托爾兄弟 (TOL) 2017 Q3 法說會逐字稿

Good morning, and welcome to the Toll Brothers Third 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.

Please go ahead.

Thank you, Austin.

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; Gregg Ziegler, Senior VP and Treasurer; and Don Salmon, President of TBI Mortgage Company.

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@tollbrothers.com.

We completed fiscal year 2017's third quarter on July 31.

Thanks to our broad geographic presence, diverse product offerings, unique brand, robust demand among affluent buyers and, of course, our great team, we continue to produce strong results.

Third quarter net income of $148.6 million rose 41% compared to fiscal year 2016's third quarter.

Earnings per share of $0.87 per share diluted rose 43% compared to fiscal year 2016's third quarter.

And pretax income of $203.6 million rose 24% compared to fiscal year 2016's third quarter.

Revenues of $1.5 billion and homebuilding deliveries of 1,899 units rose 18% in dollars and 26% in units compared to fiscal year 2016's third quarter totals.

The average price of homes delivered was $791,400 compared to $842,700 in 2016's third quarter.

The drop in average price was due to a change in mix, which was expected.

Net signed contracts of $1.81 billion and 2,163 units rose 25% in dollars and 24% in units compared to fiscal year 2016's third quarter.

The average price of net signed contracts was $837,300 compared to $830,800 in last year's third quarter.

This third quarter was our 12th consecutive quarter of year-over-year growth in total contract dollars and units, highlighted by 20% or higher year-over-year unit growth in each of the past 4 quarters.

You may have noticed in our release that we did not include the results of our nonbinding reservation deposits for the first 3 weeks of the fourth quarter compared to the same period a year ago.

We have decided to discontinue the practice of disclosing this information as we do not think it is a very reliable indicator.

In 4 the last 5 quarters and in each of the last 3 quarters, the nonbinding reservation deposits for the first few weeks of the current quarter were not indicative of the full quarter totals for final signed contracts.

With that said, Q4 is off to a strong start.

Our third quarter-end backlog of $5.31 billion and 6,282 units rose 21% in dollars and units compared to fiscal year 2016's third quarter-end backlog.

At third quarter-end, the average price of homes in backlog was $845,100, basically flat to $844,300 at fiscal year 2017's third quarter-end.

Fiscal year 2017's third quarter contracts in both units and dollars were the highest third quarter totals in 12 years.

California, with contracts up 63% in units and 75% in dollars and the West region, up 39% in units and 21% in dollars, led the way.

But many of our communities across

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We have reconnected with the speakers.

Mr. Yearley, you may continue with your presentation.

Austin, thank you.

I'm not sure -- we don't know at this end exactly where we lost connection.

I'm reluctant to start at the beginning and bore everybody.

Third quarter [tiered] contracts.

So Kira believes that I should pick up with...

I would start where the, "this third quarter was our 12th consecutive quarter of year-over-year growth."

Thank you, Marty.

So here we go.

I hope I'm not repeating too much and I also hope I'm not cutting anything out.

But take two.

This third quarter was our 12th consecutive quarter of year-over-year growth in total contract dollars and units, highlighted by 20% or higher year-over-year unit growth in each of the past 4 quarters.

You may have noticed in our release that we did not include the results of our nonbinding reservation deposits for the first 3 weeks of the fourth quarter compared to the same period a year ago.

We have decided to discontinue the practice of disclosing this information as we do not think it is a very reliable indicator.

In 4 of the last 5 quarters and in each of the last 3 quarters, the nonbinding reservation deposits for the first few weeks of the current quarter were not indicative of the full quarter totals for final signed contracts.

With that said, Q4 is off to a strong start.

Our third quarter-end backlog of $5.31 billion and 6,282 units rose 21% in dollars and units compared to fiscal year 2016's third quarter-end backlog.

At third quarter-end, the average price of homes in backlog was $845,100, basically flat to $844,300 at fiscal year 2017's third quarter-end.

Fiscal year 2017's third quarter contracts in both units and dollars were the highest third quarter totals in 12 years.

California, with contracts up 63% in units and 75% in dollars and the West region, up 39% in units and 21% in dollars, led the way.

But many of our communities across the country and across a variety of price points have contributed to this ongoing increase in contracts.

Here are some examples.

Park Side in Lake Forest, which is in Orange County, Southern Cal, has seen a lot of action.

There have been over 3,000 visitors over the last 2 months and we have taken 56 deposits at an average price of $1.2 million during those 2 months.

Boise, Idaho continues to exceed our expectations.

In the third quarter, we signed 149 agreements and delivered 74 homes.

The Reserve at Franklin Lakes, a master-plan community located in Bergen County, New Jersey, has taken 27 deposits since opening a month ago at prices averaging $1.2 million and $1.7 million for its 2 product lines.

Coastal Oaks at Nocatee, a master-plan community in Ponte Vedra in Jacksonville, Florida, has taken 41 deposits over 2 months for homes that start in the low $300,000s and go up to over $800,000.

Our diverse offerings enable us to expand our presence within our many markets.

In addition to our core move-up communities, our Active Living communities targeted to 55-plus aged buyers have produced 21% of our contracts in units for the first 3 quarters of 2017.

We have seen continued strength in our more traditional active-adult markets such as New Jersey, where Regency at Flanders has taken 23 deposits and Sea Breeze at Lacey at the Jersey Shore has taken 33 deposits over the last 2 months.

Our new Active Living markets in the West are also doing very well.

For example, Regency at Damonte Ranch in Reno, Nevada has taken 35 deposits over the past 2 months.

Millennial households, in which one buyer is 35 years of age or under, represented 23% of our contracts in units in the first 3 quarters of fiscal year '17.

After delaying forming households, the first millennials are starting families and buying homes.

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

We are seeing strength in the lower, more affordable price points.

We have to work harder to sell larger units at higher price points, although we are not competing in the super-tall or super-expensive condominium product.

This quarter, our wholly-owned City Living contracts increased in units compared to the same quarter last year as we opened 10 Provost Street at Provost Square, our first Jersey City for-sale community in a decade.

Located a block from the Grove Street PATH Station, this 28-story high-rise will contain 242 residences.

Since opening 6 weeks ago, we have taken 49 agreements.

