal in 2017, but many of those are in the latter part of the year.

In Southern Cal we will have 11 openings throughout 2017, and they are spread more equally throughout the year.

So that is why you will see a little bit more growth out of southern than northern, but that is no reflection of the markets.

They are both doing really well for us.

Okay.

Great.

And then I guess the second question, the SG&A forecast of 15.2% in the first quarter, is that essentially assuming the midpoint of the 1Q 2017 revenue outlook of about call it $862 million?

Yes it is.

Okay.

Thanks.

You're welcome.

Paul Przybylski, Wells Fargo.

Thank you.

This is Paul Przybylski on for Stephen East.

Going back to the SG&A question, first off, why the lack of leverage next year?

It appears that it's mostly weighted in the first quarter.

Is this related to the Coleman conversion, or is there a front-end load to communities?

I think with respect to the waiting in the first quarter, it is a function of what is actually going to be lower revenue for us in the first quarter compared to a year ago.

The fact that we have roughly 10% more associates around, so we lose some of that leverage there.

In our first quarter we also have a concentration of some compensation expense that will be spread more evenly through the balance of the year, but is concentrated in the first quarter.

We are spending a bit more on technology as we upgrade some systems.

We have been fortunate not to pay any licensing fees for software for almost a decade now.

We find it necessary to upgrade some of our software and processes to keep things moving smoothly here.

Okay.

And then second question, are you doing any type of further analysis on the stucco reserve?

You mentioned the Mid-Atlantic.

Any market specifically where that occurred and the vintage of those homes and any other markets where you could have similar issues in the future?

The stucco issue has been isolated for the most part to Philadelphia.

We have now completed a significant number of repairs of homes in Philadelphia and have a much better understanding of the scope and the cost that we expect going forward.

It really comes down to an industrywide issue in Philadelphia with specific construction practices that occurred here through the independent stucco contractors that all of the builders employed.

We are not seeing the issue outside of this market.

We think we have a good understanding of the issue, and I think the reserve this quarter shows that.

As I said in my prepared comments, we treasure our reputation and our brand and we are doing the right thing to repair the houses that are under warranty and are confident that we have our arms around it and are proceeding accordingly.

Great.

Thank you.

I appreciate it.

Paul, I wanted to go back to your first question too.

We are also seeing some additional advertising and marketing expenses, not only in the first quarter but for the balance of the year.

And we are investing in the model homes in the design centers and in the sales centers.

We think it is a pretty solid investment based on the results we are getting on the top line.

That is in response to his question about SG&A?

Yes.

Great.

Thank you.

I appreciate it.

Thanks, Paul.

Michael Rehaut, JPMorgan.

Hi.

This is Jason in for Mike.

First question is on the community account guidance.

You pointed to it growing -- you're expecting it to grow a similar amount versus 2016.

I wanted to confirm that includes the 15 communities from Coleman.

I know you talked a little bit about the California openings, but just wanted to get a sense as to which regions are expected to have the most growth and what the overall quarterly progression of community count should look like?

Sure.

Your first question, the answer is yes.

That guidance on community count growth includes Boise.

In FY17, right now we expect to open 99 new communities.

That is two a week, and we expect to sell out of about 79.

Which gives you the net 20 increase.

That obviously evolves over the course of the year, but right now going into the year that is where our guidance is.

Okay, great.

Where they occur, Boise of course is new.

That has 17 new communities projected in 2017.

As we mentioned, 15 have already joined us.

We expect 14 new communities to open in Seattle, which is an extremely strong market for us, 11 in Southern Cal, eight in Pennsylvania, seven in Northern Cal.

Those would be the largest -- the locations where we have the most openings.

Okay, great.

Next question, just wanted to get a sense of what you expect for interest amortization to be next year.

And then lastly, just an update on what you've see in the mortgage market since we have seen the recent uptick in rates.

Any trends there would be helpful.

Sure.

Interest amortization for this year was around 3.1% of revenues.

We expect it to tick down 10 basis points next year.

And Don Salmon is here who runs TBI Mortgage so he will be happy to answer your question about the mortgage market.

As far as rates, I think everybody sees what is going on.

There has been a slight increase, but in terms of availability, we have actually seen an increase in availability.

