托爾兄弟 (TOL) 2017 Q2 法說會逐字稿

Good day, and welcome to the Toll Brothers Second Quarter 2017 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.

Sir, please go ahead.

Thank you, Steve.

Welcome and thank you for joining us.

I'm Doug Yearley, CEO.

With me today are Bob Toll, Executive Chairman; Rick Hartman, President, 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 VP 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 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 e-mail questions to rtoll@tollbrothersinc.com.

We completed fiscal year 2017's second quarter on April 30.

Second quarter net income of $124.6 million rose 40% versus fiscal year 2016's second quarter of $89.1 million, and earnings per share of $0.73 per share diluted rose 43% compared to $0.51 per share in fiscal year 2016's second quarter.

Fiscal year 2017's second quarter pretax income was $199.2 million, up 42% over $140.4 million in fiscal year 2016's second quarter.

Revenues of $1.36 billion and the homebuilding deliveries of 1,638 units rose 22% in dollars and 26% in units compared to fiscal year 2016's second quarter total.

The average price of homes delivered was $832,400 compared to $855,500 in 2016's second quarter.

The change in per-unit price for revenues, contracts and backlog were all related to mix changes.

Net signed contracts of $2.02 billion and 2,511 units rose 23% in dollars and 26% in units compared to fiscal year 2016's second quarter.

The average price of net signed contracts was $804,200 compared to $825,000 in last year's second quarter.

Fiscal year 2017 is shaping up to be another year of substantial growth.

This second quarter was our 11th consecutive quarter of year-over-year growth in total net contract units and dollars.

We have achieved double-digit increases in each of the last 4 quarters.

For the first 3 weeks of fiscal year 2017's third quarter, nonbinding reservation deposits were up 12% in units compared to the same period in fiscal year 2016.

Our second quarter-end backlog of $5 billion and 6,018 units rose 19% in dollars and 22% in units compared to fiscal year 2016's second quarter-end backlog.

At second quarter-end, the average price of homes in backlog was $831,000 compared to $848,600 at fiscal year 2016's second quarter-end.

Based on deliveries to date and our backlog, we now project deliveries to increase from 6,100 in fiscal year 2016 to between 6,950 and 7,450 in fiscal year 2017 and revenues to increase from $5.17 billion in fiscal year 2016 to between $5.4 billion and $6.1 billion in fiscal year 2017.

Solid and improving demand and the financial strength of our affluent buyer base are driving our growth.

This was the best spring selling season we have had in over 10 years.

The number of contracts in fiscal year 2017's second quarter was the highest since 2005's third quarter, and the number of contracts per community was the highest since 2006's second quarter.

With operations now in 20 states and approximately 50 markets, our upscale suburban home communities are attracting buyers across a broad spectrum of ages and incomes.

Contracts and settlements rose in all 5 of our suburban regions this quarter.

We offer single-family homes ranging from the mid-$300,000s for some communities in places like Jacksonville, Florida; Boise, Idaho; and Houston, Texas to over $3 million in some communities in Southern and Northern California.

We offer everything from luxury townhomes and mid-rise single-story living to elegant, smaller single-family homes for first-time buyers and empty-nesters to large single-family homes for growing families.

Here are a few examples of recent sales.

At Orchard Hills in Orange County, Southern California, we have taken 41 agreements in Q2 between $2 million and $3 million with models not yet opened.

Strong sales have continued beyond the quarter.

We have just taken our 50th agreement since opening in January.

At North Oaks of Ann Arbor, a townhome community located less than 1 mile from the University of Michigan, we continue to have strong sales.

Over the last 8 weeks, we have taken 26 deposits and 18 agreements.

Our active adult product continues to perform well particularly out West.

For example, in Las Vegas at Regency at Summerlin, we have taken 28 deposits and 20 agreements in the last 2 months.

In Reno at Regency at Damonte Ranch, we have taken 36 deposits and 24 agreements over the same time period.

At Loudoun Valley Estates, a master-planned community in Ashburn, Virginia, we have taken 64 deposits and 47 agreements across 5 product lines in the past 8 weeks.

Our City Living division, which includes both wholly owned and joint venture projects, is mostly concentrated in urban New York City.

This quarter, contracts in this region were flat in units and, adjusting for the cancellation of 1 penthouse buyer, about flat in dollars as well.

While delivery patterns are always lumpy in high-rise buildings, we expect that City Living's profit margins will continue to exceed the company average for full fiscal year 2017.

At 1400 Hudson Street in Hoboken, New Jersey, we have taken 21 agreements in the past 2 months.

The building now has 200 units in backlog and is projected to begin settlement next month.

We are also seeing continued strength from renter demand in our affluent urban and suburban Toll Brothers Apartment Living properties.

Occupancy in stabilized properties, which total nearly 3,000 units, is over 95%.

