Good morning and welcome to the Toll Brothers Third Quarter Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. The company is planning to end the call at 9:30 when the market opens. I would now like to turn the conference over to Douglas Yearley, Chairman and CEO. Please go ahead.

Welcome and thank you for joining us. With me today are Marty Margin Connor, Chief Financial Officer; Fred Cooper, Senior VP of Finance and Investor Relations; Wendy Marlett, Chief Marketing Officer; and Gregg Ziegler, Senior VP and Treasurer. Before I begin I ask you to read the 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, the impact of the pandemic, interest rates, inflation and many other factors beyond our control, that could significantly affect the true results. I'm very pleased with our performance in the third quarter. Demand continues to be very strong. We are benefiting from our strategy of expanding our product lines, price point and geographies as we continue to grow the business, drive price, expand margins and improve our capital efficiency. Home sales revenues of $2.23 billion were up 37% compared to the prior year period. Adjusted gross margin of 25.6% was up 170 basis points compared to last year. Both our pretax income of $303.4 million and our EPS of $1.87 more than doubled compared to last year. We signed 3154 net contracts for approximately $2.98 billion, up 11% in units and 35% in dollars compared to the prior year period. These were third quarter records in both units and in dollars. In addition, our contracts per community at 10.2 were 20% above last year and our highest third quarter ever. Our average selling price in the quarter was approximately $945,000 up $70,000 compared to the second quarter and up $163,000 year-over-year. This increase in ASP shows the pricing power of our luxury business. This strong demand has continued into our fourth quarter. We've averaged over…

Thanks Doug and good morning everyone. Thanks for joining us. Operationally we had another great quarter. Our production teams continued their solid performance as we managed through the labor and supply chain issues that have impacted homebuilders this year. We thank them for their efforts and accomplishments. We delivered 2597 homes at an average price of approximately $860,000, generating third quarter homebuilding revenue of $2.23 billion. Deliveries were up 28% units and 37% in dollars compared to one year ago. We met our revenue projections due to our higher average price of deliveries than anticipated. Our third quarter pre-tax income was $303.4 million compared to $151.9 million in the third quarter of 2020. Net income was $234.9 million or $1.87 per share diluted compared to $114.8 million and $0.90 per share diluted one year ago. Third quarter adjusted gross margin was 25.6% of revenues compared to 23.9% in fiscal year 2020 third quarter and 80 basis points better than projected. The outperformance was due primarily to our improved pricing power and favorable mix. SG&A as a percentage of home sales revenue in the quarter was 10.5% or 110 basis points better than our guidance. We attribute this primarily to lower-than-expected selling and marketing expenses, as well as continuing in permanent overhead cost controls. Joint venture, land sales and other income was $29 million in the third quarter compared to $3.6 million in the same quarter last year. Our projection was approximately $20 million. The outperformance was driven by better-than-expected results from our mortgage operations and our Apartment Living operations. Our balance sheet remained strong. We ended our third quarter with approximately $2.7 billion of liquidity, including $946 million of cash and approximately $1.8 billion available under our $1.9 million revolving bank credit facility. In the third quarter we invested approximately…

Thank you, Marty. I would like to take this opportunity to extend my sincere thanks to the tremendous effort from all of our Toll Brothers team members. They continue to demonstrate their dedication to taking care of each other and our customers and for that I am very grateful. Now let me open it up to questions. Andrea, we're ready to go.

[Operator Instructions] And the first question comes from Deepa Raghavan of Wells Fargo. Please go ahead.

Hi, good morning, Doug, Marty, thanks for taking my questions. Doug, based on your comments on that 20% plus ROE growth target, that -- the emphasis on the plus appears to be slightly stronger than what we heard on your prior call, is that a fair observation?

Yes, and we will obviously give more detailed guidance on our fourth quarter call in three months, but yes, you picked that up correctly.

Okay, and I'm assuming that's driven by the gross margin predominantly, or is there anything else driving that?

It is driven by predominantly the gross margin, also the increase in sales and our land buying strategies that we've been talking about for the last couple years, that will continue to push that ROE up permanently.

All right, well, my follow up question is on more recent trends. Are there any trends in July and August that may be stood out for you or are worth calling out? I'm particularly looking for trends and nuances that the other June quarter ending peers haven't pointed to so far.

