Good morning, and welcome to the Toll Brothers Fourth Quarter Earnings Conference Call. [Operator Instructions] The company is planning to end the call at 9:30 when the market opens. During the Q&A, please limit yourself to one question and one follow up. Please note this event is being recorded. I would now like to turn the conference over to Douglas Yearley, CEO. Please go ahead.

Thank you, Jason. Good morning. Welcome, and thank you all for joining us. Before I begin, I ask you to read our statement on forward-looking information in our earnings release of last night and on our website. I caution you that many statements on this call are forward-looking based on assumptions about the economy, world events, housing and financial markets, interest rates, the availability of labor and materials, inflation and many other factors beyond our control that could significantly affect future results. With me today are Marty Connor, Chief Financial Officer; Rob Parahus, President and Chief Operating Officer; Fred Cooper, Senior VP of Finance and Investor Relations; Wendy Marlett, Chief Marketing Officer; and Gregg Ziegler, Senior VP and Treasurer. One person who is not with us today is Bob Toll. Bob passed away in early October at the age of 81 and this is the first time in the 56 years since Toll Brothers was founded back in 1967 that we look to a new year without him. About 500 of us gathered in November to honor Bob at our headquarters with thousands more watching on Zoom. The event was attended by national business and political leaders and by the first subcontractors who worked with Bob in the 1960s, '70s and '80s. Friends from the Philadelphia area he had known since childhood attended, along with dozens of his family members. It was a fitting tribute to a one-of-a-kind leader and a man who helped shape this industry for decades. Although he is no longer with us, Toll Brothers will always be Bob's company. We miss him very much. Turning to the business at hand. As Bob would insist, I'm pleased with our performance this year and extremely proud of the entire Toll Brothers team. In a year filled with supply…

Thanks, Doug. As you mentioned, we are pleased with our fourth quarter and full year results. Our deliveries, revenue, net income and earnings per share were all quarterly and full year records. We noticed a few analysts wrote overnight about our drop in average price per home in new contracts quarter-over-quarter. We want to point out that this is not reflective of an actual price drop, but rather the elevated average price from Q3 associated with our calculation methodology, which we described in detail last quarter. Turning to fiscal year '22's fourth quarter. We delivered 3,765 homes and generated revenues of $3.6 billion, which were up 12.7% in homes and 21.4% in dollars from a year ago. The average price of homes delivered was $951,000. Fourth quarter net income was $640.5 million or $5.63 per share diluted compared to $374.3 million and $3.02 per share diluted a year ago. Included in net income was an after-tax net benefit of approximately $105 million related to the settlement of a legal claim over a 2015 gas leak in California, including an offset for the $10 million we used to fund our new foundation. Adjusting for this net benefit, net income was $535 million or $4.71 per share, up 43% compared to last year's fourth quarter and still an all-time quarterly earnings record. For the full year, we earned $10.90 per share on a GAAP basis. Excluding the net benefits associated with the settlement and contribution, we earned $10 per share [even]. As Doug mentioned, our fourth quarter adjusted gross margin was 29%, up 310 basis points compared to 25.9% in the fourth quarter of 2021. SG&A as a percentage of revenues was 7.7% in the quarter compared to 8.8% in the same quarter one year ago. The year-over-year reduction in SG&A percentage…

Thank you, Marty. We continue to believe that the long-term prospects for the housing market remain positive despite the recent market weakness. Demographic and migration trends continue in our favor. In addition, there continues to be a substantial shortage of homes in America as how the starts have not kept up with population growth for at least the past 15 years. We believe these fundamental drivers will support the housing market well into the future. Before I open the call to questions, I want to again thank the entire Toll Brothers team for another great year. We are now facing a tougher environment. But we've been through this before. We are executing on the right strategy for our company, and I am confident that our experienced teams will once again rise to the challenge and deliver another solid year for Toll Brothers in fiscal 2023 and beyond. With that, let me open it up for questions. Jason, it's all yours.

[Operator Instructions] As a reminder, the company is planning to end the call at 9:30 when the market opens. [Operator Instructions] Our first question comes from Michael Rehaut from JPMorgan.

First, I'd love to get your sense of current pricing. You guided for a 27% gross margin for fiscal '23, which was better than we were looking for and I think speaks to the strength of the backlog and your ability to maintain some margins in the backlog. Can you try and contrast that to current pricing and the amounts of discounts that you're currently offering or incentives, trying to think about real-time gross margins and pricing in today's backdrop?