We have seen some non-banks get more interested in the market these days.

We are just steady as you go in the mortgage world today.

In surveying our sales and project management teams across the country, we are not hearing that a small rise in rates has had a negative impact on our business.

If anything, when rates go up a little bit it creates some urgency.

Remember that 20% of our buyers are all cash, and those that get a mortgage on average put 30% down and mortgage 70%.

A small move in rates is not the number one driver as to whether they buy or not.

They can afford our houses.

They can lever up higher.

We have always done well in rising rate markets so long as obviously the rates move slowly and they move because of good economic news surrounding those moves, which is what I think we have now.

Great.

Thanks.

Ivy Zelman, Zelman & Associates.

Congratulations on a good quarter.

And Bob, congratulations on your being inducted into the Hall of Fame in January.

Very exciting and well deserved.

Thank you.

I guess I have two questions.

So I will go with the bigger picture question for you, Bob, if I may and then come back if you will allow me a second one.

Bob, recognizing that there is a lot of uncertainty around the change in administration and the impact of now having a Congress that is majority Republican, looking at what the implications are from your perspective of what it means for housing and getting your perspective on some of the people that are now in election process to Secretary of Treasury Mnuchin, I'm saying these names wrong, and Carson at FHA even though you don't do much FHA, I'm curious about your opinion about it.

Ivy, I promised the people here I would not get involved in political analysis, even though it is a great opportunity.

Most of us are now studying neurosurgery believing that this is the fastest way to run 4.5 million occupied homes.

The rest of it I think I'm going to have to take a pass on, Ivy, and go back to being a homebuilder as opposed to a political analyst.

But thanks for the opportunity.

Bob, the old Bob would have given an opine on his view.

You have really been curtailed there.

A little handcuffed.

I am proud of you, Bob.

(laughter) But we would have enjoyed it.

Everyone really would have enjoyed it.

Oh well.

Maybe over a cocktail.

(laughter) Okay, Doug.

Now one for you.

Doug, when we do our channel checking, and I appreciate you mentioning John Burns research, but if you dug into that research though you would know that it was really the counties that he focused on was the state of Washington, state of California.

I think there were a few counties in Colorado.

It was pretty limited.

I think there was one in the Northeast.

When we broadly channel check the United States, we really commend you for bucking the trend.

There's no question that not even just luxury, the higher end of the market is softer on the existing home side.

I guess with you not being in luxury, if you go into Cleveland above $700,000 is considered luxury, or even in the $450,000, $500,000 in markets like Dallas and markets in Colorado above $650,000.

Every market has a breakpoint.

You have obviously demonstrated that you are doing better and people just want a new home.

Maybe you could tell us what you are seeing, because we are seeing on existing home for sure, but you are obviously doing better than existing home size -- the existing home market overall.

It is not limited just to New York City from the channel check we are doing and everything that we are seeing.

I really would appreciate, Doug, giving us some of the cutoff points where you do see the softness or what we're seeing.

And maybe it's just there is enough -- new home is such a small percent of the market that you are able to capture that person, maybe the person who can't sell their existing home that enough few of them are buying your house.

There's no question the market is soft as you move up price point and the breakpoint is different by market.

Okay.

So first with respect to John Burns.

I'm not going to minimize his story because Seattle, Northern, Southern Cal, Colorado, those are major markets for Toll Brothers today where we are doing really well.

The Northeastern counties that he referred to are locations I believe where we're also doing well.

Yes, he did not pick up every county of every major market that we and other builders are in, but his study supports our thesis and our results, which is our business is really good.

We are not in the super luxury end of the market.

We are not part of any of those stories about Greenwich, Connecticut, and the Hamptons.

I think, Ivy, one thing you have to really focus on yes, we do it really well and we are really proud of the brand and the locations and the merchandising and the way we treat our client.

That all makes us very special.

But our end of the new home business is so fragmented where we do not have a lot of high quality, well run competition.

So even if your thesis is correct, which is the higher you go in price the softer it gets, we are dominating our market.

We just don't have the competition.

We do it better than anybody else.

We are selling 6,000, 7,000, 8,000, 9,000 homes a year as we grow.

There is a huge market out there at our price point that wants a new home.