Yes, the sales and the demand throughout the third quarter were pretty consistent month-to-month, as I mentioned, in my prepared comments. In many markets we still see demand that exceeds supply, exceeds our ability to deliver, and in those markets, in those communities, we're either still on allocation. We're more aggressively driving price. We're running processes that include best and final offer to interested and pre-qualified buyers, and so that really hasn't changed. I think the one thing we have noticed in some markets, and they are primarily markets that I would describe in the Northeast and the Midwest, and the Midwest for us is really just Detroit, because we're down to one community in Chicago, where we're seeing some more of the typical summer seasonal trends. Traffic is up, web traffic is up. We continue to raise prices as we mentioned. This past Monday we had a price increase nationwide, so I don't think there's anything significantly different in July and August, except that in some markets primarily those I mentioned in the Northeast we're feeling some more seasonal trends and I, we expected that as the world opened up, as people hit the Jersey Shore or did whatever they normally do in their summer months and they are now preparing to take kids back to school, you know we're seeing in those markets, more traditional seasonal trends. But that doesn't mean a slowing and that's why I caution with the year-over-year comp, it's still a very good market, just there's some of those seasonal trends occurring out west. And for us, of course, we call that Denver west, down south. And for that I'd say the Carolinas, Georgia, for us is Atlanta, South Carolina and Florida, we are still seeing most of those markets with more demand than we can satisfy.

That’s great color, thanks very much, great quarter, thanks.

Thank you.

The next question comes from Stephen Kim of Evercore ISI. Please go ahead.

Hey guys, this is actually Bryan Adams on for Stephen Kim. Thanks for taking my questions here. I wanted to talk about the 4Q pricing guide a little bit quickly. You saw really strong price on your deliveries this quarter, I think sequentially up 6% or so, and given your comments it sounds like what you're seeing on the ground is still very strong pricing. If I look at a typical 4Q, where you often have some -- you actually have some of your highest ASPs. So, the sequential decline that you're guiding for into next quarter, is there anything unusual may be from a mix perspective that can explain that dip?

Yes, I think the biggest aspect is our City Living business. It represented about 8% of our third quarter deliveries. We expect it to represent 3% of our fourth quarter deliveries and be less than that in 2022. So, that is higher margin, higher average price business and that is influencing both the margin progression as well as the average price that we reflect in the fourth quarter. We'll have a little bit more in Q4 as well.

Hey Marty.

Yes, that's been great. Marty just finished there and he got cut off a little bit. It’s going to be, a little bit more coming out of the Pacific in the fourth quarter, which is also higher priced, higher margins, so that will have some offsetting effect on a bit west of the City Living. But then as we look forward to '22, I think you really need to pay attention to the sales prices that we -- the $945,000 sales price that you saw on the third quarter, because that is really nationwide. We've had pricing ability everywhere and that's what's going to be driving the higher price in '22.

Great, I have one follow up on margins actually and specifically wanted to talk about costs and maybe some of this dovetails with what you just said, but you're implying margins are going to be flat in 4Q, did that assume higher lumber costs in 4Q than in 3Q? And I also just wanted to get a sense of, if you think about the peak, like peak lumber being this past spring coming to a head in May, when you're expecting that to make its way into your reported results? Thanks guys.

Yes, so the lumber costs for the homes we are building will peak through Q4 '21 and Q1 '22. And then starting in Q2 and accelerating through the balance of '22 we will see, what is a significant drop in lumber. Right now with the size of our homes and the amount of lumber we put in them, our average house is down. In the future again the homes sold today, when they need lumber, will be down as much as $40,000 in lumber which will have a nice benefit in the back half of '22.

Awesome, thanks guys, great quarter.

Thank you very much.

The next question comes from Buck Horne of Raymond James and Associates, please go ahead.

Hey thanks, good morning. I just wanted to get a follow up a little bit more on the Equity Residential deal just, number one, very capital efficient, so great use of resources, but how do you determine the pricing on those assets at stabilization? I'm just curious, is there some sort of implied cap rate you go into a predetermined to construction with Equity Residential or is it kind of a right of first offer, but they don't have the obligation to buy, how does that work?

