Toll Brothers - Earnings Call - Q1 2020
February 26, 2020
Transcript
Speaker 0
Good day, and welcome to the Toll Brothers First Quarter Conference Call. All participants will be in a listen only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Douglas Yearley, Chairman and CEO.
Please go ahead.
Speaker 1
Thank you, Alyssa. Welcome, and thank you for joining us. With me today are Bob Toll, Chairman, Emeritus Marty Connor, Chief Financial Officer Fred Cooper, Senior VP of Finance and Investor Relations Wendy Marlett, Chief Marketing Officer and Greg 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 and many other factors beyond our control that could significantly affect future results.
Those listening on the web can e mail questions to investorrelationstollbrothers dot com. Last night, we reported first quarter twenty twenty home sales revenue of $1,300,000,000 with a 20.9% adjusted gross margin and net income of $56,900,000 or $0.41 per share diluted. Our first quarter backlog of 6,461 units and $5,450,000,000 was up 9% in units and 2% in dollars versus last year. First quarter deliveries revenue and earnings per share were lower than we had anticipated due to delayed closings in a few markets, principally Northern California where we missed 60 closings valued at $67,000,000 Most of these homes should deliver in our second quarter. With strong buyer demand, our first quarter contracts were up 31% in units and 28% in dollars, And our contracts per community were up 28% compared to one year ago.
California, which is now part of our Pacific Region, was up 32% in contracts and 10% in dollars in the first quarter. This was the first quarterly year over year growth in contracts in California since fiscal twenty eighteen's second quarter almost two years ago. Demand has remained strong through the start of our second quarter, and we are experiencing pricing power in many of our markets. We continue to look for opportunities to expand our luxury brand to new product lines and price points. While we intend to maintain our leadership in the luxury segment, we are also strategically adding more affordable luxury communities to capitalize on demographic trends and to expand our footprint and customer base.
Nearly 40% of our current communities offer a home with a base price of $500,000 or less. These communities should turn inventory quicker and be more capital efficient. We continue to expand our presence in new markets. We have completed three acquisitions in the past nine months in the Southeastern United States. These acquisitions brought us into five dynamic new markets: Atlanta, Nashville, Charleston, Greensboro and Myrtle Beach.
We've added three more markets with expansion into Portland, Oregon, Tampa and Salt Lake City within the past eighteen months. Single family permits rose in January to the highest seasonally adjusted annual pace since June 2007. Even so, housing supply remains tight. Interest rates remain historically low. Consumer confidence is healthy.
Household formations are strong, and unemployment is at or near record lows. According to the January existing home sales report from the National Association of Realtors, the growth in existing home sales was strongest in the $500,000 to 7 and $50,000 price range. According to the just released census report, new home sales were up 18.6% over last January, with sales of homes priced above $400,000 increasing more than 60% in the same period. With this positive macro backdrop, market fundamentals remain supportive as we continue to expand our luxury brand to new price points, product lines and geographies. Now let me turn it over to Marty.
Speaker 2
Thanks, Doug. Before I address the specifics of this quarter, I want to note that a reconciliation of the non GAAP measures referenced during today's discussion to their comparable GAAP measures can be found in the back of our earnings release. I also want to note that our guidance is subject to our normal caveats on forward looking statements. Additionally, in the coming days, we will file an eight ks detailing historical segment reporting for contracts, settlements, and backlog based on our newly realigned reporting segments. Our results for revenue and gross margin came in below expectations, driven by a combination of delayed deliveries, unfavorable mix, and additional closeout costs related to certain older communities.
These delayed deliveries, which Doug outlined and were concentrated in our higher dollar Northern California communities, are expected to settle in our second quarter. This lower delivery volume also impacted our SG and A leverage, but our SG and A in absolute dollars was generally in line with our expectations. As background for our margin guidance for the balance of the year, I want to remind you that orders declined for each quarter from 10/31/2018 to 07/31/2019. Due to the rapid rise in interest rates in the 2018, this time frame became a buyer's market where we had negative pricing power. While orders did increase in q four two thousand nineteen, pricing power was modest.
In our newly formed Pacific Region, which includes California, Portland, and Seattle, contracts in dollars did not turn positive until this 2020. Orders were up in the Pacific Region 70% in units and 30% in dollars in this quarter. This region, driven by California and Seattle, carries above company average margins. From a mix perspective, two thirds of our projected margin change from fiscal nineteen to fiscal twenty is driven by the combination of less volume and lower margins out of that Pacific Region. It takes us nine to twelve months to deliver our homes.
