Earnings Call Transcript - TOL Q1 2022

Operator, Operator

Good morning, and welcome to the Toll Brothers First Quarter Earnings Conference Call. Please note this event is being recorded. I would now like to turn the conference over to Douglas Yearley, CEO. Please go ahead.

Douglas Yearley, CEO

Thank you, Jason. Good morning. Welcome, and thank you for joining us. 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. Before I begin, I ask you to read the statement on forward-looking information in our earnings release of last night and on our website. I caution you that many statements on this call are forward-looking based on assumptions about the economy, world events, housing and financial markets, interest rates, the impact of the pandemic, the availability of labor and material, inflation and many other factors beyond our control that could significantly affect future results. I will begin by sharing some thoughts on current market conditions and sales, along with the challenges we are seeing on the production side and how we are addressing them. I will then turn it over to Marty to discuss the numbers and guidance in more detail. Our first quarter results were solid. Net income and earnings per share rose 57% and 63%, respectively. And home sales revenues grew 20% in dollars and 9% in units compared to last year's first quarter. Our adjusted gross margin of 25.6% in the quarter was 270 basis points better than last year's first quarter. And our SG&A expense as a percentage of home sales revenue improved 150 basis points over last year. At first quarter end, our backlog stood at a record $10.8 billion and 11,302 homes. Due to the strong demand we continue to see in the market and the good visibility that our backlog provides, we are reaffirming all of our full year guidance. We are pleased with our sales results in the first quarter, as we saw broad strength across all of our buyer segments and geographies. We signed 2,929 net contracts for approximately $3 billion, up 2% in units and 19% in dollars over last year's extremely strong first quarter when orders were up 59% in units compared to fiscal Q1 of 2020. Our contracts per community at 8.8 for the quarter remained well above historical averages. This was our best first quarter sales ever. The average selling price of signed contracts in the quarter once again exceeded $1 million and was up approximately $149,000 compared to last year's first quarter. Favorable demand dynamics allowed us to continue raising prices in nearly all of our communities throughout the first quarter. While demand has remained strong, we continue to face challenges on the production side, from supply chain disruptions, labor shortages and municipal delays. These challenges were compounded by additional pressure from the Omicron wave, as it spread across the country especially in January when it peaked. It is taking us approximately 2 months longer to deliver a home today versus 1 year ago. It's important to point out that these delayed deliveries are not lost. We continue to enjoy historically low cancellation rates, and our contracts are supported by an average nonrefundable down payment of $71,000. It is simply a timing issue. With demand and pricing as strong as they have been and with construction schedules that continue to extend due to supply chain, labor and similar issues, we believe the right strategy for us at this time is to limit sales and continue to focus on production. Over the past 6 weeks, we increased the number of communities on allocation from 25% to today over 50%. In many communities, we are using the traditional resale process of best and final sealed bid to maximize price. In addition, we are starting more specs in the second quarter than we typically would to replenish inventory sold last year. As a reminder, spec homes normally represent about 20% of our settlements. It is important to note that this increase in spec starts and purposefully metering sales should not impact the timing of future revenues, as we expect the spec homes started in Q2 to be sold later in the construction process and still be delivered in the first half of 2023. So we expect to start more homes than we sell in Q2, and we expect our sales pace in the second quarter to be similar to the 8.8 contracts per community that we booked in the first quarter. Our nonbinding deposits in the first 3 weeks of February were consistent with the pace of the past 9 months, which was approximately 325 deposits