In Manhattan, we sold 17 units in the third quarter at 121 East 22nd Street, our joint venture located a block north of Gramercy Park.

Revenues from City Living also increased in the third quarter of fiscal '17 compared to last year as another North Jersey Gold Coast community in Hoboken, 1400 Hudson, started deliveries.

Deliveries are expected to peak in the fourth quarter of fiscal year 2017 and continue into 2018.

Our Apartment Living platform continues to grow.

We are at 95% occupancy in roughly 3,000 units in 6 communities that have reached stabilization.

These completed communities are a component of our nationwide pipeline of 12,600 units that also includes projects in construction, under development or in approvals.

Our ownership in these joint venture projects varies between 25% and 50%.

Not only is Apartment Living growing, it is generating profits for the company.

For fiscal year 2017, we are projecting that Apartment Living will produce $22.8 million of profit compared to $4.6 million in fiscal year '16.

We expect Apartment Living earnings to continue to grow in 2018.

We recently broke ground on 2 new Apartment Living communities, 232 units at Park at Princeton Junction in New Jersey and 421 units at Carraway on the Platinum Mile in Harrison, a Westchester County suburb of New York City.

In conclusion, the macroeconomic environment remains positive.

The unemployment rate is at a 15-year low, the economy is growing, the stock market is strong and home prices continue to rise, putting equity in the pockets of those who may want to sell their existing home and move to a new one.

New home prices are significantly outpacing existing home prices.

Many buyers want new and they want it their way.

That's exactly what we provide and this bodes well for Toll Brothers over the coming years.

Now let me turn it over to Marty.

Thanks, Doug.

Before I address the specifics of this quarter, I do 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 very pleased with our income statement results this quarter.

Net income grew 41%, earnings per share grew 43%, and we were near the high end of our projection in nearly all key metrics.

Fiscal year 2017's third quarter tax expense was positively impacted by a net $27.9 million benefit associated primarily with the reversal of a state-deferred tax asset valuation allowance.

Gross margin was 21.7% of revenues.

Adjusted gross margin, which excludes interest and impairments, was 25% of revenues, up 70 basis points sequentially and exceeding our previous guidance.

This was primarily due to state reimbursements of previously spent brownfield environmental cleanup costs and a reversal of a no longer necessary accrual for off-site improvements at a completed community.

SG&A was down to 10.3% of revenues compared to 10.6% last year.

Third quarter interest expense included in cost of sales was 3.1% of revenues, the same as 2016's third quarter.

We recorded $2.4 million in inventory impairments, nothing unusual there.

Turning to the capital markets.

In the third quarter, we issued an additional $150 million of our 4.875% 10-year senior notes due in 2027, but they were priced at a yield of 4.4%.

Last week, we elected to redeem our $287.5 million in convertible securities on September 15, 2017.

With $946 million in cash and $1.15 billion available under our credit facility at third quarter-end, we are positioned to retire the $400 million of 8.91% senior notes maturing in October 2017, as well as the $288 million of convertible securities in September 2017, both with cash.

Retirement of this debt will lower our leverage, remove approximately 5.9 million shares from our share count, and reduce our interest cost as we enter fiscal year 2018.

We paid our second quarterly dividend of $0.08 per share on July 28, 2017, and we also repurchased 1.9 million shares in the third quarter at an aggregate purchase price of $75.3 million.

So far in the fourth quarter, we have purchased an additional 580,000 shares at an aggregate purchase price of $22.3 million.

So cumulatively, since the start of fiscal year 2017, we have repurchased approximately 3.1 million shares for a total purchase price of approximately $113 million.

These actions are part of our continued focus on improving our return on equity.

In addition to our growth in earnings, our stock repurchases and our dividend, we have reduced the number of years of land we own in relation to our current deliveries by over 1 year from last year's third quarter.

Our weighted average diluted share count this quarter was 171.4 million shares and included the aforementioned 5.9 million shares unissued associated with our convertible bonds, which are treated as outstanding.

As noted above, we have called these bonds effective September 15, 2017.

And thus, the shares will be removed from our share count at that date.

So for modeling purposes, we estimate our fourth quarter weighted average share count to be 170.5 million shares.

We ended fiscal year '17's third quarter with a debt-to-capital ratio of 45.8% and a net debt-to-capital ratio of 38.4%.

With the aforementioned debt payoffs, we expect the year-end ratio to be in the low 30s.

Subject to our normal caveats regarding forward-looking statements, we offer the following guidance.

We now estimate we will deliver between 7,000 and 7,300 homes in fiscal year 2017 compared to previous guidance of 6,950 had 7,450 units.

We believe the average delivered price for fiscal year '17's full year will be between $800,000 and $825,000 per home.

This translates to projected revenues of between $5.6 billion and $6 billion in fiscal year '17 compared to $5.17 billion in fiscal year '16.

We and other builders have been impacted by the floor joist recall by a major lumber manufacturer.

We were prepared to raise the midpoint of our full year fiscal '17 delivery guidance by 100 units from a midpoint of 7,200 deliveries to 7,300 deliveries.

But our fourth quarter and full fiscal year '17 projections were reduced by approximately 150 impacted homes, which will be now delivered in fiscal year '18.

Therefore, we are guiding the full fiscal year '17 delivery projections midpoint down 50 units.

We had approximately 20 home closings in the third quarter, representing $18 million in revenue that have been delayed until subsequent periods due to the floor joist issue.

We have approximately 10 settled homes and 340 homes in backlog impacted by the floor joist issue.

We are working hard with the manufacturer, our suppliers and our homebuyers to minimize delays and cancellations.

Appropriately, the manufacturer is absorbing the cost associated with resolving these issues.

We have updated our previous guidance for full fiscal year '17 adjusted gross margin to be between 24.8% and 25% of revenues and SG&A down to 10.4% of revenues.

Other income and income from unconsolidated entities is projected to be between $160 million and $180 million as we will have fewer deliveries out of our New York City joint venture projects than previously anticipated.

These closings are now expected to occur in fiscal year '18.

Our effective tax rate is expected to be approximately 35% for fiscal year '17.

To summarize our full year guidance, we have reduced our unit delivery guidance midpoint by just 50 units associated with the floor joist recall while increasing the midpoint of our average delivered price by $12,500.