They want a home from Toll Brothers because we do it the best.

And I applaud you for that.

But I want you to go beyond that to talk about like you used to when Bob and you would go around the horn.

In Dallas, where are you relative -- where's the market?

Are you seeing the slowing in the $600,000 or the $450,000s?

Maybe you can buck that trend, but to acknowledge what you are seeing would be helpful.

I gave in my statements the markets that are really strong.

I don't need to repeat those.

There were many out west but there were also many in the east.

The markets right now that are softer for us would be Minneapolis, we have two communities; Illinois, which we have talked about for years as just not returning as we thought it would; Houston, which we have talked about many times and it is at the higher price point yes that it is definitely softer and it is the location where we will have our first launch of T Select; Connecticut, where we have not bought land in years and we have shrunk in size and it has its own issues, not just $5 million in Greenwich but throughout the state.

And then Maryland, which has also been soft for a while.

We have talked about it and we are doing really well in northern Virginia, but we have struggled in Maryland.

That is the bucket of locations where we build that we have seen softness, and we have redirected our Company into other areas as you can see through the growth out West and in other places to account for it.

Is that like the old days?

Yes.

Good job.

Thank you and good luck.

I really appreciate it.

Happy holidays.

You too, Ivy.

Jack Micenko, SIG.

Hey, good morning.

Marty, I wanted to go back to some of your prepared comments around the ROE.

You have been [newing] the apartments in JV.

You are moving -- it sounds like you are moving more on the City Living side.

But you mentioned master plan.

Is that -- I don't want to interpret this wrong, are you looking to do more JV of current ownership of master plan as you work to continue to improve the returns?

I think it is something we're going to consider, but I am speaking predominantly about our master plan in Houston.

We have a joint venture with another builder in the Maryland market.

We have a homebuilding joint venture down in Jupiter, Florida.

We have an Austin-based joint venture.

We have a Southern California joint venture.

We are looking at one in Arizona.

It is more ones we have already done and ones that are on the drawing board, not moving any of our land that we currently hold into a master plan.

That is tricky from an accounting perspective to get rid of something you own and still have a right to buy some of it back.

Okay.

So more on the go forward versus anything else.

And then you are targeting a 12 ROE.

Is that -- does that number go higher in 2018 as you institute some of these plans?

Where are you looking, assuming reasonable market conditions like we have now on the demand side?

I think we are projecting an ROE in excess of 12% for next year.

We would look for 50 to 100 points increase on that as we get to 2018, as some of those initiatives that are outlined start to take hold for a full year of 2018.

Okay.

If I could sneak one more in.

Land and land development this quarter?

Land was $78 million.

What is the land development, Gregg?

Sorry.

Bear with me, everybody.

Land development spend was $207 million for Q4 of 2017.

I'm sorry.

Hold on.

Yes.

Sorry.

I broke out the wrong year on there.

I'll have to give you that after the call.

Sorry, I broke out 2017.

We will get that to you.

Our apologies.

We gave you a hint.

(laughter)

Thanks.

Jade Rahmani, KBW.

This is actually Ryan Tomasello on for Jade.

Thanks for taking my questions.

Regarding City Living, we appreciate the color you gave in your prepared remarks.

Could you opine a bit more on the visibility you have for new supply coming on in the market in your price point in particular in the neighborhoods that you are in, say over the next 12 to 24 months?

Also, perhaps what types of trends you are seeing in terms of pricing or any concessions in the remaining inventory at the projects that are currently in their last sell out phases?

Sure.

In general we believe supply will be coming down in New York City as compared to the last two years when every other block had a crane in the air.

Obviously we are keeping a close eye on some properties that opportunistically may become available because developers aren't moving forward.

I remind you that we have not purchased property in New York in over two years.

We are looking.

We had deal flow internally, but we are very strict on that 35% or better gross margin, and if it is not pencilling in today's market we are not buying.

With respect to our own pipeline, we are excited about a building that will be going up shortly in Jersey City.

We have one tower there for apartments, and the second tower in the same location will be condo, and we think we are well positioned and that building should prove to be very successful.

Everything we do to date, knock on wood, in Hoboken has been spectacular, and we are selling our way through a building in Hudson Tea that will start delivering later in 2017 that has had tremendous sales.