per week. We could have taken more deposits these past 3 weeks, but we chose not to in order to focus on production and manage build times. In order to further streamline our operations and mitigate potential production bottlenecks, we also continue to optimize the number of available floor plans and options we make available in a given community, offering buyers better choices by focusing on those that are most popular and more readily available. And we continue to work closely with our subcontractors and national suppliers so we can anticipate supply chain issues and labor delays and make any necessary adjustments. While we do not anticipate any meaningful improvement in supply chain and labor shortages in the near term, we are encouraged by the recent steep drop in COVID cases and the relaxing of many pandemic restrictions. Turning back to the demand side of the equation. The housing market and demand for our homes in particular, is being propelled by strong demographics from both the millennial and boomer generations, a substantial imbalance between the tight supply of homes and continued pent-up demand, the wealth effect of rising existing home equity, migration trends and the greater appreciation for home. We believe these long-term tailwinds will continue to support demand for our homes well into the future. We continue to see people move from states where home values, taxes and cost of living are higher to less expensive regions. This dynamic is spurring demand in markets across the country and particularly in the Sunbelt and Mountain states, where we have expanded in recent years. For these buyers, affordability is less of an issue. We have also not seen an impact on demand from the recent increase in mortgage rates. I remind you that our customers are generally better insulated from affordability concerns compared to buyers in the entry-level market. Our buyers tend to have higher incomes and they benefited from multiple years of appreciation in their investment portfolios and their existing homes. They also understand that when they contract with us today, their interest rate will not lock until they are much closer to settlement. So we don't believe that demand for our homes is being pulled forward by buyers, who are focused on beating a rise in rates. Also keep in mind that rates have no impact on monthly payments for about 15% to 20% of our customers, who pay all cash, and that another approximately 30% of our buyers borrowed jumbo rates, which are currently 5/8 of a point lower than conforming for our clients. And overall, our customers average less than 70% loan to value in their mortgages. In fact, we've analyzed our backlog and estimate that rates would have to increase to approximately 5.25% before just 10% of our backlog would need to consider an arm, a higher down payment or other alternative mortgage. This speaks to the creditworthiness and healthy balance sheets of our customers. As I mentioned earlier, we are reaffirming all of our guidance including a return on beginning equity for fiscal 2022 of approximately 23%. We also expect to generate substantial cash flow in 2022. Our highest capital allocation priority continues to be investment in the growth of the business, including through disciplined and capital-efficient land buying. Of the approximately 86,500 lots we owned and controlled at January 31, 54% were optioned and 46% were owned compared to 46% optioned 1 year ago. Our shift to more optioned lots is an important part of our capital efficiency strategy and our focus on returns. This lot position also provides us with all the land we need for our projected community count growth in fiscal year 2022 and beyond. We continue to expect approximately 10% community count growth by the end of fiscal '22 from the 340 communities we were operating at the end of fiscal 2021. We continue to use excess cash to further reduce leverage and return capital to shareholders. In the first quarter, we repaid $410 million of our senior notes. We also repurchased $185 million of our stock, which reduced our outstanding share count by approximately 2.5%, and we paid dividends of approximately $21 million. Our balance sheet remains strong with ample liquidity, strong expected cash flow generation and declining leverage. These factors, along with the positive fundamentals underlying our business, contributed to Moody's upgrading us to an investment-grade credit rating last month. With that, I'll turn it over to Marty.

