Toll Brothers, Inc. (TOL) Q2 2020 Earnings Call Transcript

Good morning, and welcome to the Toll Brothers Second Quarter Earnings Conference Call. All participants will be in listen-only mode. Please note this event is being recorded. Now, I’d like to turn the conference over to Mr. Douglas Yearley, Chairman and CEO. Please go ahead.

Thank you very much. Welcome and thank you for joining us today. I hope you and your families and colleagues are staying safe and healthy. With me today are Marty 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 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 current and long-term impact of the COVID-19 pandemic, and many other factors beyond our control that could significantly affect future results. As noted in our May 6 press release, due to the uncertainty surrounding COVID-19 and its impact, we have withdrawn our second quarter and fiscal year 2020 guidance. Now, let’s begin. We are pleased with our performance in the second quarter. Under complex and challenging circumstances, our teams delivered 1,923 homes and produced revenues of $1.52 billion; our second quarter adjusted gross margin of 21% and our net income of $75.7 million or $0.59 per share diluted; our second quarter-end backlog of 6,428 units and $5.49 billion was down just 1% in units and 3% in dollars; and our net signed contracts of $1.55 billion and 1,886 units were down 22% each from one year ago. Our second quarter was essentially bifurcated by the impact of COVID-19, fueled by strong demand, a healthy economy, low mortgage rates, and a limited supply of new and existing homes nationwide, our net signed contracts were up 43% through the six weeks ended March 15, compared to the prior year’s same period. With approximately 40% of our selling communities and 50% of the dollar value of our backlog concentrated in highly impacted markets, including Pennsylvania; New Jersey; New York City and its suburbs; Connecticut; Massachusetts; Michigan; metro Seattle and California, government stay-at-home and business closure orders made it especially challenging to sell, construct, and deliver homes. In these markets during this restricted period, most of our sales centers were required to be physically closed and operating virtually or open by appointment only. As a result, from March 16 through April 30, our net signed contracts declined 64% year-over-year. Net signed contracts declined 79% in these highly impacted markets over the same period versus 52% in our other markets. Fortunately, government restrictions have eased, and sales and construction operations have resumed in almost all of our markets. While net signed contracts in the first four weeks of May were down 37% year-over-year, we are very encouraged by recent deposit activity. Our deposits, which represent a leading indicator of current market demand, were up 13% over the past three weeks versus the same three-week period last year. Year-over-year deposits from last week were the highest since 2005 on both a same store and gross basis. As a reminder, our customers first post a refundable deposit that reserves the home site and affords them time to make final decisions on architectural design and structural options to personalize their home before signing a binding contract. This process from deposit to contract typically takes about three weeks. Importantly, our recent deposit-to-contract conversion ratio has remained consistent with pre-COVID-19 levels. Web traffic has also steadily improved from the lows we experienced in mid-March and has returned to the same strong activity we enjoyed pre-COVID-19 with web traffic in this most recent week actually exceeding pre-COVID levels for each week of February and March. Foot traffic through our sales centers has also increased significantly. These early trends suggest that the housing market may be more resilient than anticipated just two months ago. During the lockdown, our teams quickly adapted to a new operating environment and transitioned to a combination of remote ways of working, virtual communications with our customers and safe construction practices. Our focus was on keeping our employees, trade partners, and customers safe and our business running. The online and community sales teams engaged home shoppers in person, by phone, and online. Design studio appointments moved forward in person and virtually. Closings continued to occur, often by remote and paperless practices for customers eager to move into their new Toll Brothers homes. Through creativity and virtual tools, we were able to continue to provide a high-quality home buying experience that defines our trusted brand. As we prepare for a further reopening of the economy, we continue to develop new ways of running our business to meet the many challenges presented by the pandemic and its impact on the economy. We have learned to operate more efficiently, which will make us better now and in the future. We also intend to continue pursuing our strategy of diversifying our product mix and geographic presence with a focus on more affordable luxury home communities and expansion into higher growth, southern and western markets. We believe this strategy will enable us to reach a larger segment of the affluent home buying market. Now, let me turn it over to Marty.

