Toll Brothers, Inc. (NYSE:TOL) Q4 2023 Earnings Call Transcript December 6, 2023
Operator: Good morning, and welcome to the Toll Brothers Fourth Quarter Fiscal Year 2023 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] 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 also note this event is being recorded. I would now like to turn the conference over to Douglas Yearley, CEO. Please go ahead, sir.
Douglas Yearley: Thank you, Rocco. Good morning. Welcome and thank all of you 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.
Fiscal 2023 and the fourth quarter were terrific for Toll Brothers. Our income and earnings per share for the full year were all-time highs and we ended the year with a 72% increase in fourth quarter signed contracts compared to Q4 2022. We delivered 2,755 homes and generated $2.95 billion in home sales revenues in the fourth quarter, $211 million above the midpoint of our guidance. Our adjusted gross margin was 29.1% and our SG&A expense as a percentage of home sales revenues was 8.2%, each beating guidance by 60 basis points. The combination of top-line outperformance and improved operating efficiency resulted in net income of $445.5 million or $4.11 per diluted share, our second best fourth quarter ever behind only last year's fourth quarter.
Over the full year, we delivered 9,597 homes at an average price of approximately $1,030,000, generating record homebuilding revenues of $9.9 billion. Our full-year adjusted gross margin was 28.7%, a 120 basis-point increase over 2022 and 20 basis points better than guidance. SG&A expense as a percentage of home sales revenues was 9.2%, an improvement of 90 basis points compared to last year and also 20 basis points better than guidance. Earnings in fiscal year 2023 were $1.4 billion or $12.36 per diluted share, both company records. Our book value per share was $65.49 at year-end and our return on beginning equity was 22.8%. We accomplished these results despite mortgage rates reaching generational highs, global unrest, gridlock in Washington, and fears of a recession.
Our success was due in large part to our strategies of not chasing sales at a lower margin in the second half of 2022, increasing our supply of spec homes, and focusing on operational efficiency. Turning to market conditions. We continued to see solid demand for our homes in the fourth quarter as a tight resale market continued to drive buyers to new homes. We signed 2,038 net contracts at an average price of $989,000 up 72% in units compared to Q4 2022. The average price was down 11% year-over-year, but essentially flat over the prior three quarters of 2023. The decline in ASP was due primarily to mix. In fact, we raised our average net price after incentives by $16,000 in the quarter. Remember that our mix shifts and lower ASPs should not be a surprise.
It means our strategy of broadening our product offerings to include lower price points and capture greater market share and growth opportunities is working. Along these lines, our affordable luxury and active adult communities were our strongest performers in the quarter. Unit sales of affordable luxury homes are up 109% in Q4 2023 compared to Q4 2022, and active adult was up 82%. In Q4, affordable luxury accounted for approximately 46% of our unit sales, luxury was 31%, and active adult was 23%. On a dollar basis, affordable luxury was 38%, luxury was 43%, and active adult was 19%. Geographically, our Pacific region was up nearly 250% in agreements in the fourth quarter versus the prior year, followed by our Mountain region, which saw a 127% increase and the South of 87%.
Our strongest markets in the quarter were Denver, Boise, Southern California, all of Texas, and the Mid-Atlantic from Atlanta up the Eastern Seaboard to Boston. In terms of cadence for the quarter, demand followed the typical seasonal pattern with September being the strongest for deposits. October was stronger than expected given the rise in mortgage rates, and we were encouraged that we did not have to increase incentives to drive sales in that month. As I mentioned, we actually raised our average price by $16,000 in the quarter, broken down as a $12,000 increase in base price and a $4,000 decrease in incentives. Demand has remained solid into the start of our first quarter and is consistent with normal seasonality. As a reminder, historically net orders declined about 20% from our fourth to first quarter primarily because of the holiday months of November and December following our first quarter.
We are anticipating a modestly better trend this year as we are encouraged by the recent 75 basis point decline in mortgage rates. With inflation easing over the past few quarters, we believe rates may drop further and the timing of the rate decline is setting up nicely for the upcoming spring selling season. This timing also plays well into our strategy of increasing our spec supply and growing our community count. In the fourth quarter, spec homes represented approximately 42% of our orders and 33% of our deliveries. We expect that spec sold in fiscal 2024 will account for approximately 35% of deliveries in 2024. Remember, that we define a spec as any home without a buyer that has a foundation poured. We sell our specs at various stages of construction, which allows many of our buyer the opportunity to still personalize their homes with finishes that match their case.