Martin Connor, CFO

Thanks, Doug. In our first quarter, we delivered 1,929 homes at an average price of approximately $875,000, generating homebuilding revenues of $1.69 billion, which was up 9% in units and 20% in dollars from 1 year ago. Settlements came in 71 units below our expectation due to the supply chain disruptions, labor shortages and municipal delays that Doug mentioned. We felt the greatest impact in January, the last month of our quarter as the effects of the spread of Omicron were most acute. Fortunately, Omicron and the pandemic now seems to be waning. Our first quarter pretax and net income were $200.8 million and $151.9 million, respectively, both up approximately 57% compared to $127.4 million and $96.5 million, respectively, in the first quarter of 2021. Earnings per share in the first quarter were $1.24 per share diluted, up 63% compared to the $0.76 per share diluted that we earned 1 year ago. The net income and earnings per share growth percentages were approximately triple our revenue growth percentage growth. Our first quarter adjusted gross margin was 25.6% compared to 22.9% in the first quarter of 2021. The 270 basis point improvement reflects the strong pricing environment over the last year. It also includes the impact of elevated lumber prices from last spring in this quarter's closings. We continue to project an adjusted gross margin of approximately 27.5% for the full year. We expect adjusted gross margin of 25.5% for the second quarter of fiscal year '22, as the impact of elevated lumber prices from last spring continues. This will be followed by a ramp-up in our gross margin in the third quarter and a greater ramp in our fourth quarter. SG&A as a percentage of revenue was 13.4% in the first quarter compared to 14.9% in Q1 of last year and 70 basis points better than projected. Joint venture, land sales and other income met our guidance at approximately $30 million in the first quarter. Impairments and write-offs were $2.2 million in the quarter. Our tax rate in the quarter was 24.4% compared to guidance of 26%. Turning to future guidance. We are projecting fiscal year 2022 second quarter deliveries of 2,350 homes with an average price between $865,000 and $885,000. We are maintaining our full year delivery guidance of between 11,250 and 12,000 homes with an average price between $875,000 and $895,000. Deliveries will be back half weighted and will be consistent with seasonal patterns. We expect interest in cost of sales to be approximately 2.1% in the second quarter. We project second quarter SG&A as a percentage of home sales revenues to be approximately 11.9%. For the full year, we continue to project SG&A as a percentage of home sales revenues to be approximately 10.5%. We expect community count to be approximately 330 at the end of the second quarter and 375 by fiscal year-end. Other income, income from unconsolidated entities and land sales gross profit is expected to be approximately $5 million in the second quarter and $100 million for the full year. We project a tax rate of approximately 26% for the second quarter and 25.8% for the year. Our weighted average share count is expected to be $121.5 million for the full year and $122 million for the second quarter. Based on all these factors, we continue to project approximately $10 per share in full year earnings per share and a return on beginning equity of approximately 23%.

Douglas Yearley, CEO

Thanks, Marty. This month, FORTUNE Magazine named us the #1 World's Most Admired Homebuilding company. This is the 7th time we have received this high honor. I would like to thank all of our Toll Brothers team members for achieving this tremendous recognition. They continue to demonstrate their dedication to our brand and our customers, and for that, I am very proud and very grateful. As Toll Brothers enters its 55th year in business, I'm excited about the current market and the long-term prospects for our company. Now let me turn it over to Jason for questions.

Operator, Operator

Our first question comes from Anthony Pettinari from Citi.

Unidentified Analyst, Analyst

This is Ashu Sanan on for Anthony. I guess my question is, the last time we saw rates rising in the 2018 timeframe, your sales pace did slow down meaningfully. So I was just wondering what were maybe some of the early warning signs in 2018, 2019 timeframe that were showing the demand than maybe we should be looking for around now. And then I know you haven't seen any impact on demand yet, but have any of those warning sign metrics started to weaken for you at all?

Douglas Yearley, CEO

Very good question. The warning signs are web traffic, foot traffic. And right now, web traffic and foot traffic are up significantly.

Unidentified Analyst, Analyst

Okay. As a follow-up, I want to discuss your sales pace in 2021, where you sold slightly over 3 homes per community each month in the quarter, which is similar to what you expect for Q2. I’m curious if this sales pace is sustainable as a new normal for the remainder of the year and beyond, or if we should consider that 10% growth in community count might come at the expense of a potential normalization in sales pace.

Douglas Yearley, CEO

Currently, we are selling approximately 37 homes per community annually and settling at about 35 homes per community, which reflects the challenges that builders have previously discussed. We are confident that we will increase our settlement rate as supply chain and labor issues improve, likely in the later part of this year. As mentioned, our focus will shift to increasing new starts this quarter. We are currently about 600 spec or quick move-in homes behind due to high sales over the past year and a half during a strong market. We are committed to initiating many more homes in the second quarter, which is why we have placed over 50% of our communities on allocation.

Unidentified Analyst, Analyst

Okay. That's very helpful. I'll turn it over.

Operator, Operator

The next question comes from Stephen Kim from Evercore ISI.