Thanks, Doug. Our adjusted gross margin of 21% was better than we expected this quarter. We attribute this to a combination of pre-COVID-19 pricing power, stronger cost controls, and a favorable mix of deliveries. The average delivered price of our homes in the second quarter was $789,000 compared to the midpoint of our expectations of $810,000, due primarily to more deliveries of affordable luxury homes in Idaho and delays in deliveries in higher-priced markets such as California that were heavily impacted by shutdowns. Our balance sheet remained strong. We ended our second quarter with $2 billion of liquidity, including $741 million of cash and $1.3 billion available under our $1.9 billion revolving bank credit facility, which does not mature until November of 2024. The weighted average maturity of our debt is more than five years, and we have no significant debt maturities until 2022. During the quarter, we paid $0.11 in dividends and repurchased 4.3 million shares of our common stock for $157.5 million. These repurchases all occurred prior to the onset of the pandemic in mid-March. At the end of our fiscal second quarter, book value per share was $36.34. During the second quarter, we took a number of actions to reduce spending, maximize liquidity and maintain financial flexibility in order to deal with current challenges and be prepared for potential opportunities that may arise during the recovery. One of our initial steps in mid-March was a sizeable draw on our bank revolving credit facility due to initial concerns regarding potential bank liquidity and capital market accessibility. All of this draw has been repaid, as those concerns have abated and the capital markets have been open for homebuilders and many other sectors. We are very focused on converting our backlog, which should generate significant cash. Our backlog at the end of April stood at 6,428 homes and $5.5 billion, providing us with good visibility on cash inflows for the next few quarters, as cancellations have remained low. Another major step that we took to preserve liquidity was to significantly reduce spending on new land acquisitions and land development. We evaluated all pending land deals in our pipeline and requested additional time on deals with near-term cash outlays. Most of our sellers were receptive, although we did have one sizable deal in Virginia, where we could not come to terms with the seller. We therefore wrote off $10.7 million in sunk cost, which constituted most of our second quarter impairment charge. Land acquisition spend dropped from February to March and was essentially zero in April. Land development spend was also significantly down. With 37,100 owned lots, of which 17,200 are already improved, we can and will choose to selectively invest in new land acquisitions based on local market conditions. We believe that our attractively located land pipeline in the most desirable markets will position us for growth as the economy recovers. With our strong balance sheet, we will continue to be opportunistic as land and other growth opportunities become available. In light of the uncertainties presented by the pandemic, we also acted quickly to accelerate our efforts and improve efficiencies and rationalize overhead expenses by reducing G&A spending. These actions included, among other things, a hiring freeze and reductions to payroll through a combination of job eliminations and employee furloughs. While these decisions were difficult to make, we believe they will help our business in the near term and make us more efficient over the long term. We anticipate that these actions will decrease overhead expenses by approximately $50 million on an annualized basis going forward and we expect to realize approximately $25 million of savings over the remainder of fiscal 2020. Included in our second quarter SG&A is approximately $8 million in severance costs, offset by the reversal of an $8 million accrual for discretionary benefit plan contributions that will not be made. We will continue to review our cost structure as we further refine operating efficiencies and as market conditions evolve. As we look to the third quarter, we expect some delivery times to remain challenged due to the several weeks of lost or limited construction activity in certain shutdown markets in our second quarter as well as evolving construction practices. We also expect our JV, land sales, and other income in the next few quarters to be lower due to market conditions. We will delay selling several of our completed apartment communities and other assets until the market for those sales improves. Nonetheless, during the second quarter, we did complete the previously contracted sale of our golf course operations, which generated approximately $13 million in gains in other income. Now, let me turn it over to Gregg Ziegler.

Thank you, Marty. We have continued to see ample mortgage availability for our customers. Approximately 20% are all cash buyers and take no mortgage, and only 25% take a jumbo mortgage. Our customers, who take a mortgage, borrow on average 70% of the home price and contribute the rest in equity. With average FICO credit scores above 760, our buyers have had little trouble getting mortgages. Also, we do not retain the servicing rights to these loans. Marty mentioned the size of our backlog and the cash flow it is expected to generate. Our contracts are backed on average by a nonrefundable down payment of $70,000. Obviously, this represents a significant financial commitment. Our customers also become emotionally committed to their new home as they personalize it with structural options and, in turn, an interior design selection through our design studio process. Our buyers also tend to be more financially secure with better long-term job prospects and accumulated wealth. We believe that these factors have contributed to our relatively low cancellation rates. As a percentage of backlog, our cancellation rate was 3.1% in our fiscal second quarter compared to 3.0% in the first quarter, and as a percentage of gross contracts signed was 9.7% in our second quarter versus 9.4% in the first quarter. Our Apartment Living business has been healthy. Across our stabilized properties, we are 96% leased. Rent collections have remained stable with April delinquencies only down 1%, above the average for January through March, and May up approximately 3% compared to the first few months of the calendar year. We continue to have access to the capital markets for new apartment project construction debt and equity financing. In mid-April, we closed on a new Toll Brothers Apartment Living joint venture to develop a 289-unit rental community in Boston’s Woburn suburb. We received various debt and equity term sheets since mid-March for the projects and expect to close several additional joint ventures for Apartment Living projects in the second half of fiscal 2020. Now, let me turn the call back over to Doug.

Thank you, Gregg. Thank you, Marty. We are encouraged by the pickup in deposits in May, but remain cautious as to the long-term impact of the pandemic on the economy and the housing market. We expect to have a clearer view of the long-term implications of this later this summer and fall as the economy reopens and people return to the workforce. We believe Americans, now more than ever, appreciate the comforts of home. Our marketing efforts are focused on your home is your sanctuary and your home is the most important place in the world. With our trusted brand, experienced management team, diversified product offerings, strong liquidity, and high-quality land holdings, we believe we are well-prepared for the immediate challenges ahead. We also believe we are well-positioned to take advantage of the favorable long-term demographic and supply-demand trends that underlie the housing industry, and which we expect to continue as the economy recovers. Before opening it up to questions, I would like to thank all of our Toll Brothers team members, whether it’s our operation teams who were able to deliver over 1,900 homes this quarter in extremely difficult conditions or our sales teams who guide our customers through the home buying process, or the rest of the Toll Brothers family. I am so proud of how they have responded to the challenges we have faced during this time. We have seen firsthand their creative thinking, how hard they are working, and their incredibly positive spirit. They are completely dedicated to moving our great Company forward while taking care of our customers, every step of the way. Nick, let’s open it up to questions.