In the past 6 months, we have recapitalized 2 recently stabilized rental projects totaling 815 units, 1 urban and 1 suburban, bringing in long-term investor partners to exit our development partners and to reduce our own ownership stake.

This was consistent with our original strategy.

The total cost to develop these 2 joint venture properties was $247 million.

The value at stabilization based on the exit price our partners received was $366.5 million, which reflects $120 million of added value we created in these high-quality rental locations bearing the Toll Brothers Apartment Living brand.

In the first 6 months of fiscal year 2017, the recaps contributed $26.7 million to income from unconsolidated entities based on the disposition of half of our interest in each of the 2 properties.

We continue to own 25% of each and generate fees as we manage both properties.

The combination of Toll Apartment Living's current stabilized properties and our pipeline of units under construction in lease-up or in development totals over 11,000 units.

With our well-established footprint in the Washington, D.C. to Boston corridor and new operations in Atlanta, California, Texas and Arizona, we hope to double the size in units of Toll Apartment Living in the next 3 to 5 years.

Now let me turn it over to Marty.

Thanks, Doug.

Before I address the specifics of this quarter, I want to note that a reconciliation of the non-GAAP measures referenced during today's discussion to their comparable GAAP measures can be found in the back of today's press release.

We are pleased with our income statement results this quarter.

Net income grew 40%; earnings per share grew 43%; and we hit the high end of our projection in nearly all key metrics.

Revenues, deliveries and average delivered price were at the top of our guidance, and that drove SG&A down to 10.8% of revenues.

Gross margin was 21%, and adjusted gross margin, which excludes interest and impairments, was 24.3% of revenues.

Second quarter interest expense included in cost of sales was 3% of revenues compared to 3.2% from 2016's second quarter.

We recorded $4.3 million in inventory impairments.

In the second quarter, we issued $300 million of 10-year bonds at a rate of 4.875%.

With $691 million in cash and $1.18 billion under our credit facility available at second quarter-end, we are opportunistically positioned for various things, including to retire our $400 million of debt maturing in October of 2017 as well as potentially our $288 million in convertible bonds in late calendar 2017.

We paid our first quarterly dividend on April 28, 2017, of $0.08 per share, and we ended 2017's second quarter with a debt-to-capital ratio of 45.4% while our net debt-to-capital ratio dropped to 39.8%.

Our weighted average diluted share count this quarter was 171.4 million shares, and that includes 5 million unissued shares that are treated as outstanding associated with our convertible bonds.

These bonds are convertible at an adjusted share price of $48.97 and are callable by us in September 2017 or putable to us in December 2017.

For modeling purposes, with these carrying a 0.5% interest rate, it's probably best to assume they will be put to us in December and fall out of the share count then.

In our income from unconsolidated entities, we benefited from a $20.5 million gain on a sale of a share of our ownership in a Toll Brothers Apartment Living joint ventured rental project.

We had previously projected this for our third quarter of fiscal year 2017.

This was the second project this year in which we round-tripped capital by selling a portion of our ownership position and reducing our basis in a property that had achieved stabilization.

The IRR on these 2 joint venture projects is in the mid-20s.

Subject to our normal caveats regarding forward-looking statements, we offer the following guidance: Based on our strong results through fiscal '17's first 6 months, we are revising our target of 2017 return on beginning equity upward to 12.5% from 12% previously.

With respect to full fiscal year '17 guidance, we are increasing the midpoint of our guidance by 100 homes and now expect to deliver between 6,950 and 7,450 homes at an average delivered price per home of between $775,000 and $825,000 for fiscal year 2017.

The rest of our full year guidance is unchanged from our previous 2 calls.

Adjusted gross margin of between 24.8% and 25.3% of revenues, SG&A as a percentage of revenues of 10.6%, other income and income from unconsolidated entities of $160 million to $200 million and an effective tax rate of approximately 37.5%.

For fiscal year 2017's third quarter, we project deliveries of between 1,675 and 1,975 units at an average delivered sale price of between $790,000 and $815,000.

Adjusted gross margin is expected to improve 10 basis points from fiscal year '17's second quarter results while SG&A as a percentage of revenues is projected to be about 10.4%.

Other income and income from unconsolidated entities is projected to be between $15 million and $30 million, and we project the effective tax rate for our third quarter to be approximately 39%.

Let me turn it over to Bob.

Thanks, Marty.

We believe our strong results are being supported by the release of pent-up demand.

Single-family housing starts rose to 835,000 in April.

However, that is still just half the previous peak of 1.72 million in 2005.

Many factors are bringing buyers off the fence right now.

These include low interest rates, urgency created by the limited supply of resale and new homes and improving personal balance sheets and credit profiles.

Our luxury buyers are further benefiting from a solid employment picture, strong consumer confidence, a robust stock market and increasing equity in their existing homes.

Additionally, as The Wall Street Journal recently reported, the number of new-owner households was double the number of new-renter households in the first calendar quarter of this year.