130 plus or minus in the last year at $900 to $1,000 a foot.

That building will continue to sell and deliver later in the year.

We have a property in Tribeca called 91 Leonard that is under construction, and will open for sale towards the end of 2017.

Then we have King Street, which is in west Soho, which will open in 2018.

That is in addition, of course, to what is already open that we talk about regularly.

From our perspective, we are very happy with the new properties coming on, where they are located.

Our basis still works, as I said in prepared comments.

It still exceeds the 35% underwriting gross margin.

For the overall supply of the market, we are cautiously optimistic that it appears there will be less supply coming on over the next few years based upon what is being entitled and going through the predevelopment phase.

For new acquisitions, we will continue to be very opportunistic and very careful and we will see how that plays out.

Great.

That was good color.

And then secondly, can you give some additional color on what is driving the mix shift impact on margins, particularly if it is constricted in certain markets?

And perhaps how much of that 25 to 35 bp compression headwind is being driven by the expected decline in City Living?

So, it is a very challenging question for me to ask.

I have in front of me -- or for me to answer.

It is easy to ask.

(laughter)

I have in front of me a list of all 40 of our markets and what margins were in 2016 and what we expect them to be in 2017, and what volume was in 2016 and what we expect it to be in 2017.

It is true that New York will grow nearly 70% in revenues, which makes it a bigger piece of a bigger pie, but we are going to lose 3 to 4 points in revenue on that.

I'm sorry, in margin on that.

Excuse me.

In Seattle though, on the other hand, we expect it to grow 15% and add 3 points to its margin.

California will be a little bit flat.

North will be down and south will be up, but overall it will be a little bit flat.

The margin there on a net basis is going to move about a half a point down, which is a function of mix.

You go to Dallas where volume is going to be the same, which makes it a smaller piece of the total, and we'll see margins go down 2% -- two percentage points.

New Jersey we're going up half a point.

It is a bunch of different factors, Ryan, that it is tough to draw a theme.

Our margin moves around based on mix shift, based on cost pressures, and based on pricing power.

But a theme cannot be drawn around the country on all that.

Okay.

Great.

I appreciate that commentary.

Nishu Sood, Deutsche Bank.

Thanks.

Marty, just following up on that.

It is difficult, as you mentioned, to draw a general theme about it, but I think the broader question that investors are debating is whether there is enough pricing power to continue to cover the cost creep, both on the materials and the labor and the land basis side.

To the extent that from your data it is possible to talk about that dynamic, and I don't know if it is helpful to go regionally to some extent.

I think that might be helpful.

Sure.

I think overall our incentives have not moved.

They are still $20,000 to $25,000 per house.

It moves a little bit geographically by quarter.

Costs have gone up around $2,600 on average in this quarter.

So call that $10,000 or $11,000 annualized.

We have seen price increases in the neighborhood of $3,000 to $4,000 on average.

For the quarter.

For the quarter.

There is also the land input costs that go up.

To get to the crux of the matter, it is consistent with what we have said in the past.

It is very challenging in this environment to overall improve margins, but we are doing a pretty good job of staying relatively flat in most of our markets.

What you are seeing is a mix shift.

In our fourth quarter, our margins were negatively impacted by an approximately $5 million actuarially determined increase in warranty and other reserves.

That explains a bit of our margin drop off compared to expectations in the fourth quarter.

We are pretty proud of the margin expectations we set for next year, particularly on a comparative basis with our industry.

Got it.

That is very helpful.

On the return on equity, really appreciate all the details there.

I wanted to ask about the share buyback component of it and the inventory turns.

The inventory turns, you mentioned T Select as the potential to improve inventory turns, the Coleman acquisition as an example of improving inventory turns.

Those businesses are call them departures from the traditional lower turn, more land intensive, longer time frame Toll Brothers projects.

Just in terms of incremental investment, you might see some improved turns, but what can you do on the bulk of your existing business to improved turn?

And are those two examples -- do they tell us anything about the new deals that you are bringing on and whether those are faster turn?

So, in certain markets, the upfront cost of land as a percentage of the ultimate home sale revenue is lower than in other markets.

The availability of a tract of land in those markets may be also less constrained, so you can replace it easier.