Thank you. We’ll now begin the question-and-answer session. First question is from John Lovallo, Bank of America Merrill Lynch. Please go ahead.

Thank you for taking my questions. And I hope everybody is well on the team. First question is, I think it was in the third quarter of ‘17, maybe the fourth quarter, you guys got out of the business of providing kind of that non-binding deposit results because they just weren’t indicative of full quarter signed contracts. So just curious why you think that this might be a more reliable indicator now?

Thanks, John. Several years ago, we used to provide detailed information about the three or four weeks between the end of a quarter and the earnings call. We realized it was better to give a general commentary, stating that the prior three or four weeks had been similar to the previous quarter. We feel optimistic about the market conditions from the last few weeks. However, we believe that this time, the market, investors, and analysts are looking for as much detail as possible, and that’s exactly what we’ve provided. I think other builders have done the same. We have aimed for full transparency in sharing agreement information, not only pre and post-COVID for the month of May but also what we believe represents the best indication of the current market. This is not to imply that this will continue throughout the quarter. I cannot comment on that. However, in the last three weeks, our best indicator has been our deposits, following the process we've described, where a deposit converts to an agreement in about three weeks. It's also important to note that our conversion ratio from deposit to agreement has remained consistent since March 15th, similar to what it was in the months before that. Just to clarify, that ratio is about 65% for us.

And then, maybe just taking a step back, so clearly uncertainty in the market and the direction of things, but in your gut Doug, I mean, how confident are you in sort of the sustainability of the current activity? And what would you need to see to begin buying land more consistently across your markets?

I can’t comment on what’s coming over the next few months. I am very encouraged by the last three weeks. We had a really tough geographic footprint in terms of the markets that we are active in and how shut down they were. And it wasn’t just that the government closed construction, that the government closed sales, that the government had shelter-in-place. It was that these markets were also hotspots, so that we had a clientele that was more vigilant in staying home and being more careful. As that has lifted and the last lifting was around the 9th of May, the only market we have left that has not opened up constructions or sales is New York, and at least suburban New York is coming shortly, I think the city will be a little bit longer. But as that has lifted since early May, I feel a lot better than I felt in mid-April, than I felt in mid-March, because we are now seeing significant increases in traffic. Obviously, the deposits are up significantly. I mentioned that this past week was the highest deposit number both gross and on a same store basis since 2005. But that’s the extent to which I’m commenting. I’m not going to project forward because of the uncertainties of the market we are in, but I certainly feel very good right now, based upon the last three weeks’ activities, as almost all of our markets have reopened.

Thank you. Our next question comes from Alan Ratner, Zelman & Associates. Please go ahead.

Dough, I am just curious with that improvement you’ve seen the last three weeks. Can you extrapolate or expand on that a little bit more? Just curious if there’s been any kind of pricing actions that you guys took maybe at the end of April that would have spurred some of that activity. I know you were offering I think an interest rate incentive for a while, but just curious if you’ve taken any steps on the pricing front. And then, just more broadly, are you seeing any kind of unique nuances with where that demand is coming from? Is there a specific price point or perhaps region where activity has bounced back sharper than others or is it fairly widespread across the footprint?

Sure. Alan, my pleasure to answer your two questions. On pricing, no, we are not incentivizing. The only special we’ve run is on quick delivery homes, what we call our spec homes that will deliver by mid-summer. For a while, we were offering a 2.99% 30-year mortgage. It’s interesting that the rate got down to 2.99%. So, there was no cost to us by the end of even marketing 2.99%. So, that was the extent of any incentivizing anywhere. I’m actually pleased that in a couple of locations, let’s call it 10 to 20, around the country, we had some modest price increases over the last three to four weeks. A few have been new grand openings that have been very successful and others have been established communities that have a very strong demand. But, in terms of running any special to drive the last three weeks of strong activity, absolutely not. And I’m not inclined to incentivize right now at all. I don’t think we need to and I don’t think this is the time to do that. In terms of market strength recently, we continue to see very strong activity in Boise, Idaho, in Northern Virginia and Orlando. Seattle was very hot before March 15, and then of course, slowed dramatically because the state was shut down to both construction and sales. And now that Seattle has reopened, that market is back to being very, very strong. So, we’re encouraged there. The Texas market, Houston, Dallas, and Austin are all doing very well. Denver, Colorado has been extremely strong, and then South Carolina, three new markets for us, and Atlanta, a new market for us have also been quite strong. So that footprint is Southeast, over through Texas, the Mountain states and Seattle I think is sort of the ring I’d say has been the strongest for us.

That’s really helpful. I appreciate that. And just I guess on the price point and I guess a little bit more of a strategic question. I think, initially, we were hearing from builders that entry-level and spec product specifically was really most in demand. And anybody that kind of had to leave an apartment, they were looking for something pretty quick to move into. So, I’m curious within your price point band, are you seeing relatively stronger activity at those more affordable offerings you do provide? And has there been any thought about maybe adding a few more specs on the ground just to kind of satisfy that demand with resale inventory as tight as it’s been?