According to Trulia, this was the first time in a decade that new homebuyers have exceeded new home renters.

Clearly, the new home market is alive and well.

And back to Doug.

Thank you, Bob.

My pleasure.

We believe we are benefiting from the appeal and national recognition of the Toll Brothers' brand and a lack of large-scale competition in the affordable end of the luxury new home market.

The breadth of products we offer, our beautiful home designs and our ability to appeal to a wide range of demographic groups, including affluent move-up, empty nester and millennial buyers, are also fueling our advantage.

Increasingly, homebuyers choose to buy new over used homes, particularly in the luxury market where consumers want and can afford to customize their homes.

We think our customization program differentiates us within our segment of the luxury market.

Buyers are spending, on average, over $120,000 to further customize their already well-appointed homes.

The supply of new and existing homes continues to trail the growth in population and households.

We are producing strong results even with industry-wide home production levels still well below historic norms.

Our affluent discerning buyer base, combined with our strong balance sheet and well-located communities, is enabling us to outpace the industry in many metrics.

As I mentioned earlier, this was the best spring selling season we have had in over 10 years.

We attribute our strong results to the expansion strategy we have undertaken over the past decade to diversify our luxury market product lines and geographic footprint.

We have a great land supply to support further growth, a brand that we believe is tops in the industry and a seasoned and dedicated team that positions us to continue to lead the luxury new home market in the years ahead.

Steve, let's open it up for questions.

(Operator Instructions) And our first question comes from Robert Wetenhall with RBC Capital Markets.

Wanted to ask -- you had a massive surge in the West in your orders, and it seems like across the portfolio, you're seeing strength.

What drove that big uptick?

And when you're thinking about on a regional basis, strengths and any softness, it sounds like everything is going in the right direction.

Is that the right way to think about it?

And maybe if you just comment on why the West is so good.

Bob, the West is great in all regards.

We had significant order growth in Arizona; Colorado; Idaho, of course, is new to us and doing very well; Las Vegas; Reno.

The only place that was down in the West, and it's strictly mixed because we love the market, was Seattle.

And we have more openings coming, so we'll make up for that.

But the West was absolutely fabulous in all regards.

We, of course, now report California independently, which is as West as we get.

And I have the same comments for all of California as I just made for our Western region: It's just fabulous.

That's obviously positive, and I'm glad you're leveraged to the strong demand out there.

You came in at the high end of your adjusted gross margin guidance.

We're hearing a lot about lumber tariffs, the higher cost for land and labor.

Direct costs are rising, too.

But it seems like you're successfully navigating them in a very productive fashion even when you're getting a weaker mix on ASP.

That's a tough balancing act.

And I was just curious, how -- what are you doing, obviously, something correctly to continue to get that highly profitable gross margin?

Is it sustainable?

Or do you -- what are you thinking in the back half of the year?

Well, I think, Bob, we've given guidance on the third quarter.

We've given guidance for the full year.

So it's pretty evident that we expect margin in the fourth quarter to grow.

That's a function of mix because we are seeing some headwinds associated with managing through the labor, lumber and land issues as well as some other costs.

But with deliveries happening at 1400 Hudson in our New York City Living segment as well as an increase in our California deliveries, we expect fourth quarter margin to be up over third quarter.

And we're happy that we're able to continue to reiterate our beginning-of-the-year margin guidance.

Got it.

And just if I could sneak one last in.

It seems like your orders are coming in ahead of expectations.

How should we be thinking about backlog conversion in 2H relative to last year?

I think -- again, we've given pretty specific guidance for backlog conversion for the third quarter and for the full year.

One other comment I wanted to make with respect to margin is our active adult segment and our Idaho business is producing more sales than we had expected at the beginning of the year.

And that is product that we'll be able to deliver this year.

And so that will generate a better ROE.

But since that business is a bit lower margin than our average, it does offset some of the New York and California news that I mentioned a comment ago.

Our next question comes from Michael Rehaut with JPMorgan Securities.

First question.

Obviously, with the positive absorptions and a lot of the strength that you're pointing to in your different markets, I was curious about how you're thinking about price.

And maybe you could give us a sense of what the -- what type of a rate of like-for-like price increases you're seeing.

If you can kind of give perhaps a blended average across your communities or any type of sense.

We heard out of our conference earlier -- or, I'm sorry, last week that a couple of builders are still kind of seeing maybe only about low single-digit type of appreciation.

Is that -- given the strength that you're seeing in the sales pace, is that something that -- are you seeing that type of rate of price inflation?

Or is it perhaps better in some regions?

Mike, this is Doug.

It's certainly better in some regions and it's worse in others.

California and Seattle have had -- we've had the ability to raise prices the most.

For the quarter, we -- on average, nationwide, we raised prices a little more than $5,000 per home.