Those markets are more conducive to a shorter build time and quicker inventory turns and an improved return on equity.

Many of our other markets where the land is tougher to find, it's higher as a percentage of the total sale price, it's not as conducive to that.

We are balancing those higher turn, quick return, higher return on equity markets with those markets where we think it is more appropriate to drive gross margin increase.

This is Doug.

Please understand that our special sauce is the Toll Brothers luxury home, that $850,000 home nationwide, $680,000 out of Cali and New York City where you come in, you have the opportunity to build or to choose a lot of upgrades, to go to our beautiful regional design studio and pick all of your finishes.

That is the American dream that we sell to the move-up buyer, and that house takes longer to build.

We have historically had great pricing power in that business which has led to terrific ROEs, and this cycle has been a slower recovery.

We have not had quite the same pricing power.

We are not giving up on that business at all.

That is what we do.

We are supplementing that business with City Living, with Boise, with apartments, with some joint ventures in the big master plans where we are being much more capital efficient.

Student housing.

Student housing.

You will continue to see out of Toll Brothers a continued mix of everything you can think of that is luxury, including the three series BMW to serve the millennial at 34 years old that has more money than my generation of boomers that bought it at 25 years old.

That will be less upgrades, no design studio, a faster turn, lower margin but higher ROE, but that is just a mix into what we do.

That is one more component of what we do.

We are not turning this ship in a dramatic direction.

We love our business.

We are just supplementing it with one more product line that we think will help ROE, but most importantly will bring in more buyers that we have not yet touched.

Got it.

That is very, very helpful.

The share repurchase, just real quick on that.

You mentioned it, Marty I believe, as part of the return on equity improvement.

Does that mean we should view it as part of the program to improve returns?

Therefore, that you will continue to prioritize that in 2017?

Or should we continue to think about it in the traditional mold of just being opportunistic?

I think you should think of it at this point as being opportunistic, and the expectation I set for next year presumes nothing in addition to what we have already done.

Okay.

Great.

Thank you.

You're welcome.

Ken Zener, KeyBanc.

Good morning, gentlemen.

Good morning.

Marty, the comments that you gave regarding the piece of paper you have in front of you, I think were very insightful.

If you want to help us out with a supplemental, that would be much appreciated.

(laughter)

You're breaking up, Ken.

(laughter)

It seems to me that while you do have all those different markets, Seattle is the only one where net pricing is leading really to margin expansion given the higher either labor and/or land cost running through your different businesses.

I guess my question --

I would say, Ken, that's the best example.

We are seeing pricing power in a number of other markets as well, including California.

Right.

But I think you said your margins were going to be down on that piece of paper in California.

Because of mix.

Because of mix.

Right.

I guess I apologize if I missed it at the very beginning.

Did you comment for the West Coast and/or New York for the foreign buyer mix?

And if you could add Seattle into that commentary, Doug, I would appreciate it.

Sure.

We did not comment.

Our foreign buyer percentages really have not changed.

California, City Living, and Seattle are by far one, two, and three.

Actually it goes California, Seattle, and then City Living in that order.

We are running 5.4% companywide foreign buyers.

It is about 20% in Cali, it is about 25% this past quarter in Seattle, and down to 8% in New York City Living.

It has moved a little bit quarter by quarter, but that again can just be mix driven.

We think the Seattle tick up may be a reaction to the Vancouver taxes that have been charged for foreign buyers.

Because in the third quarter of 2016, Seattle was 16% foreign and it jumped up to 27% in the fourth quarter.

We will have to see how that plays out over the next few quarters.

So there you have it.

5.4% nationwide, but it is really a story about three specific markets.

Right.

I understand.

Now, this is looking out beyond what you're going to give guidance to, but in terms of how you've structured the Company in terms of these ancillary businesses, other income, which you guided to a list this year 2017 expected, does that rate, given the capital you deployed in those businesses, your $160 million, $200 million, is that something that would continue for several years in your opinion?

Well, it is very lumpy.

That $160 million to $200 million is being driven to a large extent by two JV buildings in New York City that are now delivering units, Pierhouse at Brooklyn Bridge Park and The Sutton over in Sutton Place.