Our affordable luxury business showed a year-over-year increase in the second quarter, which aligned with our expectations based on the factors you mentioned. Our luxury business remained flat, while our age-targeted and empty nester segment saw a decline, which we anticipated as those clients tend to be more cautious. Additionally, some of our active adult communities are located in destination areas that require travel, and travel has been limited in recent months. To summarize, affordable luxury is up, luxury is flat, and age-targeted and empty nester has decreased. Currently, about 15% to 17% of our homes are in various stages of construction, and we define quick delivery as homes that have started construction. We aim for our quick delivery inventory to focus more on affordable luxury and townhomes, rather than on empty nester and age-targeted products. This strategy has been in place even before COVID-19, as that buyer group typically seeks to customize their home and tends to make fewer major purchases. Therefore, we prefer to keep less speculative inventory in this category. I remain confident in our quick delivery range of 15% to 18%, and we will continue to prioritize lower-priced and attached communities as per our strategic plan. I don't foresee any changes to this approach.

I appreciate it. Thanks a lot. Good luck and stay safe.

Thank you.

Thank you. Next question is from Matthew Bouley, Barclays. Please go ahead.

Hey. Good morning. Thanks for taking the questions. I hope everyone’s doing well. On the gross margin and mix, I think, Marty, you mentioned that favorable mix was part of the strength in the second quarter. I guess, my question is number one, is that a comment, I guess on just the overall decline in the north region closings, which obviously runs a little bit lower margin, or is there something more specific than that? And number two, I guess, should we assume that there is, I guess, a continued tailwind to gross margins in the second half, perhaps for the same reason. Thank you.

Well, with respect to the margin performance in the second quarter, the order in which I gave the rationales is the weighting relatively of the reason. So, it was price increases that we had in the past, it was cost control, and then to much lesser extent just some positive mix. And it’s tough to get into the specifics of whether that was the north or otherwise. So, I won’t. With respect to the future, I’m sorry, but as we’ve noted earlier, and in our release, we’re just not going to give any guidance. There are just too many variables in these uncertain times to go in that direction.

Okay, fair enough. And then, I guess, secondly, at a higher level. When you think about your exposure to these regions, which have been more severely impacted by the lockdowns, there’s the narrative that I’m sure we’ve all heard just around sort of that urban flight from some of these cities. Just curious, if your sales folks have started to see any traffic from that specifically, just anything notable or needle moving yet?

Not yet. Again, travel is highly restricted. We are encouraged, as I’ve mentioned, by the significant increase in traffic and deposits in those markets that were closed through April.

Thank you. Next question comes from Stephen Kim, Evercore ISI. Please go ahead.

Thank you, everyone. I appreciate the positive insights shared here. I want to address the topic of deposits right away. A year ago around this time, you commented on May's deposit activity, noting some encouraging trends and that your contracts for May were up. It seems to me that your deposits haven't had an easy comparison during the first three weeks of May, but please correct me if I’m mistaken. My question is about the age of your buyers. Do you have an estimate of what percentage of your buyers are over 60 years old? Has this demographic changed much concerning the recent deposit and contract activity?

Stephen, I have three people here going through a lot of documents. It's a good thing we’re working together on this. We will have to follow up with you on the percentage of buyers over 60. Generally, our active adult communities are aimed at younger active adults who enjoy amenities and a healthy lifestyle. We focus on 55-year-olds who may appear younger and are very healthy; that's our target audience. We will provide that number but, sorry, Greg?

Stephen, this is helpful. We don’t do it at 60. We looked at it at 50 and older. We looked at our settlements. And so, for this quarter, 52% of our settlements had a buyer that was 50 or older. And if we want to reference it from a year ago, Q2 ‘19, it was 49%. So, it seems relatively consistent.

There are many families in their early to mid-50s who are still purchasing move-up homes. What Stephen is pointing out is the real active adult, empty nester market, which begins at age 55 and continues from there. However, I'm trying to gather more information and haven't received an answer yet, so we will follow up on that. Regarding your first question about the comparison, it is indeed a challenging comparison, especially considering the first week of May last year. For those of you who have been with Toll for quite some time, you may remember that we have held a national sales event every April for many years. We get our vendors to offer discounts on upgrades and engage in extensive marketing across the country. This event occurred in 2019 and carried through to the first week of May. The final week of the event is typically the largest for deposit activity because people want to take advantage of the expiring offers. This year, however, we did not hold that event in April and are currently considering when it might take place. I am feeling optimistic about the market at the moment, so stay tuned. The absence of the event certainly affected April significantly and amplified the impact of COVID-19, which persisted into the first week of May. However, as I've mentioned, we have seen all our markets reopening, and in New York specifically, we experienced three very strong weeks of deposits.

Yes, that’s really helpful. So, that 13% number is not really benefiting from an easy comparison in April; if anything, it had a particularly difficult comparison.

I apologize for the interruption. To finish my thought, for the month of May, we experienced a 13% increase over three weeks, but our deposits remained flat for the month. This is related to the challenging comparison in the first week, as we were closed in some locations and it coincided with the last week of last year's sales event.

Thank you. Our next question comes from Michael Rehaut, JP Morgan Securities. Please go ahead.

Thanks. Good morning, everyone. I hope you’re all safe and healthy. For my first question, I’d like to revisit the May data points you provided, which have been very useful. Given the varying levels of detail around deposits, I want to clarify something. You mentioned in your comments and press release that the deposit to contract ratio remains constant. Should we interpret the recent increase in deposits, particularly the 13% growth over the last few weeks, as an indication that you anticipate positive order growth in June, assuming these conversion ratios remain steady?

