Toll Brothers, Inc. Q1 FY2024 Earnings Call

Good morning, everyone and welcome to the Toll Brothers First Quarter Fiscal Year 2024 Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. 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 today’s event is being recorded. And at this time I’d like to turn the floor over to Douglas Yearley, CEO. Please go ahead, sir.

Thank you, Jamie. Good morning. Welcome and thank you all for joining us. Before I begin, I ask you to read our statement on forward-looking information in our earnings release of last night and on our website. I caution you that many statements on this call are forward-looking based on assumptions about the economy, world events, housing and financial markets, interest rates, the availability of labor and materials, inflation, and many other factors beyond our control that could significantly affect future results. With me today are Marty Connor, Chief Financial Officer; Rob Parahus, President and Chief Operating Officer; Fred Cooper, Senior VP of Finance and Investor Relations; Wendy Marlett, Chief Marketing Officer; and Gregg Ziegler, Senior VP and Treasurer. I'm very pleased with our strong first quarter results. We beat our guidance across the board and saw another quarter of solid sales with contracts, up 40% in units and 42% in dollars compared to last year. In addition, since the start of the spring selling season in mid-January, we have seen a meaningful uptick in demand that has continued through this past weekend. In our first quarter, we delivered 1,927 homes at an average price of approximately $1 million, generating record first quarter home sales of $1.93 billion, up 10.4% in dollars, compared to the first quarter of fiscal 2023. Our adjusted gross margin was 28.9%, 90 basis points better than guidance and 140 basis points better than last year's first quarter. The outperformance versus our guidance was due to mix, driven by earlier than expected deliveries in certain of our higher margin Pacific and Mid-Atlantic communities and fewer than expected deliveries in lower margin mountain communities. SG&A expense at 11.9% of home sales revenues was 20 basis points better than last year's first quarter and 50 basis points better than guidance. In addition to greater fixed cost leverage from higher revenues, we continued to benefit from cost reduction initiatives we've taken over the past several years. We continue to look for ways to operate more efficiently. Pre-tax income was $311.2 million and earnings per share were $2.25 diluted, up 23% and 32% respectively, compared to last year's first quarter. With the outperformance in our first quarter and a strong start to the spring selling season, we are raising our full-year guidance across all of our key home building metrics. At the midpoint of our guidance, we now expect full-year deliveries of 10,250 homes, an adjusted gross margin of 28% and an SG&A margin of 9.8%. In addition, earlier this month we sold a parcel of land to a commercial developer for net cash proceeds of $180.7 million, which will result in a pre-tax land sale gain of approximately $175 million in our second quarter. We are raising our full-year joint venture and other income guidance from $125 million to $260 million. Factoring in both the increase in our home building guidance and the impact of this land sale, we now expect to earn between $13.25 and $13.75 per diluted share in fiscal 2024, up from the $12 to $12.50 we guided to last quarter. We now also expect a return on beginning equity to be approximately 21% in fiscal 2024, which would be our third year in a row above 20%. Turning to market conditions. Demand in the first quarter was solid. We signed 2,042 net contracts at an average price of $1.11 million up 40% in units and 42% in total dollars compared to the first quarter of 2023. Demand in our first quarter steadily improved as the quarter progressed, following the normal seasonal pattern. December was stronger than November and January was significantly stronger than December. Based on both deposit and agreement