Sure, Buck and a great shout of to Charlie Watts last night, that was cool. Yes, I'm the old guy in the room. Okay, I'm not going to tell you how many times I've seen The Rolling Stones, starting in high school you know the que sera. We're really excited about the EQR deal, it's just so nice to be aligned and in partnership with the leading luxury apartment owner, manager, in the country, such a fantastic company that we have a track record with. We built a very large, complicated high rise with EQR 10 or 15 years ago, in New York City, bottom half is rental and top half was luxury condos that we sold. And so we've really, it is such a pleasure to have a relationship with a company that talks our talk, walks our walk, gets the business. They're going to help us because they have so much intelligence and so many of these markets we're operating with them. The key to us was driving capital efficiency through the apartment business. They will now come in and help us cover pre-development costs before we buy the land. They will invest that land closing with us and then we are committed to sell all of the assets at stabilization. We're not going to hold apartments long-term anymore. We understand the need to recycle the investment, to show investors regular predictable, sustainable earnings, and how we -- to your specific question, after my sales pitch here, how you -- how we come up with an exit price, it’s a very thoughtful, pragmatic approach that allows EQR without a complicated marketing process, but with appraisers involved, to buy us out. Now remember, they have 75% of the investment. They only have to buy out the 25% of Toll. So they're going to get the benefit with their 75% investment of any uptick in value. If we're unable to agree or if for some reason they don't want the assets, then we're going to sell. We're not going to hold it. We're still going to sell it. So we're going to get our money back at stabilization, but they have to pay fair value. They know they're not going to be taking advantage of us by getting a price that's under market. But we also understand that we're saving marketing dollars with brokers and running a process and the delay that's involved in running those processes, and a due diligence process with a third party that you're not sure how it works out in the end. And so, that's the basic parameters around how it works. Marty, anything you want to add to that?

I think they can bring some operating efficiencies to the projects through their property management, that will enhance the value. They have a relatively inexpensive cost of capital. So we know we're selling to an efficient capital source. And as Doug mentioned, they will really only buy in a quarter the asset at fair value. They have the other three quarters of it at cost.

Right. And so yes, we're, this is a win-win. EQR, they wanted a strong development partner to feed them new opportunities and we wanted a capital efficient platform and we've gotten it through the best in the industry. Now there are markets not covered. There are some properties that won't be covered. For example, our student housing business is not something that EQR at the moment is interested in. They can't take advantage of opportunities own assets the way others may be able to. And so we are actively talking to the other private equity players that we have built this business with, to find one or more structural, permanent long-term partners to complete the business model, very similar to what we've done with EQR on their markets.

That is great color. Thank you so much. That's a really fantastic deal. I really liked the platform there, so congrats on that. Second, I guess I'll follow up in a different direction. There is some new legislation that seems to be percolating through Washington. I guess Senator Wyden got a new housing bill or proposal as part of the new infrastructure plan that includes things like a $15,000 first time buyer tax credit, also looks like a developer tax credit to kind of stimulate new homebuilding supply in lower income market areas or maybe more outlying areas. I'm just wondering if you guys have had any time to look at those proposals or have any general thoughts or impressions about how a first time buyer tax credit could impact a market like it is today or any other thoughts on that, that potential legislation?

Yes, we haven't had a lot of time to study it. Anything that Washington does to promote, stimulate homeownership, even if it's a bit below our typical price point, is good for the industry. It's good for Toll Brothers. We're, as coming down in price through affordable luxury. There have been tax credits in the past that have been effective in stimulating demand. There is a significant housing shortage in this country and in certain states, the obvious one is California. There's an affordability issue. That has to be addressed. So we are, we in the industry would be fully supportive of Washington's continued focus on this housing crisis on promoting homeownership. And so, as this develops, and of course we don't know where it's go, it's impossible to predict right now, we as Toll Brothers, and of course, as an industry, and working through our Lobbying Group, leading builders of America will be all over it and I'm sure will be supportive.

Yes. And as we mentioned in the prepared remarks, nearly 30% of our buyers right now, are first time homebuyers, at least one person on the deed. We need to see what the specifics of the legislation might entail, whether it's one or both, and whether there's income limits there. We are active in our apartment business in our opportunities zone. So we do serve some areas that are, that may be enveloped by some of these other provisions. And in many situations, we have affordable housing components of some of the developments we do, so we'll have to study whether that's beneficial to us or not.

Great, thanks for color, guys. Great quarter.

Welcome. Thank you, Buck.

The next question comes from Mike Dahl of RBC Capital Markets. Please go ahead.

Good morning, thanks for taking my questions. Yes, the EQR deal is really interesting. I want to start with a question on that, I guess, a two-part question. You've got the 25% interest, but you also have these fee structures in place, plus the promote on sale. Should we think of it as on an ultimate sale that your return on investment is greater than that 25%, given the fee structures that are in place or any other color there on quantifying that?. And then the second part is just on the initial three assets, just how to think about that, and whether that's embedded in terms of some of the other income guide for 4Q?

So on your first question, yes we expect to receive more than 25% of the sale proceeds. That's how even forgetting fees, that’s how a promote works. And, we have that now with our existing, more fragmented business model, where we have multiple private equity partners. But now this all consolidates it and we'll just make it a lot more efficient. Marty why don’t you cover those three assets?