Mike, I don’t have that crystal ball. We’re being fully transparent in giving you detailed data week by week. You understand our business, you understand our conversion ratios. I think, we’ve been crystal clear on what has happened over the last three weeks. And then, I just answered Stephen’s question on the first week of May. So, today, we’re basically flat for the month of May and outstanding deposits. And you can take it from there.

Okay, Doug. I apologize for the direct question, but there seems to be a lot of focus on the data point, so I'm trying to get more clarity. Additionally, there's been considerable attention on the differences between various regions regarding speculative builds versus build-to-order. It makes sense that you are focusing on your core strategies while also adjusting to target more affordable products in different markets. As you evaluate these markets, particularly where some are demonstrating stronger performance than others, do you have the capability to potentially increase your development or land spending in those areas that might see increased demand due to COVID-19? Or are you planning to just monitor the situation and see how things evolve in the coming quarters?

In terms of specs and where we stand, I think a frame of reference, as we’ve moved into more affordable luxury price points and certain geographies where spec building is appropriate, might be the following: A year ago, we had around 1,300 specs, and right now, we have close to 1,600 specs. So, we have developed a few more specs. And as we went through the darkest days of mid-March, we evaluated whether to stop specs or continue. And candidly, we did stop for a couple weeks and then said, get at it and finish the ones that we had started. And we are selectively starting new ones in light of the factors that you mentioned.

Yes. Initially, in late March or early April, we maintained quick deliveries for homes at the foundation level, and if they were being framed, we ensured they were made weather tight. Then we paused. Fast forward to early May, we directed everyone to proceed with all spec inventory that was in progress, regardless of whether it was at the foundation stage, weather tight, or any other phase, as we feel more optimistic about the market. We encouraged the continuation of spec builds. In select locations, we received high-level approval to begin new spec inventory, but we will approach this cautiously. It will be tailored to specific market conditions and price points. Additionally, I want to clarify something I misstated earlier. I mentioned that deposits for the entire month of May were flat, as were outstanding deposits, which was incorrect. Outstanding deposits refer to those we are still working with who have either not requested their deposits back, about 35%, or are moving forward with an agreement, which is 65%. Currently, outstanding deposits have risen by 15%, contrary to my earlier statement about being flat.

So, that’s the pile of deposits the future agreements will come from.

Right.

Thank you. The next question is from Mike Dahl, RBC Capital Markets. Please go ahead.

I have a few follow-up questions regarding May. Doug, you provided the actual order agreements broken down between your highly impacted markets and other markets from mid-March through the end of April. I would like to know if you could offer the same breakdown in relation to the 37% decline for the overall business—do you have the division between your highly impacted markets and others? Additionally, I would like to know how the recent small acquisition contributed to both orders and deposits.

Sure. Let's start with the May agreements, which reflect the April deposits when the heavily affected markets were still closed. I can address your question about the deposits in May from those markets that have reopened. From May 16 to April 30, the markets most impacted for agreements included New York City Living down 96%, New Jersey suburb down 94%, New York suburb down 80%, and California, where Northern California was fully closed and LA County was closed, while Orange County was partially open, was down 81%. Pennsylvania was down 77%, and also closed. When we look at the May agreements, which are down 37% so far, those numbers improved slightly because they include mid-April deposits, which were better than late March deposits. Therefore, New York City Living was down 86%, New Jersey suburb was down 73%, California was down 63%, and Pennsylvania rebounded from being down 77% in April to down 42% for those agreements in May. Now, regarding the deposits in May when those markets reopened, except for City Living, which remains closed, all other markets have recovered more than half of their reductions in agreement activity with the May deposits. Did that address your question?

I think it did. He had a question on Thrive as well. So, Thrive did not add any contract in May. It had one deposit in May. There is one community opened for sale associated with Thrive at this point. And remember, it closed door in Q2.

Thank you. That’s really helpful. What’s the timeline for you on that?

Just a moment.

Thank you for the information regarding both the deposits and the agreements. I have a follow-up question, which is more about your perspective rather than seeking guidance. We're in a unique situation where many of your large markets have transitioned from full shutdowns to various levels of partial openings. Even if there has been some demand loss, you may still need to accommodate a month and a half or two months' worth of demand into a shorter timeframe. From your viewpoint, when do you think you'll have enough insight to determine if this situation represents a mix of postponed or advanced demand, or if it reflects something more sustainable?

I think, by mid-summer, that’s just me. I said it in my prepared comments that I’m very encouraged, but I’m still cautious. Is this pent-up demand that came out quick, or is there something more to it? Right now, it feels like there’s something more to it. But it’s going to take some time to fully appreciate. And I think, the July, August, September timeframe, when most states have moved from red to yellow to green, and we know how many furloughs are coming back to work around the country, and we know what different parts of the economy look like, we’ll all have a much better idea. So, that’s where my head is on it.

Okay. Thanks, Doug.

It is important to remember the long-term importance of owning a home. And that’s what I go back to the way we do it, our brand, our opportunity to give you great value where you can design it yourself and customize it yourself. And we are going to continue to focus on our marketing campaigns that are all about your home is your sanctuary. There is such a huge nesting going on in this country. We all feel it, we’re all living it. And once we get through this, and the world is back to normal, I am really excited about where we’re headed.