Sure, Michael. So our guide is 27%. And I think Marty clearly laid out some caution we have in '23 because of the current environment. If you look on paper at those 8,100 homes in backlog, the margin is higher than 27%. But we are putting a cushion on that because we do know that there will be what we think is some modest elevation of cancellations. We also have some additional homes that we need to sell to hit the $8,500 midpoint of the '23 delivery. And so we buffered it a bit when we've come in with our guide of 27% because of the current market conditions. In terms of where we are today, the average incentive nationwide on the next home sold is 8%. And remember, that's not coming off of zero. Even in the very good times through COVID, we always had an incentive in the range of 3% to 4% guys. Is that about right?

Yes, yes, $25,000.

$25,000.

Great. No, that's very helpful. I guess secondly, you noted the SG&A for fiscal '23 on a flat dollar spend, can you kind of walk through the puts and takes of that? And to the extent that revenues would be, let's say, less than expected. Where is your ability to flex there and conversely, if you're able to close more homes due to better cycle times, how should we think about the variable on the upside?

Mike, it's good to hear from you. I think SG&A is a significant focus of ours. Unfortunately, as an operating entity, we are not immune to the effects of inflation. And so we're pretty proud that we're able to keep the number flat year-over-year. Now that is on a lower expected revenue basis. So every day, we're working towards some initiatives to try and evaluate headcount and deal with some of these inflationary pressures. Our personnel are down around 6% in the last six months. Our open positions are down significantly over that same period of time. So we are doing a nice job of holding the line on headcount. We are facing an environment where we may need to turn the dial up a little bit on marketing spend and outside broker commissions. So we are working diligently to keep SG&A as low as we possibly can. Obviously, more revenue will help and less revenue or hurt in terms of the leverage. We've given you our best estimate of what we think it will be for 2023.

Our next question comes from Stephen Kim from Evercore ISI.

It was all super helpful, particularly the comment about the strategy around the spring selling season being a better time to get more aggressive on things. Just I guess, as a point of clarification, Bob Toll, I remember, talked about the spring selling season really begins in some places in January. And I guess I wanted to get some clarity on your incentive number there that you gave today about 8%. Obviously, I would assume that it's including everything, whether it be rate locks and rate buydowns and so just if you could clarify, is there anything that would be decremental to your gross margin that you're doing in the negotiation with the buyer that's not in that 8%. And then your order ASP, I think you said last quarter, like-for-like was like $1.15 million on average or something like that or like up 7%. Just wondering if this quarter's reported order ASP, you think is pretty much like-for-like or if it's a different number?

So I'll answer the first part. And then Marty, you can jump into the second part. Stephen, the 8% is all inclusive of whether it be price drops, incentive increases or closing cost assistance or mortgage buydowns or anything that we can think of and that you can think of is included within that 8%. And yes, Bob, you said talked about Super Bowl Sunday to Easter or the Super Bowl now in February. So it's a few weeks before Super Bowl Sunday, and it generally extends through late April is the heart of the traditional new home selling season. And as I mentioned, even in tougher times, we always expect more homes sold during that period than other times of the year. And so I think we strategically have made a good decision to work hard on delivering our backlog and protect it to incentivize where there is elasticity where the market is responding to incentives. But to really wait for delivery times to come down for building costs to start coming down and to focus on when it makes the most sense to be a bit more aggressive to go chase deals if we need to do that. And that is by each community, by each market and based, of course, upon the overall bigger macro market conditions and economies. And so that is the strategy in place. I also talked about layering in some additional spec build where appropriate in those markets that have better dynamics and to do that at a time when we can build those specs for a bit less to set up good results for 2024. Marty?

Yes. I think I'm going to default to it is a like-for-like analysis with the number you quoted of $1.150 million. But I would caution that like-for-like is very tough for us because we have differences in geographic mix quarter-over-quarter. And we have differences in our various segments of aff lux, active-adult and luxury. So it says like-for-like as we ever get.

Aff lux would be affordable luxury.

Yes.

When you saw -- we're going to get that out -- I heard that yesterday, I'm not going for that one. When you sell home some $300,000 to $4 million, it's just quarter-to-quarter, there can just be such differences because of geographic mix and price point mix.