activity, our January was better than normal seasonality. The strong demand has continued through the first three weeks of February. From a geographic standpoint, demand was broadly distributed across our footprint. We saw particular strength in our Pacific region, including all of California and Seattle and also in Las Vegas, all of Texas, Denver and from Atlanta up through Boston. Demand was solid across all product types as well, with affordable luxury accounting for 45% of our units and 34% of dollars, luxury 36% and 49%, and Active Adult 19% and 17%. Another indicator of healthy demand was our deposit-to-agreement conversion ratio, which at 76% in the first quarter was significantly higher than our five-year average of 67%. We are pleased that we have been able to continue taking advantage of healthy demand while managing our incentives. While mortgage rate buy downs are heavily marketed and offered nationwide, very few of our buyers use incentive dollars to buy down their rates. The vast majority of our customers can qualify for a market rate mortgage without buy down, and they prefer to use any incentive offered on design studio upgrades or to reduce their closing costs. Additionally, consistent with the past several quarters, approximately 25% of our buyers paid all cash in the first quarter and the LTVs for buyers who took a mortgage dropped to approximately 67%, 200 basis points lower than our average over the prior four quarters. So for the 75% of our buyers who took a mortgage, on average, they put down 33%. All of these factors highlight the financial strength of our more affluent customers. During the quarter, we once again benefited from our strategy of increasing our supply of spec homes, which represented approximately 50% of orders and 40% of deliveries in the first quarter. As we have discussed before, we sell our specs at various stages of construction from foundation to finished home. This allows many of our spec buyers the opportunity to visit our design studios and personalize their homes with finishes that match their tastes. Choice, a pillar of Toll Brothers, is still part of our spec strategy. This benefits our margins as design studio upgrades tend to be highly accretive. We are also pleased that our cancellation rate in the first quarter remained consistent with recent quarters at 2.9% of beginning backlog. Our low cancellation rate speaks to the financial strength of our buyers, as well as the sizable deposits they make and how emotionally invested they become as they personalize their new Toll Brothers home. We continue to expect community count growth to help drive results in fiscal 2024 and beyond. In the first quarter, we were operating from 377 communities, two more than we guided to last quarter, and we remain on target to reach our year-end guidance of approximately 410 communities, which would be an approximate 10% increase from fiscal year-end 2023. Importantly, we control sufficient land for community cap growth beyond 2024. At first quarter end, we controlled approximately 70,400 lots, 49% of which were optioned. This land position allows us to be highly selective and disciplined as we assess new land opportunities. We believe we have a competitive advantage acquiring land in prime locations, where very few of the big well-capitalized publics and privates operate. Our main competition for this land tends to be the smaller local and regional builders who are not as well capitalized. Our balance sheet is very healthy with ample liquidity, low net debt and no significant near-term debt maturities. We also continue to expect strong cash flow generation from operations this year. In addition, as I mentioned earlier, we received $181 million in cash from a land sale at the start of our second quarter. As a result, we are increasing the amount we are budgeting for fiscal 2024 share repurchases from $400 million to $500 million. Longer term, we continue to expect buybacks and dividends to remain an important part of our capital allocation priorities. With that, I will turn it over to Marty.