So the three assets, we already own that land, we have not commenced any construction. They are relatively inexpensive pieces of land, but it will be part of our initiative to reduce the capital that we have in Apartment Living. Our Apartment Living investment has gone down from $770 million at the beginning of the year to $650 million. Right now it will drop a little bit further as a result of that. Those three assets still need to be developed. They need to be leased up and so that's a 2023, 2024 sort of income event. But we did sell an asset in our third quarter to Equity Residential, and we've already sold an asset in our fourth quarter to them that weren't developed under this program, but were marketed in the general marketplace, if you will. And that fourth quarter gain is embedded in our $40 million guidance for the fourth quarter.

Okay, that's very helpful. And then my second question is really on the returns and capital efficiency, because clearly, you're trying to do your best to articulate this to the investment community. It seems like it's potentially one of the more underappreciated areas. And obviously, margins in the near term sales to your point, Doug, those contribute to the return on equity next year, but it looks like you're at the point where all of the actions on capital efficiency are hitting an inflection point in 2022 or more of an inflection point in 2022. So I guess the question is, are there certain quantitative targets that you're going to be setting out, not just saying the returns are in excess of 20%, but something like asset turns, for example, where that's been kind of the main area that you may have not performed as well as some peers that looks up to change. How are you thinking about that or how should we be thinking about potential for improvement in asset turns over the next year or two?

So on the call in three months we will give a lot more detail on 2022 in terms of margin, in terms of ROE, but you're right. 2022's ROE right now is partially due to the new land buying and other efficiency strategies that we started a couple of years ago. But it's primarily being driven by this beautiful wave we're all on of driving price, having high sales numbers and having high gross margins. But beyond that, the reason we're so confident is sustainability of the higher ROE that will be north of 20 long-term is because of the land we've been buying. We are so disciplined now on internally we call it IRR, but that translates easily to a macro ROE for the company, each land deal has to pass such a higher hurdle, that as that comes through, and delivers into 2023 and beyond. It's just a new company, it's a new business and it's structurally changed. And if the market doesn't get it, that's not for us, for a lack of us trying to explain it, I think we understand that we have to prove it out and I'm very confident it's coming. We have so many different ways we can buy land now and continue to grow this company, whether it be through land banking or through joint ventures. If you purchase money, mortgages with land sellers or getting longer term payment terms with land sellers and that is all working its way through the new communities that we'll be opening and that we'll be delivering homes.

Yes, I think you see a bunch of these initiatives already reflected in our balance sheet, where our owned land is down to 47% when it was 75%, 80%, five years ago of total. We've made great progress on that recently, seen a little bit of these initiatives in our JV and other line that's grown a little bit as we've put some of our larger communities into joint venture. You see it in our cash flow that's being generated, significant cash flow this year, last year and projected for next year, that allows us the flexibility to buy some stock back, pay down some debt, increase our dividend. All of those things are driven by some of the ROE initiatives. It's not just how we do things, it's how we inherently think about things now, too that's influenced with our ROE mentality.

It's great to see it coming through or starting to come through. Thanks for taking my questions.

You’re very welcome. Thank you.

The next question comes from Alan Ratner of Zelman and Associates. Please go ahead.

Hey, guys, good morning. Thanks for taking my questions and I appreciate all the color so far. So I'd love to ask maybe an additional question on the ROE topic. I obviously, the asset efficiency is huge and we could see that filtering through over the next couple of years. I guess my question is, when you think about the sustainability of those options, and land banking availability, we've seen over time that tends to be somewhat cyclical. I mean, your option share got as high as 60% in the last cycle, too. And generally, that capital tends to dry up a little bit if the market moves sideways or where we enter a recession. So I guess beyond 2022 the confidence there, do you think it's different this time in that there's longer term capital being attracted to this space that will kind of stick with it through a potential downturn in the future? And I'll stop there and I have a follow up, thanks.

Alan, I think some of the growth in owned land from the last cycle was a function of the ability to walk from options and the risk profile the option concentration gives you. So it wasn't necessarily driven as much by a lack of capital sources, although I'll admit that it was a function of choosing not to move forward with those deals, which is a positive side benefit of the return on equity initiatives here in circumstances that aren't as great as they are today. So I think there are much more significant piles of capital interested in this business as all of us builders have fundamentally changed the way we look at our business to be more return on equity focused and are providing solid returns to these capital efficient structure supporters, while also improving our own capital efficiency.