Stephen Kim, Analyst

Thank you for the insightful information about the buyers and the factors you discussed regarding demand not being pulled forward. I found it interesting that our model indicates your net debt could easily return to the low 20s. My question is about your outlook for return on equity, which is around 23%. Can you provide an idea of the range of net debt to capitalization you expect by the end of the year? Additionally, you mentioned specifications, but you are among the few builders that do not offer a detailed breakdown of the number of homes under construction at any given time. Could you share that number for this quarter and the same period last year?

Martin Connor, CFO

So Stephen, with respect to the debt question, I think you're directionally accurate. I think we're interested in operating in the low to mid-20s, but the timing of land opportunities or builder acquisition opportunities can always impact that from quarter to quarter or from year-end to year-end. We're encouraged by the fact that our plans have been shared with Moody's, and they moved us up to investment grade. And so we feel very comfortable operating in those levels with the liquidity we have, the cash generation we foresee and the growth opportunities we have on balance sheet or in process. With respect to your second question, which is the number of starts. I don't know that we have that with us this morning. As Doug mentioned, a lot of our starts in the second quarter will be to replenish our depleted spec inventory. So we expect to start in the second quarter in the neighborhood of 3,400 to 3,600 units.

Douglas Yearley, CEO

In the first quarter, we began about as many homes as we sold. However, last year, we were selling slightly more homes than we were starting, which is one of the key reasons we've increased our allocations for now. We plan to increase our spec count, and as Marty mentioned, this quarter we will start more homes than we sell. These homes should have a shorter construction cycle time because, in the initial stages, we won't have a client, allowing us to move more quickly. We believe they will be delivered in the same time frame as if they had been sold. If the market continues as it is, we are optimistic that there could be additional margin in these homes since they will be sold later in the cycle.

Stephen Kim, Analyst

Yes, there's no doubt about that. One of the interesting aspects of times like these is the higher margins on specifications. My second question is about your current trading position, which is quite close to your book value. In considering this, I analyzed the extent of land ownership and the number of lots you have, which likely reflect pre-pandemic pricing. Our analysis indicates that it's possible all of that could have been based on prices negotiated before the pandemic. However, there are two assumptions to consider. First, I wondered if you could comment on whether your land values are increasing at a rate that exceeds home price appreciation, as I've heard it could be double the rate of home price growth. Secondly, regarding your options, my understanding is that some have an escalator feature, which is usually capped. Therefore, during this period when land values have increased significantly over the last two years, those escalators might not keep pace. This suggests there could be an inherent advantage in the options you had during the pandemic. Are those two assumptions accurate?

Douglas Yearley, CEO

It's a very complicated answer, and I don't want to get too bogged down. Let me start by saying that 77% of the land we own was contracted before the pandemic. Regarding the deal structures, most of our agreements do not include additional payments based on our success; we simply pay for the land, and we may not pay everything upfront. Due to our focus on capital efficiency, we might be paying over time, which could involve an interest rate. In the case of a land banker, there is typically an interest rate for delaying the payment for that land. However, most of our deals don't have additional incentives, meaning the land seller does not share in our success after the sale. That said, some agreements do include a kicker, where the seller may receive a small percentage of the home’s final sale price or, in very limited cases, a profit participation that requires them to understand our accounting practices and engage in negotiations over profit calculation. So one is revenue, which is a percentage of the home price itself and the other would be a share of the profit made, but those are the exceptions. Most cases do not have that. But to your point, when they do have a revenue or profit participation, we have the outsized component of that. So we are benefiting far more than our seller as our prices or our profitability goes up.

Operator, Operator

The next question comes from Alan Ratner from Zelman and Associates.

Alan Ratner, Analyst

Doug, I'd love to follow up, I think, on a comment you made to a prior question about the supply chain, and I think you kind of made a hopeful comment that as the year goes on, maybe things will at least stabilize or maybe even improve a bit. And I'm just curious your thoughts because you guys seem to be following a similar playbook that a lot of the industry is right now in terms of limiting sales, ramping spec starts. Obviously, community count is going to be growing a lot. So I guess where I struggle a little bit is and I'd love to hear your thoughts are why would the supply chain stabilize if the industry is all kind of trying to ramp up the volume of specs over the next 3 months, 6 months? Community count is going to be growing double digits for just about everybody over the next 9 months. What is the catalyst that would actually cause the supply chain to stabilize or even improve?