Thanks, Doug. We are very pleased with our first quarter results. We grew both our top and bottom lines and operated more efficiently compared to last year. First quarter net income was $239.6 million or $2.25 per share diluted, up 25% and 32%, respectively, compared to $191.5 million and $1.70 per share diluted a year ago. Our net income and earnings per share were both first quarter records. We delivered 1,927 homes, and generated homebuilding revenues of $1.93 billion. The average price of homes delivered in the quarter was $1.3 billion. We signed 2,042 net agreements for $2.06 billion in that first quarter, up 40% in units and 42% in dollars, compared to the first quarter of fiscal year 2023. The average price of contracts signed in the quarter was approximately $1.11 million, this was up 1.6% year-over-year and 2.3% on a sequential basis. Our first quarter adjusted gross margin was 28.9%, up 140 basis points compared to 27.5% in the first quarter of 2023. As Doug mentioned, Q1 gross margin exceeded our guidance due primarily to more deliveries in our higher-margin Pacific and Mid-Atlantic regions and less-than-expected deliveries in our lower-margin Mountain region. We expect the inverse to be true in our second quarter, and this is reflected in our second quarter adjusted gross margin guidance of 27.6%. Overall, we have increased our full year adjusted gross margin 10 basis points to 28.0%. Write-offs in our home sales gross margin totaled $1.5 million in the quarter and were all associated with predevelopment costs on deals we are no longer pursuing. SG&A as a percentage of homebuilding revenue was 11.9% in the first quarter, compared to 12.1% in the same quarter one year ago. Note that our SG&A expense in that first quarter includes $14 million of accelerated employee stock-based compensation expense that only hits in the first quarter. The year-over-year 20 basis point reduction in SG&A margin reflects leverage from increased revenues as well as benefits from tighter cost controls in the face of inflation. Joint venture, land sales and other income was $8.6 million during the first quarter compared to $16.8 million in the first quarter of fiscal year '23 and compared to our guidance of a $10 million loss. We exceeded our guidance due primarily to better-than-expected results in our mortgage unit and higher-than-projected interest income. Our tax rate in the first quarter was 23% or about 300 basis points lower than guidance due to the accounting benefit of stock compensation deductions, which we do not expect to repeat at the same level for the rest of the year. We ended the first quarter with over $2.5 billion of liquidity, including approximately $755 million of cash and $1.8 billion of availability under our revolving bank credit facility. Our facility has four years until maturity. Our net debt-to-capital ratio was 21.4% at first quarter end, down from 27.5%, one year ago. We have no significant maturities of our long-term debt until fiscal 2026 when $350 million of notes come due in November of 2025. Our community count at quarter end was 377 compared to our guide of 375. Looking forward, our guidance is subject to the usual caveats regarding such forward-looking information. We are projecting fiscal 2024 second quarter deliveries of approximately 2,400 to 2,500 homes, with an average delivered price of between $1 million and $1.1 million. For fiscal year 2024, we are increasing our projected deliveries to be between 10,000 and 10,500 homes with an average price between $940,000 and $960,000. As I noted earlier, we expect adjusted gross margin to be 27.6% in the second quarter and 28% for the full-year, 10 basis points better than our previous full-year guidance. We expect interest in cost of sales to be approximately 1.3% in the second quarter and for the full year. This is also a 10 basis point improvement from our earlier guide. We project second quarter SG&A as a percentage of home sales revenues to be approximately 9.7%. For the full year, we expect it to be 9.8%, another improvement of 10 basis points compared to our previous guidance. Other income, income from unconsolidated entities and land sales gross profit in the second quarter is expected to be approximately $180 million, which reflects the impact of the commercial land sale Doug mentioned. We now expect it to be $260 million for the full-year, which is up significantly from our prior guide of $125 million. Aside from the land sale, much of this full-year other income is projected from sales of our interests in certain stabilized apartment communities developed by Toll Brothers Apartment Living in joint venture with various partners. We project the second quarter tax rate to be approximately 25.8% and the full year rate to be approximately 25.5%. That's a 50 basis points improvement compared to our prior full-year guidance. Our weighted average share count is expected to be approximately 106 million for the second quarter and 105 million for the full-year. This assumes we repurchased approximately $166 million of common stock per quarter for the remainder of the year, to reach the $500 million guide, Doug referred to earlier. As Doug mentioned, with our updated guidance and the Q2 land sale gain we now expect to earn between $13.25 and $13.75 per diluted share in fiscal 2024. This would result in a full-year return on beginning equity of approximately 21% and would put our year-end book value per share at approximately $77 per share. Now let me turn it back to Doug.