This increased the midpoint of our revenue guidance by $50 million.

Our gross margin midpoint was lowered by 15 basis points but this was more than offset by a 20 basis point improvement in SG&A leverage, resulting in a net improvement of 5 basis points.

While we lowered the midpoint of JV and other income due to delays in closings, this is offset by incremental revenue and a lower tax rate.

So while there are a number of components of our full year guidance that have changed, there is almost no change in our net income midpoint.

And in fact, absent the floor joist delays, net income guidance would have been increased.

For fourth quarter, we expect deliveries of between 2,275 and 2,575 units with an average price of between $840,000 and $860,000.

We expect fourth quarter fiscal year '17 adjusted gross margin to improve 35 to 50 basis points from fiscal year '17's third quarter results.

Fiscal year '17's fourth quarter SG&A is approximately 8% of revenues.

Our fourth quarter 2017 other income and income from unconsolidated entities is projected to be between $10 million and $30 million.

The fiscal year 2017 fourth quarter effective tax rate is projected to be approximately 38%.

Regarding fiscal year-end '17 community count, due to the strong pace of sales at many of our current communities, we are selling through some communities more quickly than anticipated and now expect to end '17 with between 300 and 310 selling communities.

While we are not giving any specific guidance until December, we do intend to increase community count in fiscal year '18 based on our existing supply of lots and prospective purchases of land.

We ended fiscal year '17's third quarter with approximately 47,800 lots owned and optioned, compared to 46,600 1 quarter earlier and 48,700 1 year earlier.

At fiscal year '17's third quarter-end, approximately 32,400 of these lots were owned, of which approximately half, 17,600 including those in backlog, where substantially improved.

These owned lots represent a 4.5 year supply based on the midpoint of our fiscal year '17 projected deliveries.

This is down from 5.8 years of owned land based on fiscal year '16 deliveries at the end of Q3 and fiscal year '16.

Now let me turn it over to Bob.

Thank you, Marty.

In early June, we celebrated the 50th anniversary of the founding of Toll Brothers.

I am so proud of how we have evolved from a local suburban Philadelphia home builder into

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Management, you may proceed with your remarks.

Thank you.

You're on.

Thank you, Marty.

In early June, we celebrated the 50th anniversary of the founding of Toll Brothers.

I am so proud of how we have evolved from a local suburban Philadelphia home builder into America's Luxury Home Builder.

We are now a national Fortune 500 company operating across 50 suburban and urban markets in 20 states.

Our growth has been driven by a relentless focus on quality, value and service, the establishment of a great brand and reputation in the luxury market, our broad geographic presence and our diversified platform of for-sale and rental communities serving everyone from baby boomers to millennials.

We believe the industry has room to run.

Single-family housing starts, at $811,000, are still well below the 50-year industry average of 1.02 million units.

The homeownership rate is on the rise but also still below historic norms.

Interest rates remain low, unemployment is low and more buyers are entering the upscale market.

Based on these trends, we believe Toll Brothers is well positioned for future growth.

Now, back to Doug.

Thank you, Bob.

Thank you, Marty.

Austin, we are ready for questions.

(Operator Instructions) And our first question comes from Stephen East with Wells Fargo.

Maybe -- Marty, maybe I'll start with you on the gross margin guidance.

If you look at guidance this quarter versus what was implied from last quarter, it's come down.

It's a little bit down year-over-year.

Could you talk about what the drivers were?

And how you expect those to play out?

I assume we've got some elevated costs in there.

But I wanted to know if there was anything else that we were missing that wasn't there last quarter?

Sure, Stephen.

I think it's important to mention that the net change in our midpoint of our guidance was only 15 basis points and that was offset by improvement in SG&A.

So operationally, we have an improvement to talk about.

That being said, from a margin perspective, most of the change is a function of mix.

There are certainly some cost increases for both land, labor and materials that we are dealing with but we're generally offsetting those costs with improved pricing.

But the loss of some of the Weyerhaeuser units, which are a little bit higher margin than what we are trying to replace them with, which are generally smaller, quicker build, in some cases QDH sales, impacted the numbers.

It's tough to get into much more specifics than that.

It's a slight small change, and we have some good news to offset it.

I just want to clarify, Stephen, that we haven't lost the Weyerhaeuser houses.

They've been pushed forward 60 to 90 days.

Okay.

Got you.

And Doug, you all have done a great job driving growth this cycle, growth, profitability.

You've gone into a lot of stuff, apartments, T Select, et cetera.

As you look at your game plan moving forward, say for the rest of the cycle, I mean, how do you see it playing out?

I'm asking from a product mix, geography, cash allocation.

I know you all are spending a lot more time and focus on returns.

So I'm just trying to get an idea of the way you view your business moving forward versus how much you all have already changed as you have gone through this cycle?

It's a great question.

I am, as Bob said, so proud of where this company is today.

I think we have a lot of runway in front of us.

We've led the industry for the last year in order growth.

We've been 20% north every quarter, 4 quarters in a row in order growth, selling houses at $800,000.

And we have great variety that's growing as we do more and more active adult, as we focus more and more on millennials, as we move into more and more geographies.

We focused in the West dramatically, significantly over the last 5 years and that's, obviously, paid off.

So you're going to continue to see more of the same out of us, where we will continue to be, I think, very astute, very careful but very opportunistic on the land buying side.

We are focused on growth markets.

They're not all out West, many of them are, but we've had great success lately in Northern Virginia and in New Jersey and even in Philadelphia.

So it's truly a national platform.

And you'll just continue to see more variety in the markets we're in with the possibility of adding on a new market here or there.

We've been pretty good at that.

So I feel great about where we are positioned, the brand, the land holdings we have, the land opportunities we are looking at.

And you are correct, return on equity has become more of a focus, which means we're trying to structure land buys a little differently.

We're focused on the dividend, we're focused on stock buybacks, we're focused on joint venturing certain very expensive maybe slightly higher risk buildings or properties, we'll sell land off.

So Stephen, it's going to be more of what you've seen over the last 5 years that has allowed us to, I think, position ourselves [the best] of anybody in the industry and more of the same to come.

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

So on the theme of ROE and the focus there, you guys have done a great job, as you mentioned, Doug, on the order front.