We had costs go up about $2,500 per home, so we continue on a national level, on average, to outpace cost increases but not by a whole lot, by $2,500.

But when I focus on those areas that have been strongest, you'll look to where we sold the most homes this quarter, and that's Southern Cal, Northern Cal, Seattle, Northern Virginia, New Jersey, Las Vegas, Reno.

So most of -- and Michigan.

So many of those markets are out West.

But some of the old, steady performers from the old days of New Jersey and Northern Virginia and Michigan have continued to perform very well, where we've had pricing power.

But when you blend it all together, it's those numbers I started with, up a little more than $5,000 price increase and about $2,500 cost creep.

And those are house construction costs that are creeping.

It does not factor in land or land improvement costs, which are also creeping.

Right.

No.

No, that's helpful.

I guess, just secondly, if I have this right from a modeling perspective, it looks like your -- in terms of squaring into your guidance, that your fourth quarter SG&A might be up a little bit year-over-year.

I wanted to know if we have that right and perhaps what's driving that if it's kind of extra costs in front of next year.

If community count continues to grow, are there some mix issues or anything like that?

I think it's a function of the growth of the company.

And while we are managing costs carefully, I think we anticipate with the growth in backlog, growth in sales, growth in communities we project, we need a few more bodies around here.

Okay.

And just one quick one if I could on the modeling side.

The increase in the tax rate -- the new rate that you're pointing to for 2017, is that something that, all else equal, I know there's a lot of puts and takes, but is good of a place marker as any to use for 2018?

Or are there a couple of items that maybe is temporary that won't continue into next year?

I think it's tough for us to project into next year, so we're not going to do that.

We're not sure what's going to happen with tax rates.

Our blip-up in the third quarter projection is a function of trying to defer some income for tax purposes into later years in the hopes that we have some lower tax rates.

And in deferring income, you reduce the amount of Section 199 credits you're eligible for.

Our next question comes from Stephen East with Wells Fargo.

Maybe a quick follow-on question on the order front.

Could you just give us an update on when your Northern California communities are coming online in Porter Ranch?

And then Doug, you had talked about the different categories driving your business.

Could you sort of rank-order your traditional business, your active adult, T Select, attached townhome, to give us a feel for where you all think you're getting the most bang if you would?

Sure.

I think there's 3 questions there, so I'll take my time to get through them.

First, on Northern Cal, we expect 7 community openings in late 2017.

And that's exciting for us.

They're all terrific.

In Southern Cal, we expect 5 community openings in late 2017.

With respect to Porter Ranch, which is in Southern Cal, the recovery from the gas leak of now, what, 15 months ago or more, 17 months ago, is on track.

I was out there a few weeks ago.

I was very happy with what I saw.

We have lots of traffic.

The schools are opened.

The retail's opened.

It is a thriving community of 20,000 residents.

We are at about 2/3 to 3/4 the sales pace of pre-leak, which is about where we thought we would be.

I'm very happy with the new openings we have, the new model presentations, and we actually have one more Porter Ranch community opening later this year.

So I think with every week that passes and we get further from the leak, the community gets more and more back to normal.

And I feel good about where Porter Ranch is today and where I believe it will continue to improve and be over the next 3, 6, 9, 12 months.

So everything is on schedule there.

With respect to product lines and how I would rank them, Stephen, the business is clicking.

I'm thrilled and very proud of the diversification that we've strategized towards for the last 10 years, both geographically and with product mix.

As we talked about, we've got an active adult out West now.

We had a big presence in the East, and we're doing very well in Denver and now in Reno and Las Vegas.

We have a new opportunity we're pursuing approvals on for a large active adult community in greater Phoenix.

And you'll see more and more active adult in the Western states, hopefully in California and hopefully even in Texas.

And with the affluent boomers downsizing and Toll offering that luxury active adult, I think that's a -- that will be a big -- bigger part of our future.

Our move-up business in the suburbs is terrific.

I highlighted a community in Northern Virginia that's classic Toll Brothers move-up, which is booming.

The millennial products, whether it be the townhomes in Ann Arbor or whether it be the new T Select line, which we've just launched in Houston and will be launching shortly in 2 locations in Philly, I have great hope for.

And then, of course, the traditional move-up, which I mentioned the one example in Northern Virginia, but that's a big part of our business in many locations.

So the only thing I failed to mention is City Living in that mix.

New York's flat.

We're doing just fine.

We have high margins, as we've talked about, now for over a year.

In certain buildings on certain units, we have had to raise incentives.

But I am happy with the business.

200 in backlog about to deliver out of Hoboken at extremely high margin.

It's exciting for us with continued good sales.

We have 18 sales since October in our flagship building at 22nd Street that I'm happy with in this market.

We have a building we're pursuing approvals on in Philadelphia.

We have a building that's now delivering in Bethesda, Maryland, and we have 3 new land opportunities in the L.A. market that Rick Hartman and I have both put our eyes on over the last month, and we're very excited about that.