Douglas Yearley, CEO

It's a great question. I want to clarify that we haven't anticipated any improvement. In fact, we've recently increased our contingency plans and building costs to be more cautious. The guidance we're providing reflects an expectation that significant stress and pricing pressure will persist. Reflecting on the current situation, in January, 9 million Americans were reported sick, which is vastly higher than the normal 2 to 3 million before COVID. The previous peak was 6 million a year ago. January was extremely challenging for us. We faced difficulties obtaining building inspections because the inspectors were not available, and we couldn't secure Certificates of Occupancy because the town clerks were also unavailable. Many of our employees were at home, and it affected us in various aspects of life, including at my child's school and in our social circles. However, this situation is changing rapidly. Recently, my child went back to school, and I'm feeling optimistic as things are rapidly changing towards normalcy. The situation at the L.A. and Long Beach ports has improved; there are no longer 100 freighters anchored and thousands of containers left on the docks. I've heard that major suppliers are starting to see improvements, allowing them to operate their factories at full capacity and coordinate with truckers for transportation. I agree with you, Alan. Builders are seeing growth, and there is significant activity in the market, which remains strong. Therefore, I am hopeful and cautiously optimistic that as this year unfolds, we will experience a more normal, albeit still somewhat challenged, production environment.

Martin Connor, CFO

I think to follow on to that a little, Alan, we are offering product that we know is available. We are choosing product in these spec homes that we are building that we know is available. And we are narrowing to the most popular items what is offered in our design studios. And that actually marries with what the manufacturers are producing. They've narrowed how much they produce to drive efficiency.

Alan Ratner, Analyst

Got it. Appreciate the comments there. I know it's a tough environment to predict here. So it's helpful to hear how you're thinking about it. Second question, I would love to just dig in a little bit in terms of the mix of your business. I think one of the areas that perhaps there was some optimism on in terms of navigating some of the extending cycle times was the growth in affordable luxury and the growth in newer markets where perhaps cycle times historically have not been quite as extended as the coast. So I'm curious if I look at your average price growth, it's been very strong, kind of consistent with the broader industry. So it doesn't seem like there's really been much of a mix towards more affordable product or kind of more affordable markets, your cycle times obviously have not yet stabilized. So should I interpret that, that you're actually just seeing incrementally stronger demand from the luxury higher-end price point? Or is that not the correct interpretation and there's something else going on underneath the surface there?

Douglas Yearley, CEO

No, we are committed to the affordable luxury segment and to new markets that tend to be lower priced. There has been significantly less city living in 2022, with almost no city living deliveries due to the timing of building completions and our decision to intentionally slow that segment down as COVID affected the market. The shift from city living has increased in active adult, age-restricted communities primarily. However, we are raising prices across the board. Therefore, don't interpret the $1 million-plus sales price over the last two quarters as strictly coastal, even though these are high-cost areas. We entered Boise four years ago, selling homes for around $325,000, and our average home price in Boise now is approximately $650,000. I could tell a similar story for many markets across the country. There seems to be a new understanding of what affordable means, and many of these markets are experiencing equal or greater percentage increases in sales prices compared to some coastal regions. When we combine everything, the price is exceeding $1 million. However, we appreciate the combination. A large portion of the land we are acquiring remains in these new, lower-priced markets where we can provide more affordable homes. As I mentioned, those homes are appreciating just as quickly, if not faster, than in other locations. Therefore, there is no change in strategy; it is simply a matter of rising prices everywhere.

Operator, Operator

The next question comes from Deepa Raghavan from Wells Fargo.

Deepa Raghavan, Analyst

If your 2022 results are fairly certain at this point, considering your backlog visibility, what is causing the wide range in your guidance? Are you anticipating the spring selling season, or is the supply chain still limiting the high and low ends? Do you have any insights on that?

Douglas Yearley, CEO

Yes. Go ahead, Marty.