And I think it's interesting how much improvement you've seen on the absorption side.

Because the Toll Brothers, of old, probably at this point in the cycle, might have been pushing price to get that margin even higher back to where you were in the prior cycle.

And as I look at the community count, the closeouts there, perhaps some people are maybe a little bit concerned about the sustainability of that growth.

But can you maybe just talk through a little bit your current views on the price versus volume dynamic?

And whether even with a flattish community count, is there still further room to run on the absorption side as you guys are really focusing on picking up that cycle, turnover on the asset front?

There's definitely more room to run on the absorption side.

There are certain markets that we talked about like Southern California and Seattle and Northern Cal and even Nevada as another example where we have some of the highest absorptions that we've seen in a decade.

But we have the teams in place, the land in place to sell more homes.

For the most part, we are not maxing out our delivery time frames.

We're not 12, 14 months out.

Trades have been tougher to find, but that's easing as the business improves and more workers come back to housing.

But there's many markets, Alan, where we are below company historic averages for absorption.

We have the teams in place and there's plenty of room to run.

I do want to comment that we are not compromising margin for sales.

You are not seeing our gross margin go down in any significant way because we're trying to drive top line.

This has been a different recovery than other cycles, as we talked about many times, where we have not had the nationwide pricing power that we've seen through prior cycles.

We've had local pricing power in primarily Western states, but more recently, as an example in Northern Virginia, and more recently as an example in New Jersey.

But generally, while we've been able to offset cost creep with pricing, it has not been dramatic where the industry and Toll have not seen a significant expansion of margin.

But I am happy that we've been able to maintain margin and produce these 20-plus percent order growth over the last year.

Absolutely.

That's very helpful, Doug.

And just on the pricing power comment, the fact that maybe you are starting to see that pick up a little bit in some markets that were slower to develop, I was curious if you could just kind of think about your footprint right now and it's great that it seems like you're able to offset the cost creep.

Are there any markets where you feel like that pricing power is hitting a bit of a wall and you're seeing some pushback from your consumers?

No.

Simple enough.

And I'll comment on -- I was in Northern Virginia 2 weeks ago for a division visit.

And the Division President says to me after I visit these communities with tons of action.

He says, "Doug, you know what sales keeps telling me?

This is not a normal summer.

August feels like February." And when I hear that coming out of Northern Virginia, that makes me feel pretty good.

Our next question is from Robert Wetenhall with RBC Capital Markets.

Just keying off Doug's comments.

You're a pretty down the fairway kind of guy and there's a lot of enthusiasm that both in New York and your comments about Virginia, California seems tremendous.

Do you think that there is something different in the structure of the market today, which is allowing pricing to accelerate at the pace?

And maybe you could just tie that together a little bit and give us a sneak preview of next year in terms of how you're going to manage the robust demand you're seeing?

I don't think there's anything all that different.

I think, the example you raised of -- let's talk about Southern California.

It used to be that L.A. County garnered a premium in price to Orange County.

Orange County was on the outskirts.

And today, Orange County is benefiting from a significant premium in pricing to L.A. County.

That, of course, means land prices have been driven up.

But what's happened there is there's great schools, it's a great lifestyle.

We are very well positioned within Orange County and have significant pricing power right now.

And there's really no signs of a bubble or of issues because, remember, mortgage money is very tight.

We don't have people buying houses for investment who are not occupying those homes.

We don't see overspec building.

The economy is growing, the jobs are growing.

And so I am hopeful and confident that 2018 in Southern Cal should be a continuation of the success we're seeing right now.

And we're positioned to take advantage of it with the landholdings we have.

We talked about Shapell for many years.

That deal is now 4 years old.

And everything we're now building in Orange County is our own land that was either acquired before or after Shapell but is no longer part of that transaction.

So we are continuing to be opportunistic in the land market.

There's master-plan communities that -- we're like the Whole Foods of homebuilding, right?

They want us in the community.

They want to bring Toll in, we drive price, we have great architecture, we provide a great customer experience.

And we're being invited in to what we think are some of the best locations in master-plan communities and able to take advantage of it.

So I feel very good about California and the entire West for '18.

And we have the land and the teams to take advantage of it.

That's -- the housing market out there is certainly encouraging.

Maybe you could comment for a second, your ASP growth in the upcoming quarter is really strong.

And just to Stephen East's earlier comments, it seems like there's a little bit of margin pressure.

Not really thinking about next quarter but more into '18.

With this pricing tailwind you have, what's your ability to manage in-cost inflation?

And how do we think about gross margins going into next year?

Bob, we'll give some guidance on gross margin in December for 2018 like we always do.

And I think it's too preliminary for us to make a comment on it.

Got it.

If I could just sneak one in.

Marty, what was your comment about community count growth given the fast pace of absorption?

I think, our comment was that 2017 year-end community count should be between 300 and 310 communities, and it's our intention to grow from that number in 2018.

Our next question comes from Michael Rehaut with JPMorgan.

It's Jason in for Mike.

First question, looking at the SG&A, it looks like for this year, it's on track to be pretty flattish relative to last year.

Just wanted to see what you are seeing on that front, how you're thinking about SG&A as we go into next year and if you would expect it to improve off of current levels?

And then if there are any bigger opportunities that you've identified that could drive SG&A down over a longer period of time?

I think I'm going to default to the same general answer I gave earlier.

We'll give 2018 guidance in December.

We're pleased with what we've been able to accomplish and project to accomplish in 2017 compared to our expectations at the beginning of the year.

We continue to progress on some of the technology initiatives and investments we mentioned at the beginning of this year and are optimistic about the long-term benefits those will give us.

Okay.

And then on the other and JV income, which was lowered slightly, I think, due to fewer NYC JV projects.

Just wanted to see if -- are those projects that are being delayed until 2018?

I just want to make sure I understand the moving parts there.

So those are really associated with half a dozen to a dozen units that we had previously expected to sell and settle in 2017 that we now expect for 2018.

Our next question is from Stephen Kim with Evercore ISI.

This is Trey on for Steve.

So kind of going back to this [price or space] and kind of talking about -- more about California specifically.

You definitely had a really good quarter with your orders up 60%-plus in the quarter.

And you're no longer going up against the easy comps that you were given with the Porter Ranch issue.