So overall, I guess, my long answer to you is every part of the business is clicking, and I think we're well positioned with land holdings and with brand and with geographic locations to continue to do well in all market segments in the future.

All right.

I appreciate that.

And this is a shorter question, I think, for Marty.

Marty, you raised your target for your annual returns.

I guess, do you have a targeted improvement that you all are shooting for?

And as you look at this, as I look at your returns, probably asset turnover is where you can get the most bang for your buck.

But that's also the hardest to accomplish, takes the longest.

So as you're looking at moving your targets up, what's your biggest driver that you're seeing?

And do you have a targeted improvement?

I think we set a target for '17.

At the end of this year, we'll set a target for '18.

We have exceeded our target for '17, so we're pretty pleased with that.

I think that's a function of good demand.

Future improvements in our ROE are going to be driven by our land basis and that turnover.

Buying the land on terms on a deferred basis, while it may cost us a bit more, it should improve our return on equity.

Our next question comes from Alan Ratner with Zelman & Associates.

And congrats to Bob and Bruce for your induction into the BUILDER Hall of Fame a few weeks ago.

Very impressive.

So my first question.

Just on the comments in the release about buyers increasingly choosing new over existing.

I think that it's clear we're seeing that trend across a lot of major markets in the country.

Given the fact that most of your buyers have a home to sell, just curious what you're hearing from your salespeople as far as any changes in either the relative ease or difficulty in your buyers' ability to sell their home.

Have you seen more price capitulation on their part to kind of move that inventory?

Or have you seen any changes in contingency orders?

I'd imagine you're not doing a whole lot of those these days.

But anything you can give us there anecdotally would be helpful.

Sure, Alan.

We do not do contingency orders.

That's never been a part of our business.

What we're hearing from sales is that the resale of our buyers' home is not an issue.

Remember, our houses generally take 7 to 12 months to build.

In some cases, we do have spec inventory that will turn faster.

But as the resale markets are improving, as more and more buyers have equity in their homes, they appear to be confident that during the time frame to build their new home, they will have plenty of time to sell their existing home, and they want to move up and here they come.

And we're seeing that pent-up demand come out, and it's just not a conversation that sales is apparently having with our clients.

Great.

Second question.

On the margin, Marty, you made the comment that fourth quarter margins, which should be up nicely, it's really mix-driven.

I can understand the Hoboken deliveries obviously contributing to that, but you mentioned also the West and California, which seems like that should continue to be a pretty meaningful chunk of your business.

And with the order growth there, I'd imagine that the margin profile is pretty favorable relative to the company average.

So why shouldn't we expect that to at least continue, heading into 2018, to benefit from the West?

Well, I think the margin profile with respect to California is definitely favorable to the company average.

With respect to the active adult product that is growing at a 38% clip, it's not as favorable to the company average.

So the plus on the California side and the plus on the active adult side have a tendency to offset each other.

So should we think about just the overall margin profile today, just think more about the full year average, something in that 25% range as being where you're at least thinking the baseline should be going forward?

We're not going to get into margin going forward beyond the 6 months we've given you guidance for, Al.

Our next question comes from Stephen Kim with Evercore ISI.

It's actually Trey on for Steve.

I want to stay in California for a minute.

Going back, historically, it grew as you acquired Shapell.

And since then, it's definitely increased in your overall mix.

As it stands today, it's somewhere around 30% of your sales and 15-ish percent of your closings.

How do you guys think about your exposure to California, both in units and potentially dollars?

During the next year or 2, can you see continued mix shift out there?

Or do you think as a percentage of your business, it's fairly representative of how you think it's going to stay?

Trey, I think it's fairly representative of where it will be next year based on the land that we control and the openings we have coming.

You are correct.

California represented 29% of the second quarter contracts in dollars.

I remember the price out there is quite a bit higher than our average.

We're thrilled with our locations, and our new openings have exceeded expectations.

We don't see overheated market.

We don't see investors.

We certainly all know mortgage money is not easy.

The percentage of foreign buyers has stayed stable, and they have been -- quite easily been able to finance their homes or get cash into us to purchase their homes with truly no issues.

I've checked with our mortgage company.

I've checked with our California teams, and it has been business as usual for some time now with that foreign buyer.

So it's a cliché, but location, location, location.

The Shapell deal, combined with new acquisitions we have done in both Northern and Southern California, continue to position us in the best locations.

And as I've said on this call many times, you got to go see it to believe it to understand these Toll communities we're building, the architecture, the indoor/outdoor living.

It's special, and I'm feeling very good about our position in California and our future there.

Got it.

And then more broadly, just given your strong pace of sales, as you've really seen over the past 3, 4 quarters, how has that changed, if at all, your thoughts on your ability to continue to grow your community count?