Guys, I appreciate that Marty, maybe we can follow up a little bit more on that offline, but maybe moving back to the fundamentals for a second. Doug, on the nationwide price increase on Monday, can you talk a little bit about the magnitude of that increase and kind of what the trend has been there lately? Have you been kind of maintaining the same pace of price increases? Have they monitored the rate a little bit and what's the thinking going forward? I know a few builders have said, they're not expecting to see the same type of pricing power going forward, it doesn't sound like that you guys see it the same way.

Monday's price increase was not all that big, it was 1%. It's an opportunity to get sales excited, get them to make some phone calls, and say, hey, you got to get in this weekend, because the boss tells me Monday, I'm going to have a new price sheet my hand. And so we use these price increases locally. And on occasion, with a nationwide program like Monday to drive urgency and it's very effective. So to me what happened Monday is less about the 1%. I'll take it, I like it. But it's really about putting another tool in the toolbox of the sales team to go make a phone call and create that urgency. We -- I’m not going to disagree with some of the other builders. And it goes back to my earlier comments that in some markets, we're seeing more traditional seasonal patterns of sales activity. So, in those markets that I described, out west and down south, where we still have demand, far exceeding our ability to supply, we're raising prices as we were through last winter and spring. And in other markets, where we have seen good, but what I'll say is not great or not frothy demand that we saw last year, we're being more careful. I think that that's the best way that I can describe it to you, Alan.

Got it. That makes sense. I appreciate it. Thanks a lot.

And also just as a, we do these national sales events, which again, it's another reason to, it's another tool in the toolbox to get sales people to make phone calls and say, hey, for the next three weeks, you got to come in, we're having a national sales event. It's usually a modest, may be the cabinet company has agreed to give us a second or third upgrade to the kitchen cabinets, it doesn't cost us anything but gets some action cooking. We did not have a national sales event in the third quarter. We did have one in the third quarter of 2020. But we decided to take a quarter off, so we were encouraged, further encouraged by the sales activity in Q3 without having that national sales event occur.

The next question comes from Susan Maklari of Goldman Sachs. Please go ahead.

Thank you. Good morning, everyone.

Good morning, Susan.

Hi Susan. My first question is, can you talk a little bit about the StoryBook deal? What is the M&A pipeline looking like today? How are you thinking about the ability to get future deals done and maybe, kind of what brought StoryBook to you and what helped you to get over the finish line with that?

Sure. StoryBook is a small, lower priced home builder in Las Vegas, incredibly efficient, remarkably high margins for the price point of their homes. We started conversations with them pre-COVID-19. We then put those conversations on hold in the spring and summer of 2020 when we were all pretty scared by COVID and we were able to keep the relationship moving and get the deal closed a few weeks ago. Five years ago, we wouldn't have looked at StoryBook, because we wouldn't have gone down in price that way. Now, as we have, as we're doing more and more affordable luxury, as we have acquired a couple of different affordable luxury price point builders, Sabal Homes, an example, in South Carolina, Coleman Homes, an example in Boise. We're learning from these builders that are super efficient in their field construction methodologies. And so, while a small deal, it's a good deal for us, not just for Vegas, but we think to teach -- to continue to teach us to be better lower price homebuilders. In terms of deal flow, things are heating up quickly on the M&A front, just with the smaller builders. I'm not talking big-to-big or big demand, I'm talking, it just seems like there are more and more opportunities in markets throughout the country for the small local builder who has decided to take their terrific 2021 numbers and hire a broker and hit the market. And so, we're nothing to talk about, but we're active. Our M&A group is seeing more deal flow than they've seen in a long time.

Okay, that's great color. My follow up question is on the SG&A. That obviously came in over 100 basis points lower than what we were expecting for this quarter, you guided it down a little bit more for the fourth quarter. Can you talk to, what really drove those actions that you've been putting in place in terms of reducing the overhead to come through this quarter and the sustainability of that especially as we look to fiscal 2022?

Got it. I think a lot of the initiatives there Susan, are associated with a bit less marketing spend, better control on our model home cost, some reduction in commission expense that we are seeing. And then from a true overhead perspective, we are very tight on cost controls around the organization and here at corporate and we think most of those things will be permanent. And our employee count dropped pretty significantly a year ago and we are keeping a tight rein on any additions to the employee count. The teams are doing great jobs with fewer people.

Okay, good. All right, good luck with everything.

Thanks, Susan.

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

Thanks, Andrea. Thanks, everyone, for listening in for your interest. Hope you have a safe and healthy and happy few final weeks of summer. And we look forward to speaking with you over the next few months and of course giving you more detailed updates on 2022 in December. Be well, thanks.

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