And wondering if you could talk about what's going on in that market to see such robust growth happening out in California.

It's -- as I mentioned before, it is primarily driven by Orange County.

Porter Ranch is performing at about 2/3 the performance of the sales we saw before the gas leak.

It's on track for us.

It's on schedule.

We knew it would be -- it would take some time to come back fully.

The community is -- our models -- our sales centers are open.

The retail is open.

The schools are open.

Everything is good.

It's just taken some time.

And we're of the belief that '18 will improve upon '17 as '17 had improved upon '16 because it will be 2 years this October when that gas leak occurred.

But the numbers you're seeing, the success that we're seeing in Southern Cal is being driven by a very successful community in Northern San Diego County called Robertson Ranch.

And then again, the balance of it, for the most part, is coming out of a number of very successful communities in Orange County.

Got it.

And then turning to Apartment Living for a minute.

You guys are at around 3,000 units in 6 projects and about 4x that, seems like, in your pipeline, which should hopefully show up in the short to intermediate term as those get rolling and start to fill up.

But how are you thinking about that business longer term?

Do you think it could really become a core part of the Toll story like City Living has become?

I do.

We have grown the business significantly over the last 3 years.

We started out Washington, D.C. to Boston.

And we now have opportunities in Atlanta, in Dallas, in Southern Cal, in Northern Cal, in Phoenix.

Looking hard in Houston, looking hard in Seattle, looking hard in Denver.

And so it's -- obviously, as we get into more markets, there's more opportunity and you will see that business grow significantly.

And we will continue to hold some assets for the long term and either recapitalize or sell down or sell out of other properties at stabilization as we've done over the last few quarters and as we anticipate to do through next year and thereafter.

Our next question is from John Lovallo with Bank of America.

First question is consumer confidence has been really strong despite what's going on in North Korea, despite what's going on with some of the uncertainty in Washington.

So I guess the question is, does this surprise you?

I mean, I realize the economy is doing reasonably well and things are moving in the right direction.

But is this kind of continuation of confidence in demand, given the backdrop I laid out, a surprise to you?

No.

Remember where we were and how deep it got and how we've slowly come back.

So this country produced 1.5 million or more houses for 30 years, peaking at over 2 million in '04 and '05.

We fell to 1/3 of that or less from '07 and '11.

And we're still not back to the 1.5 million, we're really nowhere near it.

So we have had pent-up demand building that continues to build even in this good market because of how deep and dark the housing recession was.

And we just have years and years of buyers who sat on the sidelines who are now coming back out.

You lay on top of that the millennials, which is a bigger generation than the boomers, who are now -- the leading edge of the millennials are becoming of age to buy homes.

And they are buying in their mid-30s, which means they're more affluent.

And so I'm not surprised.

I'm actually surprised at how slow the recovery has been.

And that's why, I think, we have a lot of runway out in front of us.

Yes, we would agree with that.

That's helpful.

And then Marty, in terms of the slight 15 basis point reduction in the midpoint of the gross margin range for 2017, I know you mentioned the floor joist component.

But in terms of the City Living deliveries that got pushed into 2018, were those consolidated deliveries or were those JV deliveries?

The ones I referred to earlier were JV deliveries.

It would not impact the margin guidance.

Our next question is from Carl Reichardt with BTIG.

One cleanup question for you, Marty.

What was the basis-point impact of the cleanup cost reimbursement and the accrual reversal on the gross margin this quarter?

The total amount of dollars was around $10.5 million.

So that was around 50 to 60 basis points on margin.

Okay.

And then, Doug, can you talk a little bit about the T Select, how it's been selling, what the rollout plans are?

And is the target market similar to the sort of mid-30s higher-end millennial or younger than that?

I'd just like to know what you think the future of that product is.

Sure.

So we've been building T Select type product without labeling it T Select in places like Boise, Idaho and Jacksonville, Florida and townhomes in Ann Arbor, Michigan and other -- some townhomes in Northern Virginia.

So we know the business.

We decided to brand it T Select in certain communities to draw some attention to it for primarily what you described, Carl, as the 35-year-old, leading-edge, slightly more affluent millennial.

Right now, we have 2 communities in Houston, and we just opened in the last 2 weeks, 2 communities in Philadelphia.

It is -- we don't send you off to the fancy design studio, we don't show you hundreds of ways that you can redesign and add on structurally to your home.

It's more spec building, it's much faster turn.

And it's a streamlined approach but you're still going to get, we think, a Toll Brothers experience and the great attention we give our client.

So it's moving slowly as we expected it to, and frankly, as we want it to, and you will continue to see a handful of T Select communities being launched in different markets around the country over the next year.

I don't think it will have any significant impact on our business.

And frankly, we're learning more about T Select through our other operations in places like Jacksonville, in places like Boise that already do it without that brand.

And so I think what you'll see is some communities call it T Select, but in other places where we already do that, we'll just build it under the Toll Brothers banner.

The key, I think and the messaging of this is that we are committed to sell homes to the leading, more affluent edge of the millennials because we're not going to wait for them to buy their second or third move-up house, which in a decade, they will obviously be doing.

But we want to catch them earlier in the cycle.

And we've had great feedback where buyers were unaware that they could afford and find a Toll Brothers community that would be suitable for them for their first home.

So that's the strategy and that's a brief summary of the launch of it.

Our next question is from Nishu Sood with Deutsche Bank.

This is Tim on for Nishu.

So my first question, I just wanted to dig a bit into demand trends.

And specifically, Doug, you mentioned the breakdown in the relationship between the nonbinding deposits and the orders, I was just wondering has anything changed in the selling process or the -- I guess the type of buyer that you're attracting that could be the cause for this breakdown.

Obviously, you are moving more into the millennials and the baby boomers.

Is that what could be driving the -- I guess the breakdown of the correlation there?

No, it's a good question, and it's certainly fair for us to explain it further.

So all of you will recall, we used to give 3-week information on agreements, and we used to give 3-week information on deposits.

First of all, we recognize that we were one of the few or maybe the only builder that did that.

And on the agreement side, we recognized a year or so ago that because the agreements for the beginning of a quarter, in many cases, reflect deposits that had been taken in the last month of the prior quarter.