Do you think you're potentially at risk given these strong order trends of closing some communities out faster than you had initially expected and the potential for a community gap at some point over the next, call it, year or 2?

So we're maintaining our community count guidance for the year.

But we do recognize that as well as we've done communities will in some locations, be selling out faster than we had first projected.

So we need to hustle and get future communities opened, and we are focused on that.

But for the time being, we're going to stick with our guidance.

We have plenty of land.

And as we sell through, we will work hard to open new communities so that we don't have the gaps that you described.

Our next question comes from Mike Dahl with Barclays.

This is Anthony Trainor filling in for Mike.

My first question I wanted to talk about, Idaho and Coleman Homes.

I just wanted to clarify first.

If you said that the gross margins in there are below company average, is that because of purchase accounting in this year?

Or if there is -- or is that business underwritten to a lower gross margin than the rest of the company?

It's a function of purchase accounting to a certain extent, but it's also the underwriting with respect to that higher return-on-equity business.

Okay.

Like in the past, I think you talked about a 30 to 40 basis point headwind on full year gross margins because of purchase accounting.

That's still unchanged, right, and that, I guess, you've now moved past most of that?

Well, I think that's roughly still accurate.

Boise looks like it may have more deliveries this year than we had previously expected, but the market's strong.

And then for my second question.

Just wondering if you could talk a little bit more about the material side.

You guys have given your extended delivery time frame.

It probably takes a little bit longer for material inflation to roll through your business.

So if you could just kind of talk about how the rise in materials, specifically lumber, has kind of impacted your outlook on margins from when you gave the guide back in December.

As I mentioned, our costs were up about $2,500 this quarter.

That was driven by lumber, labor and then, to some extent, some other materials.

But lumber and labor was the biggest part of it.

We are generally successful in locking in cost when a home is sold, so we are not blindsided with the cost of our backlog going up.

Where this goes in the future, we think most of the lumber increases have been baked in.

There's a lot of headlines now about lumber pricing and tariffs on Canadian lumber, which affect Doug fir as opposed to southern pine, which, of course, comes out of Southern U.S. Parts of our houses are Doug fir; parts of our houses are southern pine.

And the Doug fir component out of Canada has gone up months before the tariff conversation and, I think, in anticipation of it.

So I can't say it's all behind us, but we feel pretty comfortable that most of those increases have been fully baked into our numbers and the projections we've given to you.

Our next question comes from John Lovallo with Bank of America, Merrill Lynch.

The first question, I guess, is maybe if you could give us some thoughts on 2018 when the deliveries from Brooklyn Bridge Park and the Sutton kind of roll through.

What are some of the levers you can pull to kind of fill that gap in JV income if you will?

Well, I think if you look back over '14, '15 and '16, we had nearly $100 million of JV and other income in each of those 3 years.

It is ticking up this year in large measure because of Pierhouse deliveries in Sutton and this apartment project we sold.

We'll give guidance for 2018 in the future, but we have a pretty solid baseline of around $50 million of other income before any JVs.

And then the JVs, we'll give guidance on in December.

But we have a number of apartment projects where we could sell out or sell down our interest that -- as well as some other levers with respect to some of our commercial opportunities, our security business, et cetera, that we can, from time to time, execute on to generate income.

In my prepared comments, I went into great detail on the 2 apartment communities where we sold down our interest, recapitalized to the assets and produced about a $25 plus-or-minus million income.

And we did that to show that those are not one-offs; that is part of our business plan for the apartments.

Some we will hold long term; some we will recapitalize and take a smaller ownership position; and some we will sell outright.

And so those are levers that we can pull regularly, particularly as that business grows from 11,000 units to what I mentioned we hope to be 20,000 or more in 3 to 5 years.

And you will continue to see opportunities for us to add to the other income line through sales and recapitalization.

Okay.

That's really helpful, guys.

And then the second question would be -- we've heard from several sources of green shoots kind of in the labor market developing and recognizing that your labor base is a little bit different than that of some of the other builders.

I mean, are you seeing any incremental labor coming into the market?

Or are you seeing any incremental easing that's noteworthy?

It's not getting worse.

There certainly are some green shoots in local markets.

The easiest markets appear to be the Midwest and Houston.

The -- I think we've proven in the last 2 quarters with our revenue line and our ability to deliver that we are fighting the fight as well or better than many others.

And Rick Hartman is here with us.

He runs operations.

And Rick, it's certainly my belief and feeling that we have labor under control.

It's getting moderately better, and we're able to deliver the houses when we say we will.

Yes.

I mean, they -- except the out West, the subs are gearing it up, they are adding staff to keep us on pace.

But we are seeing some growing pains in markets like Michigan where the trade base there is not as broad.

But for the most part, things have eased a little bit.

And in most of the market, things have gotten slightly better.

Our next question comes from Jack Micenko with SIG.

Marty, I wanted to come back to the ROE discussion a little bit.