So we do expect sales from the improving market that began in late twenty nineteen to benefit adjusted home sales gross margin in our second half by approximately 100 basis points compared to the 2020. Most of this recent strong demand environment, evidenced by our growth in contracts and absorption pace and our increase in pricing power, coupled with our projected 10% community count expansion, should also contribute to margin and earnings improvement in fiscal twenty twenty one. With our focus on capital efficiency, we are committed to improving our return on equity. In the 2020, we repurchased $476,000,000 of stock at an average price of $40.73 per share. This reduced our share count by 11,700,000.0 shares or 8%.
We expect share repurchases to remain a significant component of our capital allocation strategy. Our balance sheet remains strong. We ended the first quarter with $520,000,000 in cash and equivalents and had $1,590,000,000 available under our bank revolving credit facility. We have no public or bank debt maturities in the next twenty four months, and our weighted average debt maturity is five and a half years. Our strong balance sheet, extended maturities, and available liquidity allows us to grow our business through land purchases and selective homebuilder acquisitions.
We have increased our land owned and controlled by approximately 8,000 lots since a year ago. Our first quarter twenty twenty book value per share was $35.87, and our net debt to capital ratio was 42.3%. Looking forward, we are projecting second quarter deliveries of between eighteen fifty and two thousand and fifty units with an average price of between 800,000 and $820,000. We are projecting full fiscal year deliveries of between eighty six hundred and ninety one hundred units with an average price of between that same $800,000 and $820,000 We expected adjusted home sales gross margin in our second quarter to be approximately 20.5% with full fiscal year adjusted home sales gross margin of approximately 21.25%. This implies a 100 basis point improvement in the 2020 versus the first half.
We project second quarter SG and A as a percentage of home sales revenues to be approximately 12.4% and full fiscal year SG and A as a percentage of home sales revenues to be approximately 11.4%. As we discussed on our fourth quarter conference call, our projected 10% growth in community count by fiscal year end twenty twenty involves investment in personnel and other costs in advance of revenue generation. In addition, we continue to implement our IT system upgrades. This is causing SG and A as a percentage of revenues to be higher this fiscal year. Second quarter other income, income from unconsolidated entities and land sales gross profit, is expected to be approximately $5,000,000 But we expect full fiscal year twenty twenty other income, income from unconsolidated entities and land sales gross profit to be approximately $115,000,000 We project the second quarter tax rate of approximately 26% and fiscal year tax rate of approximately 25%.
Our current Q1 fiscal year twenty twenty quarter tax rate was benefited by the reinstatement of the energy tax credit. Our second quarter weighted average share count is expected to be approximately 132,000,000 with a weighted average diluted share count of 133,000,000 for the year. Now let me turn it back to Doug.
Speaker 1
Thank you, Marty. At this point, Alyssa, let's open it up for questions.
Speaker 0
Thank you. We will now begin the question and answer session. To ask a question, you may press star then one on your touch tone phone. If you are using a speakerphone, please pick up your handset Please go ahead.
Speaker 3
Good morning. I have several questions. Maybe, Doug, if you can help us understand why, when you indicated that 1Q would be the low watermark just several months ago, are we now seeing margins in 2Q that are going to be lower than 1Q? That's my first question.
Speaker 1
Sure. Marty's got the list, so he's gonna take it. Ivy?
Speaker 2
Well, I I think the Northern California slippage that we saw is also coming with a bit lower margin than we had previously anticipated due to some production delays and production issues. That's the bulk of it. The the the rest of it is mix, including a little less, Seattle than we had anticipated.
Speaker 3
You know, when you say production issues and, you know, closeout costs higher than expected and just operational management challenges, maybe you can elaborate for us what's going on under the hood.
Speaker 1
Sure. The the issue in Northern Cal, which we have talked of before, is a very large high density condominium community called Metro Crossing in Fremont. It it is it has about 600 units. We had terrific sales. It's a very, very complicated, site with all condominium, which means it gets built at once and delivered basically at once.