Great. Yes. No, I appreciate that. Second question I have relates to the impact of mortgage rates. And I know that you talked about the fact that your buyer is not as sensitive to mortgage rates in terms of affordability. And yet, your buyer is also fairly savvy. And mortgage rates right now are -- we just had it reported at 6.4%. I mean it's already down like 70 basis points or something like that in a very short period of time. The spreads are still super wide. I think it's entirely possible you could see a mortgage rate come down meaningfully in the next six months. And so my question is, if that happens, do you think your buyer would -- that you would see an improvement, a tangible palpable improvement in demand as your buyer opportunistically takes advantage of that? Or do you think your buyer is basically insensitive to rates regardless if they fall or rise -- relatively insensitive, sorry, I should say?

Okay. Yes. So I don't think our buyer is even relatively insensitive to rates. I think they're very smart. They're wealthy and they are definitely aware of and focused on rates. Back in August, when we were all together, I spoke of some green shoots because rates had broken below 6% and we were encouraged for a few weeks. And of course, that went away as rates went up into the low to mid-7s. And now they are in, call it, the mid-6s. And there are some very, very modest green shoots of the last few weeks as rates have come down, but I am not ready to get sucked back into the conversation I had with all of you in August when we felt better because it's just -- we had Thanksgiving in the middle of this, and it's just not enough time to understand if that move from 7.25% to 6.5% is enough to start triggering more demand. It's December, it's not the timing of the year to really comment on that. And we got a bit burned by the comments that the industry made in August that didn't play out. But longer term, if these rates can break through 6% and get into the 5s, I think we're really going to be on to something. And I think that applies to whether it be first time or whether it be the Toll Brothers buyer. Our buyers are definitely wealthier, they have more equity in their homes, if in fact, they have a home that they're going to be selling. There's more cash that they put up. There's lower leverage on the mortgage. And so we have a lot of good things going for us. But they are absolutely aware of and sensitive to where rates are moving.

Yes. That's what I think as well. Thanks very much, Doug. Just as a clarification, though, can they lock the rate when they're buying like through the end -- through the close?

They can lock -- we can help them lock or they can lock a rate one year out, and that's why delivery times for us coming down is very helpful because when we were quoting 14, 16 months in some of these communities that were so backed up, it was very difficult to lock. They can -- let me explain when I say lock, they can cap a rate a year after, and it may flow down. They can lock a rate about 110 days before closing where they can definitively lock in a mortgage rate, but you can buy a cap as far as one year out.

It may not be very attractive from a pricing perspective to the consumer but it's available.

But I do think if a buyer wants to buy a build-to-order home from Toll and it's a, call it -- let's just say it's a 13-month delivery, and they can't do anything with it right now in terms of a lock and let's say they have a home to sell, I think there may very well be some growing confidence over the next three to six months, that rates will be coming down when they can lock, call it, seven, eight, nine months out. And as those rates come down, that will make it easier for them to sell their existing home and we'll give them a lower rate on the Toll home. And I think some people already feel that way. But I think that should grow as the Fed gets closer to being done with their business.

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

Thanks for all the great detail so far. First question just on the margin guidance, and I certainly appreciate the disclaimer there about the unknown and the uncertainty I was just hoping to dig in a little bit more to the trajectory you guys have. Effectively, it sounds like it incorporates margins holding pretty flat through the year with the 1Q guide identical to the full year. Is there cost relief being assumed there that might be offsetting higher incentives and pricing pressure on specs as the year unfolds there? Is it mix driven? Why -- I'm just trying to think through why margins would hold stable for the year in an environment right now that seems like it's -- pricing is under pressure?

We haven't built in cost reductions in the backlog. We continue to maintain high, what we call, building cost reserves or contingencies in our underwriting. And as for, Marty, sequentially through the year?

I think the biggest factor in what would be perceived to be a declining margin environment that's offsetting that is the lumber pricing inherent in our deliveries as the year goes on. Lumber fell steadily over the last few quarters, and that will be reflective and supportive of a more flat margin for 2023.

You had that number -- just from the third quarter to the fourth quarter, lumber dropped $12,000 to $14,000 per house just in one quarter there.

Okay. So basically, to think about that incentive number you gave earlier at 8%. It's up probably 400 basis points, 500 basis points from nine months or so ago. A lot of that is being offset, at least as '23 progresses through lower lumber on a per loan basis.

I think if we need to point to one offsetting factor, it's the lumber.