As you know, we talk about it all the time, the City Living business is lumpy.

We sell, we build, and then we deliver.

It just so happens that this year we have two joint ventures that have significant deliveries at significant profit that are hitting in a big way this year.

We have buckets for subsequent years.

We are going to be recapitalizing and probably selling some apartments.

We have a security company that at certain times we sell accounts to one of the big boys.

We own a parking garage in Hoboken that is very valuable.

There is a lot of different things that can go to other income.

We are putting some of our master plan communities into JV, et cetera.

We are not prepared to guide toward 2018, but to date it has been driven a lot by when the big buildings in New York that are in JV deliver.

We have a pretty solid baseline of $35 million to $50 million of routine ancillary operation income that comes through the other income line.

We supplement that with some of the joint venture matters or even sales of businesses matters that Doug mentioned.

Thank you.

You're welcome.

Robert Wetenhall, RBC Capital Markets.

This is actually Marshall Mentz on for Bob.

You all had a pretty sizable sequential increase in optioned lots during the quarter.

Would you talk about the drivers of that move, both on your part strategically and then what you have been able to take advantage of in the buying environment?

In optioned lots?

Yes.

I think we have a sizable opportunity in Seattle.

Boise.

Boise.

So we have 350 -- I'm sorry.

It is the entire Boise acquisition.

(multiple speakers) Boise closed in November.

We had it under contract for 1,700 lots in October.

It shows up as optioned lots at the end of October.

That is a little bit --

That sounds like it's most of it.

Thank you.

You're welcome.

Mark Weintraub, Buckingham Research.

Thank you.

As you know, your gross margin is looking to be pretty resilient compared to some of your peers.

Some of your peers in the meantime perhaps to offset that have gotten quite aggressive on -- are putting pretty aggressive targets on SG&A, in some cases 9% and lower.

You enumerated why this coming year your SG&A as a percentage of sales might go up a little bit, but thinking beyond just 2017, is that an area where there is scope for getting that to a lower number?

Doug, does that potentially feed into the higher ROEs that you are thinking you can achieve in 2018 or beyond 2018?

Mark, we are absolutely focused on SG&A.

One of the big issues of course that drives it is our pricing power since it is a percentage of revenue.

If we see pricing power in 2018, you will see SG&A go down.

We are always looking at where we can be more efficient, but remember as we build some of these big, spectacular communities in places like California, and I talked about the number of openings we have out there for anyone on the call who has visited, our models are what is making us so successful.

Because you walk through these houses and you have to have it.

We have worked very hard at the model, the architecture, the decorating, the merchandising, the marketing.

I talk about special sauce.

That is a big part of it.

Beyond just that, I know it's a small component of SG&A, the long answer to your question is yes, we are very focused on it.

We will continue to do what we can do to manage it and get it down.

I don't think we will ever lead the pack in terms of SG&A leverage because of the nature of the product and our customer and the experience.

But it is definitely something we are focused on.

Okay.

Great.

Thank you.

Jay McCanless, Wedbush Securities.

Good afternoon, everyone.

Thanks for taking my questions.

The first question on the single-family detached business, you mentioned cycle times earlier.

Where is your average cycle time running now versus say a year ago?

I think over the last 12 months we have not seen much change.

The bigger homes take 10 to 12 months, the smaller ones take 6 to 9 months.

It hasn't moved too much.

I think last January's conference call we said we had seen two or three weeks in creep, but we have kept it at that two or three weeks.

We have not made any progress towards it, but we have not let it slip any further.

Got it.

Okay.

The second question, on T Select could you talk about maybe the margin differential for that product versus the average gross margin?

And maybe give us some idea of what percentage of the community count over the next couple of years you envision for T Select?

It is less than 5% for everything that we have identified over the next year or two.

On the margin front, I think we would accept a margin that is 2 to 3 points lower with a ROE, or what we call ROI, that is more than 2 to 3 points higher.

And that is how we've looked at some of these deals.

Okay.

That is great.

Thank you so much.

You're welcome.

This concludes our question-and-answer session.

I would like to turn the conference back over to Douglas Yearley for any closing remarks.

Gary, thank you very much.

Thanks everybody for joining us, and we wish you all a great holiday season.

See you next year.

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