Martin Connor, CFO

So I think our guide for deliveries is a width of 725 units, right, 11,250 to 12,000 with roughly 10,000 of those to go. I think that's a prudent guide in this operating environment.

Douglas Yearley, CEO

Sorry, 10,000 to go. I misunderstood. Sorry. Well, we delivered 1,929 in the first quarter.

Martin Connor, CFO

Understood. We have 10,000 units left to deliver. The reason for that range is not related to sales, as we are selling in 2023. I mentioned last quarter that the next home we sold in December had the highest margin we've seen in this cycle, and I can confirm that three months later, the next home sold today also has the highest margin we've experienced this quarter. We are continuing to raise prices more than the increase in costs, but that pertains to 2023. In terms of 2022, we faced supply chain issues that led to missed deliveries in the first quarter. We provided guidance for deliveries in the second quarter, and we have significant goals to meet in the second half. If we achieve our delivery guidance in Q2, 63% of our full-year deliveries needed to reach the midpoint of the guidance will occur in the second half. Historically, our 10-year average for second-half deliveries is around 60%, and we have assessed the construction status of our backlog, which is progressing better than in the past. Therefore, we are confident in reaching that 63%. However, we believe it is wise to maintain a 750-unit range due to the current building environment. There are some quick move-in homes that still need to be sold, but given the market conditions, we perceive a very low risk of impacting the final delivery numbers. The cautious approach we are taking is simply a reflection of the production environment we are operating in.

Deepa Raghavan, Analyst

That's helpful color. Another broad one for me. You addressed a little bit in your prepared remarks, Doug. There is a bear narrative out there that luxury builders are a little bit more price elastic. And the first move down usually happened in that portfolio, resulting in luxury builders perhaps moving buyers to other categories, as the buyers trade down in this high interest rate environment. How would you address that?

Douglas Yearley, CEO

We disagree. I believe our buyers are in a much stronger financial position. I reviewed their creditworthiness, and the average loan-to-value ratio is 70%. While a luxury home is a discretionary purchase, we have historically fared well during times of rising interest rates because our buyers still have the means to afford our homes. For them, it isn't merely a decision based on monthly payments. Most of our buyers, with the exception of some in Detroit who lease many cars, focus on improving their living situations. They aim to upgrade to larger homes as their children reach middle school, invest in second homes, or downsize into luxury communities as baby boomers, and they have the financial capacity to do so. They do not max out their mortgages. Currently, 50% of our buyers are upgrading, and 70% have homes to sell, benefiting from the equity accumulated in those homes. This equity enables them to move up. Therefore, even if interest rates increase by 25, 50, 75, or even 100 basis points, we have historically been in a better position than the starter home market, which primarily hinges on affordability and monthly payments.

Deepa Raghavan, Analyst

All right. That's great color.

Operator, Operator

The next question comes from Truman Patterson from Wolfe Research.

Truman Patterson, Analyst

First, I just wanted to hop back to one of the questions on the early warning signs and as a portion of your orders, your cancellation rate ticked up about a point year-over-year. Just saying if you had any more clarity from the field, is this just simply cancellations in the normal course of business? Or are you beginning to see the higher mortgage rates impact some buyers' ability to qualify for the mortgage?

Martin Connor, CFO

I believe the cancellation rate is low compared to our historical averages. Over the last decade, 6% has been our long-term average, and last year was particularly low. This year, it has increased slightly, but that rise is largely due to the size of our current backlog. When considering cancellations as a proportion of backlog instead of current quarter sales, there has been minimal change. We are not observing any early warning signs in cancellations. Therefore, I think the shift from the high 3s to high 4s in new contracts is somewhat misleading. Currently, it stands at 1.3% of backlog, now at 1.4%, compared to 1.3% a year ago.

Truman Patterson, Analyst

Perfect. And then second...

Martin Connor, CFO

And in a rising price environment, cancellations are an opportunity for us right now because we get to sell the home at a higher price.

Truman Patterson, Analyst

Okay. So cancellations are still beneficial for the gross margin? Okay. And...