We are feeling -- I talked about building costs beginning to come down and cycle times beginning to come down. The front-end trades, the excavator, the foundation and concrete, the framer, window installation, siding, roofing, rough mechanical, electric plumbing, HVAC, and everything you do before you insulate a home and button it up with drywall, those front-end trades are now feeling less action as there are less starts. And they're the ones coming forward now saying, "Hey, we have some capacity." And as soon as you hear the capacity word as a builder, you say, great, and here's the new price. And so there's negotiation occurring on the front end, and that will naturally move through to the back end as those finishing trades also feel less activity.

Got it. That makes sense. Second question, this is just more of a strategic question or thought. You kind of maybe alluded to this a little bit, Doug. But I think it makes a lot of sense being willing to forego some sales in the near term with the backlog you have and kind of the seasonally slower time of the year. Just given your build-to-order model, though, how long are you willing to forgo sales or kind of give up some market share, recognizing it seems like you would be setting yourself up for a pretty big air pocket in '24 unless you're willing to meaningfully increase the mix of specs in your business in '24. Because if your build cycle, even if it improves to 12 months, you're not going to have an opportunity for a lot of sales unless you see a demand improvement through in the spring of next year. So how long are you willing to kind of give up that market share in the near term and maybe not be as aggressive on pricing? Or is the answer to that spec ship that you are willing to take higher?

Great question. Our head is not in the sand. I mentioned that we're very focused strategically on '24, and we will pull the levers necessary to have homes ready to be delivered in '24, which means we will increase spec build starting in the new year. That will be ready in early mid, end of '24. And it's been interesting, the last couple of quarters, while we're about 75% build-to-order, 25% spec, and the spec business for us has been better, it's been higher margin. The client, one of the reasons is they can lock a rate for a quicker delivery, and they want a little more certainty around the finances associated with buying the home. So our spec business has done well, and we've had a bit better pricing power, which gives us confidence. We're not going 50-50 and maybe we get to 30-70. We'll have to see, but it's going to be based on certain markets and how those markets are doing and where the elasticity of demand has been. So we will continue to keep a close eye on market conditions and adapt accordingly. And if that means not just building more spec to set up those deliveries, but being a bit more aggressive on incentives, we're going to do that. We're not going to lose market share. We have the land to grow this company. We already mentioned 10% community count growth coming this year on the land we control, we have strategically delayed those openings, as I mentioned, so that they hit in a better part of the year, which is the spring season, and they hit, we're actively building models everywhere and holding off openings where in COVID, we would have opened them. We would have had what we call money shoes opening, where it's hard to get on the job site you got to work hard to buy a home. We're going to -- you're going to -- this is going to be Ritz-Carlton white glove, everything perfect, and we're going to do it at the right time of the year. So there's a lot of moving parts for us, but because of the landholdings and the ability to grow community count and our flexibility on both spec build and pricing to market where appropriate, I'm confident our strategy is in place to have a really good '24.

Our next question comes from Truman Patterson from Wolfe Research.

It's actually Paul Przybylski. I appreciate you guys giving the order incentives at 8%. I was wondering if you could combine that with your traditional market color and where incentives may be higher or lower than that average? And then also, if you could give us any color on your various business segments and how orders performed in the quarter.

Sure. Paul. Happy to do that. Interestingly, and it's the first time in some time, the East is better than the West in sales. We've talked about Smile States and everybody moving south and everybody moving west. And it's simply because at West, prices went up a lot more through COVID. And so you have markets like Boise and Phoenix as two examples out West and the Nevada markets of Reno and Vegas as examples where we had communities where prices were up over 40% through COVID and notwithstanding the long-term positive prospects for those markets because of affordability, job growth, sunshine, lifestyle, they as always happens in these cycles, the faster you go up the first you are to come down. And so the Western markets are softer. They have been slower. We have bigger backlogs out West because we were so hot out there through COVID. And so we're being a bit more protective of that backlog and a bit more careful to not chase those markets down lower which is necessary because of the inelasticity. So places like New Jersey, Philadelphia, Atlanta, Massachusetts, Michigan, Virginia and all of Florida right now are our best performers. In terms of market segments, the active adult empty nester, which it's not just 55 and over, it's the boomers that are moving down. That has been our best segment for good reasons. They pay more cash. They're less impacted by rates because they have a lot more equity in the home they raise the kids in that they've owned for 20 or 30 years, and they're more affluent and they're willing to put either all or a lot more cash up and have lower mortgages -- the softest -- and the other three segments, which -- the other two segments, which would be affordable luxury and move-up luxury are running about the same and City Living is doing the best, which is right now, New York only. We have two buildings, one in Manhattan and one in Jersey City that are crushing it in terms of sale.