Thank you. Next question is from Susan Maklari Goldman Sachs. Please go ahead.

Thank you. Good morning, everyone.

Good morning, Susan.

My first question is just around input prices. Can you talk about what you’ve seen there? We’ve obviously seen lumber spike more recently. How sustainable are you thinking that is? And how are you thinking about the outlook for some of the materials?

Cost has remained stable, and we are optimistic that in the short term, there will be opportunities to save a bit more. We'll see how this develops over the long term. This is linked to my earlier comments about whether we are experiencing a temporary increase in demand or something more enduring. Over the past year, we have been encouraged by the relatively flat costs. You are correct that lumber prices have increased slightly, but labor costs have decreased a bit. Overall, based on the numbers Gregg provided, our costs for Q2 have risen by just under $2,000 per house, which is relatively minor for us since our homes are larger and more complex. When discussing gross margin, we have successfully raised the selling price of homes significantly more than that increase.

Okay. That’s helpful. And then, following up on that. Can you just talk to any supply chain disruptions that you’ve seen? Has any of that been mitigated as things have come back? And maybe especially just given how shut down some of your markets are, how should we think about the impact of that? I know Marty, you mentioned some delays in some fiscal third quarter deliveries in there. But, can you just give us some sense of the supply chain and how things are working there?

Sure. Let’s start in the beginning. The permitting, pulling a building permit, getting the house started has had some delays in some markets as building departments have closed. Now, there was some workarounds with some towns that allowed us to go digital. The inspections of the home by building inspectors in some cases was delayed. There was also some workarounds where we actually were able to do some Skype inspections with building inspectors. So, from a municipality or governmental perspective, we have experienced some delays and some of that in certain markets may continue a bit.

But, we’re encouraged that potentially some of those Skype inspections or some of those digital permitting may help us long term. It was a bit of a cumbersome process.

Absolutely. There’s no question that we are all as an industry going to see more efficiency in permitting and inspections in closings, going to digital closings with title and mortgage companies. I didn’t know that you could notarize through DocuSign. Right? I thought you had to put yourself in front of a notary and they had to watch your signature go down. Well, that’s something that can now happen and it’s going be with us for a long time. So, on the material front, in certain markets, we’ve absolutely lost a couple of weeks here and there. We have a cabinet company in Pennsylvania that was closed for the better part of two months. They were able to manufacture their components to their kitchen cabinets, but they couldn’t assemble them. They couldn’t put the door on the box of the kitchen cabinet because there was two plants, and the second plant was closed by government regulations. So, we all as an industry have stories like that. Thankfully, it’s easing but it will cause some stress in the shorter term, as Marty pointed out for the next quarter, because of some of the backlog that was built up that has to be worked through. Labor availability, no impact. Labor is still good. Social distancing on the job site, that will have a little bit of an impact. We have to spread our trades out, we have to be more vigilant, most trades are naturally spread out, but there are certain times during when the house is built, particularly when you get into the finishes, the finishing trades where a house can get a bit crowded and we’re going to have to be a bit careful there. We may lose a little bit of time through that part of the process. So, overall, we’re managing, it is going to get better. I think the impact is more short term than long term, but it is present.

Thank you. Next question is from Truman Patterson, Wells Fargo. Please go ahead.

First, I just wanted to follow up on labor a little bit, housing slowed but it seems like it’s rebounded recently. At the same time, we’re seeing some mass layoffs across the U.S. Are you actually seeing labor availability improve as workers enter from other industries? And you mentioned that your labor costs were down. I would imagine that’s probably occurred in the past two to three months. Is that correct that you’ve been able to renegotiate the labor wage rates?

Truman, to answer the first part of your question, no, we have not observed labor moving from other industries into home building. Regarding labor costs, my comment about them being down pertains to the last few months.

Okay, great. Is there any way you could put a magnitude on that?

Pretty small. It looks like it’s under a $1,000 a house right now.

Okay. Thanks for that. And just a bigger picture question. The international Asian buyer is one of the drivers of coastal California demand. I realize you guys have repositioned some of your products in California as well. So, it might not 100% apply to you. But, given the issues with COVID, the Chinese economy, the U.S. economy, all these moving parts, how do you think this really plays out over the next couple of years? Do you expect that buyer to come back to the market or really remain absent for a while?

You’re correct. We have adjusted our strategy in California. Most Asian buyers are located in Orange County, where our presence is currently limited. In Southern California, we sell 22% of our homes to foreign buyers, a significant portion of which is Asian. While the concentration is high, it’s not exclusively Asian. I believe we will be fine in the long run. However, in the short term, travel restrictions and issues in Chinese-American relations will have an effect. These factors were already in play before COVID, as the Chinese government was tightening U.S. investment regulations. We had already made some adjustments in response to that. So, while it’s definitely a short-term challenge, I am confident we will ultimately be fine. For many years, we have seen that Chinese buyers are keen on owning real estate in California and the U.S. I remain optimistic that as the situation stabilizes, we will return to more normal sales levels, particularly to Chinese buyers.

Thank you. The next question comes from Jack Micenko, SIG. Please go ahead.