Martin Connor, CFO

Not a strategy.

Douglas Yearley, CEO

And it is not a strategy.

Truman Patterson, Analyst

Fair enough. And then second question on rate locks. Are you seeing consumers beginning to use rate locks more frequently? Are they using longer rate locks? And if so, how should we think about the cost associated with Toll and where it might impact the income statement?

Martin Connor, CFO

Yes. We have not yet seen extended period of time rate locks be asked for by our customers. They can lock a mortgage generally in a normal course within 60 to 90 days of closing, and we are seeing them take advantage of that opportunity.

Douglas Yearley, CEO

I want to emphasize that 80% of the homes we sell are built to order. This is a unique aspect of our business at our price point. Currently, these homes will take between 9 to 14 months to deliver, depending on their location and production backlog. The idea that there's a surge in demand as buyers rush to secure a lower rate is simply not true. Our buyers typically cannot lock in their homes until 60 to 90 days before delivery. Nonetheless, we are experiencing strong demand and significant pricing power. Over the past month, as interest rates have increased, buyers understand they are not in a position to lock in a lower rate when purchasing a home from us.

Truman Patterson, Analyst

Yes, it's interesting when you say that if you actually look at the data historically, you're exactly correct that it kind of dispels the pull-forward narrative. So I appreciate it.

Operator, Operator

The next question comes from John Lovallo from UBS.

John Lovallo, Analyst

The first one is curious how many communities you're implementing that best in final sealed bid in. And along those lines, how do customers tend to react to that process? And do you risk pushing some buyers away that maybe chose to purchase a new home to sort of avoid this process?

Douglas Yearley, CEO

About 90 of our 330 communities are currently utilizing the best and final offer program, which may not apply to every lot. We sometimes use it for special home sites where we anticipate high demand. In my last call, I provided detailed information about how this process works, especially in a build-to-order setting, as we typically do not bid on finished spec homes, although we can if necessary. We implement this through the lot premium, and if you're successful in bidding up the lot premium, you can then select your home and customize it to your preferences. It's important to manage this process well, and our sales team is well trained on it. If there are 30 interested parties for a home site, those in positions 25, 26, and 27 on the list tend to be satisfied because they at least have a chance. While not everyone is content, as is common in any resale situation, this is the current market condition. Buyers are adapting to it based on the resale market context. We've also developed a convenient app that allows bidding through a Toll app, which enhances transparency. I believe we've communicated this effectively. It represents a new normal in the industry. Are all buyers pleased? No, many still prefer to enter and buy a home straight from a price list. However, this is the environment we are navigating now, and I take pride in how we are managing it, as I think most buyers are understanding of the situation.

John Lovallo, Analyst

Yes. That makes a lot of sense. And then maybe going back to Steve's question from before just about where the stock is trading today. I'm curious how this impacts your capital allocation decisions. I mean, if you guys are as confident as you sound in the sustainability of the cycle, which we would agree with, I mean, would your stock be a great investment right now and even more positive signal to the market?

Douglas Yearley, CEO

Well, we bought $185 million worth of stock back at $61, guys. So I think that that gives you the answer.

Operator, Operator

The next question comes from Alex Barron from Housing Research Center.

Alex Barron, Analyst

And great job. I wanted to focus on the trend in the gross margins this year. Clearly, in the first half, you guys are in the mid-25%. And in the back half, it looks like you'll be in the high 20% range. So I know you're probably not going to give us 2023 guidance, but I'm more curious to see how you guys see margins unfolding, as we move into next year. Is it more likely to stay at the higher level or trend back towards of kind of where margins are currently?

Douglas Yearley, CEO

Yes, Alex, I mentioned earlier that the next home sold by Toll Brothers has the highest margin we've seen in the cycle. So I think that bodes very well for 2023.

Alex Barron, Analyst

Got it. Okay. Great. My other question is about expectations on orders. You had only one negative growth quarter in October and then returned to positive growth this quarter. In relation to that, you mentioned that 50% of your buyers are move-up buyers. I'm curious what percentage of your buyers are moving across state lines and what percentage are first-time buyers. I'm trying to understand your mix and what is driving the strength there.