They're all in JV.

They're all in JV that's going to come into the other income line, but we sold 80 units in Jersey City in six months at $1 million plus a unit. And we're about to open on the Upper West side of Manhattan with what we think is significant pent-up demand. So I haven't said that in a long time, but the City Living segment is doing very, very well, but it's very small and again, in joint venture.

Okay. I think over the -- let's call it, the past 12 to 18 months, maybe even a little bit longer, you probably entered maybe a half a dozen new markets. Can you maybe give us some color on where those stand? And are you still committed to those markets, given the new environment and the likelihood you haven't achieved a scale yet.

Sure. So we had in three markets in South Carolina, Charleston, Myrtle Beach and Greenville through the acquisition of 1 builder down there, it's fantastic. And those markets are doing very well. They're part of the Smile States, when we talked about Smile States and now they're part of the East as we talk about the East. So we're very, very happy with that acquisition. We had a very small acquisition in San Antonio. We have a great presence in Texas. We've previously been in San Antonio. We actually have land in San Antonio for our own account when we acquired that builder. That's a small market, and we're just beginning to integrate there, I'd say it's too early to say. But generally, Texas is doing just fine. What else more recent guys? Well, that's a new market. So Spokane, Coeur D Alene, which was not a builder acquisition, but it was a new market on the Eastern side of the State of Washington. And of course, Coeur D Alene is in Idaho, but it's right down the road from Spokane. That's had a very slow start. We just entered Long Island. And at $3 million, $4 million, we're doing really well. That's -- and we opened four months ago, not great timing, but we actually have really good sales. Nashville is a new market, just too early to tell. We have a couple of urban buildings, not high rise, but midrise and we haven't even opened our first suburban building. So that will take a little bit of time. Tampa opened maybe three years ago, terrific sales -- we're having some production issues there that we're working through. But long term, I think we're very pleased with being in Tampa and Marty put it on the board for me, and that rounds it out.

Our next question comes from Mike Dahl from RBC Capital Markets.

Doug, just following up on Alan's question and Steve's earlier around just the strategy of how you evaluate the spring and not mean sense to kind of push on a string in December. I guess any more quantification for what's kind of the trigger point on a pace basis where you just say, hey, this isn't working in the spring because the back half of your fiscal year, you ran about a 1.2 a month. So is it -- if you just flatline at 1.2, been, hey, like we've got to drive back towards 2 or whatever the number is? Or maybe just a little elaboration on metrics that you're going to be looking for and what's acceptable?

Sure. So there's not one metric. We don't have a sales quota. We've never run this company top down -- top line down but we're very mindful of the need if we get to that point of driving more sales. And I'm sorry for the vague answer, but that means that we analyze every community locally. We start having meetings with the sales team, with the community team. We do a deep dive into the market comps and we start making pricing decisions accordingly. We also may have some modest shift in product offering. Maybe you come in with a smaller house. Maybe you come in with the same house, but you pull some features out of it. There's a lot of different moves that we make. It's studied weekly, but it's studied very, very locally. So I can't tell you that if we sit at one, two sales per month and really want to be at two, we're going to start making some dramatic company-wide moves. It's going to continue to be market and community specific, and we will act accordingly as we roll through the spring season.

Understood. Okay. And then maybe from a more near-term standpoint, given some of the comments earlier in the quarter and how you say you got burned by them. But it does seem like maybe you ended the quarter closer to 1 a month. So when you make the comment about no discernible improvement, is that kind of relative to quarter end pace? Is it -- you were down 60% for the full quarter, and you're just saying still down about 60%? Maybe just give us a little more on the current sales pace and what you're trying to -- the message with that comment?

Yes. So the demand was pretty even between August, September and October. So our comments on November and the first -- the beginning of December here are related to the entire fourth quarter. So I wouldn't read more into it than that. To my earlier comment on we're going to continue to react the need to incentivize where appropriate. Remember, we haven't given up on ROE, and we are very focused on ROE, and we will continue to focus on ROE, not just in terms of any future land buying or in terms of renegotiating of existing deals, but also in terms of the need to turn inventory. And so building costs coming down, cycle time coming down, and the need to turn that inventory is front and center in our mind.

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

Jason, thank you very much. Thanks, everyone for your interest and support and great questions. We are always here to help clarify any further questions you may have. And have a wonderful, wonderful holiday season, and we'll see you in the new year. Thank you.

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