I know you had, I think in the past, had talked about 12 and then an ability to build maybe improve that another 100, and not guidance but potential.

Now that you got to 50 above or you've taken the goal here this year from 12 to 12.50, does that 100 potential still exist?

I mean, you got some opportunity on the debt side later this year.

You've got some higher-turning active adult in the Boise and T Select coming on.

Is that outlook still relatively the same?

Jack, I think to refine the 100, I think our perspective has been 50 to 100, and we're about 50 points ahead of where we thought we would be.

I'm not going to get more specific than that as it relates to continued growth in ROE in terms of a target until we approach December.

But it is something the company is actively focused upon and pleased with our results so far this year.

Okay.

A year ago, it seemed like everybody was worried about New York.

It was probably a big part of the questions you got in meetings with investors.

A year later, the concerns have subsided.

You -- I don't believe you've acquired any lots in New York since, maybe 2014, King Street, I think.

And at the same time, Doug, you talked about L.A. and some other markets.

Is this a strategy to look elsewhere?

Or is it just the bid-ask on the return profile you need in this environment just still too wide?

Are you changing your strategy here?

Or is it just there's nothing there that pencils?

Jack, we're not changing our strategy.

We've always wanted City Living to get to the West Coast, to be in Seattle.

We even looked in Vancouver.

We've looked in Boston.

I've said many times that I was frustrated City Living was only New York with a very small Philadelphia and Washington, D.C. business.

So we've been hunting for years, and we've found now what we think are 3 terrific opportunities in the Los Angeles market.

We're not downtown L.A., but we're in Beverly Hills, and we're in Westwood, and we're in some great urban portions of the L.A. market.

Small buildings, quick turns, as we've talked about many times.

We continue to look hard in New York City.

The bid-ask has been the issue.

Land prices have been too high.

It's a risky business, as we've talked about, which means you need a significantly higher gross margin, and we will not change the underwriting.

So we will certainly do more deals in New York.

Right now, we have new -- no new land buys to talk about.

But there's no change in strategy.

It's just at the moment, the opportunities have come elsewhere.

But I'm sure they'll be back to New York at some point here.

And our last land purchase in New York City was in 2014, and that was the land we just joint-ventured back in the first quarter at our basis.

The King Street opportunity was 2012.

Our next question comes from Nishu Sood with Deutsche Bank.

This is actually Tim Daley on Nishu -- on for Nishu.

So I wanted to talk on absorption then, I guess, the monthly cadence of sales pace.

So absorption growth is strong this quarter, but it had a pretty easy comp last year.

And you guys discussed California headwinds last year as kind of the source of that.

Could you walk us through the cadence of the year-over-year sales growth for each month in the quarter?

Sure.

February was down 4%, and that is primarily because of the rainstorms that hit California hard and the snow that hit Reno and hit Boise.

March was up 59% and April was up 28%.

But remember, in March and April, you had Easter/spring break weeks that were in different months year-over-year.

We had Easter in March of last year and April of this year, and there's -- and usually spring break corresponds with that.

So that's exactly right.

So that explains -- that difference between March and April, while big, is in part driven by our calendar.

All right.

No, that's very helpful.

And then as well, the comments on the first 3 weeks being up about 12% in the nonbinding contracts.

Last year, that metric you gave was about up 25%, but the corresponding contracts were flat year-over-year.

Could you give us the contract number for MA?

No.

We gave the deposit information.

All right.

No problem.

Now my second question.

Just quickly.

Can you give us the City Living gross margin during the quarter?

So the City Living gross margins in the quarter were in the upper 20s.

28%, 29%?

28%, okay.

And we expect them to be far above that in the third and fourth quarter.

All right.

Great.

So is that...

That's a function of some D.C. deliveries as well as moving some product in New York.

Right.

And with the Hudson Tea building starting deliveries next month and we mentioned we have 200 in backlog, that is an on-balance sheet, highly -- high-margin building.

All right.

And does that give you the confidence to kind of stick with that 37% you guys gave in the first 2 calls?

I think we expect it for the full year this year to be in the 35% range, which is what we underwrite these projects to.

Our next question comes from Jay McCanless with Wedbush Securities.

The first one I had, just on City Living.

Could you also talk about the revenue guidance that you gave at the beginning of the year and whether that's still valid?

Yes.

It is still valid.

No changes to that, Jay.

Okay.

And then my second question.

Could you maybe talk a little bit about 2018 in terms of community count growth and just maybe what you guys have modeled out so far?

Jay, we'll give you those numbers in December as we always do.

Our next question comes from Jade Rahmani with KBW.

This is actually Ryan Tomasello on for Jade.

Just going back to City Living in New York City.

Are you starting to be able to see beyond the supply concerns of the past few years given the pullback in construction lending and the impact that that has had on new development?

And as a follow-up to that, are there any potential opportunities to recapitalize, stall to counter projects of other developers?