Douglas Yearley, CEO

Sure. And just to clarify, because we are now restricting sales significantly, focusing on production and getting specs started Q2, as I think we made it very clear, will also be a quarter where sales will be down. 40% of our sales are to those moving to a different market to migration.

Alex Barron, Analyst

Got it. And what percentage of first-time buyers?

Douglas Yearley, CEO

30% are first-time home buyers.

Operator, Operator

The next question comes from Susan Maklari from Goldman Sachs.

Susan Maklari, Analyst

First question is you made the comment, Doug, that the web traffic remains high and that you haven't really seen any changes in that. But just wondering if you could give us any more details in terms of what you are seeing online. Are people looking at different products? Is there any change in options that they're keeping an eye on? Are they spending more or less time? And any details around what you're seeing there?

Douglas Yearley, CEO

We have approximately 9 million visitors to our website each quarter, and while our foot traffic is also increasing, not everyone is able to make purchases due to allocations. However, they are still visiting. I'm really proud of our website and our web team. As America's luxury homebuilder, we strive to have the best website in the industry, and I believe we achieve that. We monitor how much time visitors spend on our site, which is an important metric indicating engagement. We also have online sales consultants now that represent every single community in every market where they engage with clients through web, texting through phone calls, not only before communities opened to set up the grand opening, but even as communities are open and selling, and we call them online concierge service. And they're very, very engaged now with the web visitors. It's very easy to see how you can click the button and start to chat with the online concierge and they set it up. They tee up that client for the sales manager at the local community. The one thing we like to see is when they click on the directions page, because that means that they're thinking about getting in their car and running after the community. But the opportunity to look at videos now to do walk-throughs of homes to do some design of your home, custom design to fiddle with colors and products. All of that is available and I'm not going to bog down on the percentages they spend on each different page, but we track it very closely. We also changed the experience. So different pictures come up, different pages come up and we see what the client seems to like. And when you have 9 million visitors a quarter, you get some pretty good trends that allow us to figure out the most efficient, most optimal web experience. And so our website is very fluid and constantly changing. Does that help?

Susan Maklari, Analyst

Yes. But I guess are you seeing any changes in the stickiness to the website or what they're looking at? Anything that's been different in the last couple of weeks, as we've seen rates rise relative to where we were a couple of months ago or a couple of quarters ago? Or has it been consistent?

Douglas Yearley, CEO

It's been consistent. I don't think there has been any change in the buyer experience on the website in the last month or two. We track web leads from their initial visit to when they sign an agreement, and I believe most buyers today have spent some time on our website. I don’t think anything has changed recently due to rising rates or for any other reason.

Susan Maklari, Analyst

Okay. Okay. That's helpful. And then my next question is just around when we think about where the business is today, holistically, you focused a lot on growing the affordable luxury piece in the last several years. When you think about the business going into a rising rate environment with the affordable luxury piece of it today, which you didn't have in the past. How do you think about the mix shift that we could see the potential to sort of grow the luxury versus the affordable luxury pieces of things? And any changes there that could be coming?

Douglas Yearley, CEO

Yes. I'm very happy with the progress we've made over the last 3 years in widening the price point, the product offering and of course, the geographies. We're not done. There will be more affordable luxury in the mix. Right now, it's about 40% and I think it could probably get up to maybe 45%, maybe 50% over a bit of a longer term. But we're not giving up on luxury. There's still a lot of opportunity at the higher price points for us and we're seeing that success. But as I look longer term at that mix, we're beginning to approach what I think is optimal, but we're not quite there, but we've come a long way. I'd say we're probably 80% on our way towards the long-term strategic mix that we want. By the way, when I say 40%, that's on the dollar value. So the actual number of homes would be higher since those homes are less expensive.

Operator, Operator

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

Douglas Yearley, CEO

Thank you, Jason. Thanks, everyone. We really appreciate your interest and support, and happy spring. It's on its way, almost March 1. Take care.

Operator, Operator

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