Specs allow us to buy down mortgage rates and we also benefit from a faster, more efficient construction schedule. The other 65% of our projected 2024 deliveries are either in our backlog, which stood at nearly 6,600 homes and $6.95 billion at fiscal year-end or our build-to-order homes that have already sold or will be sold in this first quarter. This provides a solid base of high-margin homes to drive 2024 results. We expect community count growth to also help drive results in fiscal 2024. We plan to increase community count by 10% this year and are targeting 410 operating communities at year-end. Importantly, we control sufficient land for community count growth beyond 2024. At fiscal year-end 2023, we controlled approximately 70,700 lots, 49% of which were optioned.
Excluding the 6,578 lots committed to home buyers in our backlog, our option land represented 54% of lots. We continue to target an overall mix of 60% optioned and 40% owned over the longer-term. We also continue to be selective and disciplined in our approach to buying land. We assess all land deals whether they involve new land opportunities or take-downs under existing options with underwriting standards focused on both margins and returns. This approach and our overall focus on capital efficiency has helped drive our ROE over 20% for the past two years. In our fourth quarter, we repurchased $326 million of our common stock, bringing our full year repurchases to $556 million at an average price of $72 per share. During fiscal 2023, we repurchased approximately 7% of our diluted shares outstanding at the beginning of the year.
We also paid $91 million in dividends in fiscal 2023. Buybacks and dividends will remain an important part of our capital allocation priorities well into the future. We have budgeted another $400 million of share repurchases in fiscal 2024. With that, I'll turn it over to Marty.
Martin Connor: Thanks, Doug. As Doug mentioned, we are very pleased with our fourth quarter and full year results. Our revenue, net income, and earnings per share were all full year records. In fiscal year 2023's fourth quarter, we delivered 2,755 homes and generated home sales revenues of $2.95 billion, down 27% in homes and 18% in dollars from one year ago, reflecting the challenging sales environment from back then. The average price of homes delivered was up 13% to $1,071,000. Fourth quarter net income was $445.5 million or $4.11 per diluted share compared to $640.5 million and $5.63 per diluted share one year ago. Remember that last year's net income included a net after tax benefit of approximately $103 million related to the proceeds from the settlement of a legal claim.
Our fourth quarter adjusted gross margin, which excludes interest and inventory write-downs was 29.1% in 2023 up 10 basis points compared to 29.0% in the fourth quarter of 2022, reflecting our strategy from over a year ago not to aggressively chase sales at the expense of margin when the market was softer. SG&A as a percentage of revenues was 8.2% in the quarter compared to 7.7% in the same quarter one year ago. The year-over-year percentage increase in SG&A was primarily related to less revenue leverage. Compared to 2022, total SG&A dollars were actually down $33 million in the quarter and $68 million for the year despite inflationary pressures. Joint-venture, land sales, and other income was $36 million in the fourth quarter compared to $152.5 million in the fourth quarter of fiscal year 2022, which again included the aforementioned litigation recovery of $143 -- $141 million on a pre-tax basis.
Joint-venture, land sales, and other income in Q4 2023 included approximately $32 million of gains from the sale of stabilized apartment communities developed by Toll Brothers Apartment Living and held in joint-venture. Despite very challenging market conditions, we were able to sell two apartment communities at reasonable prices in the quarter, which is a testament to the quality of our apartment living communities. We expect to sell additional apartment communities this year. Write-offs included in home sales cost of revenues totaled $8.3 million in the quarter compared to $22.1 million in the prior year period. Land sale write-offs were $12.9 million related to the planned sale of a City Living land parcel into a joint venture. In the fourth quarter, 26% of our buyers paid all cash, consistent with the 25%, in the third quarter and up from our long-term average of 20%.