There are certainly some deals that have come back around at different pricing, and we are analyzing those.

With respect to construction financing being tighter and therefore supply easing, I think it's about flat.

Okay.

And can you provide some color on the $107 million of land acquisitions in the quarter?

What markets are you targeting for incremental land purchases?

And what's the mix been recently of finished lots versus raw land?

So the land spend this quarter of $107 million was primarily in New Jersey and California.

We are targeting land acquisition in almost all of our markets as we continue to be very opportunistic, and we have land teams working hard everywhere we build to find us great opportunities.

Our pencil, of course, is sharper in certain locations where maybe the market is not doing quite as well or we have an abundance of good land.

We analyze that, of course, market to market.

Typically, about 20% of our total land spend is on improved lots, and the balance is on lots that we need to put roads in or the developer puts roads in for us.

Our next question comes from Ken Zener with KeyBanc.

I've seen the blazer communities in California doing well, Doug.

So given the strength that you're seeing there and, Marty, your comments about asset efficiency in general, could you talk about perhaps your propensity to increase spec building in California to increase some of the land turns that you have on the Shapell asset given if -- or given that some of your buyers are interested in closing quicker than perhaps your traditional buyers?

Ken, yes, we -- remember, the price point in California at $1.6 million is not a price that gives us great comfort to build a whole bunch of spec.

I don't think that's the right business decision.

We've had tremendous demand.

The buyers have the opportunity and desire to customize their home.

We send them to our beautiful design studios and allow them to go spend hundreds of thousands of dollars on upgrades.

And that model is working very well.

So we will always have a few specs.

But we think it's smart business to continue to build to order even though that may take a little longer.

We think that maximizes the margin and gives us a very good, if not unbelievably high, ROE.

But when we blend it all together and we look at that price point and we look at the demand from the buyer to customize their own home, we think we have the mix right between spec and build to order.

Understood.

And then I guess, Marty, I just want to pull you back.

On the fourth quarter, you had a sheet of paper that had 40 markets, '16 and '17 revenues and margins.

Since we're halfway through the year, I don't know if you still have that piece of paper in front of you.

But could you talk about maybe 2 or 3 kind of markets that are leading to higher closings or are doing better than you guys expected now that we're halfway through the year?

Well, better is better if the margin is higher.

Better is not as good with respect to margin if the margin is lower than average.

So on the better where it's a negative, Boise and Dallas are performing better than we thought, and thus, are a larger percentage of our total but are at slightly lower margins, whereas California and Seattle, that have higher margins, are not doing better than we thought.

Our next question comes from Alex Barrón with HRC.

I was hoping you can comment on the orders or the contracts you gave for the 3 weeks.

Is that like an apples-to-apples comparison?

Or does that exclude Coleman?

It is deposits, and it includes all of our business everywhere, including in Boise.

Okay.

That's helpful.

And then my other question, with regards to City Living.

A couple of years ago, you guys said you had, like, a couple of thousand units opening soon or under approval.

I guess, we haven't really seen that segment.

It's been good, but it's been more flattish.

Is there an expectation that that's going to -- what's been holding it back in your opinion?

Or is there an expectation at some point it's going to start to kind of catch up in a sense?

I don't recall talking about thousands of City Living units coming.

We've certainly talked about thousands of Toll Brothers Apartment Living units coming, many of which are in high-rise buildings.

So maybe that was part of the confusion.

We are on track for the buildings that we have talked about opening.

And when we talk about flat, it has been the market conditions of New York City.

Okay.

And last question.

On the tax rate, what -- I'm sorry if I missed your comment.

But what drove the higher tax rate guidance?

The Q3 decision to defer some taxable income into subsequent years through the completed contract method, which lowers the amount of taxable income projected for this year, which therefore lowers the amount of Section 199 manufacturing credits you can get this year.

Our last question for today comes from Mark Weintraub with Buckingham Research.

Just there's one real quick follow-up.

So deferring some of the taxable income, is that just on the tax books?

Or is that on the reported P&L as well?

Tax books.

Okay.

And then second.

Fundamentals have been going well.

Your execution has been great.

Your stock price has also gone up a fair bit.

And so as you balance all that, what are your thoughts on share repurchase in the context of capital allocation options at this point?

Mark, we have a significant amount of debt, and convertible securities due or likely due in this calendar year.

And we want to position ourselves to handle those, reduce our leverage a bit as we've done a bit already on a net basis this quarter.

And beyond that, land is always an opportunity we want to be opportunistic with.

And we will continue to evaluate stock repurchase as we do all the time.

But I think those are the priorities for now.

When we think it's a good buy, we'll buy.

Right.

And as there are no further questions, I'd like to turn the conference back over to Douglas Yearley for any closing remarks.

Steve, thank you very much.

Thanks, everyone, for listening in, and have a great week.

The conference has now concluded.

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