Because, remember, our homes are big and they are complicated, and it can take people 2, 3, 4, 5 weeks to go from a deposit to an agreement.

So we recognized that 3 weeks of agreement information really wasn't giving you good guidance on where the quarter may end up.

So we moved to deposits.

And frankly, we just reflected upon the last couple of years and, in looking at the 3-week deposit information we were sharing, it was not well correlated to the agreement numbers that we were producing for the full quarter.

Part of that is, there are always deposits taken, as I mentioned, the last month of the prior quarter that are on the books or on the balance sheet as the quarter begins, that are not reflected in the new deposits of the first 3 weeks.

And part of it is, it's only 3 weeks and it's a 12-week quarter.

So if you take the time to track what's happened over the last, we've mentioned, 5 quarters, where 4 of them were not correlated and the last 3 quarters where none of those 3 were correlated, we just decided that this was the time to discontinue that specific information.

I did comment on my prepared script that we're off to a strong start in the fourth quarter.

So I don't want you to read anything into our discontinuation of this information.

I will repeat that we are off to a strong start for the beginning of the fourth quarter.

No, no, I really appreciate that color.

I guess -- and then kind of tailing onto that, is there any other metrics you look at personally?

And anything you could provide us on our side to help us, I guess, try to get a feel for how the traffic is going, whether it's foot traffic or online traffic, something along those lines?

Traffic is up modestly.

I think our web traffic is up more dramatically, I think, in the range of 30%.

We all recognize that people buy -- their buying habits are different and that they do a lot of research on the couch with the ball game on, on the iPad.

And they spend less time actually physically visiting the model homes.

But we're comfortable with traffic.

I mentioned 3,000 visitors in the last few months in a Southern California community.

It does appear in Southern California that, as Bob used to talk about, visiting a model home was a form of weekend recreation.

And in California, it still seems to be true because the traffic numbers are crazy high.

But for the most part, we run 20 visitors plus or minus per community per week.

That number is up a little bit.

And we're comfortable with where the numbers are, and we're most comfortable when we view our social media accounts and when we view our website.

And we have our online concierges, who communicate with the buyers months before we open communities through e-mail and through the Internet.

And so overall, I'm very pleased with where both online and foot traffic stands.

No, it's great color as well.

And then, I guess, just quickly moving on to the JV projects.

Obviously, the discussion around improving the ROE targets and getting to that -- I think, of the 12.5% mentioned, just wanted to double check if that's still the plan for this year?

And then as well, as we go forward, discuss how some of the risks your projects will be JV-ed a bit more than they had been in the past.

So just curious as to, I guess, what kind of share from the City Living pipeline could end up being JV versus wholly-owned, because currently, I think, there's only one project out of 6 that is earmarked for JV?

Sure.

So I think with respect to the expectation for this year of 12.5% ROE, I think, we're trending a little bit higher than that, but at this point, we're not prepared to increase the guidance.

So I think we've made significant progress this year and hope to make progress next year as well.

We'll get into more details with respect to that in December.

As it relates to joint ventures for some of our condominium projects, we have a number that are operational right now.

We expect another one to close here in the fourth quarter.

And we are going to meet later this afternoon to discuss another piece of ground and whether we want to move that into joint venture or not.

The decision is a combination of evaluation of what kind of gain we could get for selling the land we already own into the joint venture on an immediate basis, what we think of the market, what we think of the risks, and what else we have on the table, on the balance sheet for New York City.

Right.

So of the last 3 buildings to start or that will start soon in New York City, 2 of those 3 and possibly all 3 of those 3 will be built in joint venture.

Our next question is from Susan Maklari with Credit Suisse.

First, I wanted to dive in a little bit more into the Active Living part of the business.

That's an area where some of your peers have perhaps not seen things improve to the rate that had been expected and yet you've seen a decent amount of success there.

Can you talk a little bit to that?

And maybe where you are in terms of thinking about the growth and the future trajectory of that part of the company?

Sure.

We love the business.

Right now, 21% of our sales are in what we call Toll Brothers Active Living.

That is 55 and over by law, no kids in the house.

In addition to that 21%, we have many communities that are empty nester or age targeted, so they are not 55 and over by law, but they are targeted towards the move down buyer, whether that be in Scottsdale or Palm Springs or Southern Florida or wherever, but they are just not 55 and over.

So that 21% number is really just a subset of the baby boomer generation that is moving down.

But your question is specific to active adults, so I'll focus on the 55 and over.

We've been doing it for decades in the East and the Mid-Atlantic and the Mid-West.

We love the business.

We have a great brand of Regency by Toll Brothers on Active Living Community, highly amenitized our homes, while smaller, are truly jewel boxes.

You open up the little box and it's just loaded with jewels.

So we attract the different clients that I think has more disposable income, is a bit more discriminating.

Later in life, they want it their way.

We allow them to customize it their way, and it's been highly successful.

We have taken it West.

We're now in a number of locations in Denver.

We're in Las Vegas.

We're in Reno.

And we have a large community going through entitlements in the greater Phoenix market.

I'd love to get it into California, I'd love to get it into Seattle, Texas, and it'll grow.

There is no question it'll grow.

We're chasing the boomers.

They bought houses from us when they are moving up 10, 15 years ago.

And they are still our client, and we intend to find an active adult home for them, whether it'd be in the East where their grandkids and their kids live, or whether it'd be out West or down South where the sun shines.

You're going to see more and more of it out of us.

And I'm really proud about how we do it between the amenities and the quantity of the home.

We don't just provide the amenity and kind of forget the home.

The home is really important.

And again, while a jewel box, it's Toll Brothers all the way.

And our buyer has the discretionary money they are willing to spend it.

So I think that's why, if I had to explain it, we're doing so well with it.

We're maybe at a lower price point, they haven't had quite the same success.

Okay, that's very helpful.

And then building on the comment that you made that we could see Toll enter another new market or 2. Can you talk a little bit to how you think about M&A, especially in this point in the cycle?

And then given the success that you've seen in places like Boise, could that expansion perhaps come in some of these smaller markets that are a bit, maybe more off some people's radar screens and yet could be a good fit for you?

We've acquired 9 builders and what's it been now, 23 years.

I'm trying to think of the first deal I did with Geoff Edmunds in Phoenix, 22 years.