Buyers, who did take a mortgage averaged an LTV of 69% in the quarter. Our cancellation rate as a percentage of backlog was 3.4% in the fourth quarter, consistent with where this rate has been for all of 2023. We continued to generate strong cash flow in fiscal 2023 with $1.3 billion of cash flow from operations. We ended the fiscal year with over $3 billion of liquidity, including $1.3 billion of cash and $1.8 billion available under our revolving bank credit facility, which has more than four years of duration remaining. In fiscal year 2023, we invested $2.3 billion in land acquisition and land development. We also returned $653 million to shareholders through share repurchases and dividends and reduced our senior debt by $400 million. Over the past two years, we returned $1.3 billion to shareholders by repurchasing 18.9 million shares.
Our net debt to capital ratio was 17.7% at fiscal year-end, and we have no significant debt maturities until fiscal 2026. Our balance sheet is in great shape. Turning to our guidance, I'd like to remind you of the usual caveats regarding forward-looking statements. We are projecting first quarter deliveries of approximately 1,800 to 1,900 homes with an average price of between $985,000 and $1,005,000. Consistent with normal seasonal patterns, first quarter deliveries are expected to be the low point of the year with deliveries for the full fiscal year weighted to the second half. For full fiscal year 2024, we are projecting new-home deliveries of between 9,850 and 10,350 homes with an average price between $940,000 and $960,000. We expect our adjusted gross margin in the first quarter of fiscal 2024 to be 28% and for the full year to be approximately 27.9%.
The slight decline in our projected gross margin for Q1 from Q4 reflects the impact of the slower sales environment in the second half of fiscal 2022 and the first quarter of fiscal 2023, as more sales from that period will be delivering in Q1 than delivered in Q4. We expect interest in cost of sales to be approximately 1.4% in the first quarter and for the full year. This reflects the continuing benefit of our lower leverage. We project first quarter SG&A as a percentage of home sales revenues to be approximately 12.4% versus 12.1% one year ago. Included in first-quarter SG&A is about $12 million of our annual accelerated stock-compensation expense that should not recur in the remainder of the year's quarters. For the full year, we project SG&A as a percentage of home sales revenues to be approximately 9.9%.
The year-over-year projected increases in SG&A margin is due primarily to the impacts of lower revenue leverage, community count growth, and cost inflation. We continue to focus on cost control and operating efficiencies. We've made a lot of progress, but we are not done and are working to achieve additional cost savings in fiscal 2023 and beyond. Other income, income from unconsolidated entities, and land sales gross profit is expected to be a loss of $10 million in the first quarter, but a gain of $125 million for the full year, which includes the sale of stabilized apartment communities. We do not expect any sales in the first quarter, but expect to sell a number of our communities by the end of the year. We project the first quarter and full year tax rate of approximately 26%.
Our weighted average share count is expected to be approximately $106 million for the first quarter and $104 million for the full year. This assumes we repurchase a targeted $400 million of common stock this year with most of that occurring later in the year aligned with our anticipated higher cash flow. Based on land we currently own or control, we expect to grow community count by 10% by the end of fiscal 2024. Putting this all together, we project approximately $12 to $12.50 of earnings per share for the full year, which would move our book value to approximately $78 per share at fiscal year-end 2024. With that, I'll turn it back over to Doug.
Douglas Yearley: Thanks, Marty. Two years ago in December 2021, the 30-year mortgage rate was around 3%. It doubled to 6% in December 2022, and a little over a month ago, it broke through 8%. It's extraordinary to thank the mortgage rates have moved from 3% to 8% in two years. And yet during that time, we produced two consecutive years of record revenues and earnings with ROEs above 20%. We also increased our adjusted gross margin by 370 basis points, decreased our SG&A margin by 170 basis points, and today, we are projecting another year of earnings above $12 per share. And we are not the only ones to have achieved strong results in the face of rising rates. It is clear the business model of the public builders has fundamentally changed.
We have grown revenues and gained market share, lowered leverage, derisked balance sheets with a focus on capital efficiency, cash flows, and ROE, and returned a substantial amount of capital to our investors. Today, Toll Brothers trades at approximately 7 times earnings and 1.3 times book value. The average PE multiple for equally weighted S&P 500 is about 16 times. In my opinion, our valuations deserve a fresh look. Before we open it up to questions, I'd like to thank the entire Toll Brothers team for staying focused on our customers, adapting to market conditions, and consistently executing on our core strategies. Most importantly, you've helped position the company for continued success in 2024 and beyond. For that, I'm truly grateful. Now let's open it up to questions.
Rocco, we're ready to go.
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