Couple of questions kind of got close to it, but I wanted to ask strategically. Do the past two and a half months change your view? I mean, the Company’s been in transition geographically and product wise for some time now, but wondering if the last two months maybe have made you think more about accelerating or increasing the magnitude of that shift, either geographically or by product type.

No. Jack, I don’t think it has changed our mindset that already existed to continue to move south, move west, and diversify the product offerings with a bigger focus on affordable luxury. So, I think that was in play, and we will continue to execute on that strategy.

Okay. And then, different time, different place, I think you were talking about a 10% community count growth number this year. Curious that number is probably not going to be achievable. But how much of the shortfall will be balance sheet conservatism and slowing growth and preserving cash and how much it is you can’t build if you’re not allowed to in the state or the local market? And then, what does that look like sort of in the out year? Do we see that kind of push out into 2021, or this year was a pretty nice growth rate planned for community count. Just wondering how much of that is sort of the environment, how much of that is your own sort of tapping the brakes coming out of a sort of mid-March?

That’s a good question. We had planned 32 community openings in Q2 and we opened 21. And the miss of 11 was primarily associated with communities that were scheduled to open in the second half of the quarter that we froze because of the pandemic. The good news is, we have the land. We started the process of getting the marketing materials ready. And the decision as to when they open will be ours in terms of how we feel about market conditions, pent-up demand. We premarket through our online website concierge service many months in advance and get a very good indication of the amount of interest. And a lot of that drives our strategy on when we open. And so, we’re not prepared to guide right now to what the full year community count will be. We just have to wait and see how the market conditions evolve. But, we have the land and the communities ready when the market is ready.

Yes. Jack, I think for communities, we would have planned to open the back half of this year, there’s two buckets, those where we already own the land. So those will be if not open this period, they’d be open the subsequent year, or those where we are contracted to buy finished lots and open up community. As we mentioned, many of those types of deals we put on pause until the market settles out. And we will kind of re-underwrite those once we get closer to the revised timing as to whether we want to move forward or not or change the pricing of that land deal and move forward, if we can.

Got it. Okay. Thanks guys. Good luck. Thank you.

Thank you. Next question is from Jay McCanless, Wedbush Securities. Please go ahead.

Good afternoon. Thanks for taking my questions. So, the deposits that you’ve taken so far in May, could you talk about how many of those are going to be built homes versus quick move homes? And how does that ratio compare to your historical mix on contracts?

It’s around 20% quick delivery, which is fairly consistent with the 15% to 18% of quick delivery inventory that we have. And again, remember, when I say inventory, those aren’t completed homes. Those are home from foundation, all the way through the finish. So, it’s tracking fairly close to the mix we have of quick delivery versus build to order.

I just asked that question because you were talking earlier about signs of potential demand holding up. I would have frankly thought that mix of quick delivery would have been a little bit higher. So, that seems to be a positive read that your build orders are holding up that well. What about...

Yes. I think that’s right.

What about your cycle times? How much are you all having to push those out because of the OSHA rules, et cetera?

Yes. I tried to answer that a few questions ago when I went through the permitting issues and the inspection issues and the social distancing on the job site. I mean, the good news is, we’re not seeing any labor issues. We’re having here and there a few scattered material supply issues, but that’s improving. I gave you the example of the Pennsylvania cabinet company. I think our best guess right now is probably one to two weeks added construction cycle time because of social distancing on the job site. And maybe you add another week or two of contingency or security for any issues that may come up with permitting, inspections or material supply. So, let’s just round that off to two to four weeks is what we sort of conservatively built in as added time for construction. And that should improve over time as we get further from the closures we experienced in certain states.

One other quick question, I was encouraged to hear you guys are not doing incentives above and beyond the 2.99%, offer that you emailed out. But what are you seeing from your competitors, how aggressive are you seeing across the three different buckets you outlined earlier, what kind of incentives and pricing deals are you seeing your senior competitors do out there?

I’m pleased with that most of our competitors are not incentivizing. I do think at a lower price point with some finished spec inventory, if a house is completed, it needs to move. I think in that environment you may see a bit more incentivizing, but where we build at our price point, I’m pleased that I’m not seeing much of it.

Next question comes from Ryan Tomasello of KBW. Please go ahead.

This is Ryan Tomasello for Jade. Jut regarding apartments and City Living. You gave some color in your prepared remarks on the former. But can you speak a bit more about how you’re thinking about the outlook for those businesses post the dust settling? Can you remind us how much equity you currently have allocated in each of those segments? And you mentioned you’ll be closing a few apartment JVs in the second half of the year. I was wondering how much capital that relates to and what the intention is to do with those proceeds, if you expect to reinvest those back into the apartment business.

Sure. I think with respect to the apartment business, we have around $700 million invested in that business, and we hope to recoup $400 million through the balance of the next 12 months or so through JV formations. With respect to City Living, we’re actually at a good time in terms of where we have investments. We have around $170 million net invested in existing inventory, active communities. We have another $30 million in our couple off balance sheet joint ventures, and then we have some land inventory for projects that we have chosen not to start in this environment.

In terms of outlook, particularly for City Living, do you expect demand to continue being a driver for the business as the environment becomes more certain?