Thank you, Marty. Before I open it up for questions, I'd like to thank our Toll Brothers' employees for another great quarter. I'm so proud of their dedication, hard work and commitment to each other and our customers. Their talent and constant focus on our business is the driver of our long-term success. Jamie, with that, let's open it up to questions.

Ladies and gentlemen, at this time, we'll begin the question-and-answer session. As a reminder, the company is planning to end the call at 9:30 when the market opens. Our first question today comes from Jessie Letterman from Zelman & Associates. Please go ahead with your question.

Hey guys. It's actually Ivy, but thank you. First, I just want to say congratulations. It’s a great quarter and really excited about your strategic initiatives of driving returns higher with the land sale expected in '24, just thinking about other opportunities to generate cash flow to maybe do some continued buybacks or other ways to drive returns higher. But it's really been quite a tremendous improvement in just overall management, working capital and returns and love to see continued improvement. And wondering how strategically you can do so.

Thank you, Ivy. Yes, the land sale was not something we anticipated but it was a unique situation. We had a specific piece of property in Northern Virginia that we were getting approvals to build homes on, and a data center operator approached us with an offer we couldn't decline. There may be similar opportunities in the future; it's hard to predict. However, we will always seek ways to be more capital efficient, enhance our gross margin, and grow the company. This goes beyond just core homebuilding, where we aim to expand in our existing markets, and we have numerous opportunities to do so because we hold a relatively small market share in many areas at our price point. As our price points lower, we see significant opportunities to grow in the 60 markets we operate in. We offer the widest range of products and prices among builders, which we believe provides the best opportunity for core growth in homebuilding. Additionally, we will maintain our focus on the apartment business and other avenues to generate positive cash flow. As you know, we are dedicated to returning capital to our shareholders. We plan to use the majority of the proceeds from the data center sale to enhance our buyback initiatives. We remain long-term committed to our dividend and are focused on increasing it. I am pleased with our progress. The shift towards more affordable luxury price points is well underway, with over 40% of our sales and closings now in this segment. We have also committed to a greater strategy of speculative building, which is performing well; 50% of our sales in the first quarter were speculative, and 40% of our deliveries were as well. The market conditions, particularly with a tight resale environment, favor our spec offerings. Importantly, much of our spec still allows buyers to have choices at the design studio regarding finishes. Speculative building is not limited to affordable luxury or lower-priced, lower-margin communities; we are building spec across all our price points and product lines. You asked a general question, and I provided a comprehensive answer.

That's really helpful. I think one thing you've done is significantly reduce debt, resulting in the best balance sheet position ever. I believe you're likely at a comfortable debt-to-capital level. Are there opportunities for bolt-on acquisitions, considering that private companies face various disadvantages, including the cost of capital? Or is it more probable that you'll focus on organic growth and share buybacks to be capital efficient and achieve higher returns?

Yes, thank you. We're always in the conversation on M&A. We've acquired 15 builders in 30 years. We're very selective. I'm very happy with our geographic footprint. So I can't tell you that there's five or 10 markets out there that we really want to get into where you use M&A most often to enter a new market. But there are a few markets we're looking at that are new, and there's many opportunities for bolt-on M&A to get bigger and diversify the offering in an existing market. About five of our 15 acquisitions were in existing markets. So those opportunities still exist. You're right, the M&A market has heated up a lot, and we are certainly studying opportunities. But I think you're going to see more with capital return to shareholders with Toll, and you're going to see new M&A.

Great. Well, good luck, guys. Thank you.

Thanks, Ivy.

Our next question comes from Sam Reid from Wells Fargo. Please go ahead with your question.

Awesome. Thanks so much, guys, and congrats on the quarter. I wanted to touch on the updated delivery guide for '24. It clearly shows you're seeing some momentum in the spring, but my question is kind of help us gauge the level of conservatism that might be embedded in that outlook? And what would we need to see specifically in March and April for you to be comfortable to take that number up again?

Marty, do you want to go with that?

That's a tough question to answer regarding the level of conservatism. I think, Sam, it's safe to say there's no difference in the construct of our guidance right now than there traditionally has been. I think, obviously, if we see a really strong March and April, particularly with our spec strategy, that could result in additional deliveries beyond the guide that we've given. But we're very comfortable with the guidance we've given. And we'll update it in three more months.

And remember, on the build-to-order side of our business, which is 50% to 60% of our operation, these houses are big. These houses are complicated. They have upgrades because we send everybody through our design studio and let them design their house to their lifestyle. And so they take some time to build. So we're now 3.5 months into fiscal '24, and there aren't all that many communities remaining where the next sale of a build-to-order home can be delivered by the end of October. There are still some communities that can do that. But with every passing week, there are less and less. And we do have a lot of specs in process that are certainly going to be completed, sold, and delivered by year-end. But I think as the year progresses, our guidance becomes even more definitive because of the build-to-order nature of our business.

No, that's helpful. And maybe to drill down a little bit more on that kind of spec build-to-order dynamic here. So on your gross margin guide for second quarter, can you give us a sense as to what the spread between your spec deliveries and your build-to-order deliveries might be between those two buyer groups? And is there any inclination that that could potentially narrow going forward? Thanks.