So we're very selective.

In 8 of the 9 cases, we acquired a builder to enter a new market.

The only one we didn't was Shapell, where we're already in California.

But that was just really a very, very large land deal that did come with a nice homebuilding operation, but it was driven by the land deal.

And so we are opportunistic.

We're looking.

We have a dedicated team that focuses on M&A, they're running all over the country.

There are 3 markets right now that we are intrigued by.

We could enter those de novo, we could enter those though a builder acquisition or we could take a pass.

Two of those 3 are in Western states.

I think you'll continue to see some M&A out of us.

It could be a small market like Boise, which is a bit of a sleeper market.

That's a bit off the radar screen of others, or it could be a larger market that we just think we need to be in.

So stay tuned.

But while nothing to report, we are making progress in a couple of markets in terms of our investigation and bode some either land opportunities or possible builder opportunities.

Our next question comes from Jade Rahmani with KBW.

This is actually Ryan Tomasello on for Jade.

Regarding City Living, what's your current view of the supply/demand landscape overall in the New York City kind of market?

Are you -- for example, are you starting to be able to see past the supply concerns that we've seen over the past few years given the pullback in lending?

And in your City Living products, what are you seeing in terms of absorption pace, trends and incentives?

We haven't bought a deal in New York as we talked about in 3 years now.

So I think it's fair to say that many other developers have also been on the sidelines.

So supply is coming back down a bit as less new buildings are starting.

We've had a good August in New York, which has surprised us a bit because August is a time that hit The Hamptons before the action begins again after Labor Day.

And I'd have to say sitting here today, I'm a bit more encouraged by what we see in New York than I've been on the last few calls.

We're fortunate to not have very expensive trophy buildings.

We do have a handful of expensive units.

And those have been harder to move than the less expensive.

But remember, less expensive in New York.

I mentioned great sales at Gramercy Park, 17 sales in the last quarter and 30-plus sales since we opened in November, and that's $1.8 million, $2 million range.

So you have to put it in perspective as to what is affordable in New York.

Jersey City and Hoboken, absolutely on fire at $800,000 to $1 million, 49 sales in 6 weeks and deposits, agreements in 6 weeks and a new building in Jersey City at $850,000.

But even spread throughout the other units we have in our buildings in New York, we've had some encouraging sales over the last 3 weeks or so.

Too early to tell.

We'll see how it plays out when we get into September and October.

But I'm feeling right now like things are turning up.

That's really good color.

And just on the same topic.

Is any of the stress on the 57 Street corridor of interest to you?

For example, there is one project in particular that's been in the headlines lately that seems to be facing an equity shortfall.

So are there any potential opportunities to recapitalize projects like this or from other developers?

As I mentioned, we've avoided the trophy buildings, and we read the same articles you read.

And we have some intelligence on the ground because we're there.

But at the moment, I would say, no.

We are not chasing any of those opportunities even though they -- newspapers may label them distressed.

I don't think it's for us.

Our next question is from Will Randow with Citi.

On a related basis, can you guys talk about your top quartile in terms of high-end markets across the country?

I know you've glazed over this point, but I'd just like to get a sense if you're seeing incremental acceleration on a year-on-year basis and on the sequential basis versus last year.

So our top 5 or 6 markets for contracts per community -- but you mentioned, I think, I heard you mentioned something about price point, this is not the price point.

But this is the sales pace per community for the quarter would be Southern Cal, Reno, Virginia, Michigan, Northern Cal, Boise and New Jersey.

And they all sold in the range of 12.5 down to 9 sales per community for the quarter.

So with our price point, the way we do it, that's cooking.

Got it.

And then just on the joist recall issue you guys discussed.

What's roughly -- I don't know if you can talk about it the cost per home and potential upside or downside to this year's margin guidance, if your accruals aren't spot on, so to speak?

So from an accounting perspective, technically, you only have to accrue cost to repair the homes that have been delivered, not the ones that are in backlog.

But both the costs for those repairs as well as the costs for the ones in backlog, we expect and have confirmed will be absorbed by the manufacturer who supplied those joists.

So we do not expect these homes to deliver at a margin any different now than they would have delivered before.

And just to be clear, the manufacturer also covers the cost overruns.

And in terms of timing, is there any sort of juice they have to pay, if your closings get delayed?

We are in active discussions with the manufacturer as to the repair protocols and the various costs involved that include things like hotel rooms, out of pocket meal allowances, rate lock changes in fees and so forth as well as our internal team and the actual physical costs of the repairs.

Our next question is from Mark Weintraub with Buckingham Research.

I was hoping to get a little bit more color on input costs, and in particular, to best understand how, particularly like lumber or OSB, where prices have moved quite a bit as the year preceded -- or proceeded, sorry, how much of that's already showing up in the costs of the homes being sold?

Or how much of that might be yet to come?

So really kind of understand the lag that if we're looking at the framing lumber index, when does that start to kind of run through your P&L?

And then additionally, whether perhaps you've got caps and collars or other sorts of types of contract agreements that might smooth or reduce the volatility that one might expect if one was just looking at the indexes.

Mark, that's a real difficult question to get very precise on.

We contract generally on a per home basis for both the labor and as much as the materials as we can.

Certain materials are contracted a year in advance or 6 months in advance, lumber is one of those that we can go out in many regions of the country 3 to 6 months in advance.

I think the simplest way to answer your question is to say that some of those costs have flown -- have flowed through the income statement already as we've delivered homes, some more are expected.

But we've generally been able to offset those costs with increases in prices.

Okay.

And is it fair to say that you generally -- when you are selling that home, you basically are able to have an embedded price for materials known at that time, so that you have a pretty good idea what your margins are going to be on that home at the point-of-sale?

Yes.

And I think it's important to note that we don't sell these homes on a cost-plus basis.

We sell the homes based on what price the market will bear and build them based on what we contract the cost to be.

Our next question is from Jack Micenko with SIG.

So you've taken the owned inventory down from 5.8 to, it looks like 4.5 years over the last year.

How low -- how comfortable -- how low are you going comfortable on that number?

Do you break 4 and you go into the 3s?

I know couple of competitors have gone into the 3s, but that's a bit different than the way you run your business in the past.