Yes, in the short term, we will proceed with caution. Currently, we have five buildings in City Living, three of which are completed and the other two are close to completion. However, we also have some land for future buildings where construction has not yet begun, and we are currently holding onto the land. This is not limited to New York; we also have land in Seattle and Philadelphia. As Marty mentioned, we are in a good position with our City Living business, which has faced significant reductions. The five buildings I referenced include two in New Jersey (Hoboken and Jersey City) and three in Manhattan, all positioned in the mid-market segment. For pricing, we discussed around $2,000 per foot and $1,800 per foot in New Jersey, with some pricing down to about $1,000 per foot. These buildings have been performing reasonably well despite the challenges we've faced in New York over the past few years. Realistically, we understand that it will take time to determine the future of New York City. Looking ahead, I am reassured by the limited inventory of these five mid-market buildings. However, we will be very cautious with expanding City Living in and around New York City until we have a clearer understanding of the long-term market. Currently, only about 3% of our business is from Toll Brothers City Living.

Okay. And then, just in terms of the landmark, I was wondering if you’re seeing any noticeable adjustments in prices there, either positive or negative in your major markets over the past few months with the current environment?

Not yet. We walked away from a significant deal in Washington DC or Northern Virginia because we couldn't reach new terms with the land seller. However, almost every other land seller across the country has been understanding and agreed to extensions, whether that means extending the due diligence period before the deposit becomes nonrefundable, extending the closing date, or extending a necessary nonrefundable payment. There hasn't been any retrading of price so far. Sellers seem to recognize that we need more time, but they are not yet open to discussing discounts on the underlying price, and they aren't feeling distressed. We have encountered a few isolated chances to pursue some distress, but nothing significant has emerged. At this point, we are primarily focusing on extending and amending agreements.

Not a good one.

Right. I knew I didn’t get it exactly right.

Thank you. Next question comes from Carl Reichardt of BTIG. Please go ahead.

On buybacks, you’ve had a couple of peers pretty explicit about suspending buybacks. You stopped in mid-March but you sound more encouraged about business with cash flow coming in, the line is fine. What’s your perspective now on where you are with share repurchases?

It’s still suspended. I don’t think we have enough clarity at the moment. Our focus on liquidity was certainly strong in late March and early April. We drew down the line and repaid it when it became clear that our banks would remain liquid with federal government and Federal Reserve support. We want to ensure we have sufficient liquidity and a robust balance sheet to seize land opportunities if the markets face more difficulties. If the markets continue to improve, we will cautiously re-enter the land buying sector. At that point, we may consider buybacks, but for now, it’s prudent to keep that initiative on hold.

Thanks. And then, Marty or Doug on the cost cuts. It’s been never easy to lose teammates. Can you give us a little more detail on the $50 million annualized, like where that’s coming from, where the reductions were staff wise, or the other things like delayed IT spend, travel, where you’re getting those cuts across? Thanks.

Before March 15, we were already concentrating on improving efficiencies and discussing potential company-wide overhead and employee reductions. When COVID-19 occurred, we not only accelerated those discussions but also broadened the scope of individuals and initiatives involved. We permanently laid off about 600 employees out of approximately 5,000 in the Company and also furloughed another 600. I estimate that three quarters of the $50 million in cost savings is related to the layoffs, with the remaining quarter coming from other efficiency initiatives. As you mentioned, there are areas such as IT and travel, among many others, where we're focusing our efforts. Our division offices will likely be smaller moving forward as we've adapted to working more remotely. These cuts are permanent; even once the market rebounds, we are committed to being more efficient. We're continually exploring ways to improve efficiency, which could result in further opportunities for additional overhead reductions.

Thank you. The next question comes from Alex Barron, Housing Research Center. Please go ahead.

I wanted to ask about cancellations. I assume your cancellation rate was quite low before the pandemic, but I suspect it increased in March and April. I'm curious if that's the case, what caused the rise in cancellations? Was it due to job loss, a loss of confidence, or were people just waiting to see what would happen? In those cases, did you keep the money or issue refunds?

Throughout this call, we discussed that our increase in cancellations was quite modest, and we provided the reasons for that. The average down payment is $70,000. Our buyers tend to develop a strong emotional connection to their homes due to customization. Generally, our buyers are more affluent, have better job security prospects, and possess additional wealth. Even during the 2007 to 2011 period, our cancellation rate remained significantly lower than that of other builders for these reasons. We are optimistic about this situation. Do we retain the deposits? Yes, we do. Unless there’s a tragic circumstance, we believe we are a very compassionate company and may return the money in certain cases. However, since we are building homes to specific customer specifications with numerous custom changes, we are entitled to keep the $70,000 deposit for that custom home, which has been upheld. We have substantial experience with this, and that is our stance.

Okay. If I could ask another one. Have you guys seen an improvement, I guess, in the last three weeks, like lower cancellation rate? And if I could sneak another one, what percentage of those highly impacted markets, you cited New York, New Jersey, Pennsylvania, et cetera, what percentage of your business did that represent before I guess this whole thing started?

The cancellation rate remains unchanged, and I want to reiterate that it has remained low. We provided that information regarding the percentage.

I think, it was 40% of contracts and 50% of backlog.

40% of communities.

This concludes our question-and-answer session. I’d now like to turn the conference over to Mr. Douglas Yearley for closing remarks. Please go ahead.

Nick, I thank you very much. I thank everyone for your interest and support. Have a great summer and stay well. Thank you.

Conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.