Yes, it's a great question. It has narrowed. Let me give a little historical for the last few quarters. In Q4 of '23, our spec gross margin was 26.3%. In Q1 of '24, this past quarter, that jumped to 27.9%. And as you know, the gross margin for the company for the first quarter was 28.9%. So in the first quarter, specs ran exactly 100 basis points below the full gross margin for the quarter. Now some of those specs came out of the West, the Pacific region, California, and were more expensive and had a higher embedded gross margin in them, but we are definitely encouraged by the increase in spec gross margin over time here, and we think that will continue. So in terms of the second quarter guide, I think it's probably fair that that 100 basis point difference is about where we'll be.

Yes, I think so. It might be a little wider than that because back less from the Pacific it. But again, it depends to a certain extent on how strong the spring is, what we do with pricing as we progress.

Please understand that our business strategy involves the spec business having a lower gross margin. We anticipate that the spec homes will typically be constructed on more average lots that do not carry a high lot premium. We reserve the higher lot premiums for the build-to-order business, where clients tend to invest significantly more in the design studio. While we do upgrade the spec homes, we often do not elevate them to the same standards as those chosen by clients in a build-to-order purchase. Additionally, some spec inventory may eventually remain unsold as completed homes. In such cases, we recognize the need to provide incentives to encourage sales since these homes are finished and ready for delivery. Our strategy has consistently meant accepting lower gross margins in the spec business, but we are pleased with how closely this margin aligns with the overall company's margin.

Our next question comes from Stephen Kim from Evercore ISI. Please go ahead with your question.

Yes, thanks very much guys. Appreciate all the color. And I just wanted to zoom the lens out a little bit and try to get a sense for maybe if 2024 is a year where we can see some of the dust settle on rates and some of the volatility subside. If we could focus a little bit more on what your longer-term targets are and how you seek to operate the business. Let's start with what you just were talking about with an increased spec mix. I would assume that that would allow you to run at a higher level of absorptions or sales per community. I think that you've talked in the past about something in the 24%, 25% per year range. I was curious as to whether or not if this spec strategy is something that's going to be a going forward kind of a thing. We might see that more approach something like 30 a year, how you sort of feel about that. And also whether we might see your backlog turnover ratio also sort of remain or move higher, let's say, into the 40s on backlog turns. I'm not talking about the next quarter, I'm not even talking this year, I'm just talking about in general going forward.

Great question, Stephen. You're spot on. We delivered 27 homes per community in 2023, and we expect to be at 27 to 28 homes per community in 2024.

In '23, we did 23 to 24.

Did I not say that?

I think you said 27 twice. Sorry, you said 27 twice.

My apologies. We delivered 27 homes per community in 2023 and expect to deliver 27 to 28 homes per community in 2024. This improvement is partly due to our new strategy focusing on building more speculative homes, along with reduced cycle times. We believe this will enhance our performance as we move into 2025 and beyond, and we are certainly planning for that. You mentioned a goal of 30 homes per year; yes, that is within reach. Our spec strategy allows us to be agile and responsive to market demands. Currently, there is a strong demand for our spec homes, especially those we can market during the framing stage, giving clients the chance to personalize their finishes. Our shift from less than 10% of our homes being spec to now 40% to 50% demonstrates our commitment, which we believe will drive higher community absorption rates. The existing homes on the resale market remain historically limited, and even with slight interest rate reductions, the market hasn’t significantly opened up due to a lock-in effect. Moreover, even as rates decrease and the resale market adjusts, the average resale home is now 45 years old, creating a preference for new homes, driven not just by inventory shortages but also by the overall quality of the resale inventory. This trend will persist as interest rates decline.

Great, I appreciate that. I didn't catch the comment about backlog and where we could see that going, but I want to ensure I ask my second question about gross margins, SG&A, and operating margin. You've provided guidance this year for a 17% operating margin along with an SG&A rate in the high-9s. I’d like to understand how you view this in the context of your longer-term business strategy. When we examine your margin history, there have been many changes over the past couple of decades. Looking ahead, should we consider 17% as a normalized level for your business, or do you anticipate that the normalized level will be significantly different? If so, could you explain what that difference might be? Would it lean more toward lowering the SG&A or on the gross margin side compared to your full-year guidance?