So curious what's your tolerance is in the low end?

So pre downturn, we owned 1/3 of our land and optioned 2/3.

Yes, maybe a little more owned.

But yes, there were certain periods of times where (inaudible) 1/3.

40-60.

Yes, that's probably closer.

We recognize that will be very tough to achieve now.

But we had gone the other way because we shuttle the optioned land to the downturn because you could cancel your contract with the farmer and walk away from some soft costs and move on with your life when the deal didn't work anymore, tougher to do that when you own the land.

So we went from, probably 40% owned, 60% optioned to 80% owned, 20% optioned if you look back to 2009-ish in that range, and we're bringing it back.

I don't -- 50-50 would be a great goal.

It's going to be tough to get there.

I think this will be incremental.

We -- as you pointed out, we build at Main and Main.

We build in markets where you don't have land developers feeding us finished lots, that happens in some places.

But Princeton, New Jersey has no land developers feeding you finished lots.

So we are a bit more opportunistic.

And there are more cases where we have to buy the land.

We always try to structure it so that we can, even if we're buying it, maybe we can buy it over time, we can have a purchase money mortgage with the landowner and not pay all upfront which helps the ROE.

But I -- so I think what you'll see going forward is relatively modest incremental improvement in that year zone, but it will never get back down to our old historic numbers.

Right.

I think it's real hard to set a targeted number of years owned, Jack, because it's going to be influenced by a number of years option that you have at the same time.

For example, if you have 6 or 7 years' worth of optioned land that you know you can get your hands on relatively quickly, you're more comfortable operating it 2 or 3 years of owned.

If you're in a situation like we are right now, we have -- where we have a little more than 2 years of optioned land, I don't think you will see us get much below 4 years of owned land.

All right.

That's very helpful.

And then Marty, just for clarification on the units that were pushed up 150.

Would margin guidance for the fourth quarter have changed, had those units not been pushed out?

I guess the question is, outside accruals and everything else, was that a dilutive impact?

Were those units, I guess, higher than the expected average for the quarter?

I think they were a little bit higher.

I think we probably would had to move some of the margin guidance in the direction we moved it, but maybe not as far.

Our next question is from Ken Zener with KeyBanc.

So the first question I have -- really an observation -- because you guys are switching off this binding contracts, which, I think, is obviously warranted and less information is often more.

But we look at things seasonally, so your guys orders actually did quite a bit better than your historical trend.

So sequentially your pace only fell about 13%, sequentially.

Normally, meaning, last many, many, many years, it's usually 20, so I think it actually did better than seasonal trends would suggest.

And I bring that up because, one, obviously, I think, that's a good sign, but also I wonder if these higher closing paces or the orders are going to perhaps raise risks relative to opening communities next year.

If you could kind of -- and I know you're not going to give guidance, but talk about how you are gaining comfort around your forecast given the repeated misses we've seen with other builders in terms of their ability to measure those community openings?

Well, as we've talked about many times, our community count is -- and it's true of the entire industry, it is very, very difficult to nail down because you don't know how fast you're going to sell-through what you have, which is what we are experiencing right now.

And you don't know exactly when you will get that last permit that allows you to start construction.

As much as you believe that you'll have that permit in October, when they find the Indian artifacts on the property and slow you down 6 months, you have a delay.

And while that's a rare exception, I'm just pointing out that we do our best.

We hit many of our opening dates, but in other cases, something comes up and it slows us down.

It's also a bit dependent upon land acquisition, although it's fairly rare that we buy finished lots that are ready to go within a couple of months.

In certain markets, that can occur.

So we give a range, and it's really quarter-by-quarter we try to give some update to that range.

And we have the land slotted to be open next year to show community count growth.

In December, we'll give you more information about that.

Part of it may turn on, do we want to open out of a sales trailer when the roads are going in and the site's a construction mess?

Or do we want to wait and have a fully decorated model?

And some of those strategic decisions will determine when exactly communities will open.

And they can change in the middle, right?

Absolutely.

We can say, let's open before the model is done, or we can say, depending on the health of that market, maybe we want to wait until the model is done.

Right.

Or if it's new product or if the sites really torn up and it's hard to get in.

So stay tuned for the guidance, but you will see growth in '18.

And now I realize you're not giving gross margin guidance, Marty.

However, you do have a good idea of your debt schedule and your interest.

Could you talk to the interest expense component given the moving around of your debt going into the fourth quarter?

Obviously, there is some shifting parts there.

All else equal, are we looking for the interest expense and gross margins to be up or down?

And by how much in FY '18?

I think it takes a while for interest incurred to run through our income statement.

So it's hard without having studied it in detail, and I haven't yet, to give you an answer to that question.

We are retiring some 9% debt, but we're also retiring some 0.5% debt.

So our weighted average debt rate isn't going to change too much.

I think what will change is our net leverage, which means the interest we incur will be spread over a bigger inventory base but the timing of those deliveries will be extended over a number of years.

And so I think it'll go down a little bit, Ken, but it will take a while before it goes down meaningfully.

Our last question today comes from Alex Barron with Housing Research Center.

I'll try to keep it short.

I wanted to ask about the ASP of the orders in the City Living, quite a bit of movement, and especially this quarter.

I was just wondering, if going forward, are we to expect lower price points?

Or is this just a onetime quarter anomaly?

It is, Alex, it's driven by the opening of our Jersey City condo building we referenced where we've taken 49 contracts in 6 weeks at an average price of around $850,000, so that is what has brought that number down.

That's a big building.

It will continue to sell through 2018.

But we also have inventory in New York City that's much more expensive that we anticipate selling next year.

So I can't comment on where next year's number goes, but that explains what happened this quarter.

Got it.

And then as far as the tax rate, obviously, you had a state DTA reversal.

Is there much more of that, that should come down the -- down the road, either that you haven't fully reversed?

No.

There is no valuation allowance against our deferred tax asset any longer.

And with respect to accruals for tax exposures, I think, we've made some good progress over the past few years being able to reverse those into income.

That pile is not as large as it once was.

This concludes our question-and-answer session.

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

Austin, thank you very much.

Our apologies for dropping off the line a few times.

Enjoy the last few weeks of summer, and thanks for all your interest and support.

The conference has now concluded.

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