So Stephen, I think operating margin is very important to us. Returns are very important to us. I think the numbers you are seeing are pretty close to where our long-term expectations might be. 17% that you mentioned is a really good number, maybe as high as 18%; we're looking for upper teens to low-20s return on equity. I want to throw in a shout-out for JV other and land sales as it relates to generating returns as well because it is something we have a history of doing. Gross margins feel very good right now at this level. They feel relatively sustainable at this level, and we'll continue to work on reducing our SG&A with our technology investments and efficiencies that we can try and generate.

Yes. Stephen, I think we have a long-term strategy to continue to maintain a gross margin in the 27%, 28% range. We have an SG&A around 9%, which generates the operating margin at or above your 17 number.

Our next question comes from Mike Dahl from RBC Capital Markets. Please go ahead with your question.

Thanks for taking my questions. A lot of helpful color and context around how you're thinking about the business. Maybe just to draw back to kind of a little more near term. As you've seen the demand progress favorably through the last couple of months. Can you talk more specifically about what you have seen and done on pricing? Our sense is you're still kind of hub pricing relatively flat. But can you talk about what you've done on kind of net pricing and how you're balancing pace price incentives given the rebound in demand here?

In the first quarter, we implemented price increases in approximately two-thirds of our communities. We also experienced a slight rise in incentives due to an increase in spec sales to 50%. Overall, I would characterize pricing as flat. When we consider the modest price increases in two-thirds of our communities alongside the slight increase in incentives for spec sales, the overall pricing has remained stable. As we enter the spring season, we typically spend the first month gauging market conditions, as this period is crucial for assessing our momentum and pricing power for the spring. Over the past four weeks, we have seen positive developments. This is when we usually start to implement price increases nationwide, which will be modest, as we remain cautious due to slight fluctuations in interest rates. We aim to continue driving sales, and with our spec program, we are well-positioned to deliver homes. Therefore, we expect to initiate modest price increases as we move further into the spring season.

Got it. Okay. Yes, that's a follow-up in terms of how you were thinking about that relative to the more recent uptick in rates again. So I appreciate that. I guess, just secondly, on the updated other joint venture land sales, you outperformed in the quarter, you've got the new guide in there that's attributable to the one-off large parcel. It seems like ex that you didn't increase the guide by the full amount of this land sale. So maybe can you just talk through what some of the other moving pieces are in that line, whether it's kind of some of the delayed JV interest sales or anything that kind of got pushed out into fiscal '25?

Sure. At the beginning of the year, like JV land sales and other included a placeholder of $40 million to $50 million for that land sale. We didn't want to count on all of it as there was very little deposit up and such deposit was not hard, but we also didn't want to fully discount it. So we had handicapped it at a 25% to 35% likelihood of occurring. And so we included $40 million to $50 million from that in our JV and other. So when we increased the guidance, it's not just being increased for the $175 million. It's being increased a little less than that for the land sale, but some other things as well that are puts and takes. The important part is our guide was $125 million, and it's now $260 million. And a lot of that $260 million has occurred as we sit here today.

Yes, got it. That's great, thanks.

Our next question comes from Rafe Jadrosich from Bank of America. Please go ahead with your question.

Hi, good morning. Thanks for taking my question.

Good morning, Rafe.

Marty, can you just help bridge us between the first quarter gross margin of 28.9% and the second quarter guidance of 27.6%? I know there's a mix impact in there. but you are guiding to flattish delivery ASP. So I just wanted to understand, like how much was the unexpected mix benefit to 1Q? Is that the full 90 basis points? And then what is the sort of reversal of that or normalization in the second quarter?

I believe the majority of the 90 basis points was due to an increase in our high-margin mix. We anticipate an opposite effect in the second quarter. Another factor contributing to our better-than-expected performance in the first quarter was that our gross margin for quick moves in homes came in slightly higher than we expected. As we look ahead to the second quarter, we expect a decrease in deliveries in the Pacific and high-margin Mid-Atlantic regions. Additionally, we expect a higher percentage of quick moves as a part of our total deliveries compared to the first quarter.

Let's not get too hung up on quarter-to-quarter because the full year gross margin guide has been increased by 10 basis points.

And another 10 basis points on interest and cost of sales.

Got it. Okay. Yes, that's helpful and makes sense. Regarding the long-term increase in the mix of QMI or spec, there's been a strategic change that has proven successful. What has shifted in the market or in Toll's positioning that makes this more viable now than it has been historically? Is this change temporary due to the tight retail market? Should we anticipate spec percentages to fluctuate over time based on market conditions, or has there been such a structural change at Toll that running a higher percentage of spec now makes sense, unlike in the past?

Yes. The historically tight resale market highlighted a gap that we could fill. I believe this is a long-term structural change for several reasons, including the age and condition of older resale homes. Many individuals have stepped out of the market because they struggle to find quality homes. Additionally, we have expanded our geographical reach and adjusted our pricing. By building speculative homes across various price points, we've utilized our affordable luxury communities, which naturally create more spec opportunities. Consequently, I believe this strategy is established and will endure. While I can't guarantee that spec will always account for 40% to 50% of our offerings, it originated from a tight market and has gained momentum. We define a spec home as one that is foundation forward, and we've developed a strategy to market houses at different construction stages, giving clients the opportunity to benefit from our core offering of choice. With 35 design studios nationwide, buyers can select their finishes, and we can still provide faster delivery since the homes are partially built at the time of purchase. I believe this approach is here to stay.

I think there's been some change in consumer preference. Our homes are really good and attractive and well decorated and well-appointed and well designed for today's lifestyles and interests. The resales that are out there, many of them need work. You have to get somebody to do that work. You have to have the money to pay for that work after buying the house. And so I think the consumer is gravitating to new, as Doug mentioned, and what we offer is pretty attractive.

The cycle times are down a couple of months. The spec business is driving higher IRR when we open a community now, we may have five to 10 spec homes that have already been started. So when you come in to the sales center opening weekend, you don't just have to think a year out for a build-to-order home, but there's some inventory homes that are in various stages.

We get the revenue quicker that way, too.

So I think we are confident that this will continue to be a big part of our strategy as we continue to obsess with being America's luxury homebuilder and to focus on the brand. We will not let the spec strategy in any way bring down quality or take away choice or the special sauce of Toll Brothers.

Our next question comes from John Lovallo from UBS. Please go ahead with your question.

Good morning guys. Thanks for taking my questions. The first one is, if we look 2015 to 2019, so it’s a pre-covid absorptions increase, call it, 60% to 65% on average from the first quarter to the second quarter. You guys have talked about better than normal seasonality going on right now. So just curious how you're thinking about that potential step up this year.

So I mentioned that January had outsized sales to December and November, looking at past trends and February is following normal seasonality that we have seen looking back at historic trends, our traffic in the last week was the highest week of foot traffic into our model homes since February of '22. Our web traffic is up dramatically. We have great optimism for what's coming this spring with a really good start in January and February. I think that's the best answer I can give.

That's helpful and encouraging. If we examine the first quarter, the delivery average selling price you're discussing is slightly above $1 million for the upcoming quarter. Considering the full year guidance of $940 million to $960 million, it suggests a notable decline. You mentioned the mix; is that the main factor driving this change, or is there something else we should consider?

It's the entire driver. Our strategy from a few years back to lower prices to gain a larger market share is now in effect and is reflected in our deliveries. We are pleased with this price reduction because the strategy is proving effective. So that's the situation. It's entirely a matter of mix.

And that mix shift is more south, more Mid-Atlantic, a little bit more affordable luxury and a little bit more age-targeted age restricted than the first half of the year.

Our next question comes from Michael Rehaut from JPMorgan. Please go ahead with your question.

Thanks. Good afternoon, everyone. Thanks for squeezing me in before the end of the hour. First, I just wanted to circle back on the comments around gross margins where you said that you think gross margins can be sustainable going forward at 27%, 28%. Obviously, a lot of builders have kind of been working through or in the process of working through maybe a little bit of a reset from slightly higher priced land over that was purchased, perhaps also some higher development costs over the last couple of years and seeing a little bit of normalization; your comments would kind of suggest kind of staying at this higher level versus prior years, maybe a little bit of slippage, if you kind of say 27% to 28% and you're still at 28.4% for fiscal '24? I just want to make sure we're thinking about that right. And really, what's driving this higher level of gross margin, maybe a little bit of slippage in '25 to the midpoint of the range, perhaps. But what's driving that higher level of gross margin today versus prior years? And could you have any risk of slippage to more similar to your peers?

I believe we are in a strong position for land buying and our underwriting criteria are quite advantageous; half of our land was secured before December 2020. Our underwriting is straightforward, utilizing a combination score that factors in both IRR and gross margin. Depending on market conditions, team performance, and whether the lots are improved (which reduces land development risk), and considering if there is a lengthy entitlement process that may make the deal more speculative or costly, the combo score can range from the low to mid-50s to over 60. This score reflects the sum of IRR and gross margins, and we consistently observe deals that meet our criteria. Specifically, we require gross margins above 25% and IRRs exceeding 25%, and we continue to receive strong deal flow. Our underwriting approach remains conservative; we do not factor in home price appreciation and we include substantial contingencies for land development costs, as these are still rising across the industry. A key factor in our success is that we have dedicated land teams nationwide, and we typically do not compete with large public and private companies that are well-funded and willing to accept lower returns for growth. Instead, we compete with smaller local and regional builders who have lost their banking support and cannot manage large investments. This gives us an advantage in securing land, as evidenced by the 20 to 25 land deals I review every Sunday night that show solid returns.

We have 70,000 lots. So maybe we don't have to be as aggressive in the next lot as some others might have to.

There are $150,000 in upgrades being added to these homes by our clients, and these upgrades significantly enhance our company's gross margin. This is reflected in our underwriting process. As we acquire land, we are aware that we will sell these upgrades, contributing to increased margins because providing choices requires additional effort and time, with more potential issues. Therefore, we anticipate and are entitled to that higher margin.

I think you've mentioned that the combined internal rate of return and gross margin you're targeting has increased by about 10 points over the past few years. Marty, could you elaborate on that? Also, regarding the average selling price, I see you maintained your estimate of $940 million to $960 million for the full year. With $1 million achieved in the first half, this implies a figure in the low 900s for the second half. I want to ensure we're considering this accurately, although I don’t want to provide guidance for 2025. This low 900s figure, perhaps around $920 million with some adjustments for increased revenues, could be the appropriate baseline for fiscal 2025.

Yes. As I mentioned, I think our strategy to move into affordable luxury is now fully in place. So I think the drop you're seeing in the second-half of '24 to the low-9s is reflective of the future business at Toll.

Our final question today comes from Buck Horne from Raymond James. Please go ahead with your question.

Hey, I'll be brief. I appreciate the time. Just wondering, we have seen a little bit of a maybe unusual seasonal uptick in resale inventory in a couple of markets, particularly Southwest Florida and Texas. And just curious if you could speak to those regions in particular, if you think some of the addition to resale inventory there is having any noticeable impact on the business through the early part of spring selling?

Texas has been terrific. We're in 4 markets in Texas, Austin, San Antonio, Dallas, and Houston, just terrific. We've been thrilled with the business there. There's a lot of new homes in Texas. There's a lot of competition. We have a great brand there. We've been in the state a long time. And I'm very optimistic about our future there. Land is relatively easy to find. The risk is less because there are land developers that feed us lots which makes the business easier. We can have just-in-time lots provided to us, which, of course, can drive the IRR. I wouldn't read too much into Southwest Florida. We're very small there. It's one of our smaller markets in the state. But Florida, we call Florida West, which is really Naples up through Fort Myers. And that is having a really good February. In fact, Florida East, which we call Fort Lauderdale up through Stuart is also having a really good February. As the snowfalls in the north and the Midwest, the planes head south, and we're taking advantage of that.

That's fantastic. All my other questions are answered. So congrats great quarter.

Thanks very much. I think is that a wrap, Jamie, how are we doing?

Yes, sir, that will conclude today's question-and-answer session. I'll turn the floor back over to you for any closing remarks.

Jamie, thanks. You've been great. Thanks, everyone, for your interest and support. As always, great questions. We're always here offline to answer any follow-ups you may have. And thanks again. Take care.

And with that, ladies and gentlemen, we'll conclude today's conference call and presentation. We thank you for joining. You may now disconnect your lines.