We ran into significant weather issues last winter where San Francisco had the worst rains, I think, on record or at least for decades. And we had a lot of not only delays, but we had cost overruns, and we have been battling through that. We are beginning to, we started delivering in the end of, 02/2019, and we continue to struggle. And we lost most of those 60 units I referenced in Northern California as being pushed back, came out of Metro Crossing. The margin, when we opened that community and sold early on, certainly looked better looked better than the margin we we have now that we are delivering.
And so the Northern California problem is is pretty much isolated to one location that we have had major issues in.
Speaker 3
Will that be a change in management given the poor performance of Everhu oversight of this community? Because it sounds like it's execution problems, and you're saying it's specifically related to one community. So is this the division president who's not managing it properly?
Speaker 1
No. It's not.
Speaker 3
Okay. Let me ask one other question on SG and A because SG and A was really surprising on your guidance. Just understanding the significance of your deleverage there, is there any nonrecurring expectations in included in that guidance, nonrecurring items?
Speaker 2
So we had previously mentioned about nonrecurring items in our first quarter that were compensation related. They are nonrecurring in subsequent quarters, but there are components of that would that would recur in every first quarter. In addition, we continue to spend on systems upgrades that have a life that that should come to an end here in the next, eighteen to twenty four months.
Speaker 3
Alright. Real quick, Marty. Can you quantify that in terms of the IT system upgrade impact on on SG and A?
Speaker 2
It's in the neighborhood of 5,000,000 to $8,000,000 annually.
Speaker 3
Thanks, guys.
Speaker 0
Next Sorry. Question next question today comes from John Lovallo of Bank of America. Please go ahead.
Speaker 4
Hey, guys. Thank you for taking my questions. The first one, Marty, I think you mentioned that there were 60 closings that were delayed in in the Northern California market. But, you know, closings were, you know, a little bit lighter than just that that 60. Where else were you seeing, you know, delays?
Speaker 1
John, I'll take that one. You know, it's I mean, obviously, there are a number of locations that beat the projection, but those that missed by the most outside of Northern Cal, we missed 14 closings in Reno for $12,000,000 of revenue. We missed 18 closings in Jacksonville for $11,000,000 of revenue. We missed 13 closings in Northern Virginia for $10,000,000 of revenue, and we missed eight closings in Dallas for $10,000,000 of revenue. That would be the that that would be the top of the list.
Speaker 4
Okay. And then maybe just following up on that. When we think about the delay in the closings, I mean, was it related to labor, materials, or, you know, just time excuse me, pure timing or, you know, age of the backlog, etcetera?
Speaker 1
It it's it's timing. We we we you know, labor is not worse than it was three, six, nine months ago. Materials are are not worse. We're not you know, the the the Chinese tariffs or other other international issues are not affecting, the supply of our labor. It it in some cases, it's permitting.
In some cases, it's obtaining that final certificate of occupancy from the municipality. You know, subcontractors are stretched. They have been stretched. So that's been an issue that we as an industry and we at Toll have been, you know, dealing with for some time. But, you know, every quarter there are divisions that beat their numbers and there are divisions that miss their numbers.
And I think when you take the the 60 units and 60 plus million out of Northern Cal at Metro Crossing, you know, the rest of what happened around the country is fairly typical. Obviously, there were more misses than just Northern Cal, so we had a little bit more on the downside than the upside. And I just described, you know, the biggest offenders. We are obviously examining everything that happened in those locations, but there's nothing in particular concerning labor or material, that jumps out that is giving us more concern.
Speaker 2
There were also a few more cancellations this quarter than we had anticipated, and that shows up as miscl closings that aren't production related.
Speaker 4
Got it. And then lastly, how quickly can you guys get back in the market to start buying back stock?
Speaker 1
Friday.
Speaker 4
Okay. Thank you, guys.
Speaker 0
The next question today comes from Jack Micenko of SIG. Please go ahead.
Speaker 5
Hi. Good morning. Marty, I wanted to talk about the expenses. If I kinda back in the envelope, the the guide, it looks like g and a is probably up a 100, give or take, year to year in 20. You you gave us the 5 to 8,000,000 on the systems conversion that's been ongoing.
How much of the balance is sort of normal inflationary? I'm guessing probably, I don't know, 5%. And then is the is the rest then all new communities? And I'm trying to just think through what the G and A leverage then looks like in 2021 as we look at this. Because it feels like you're sort of in the middle of a bit of a repositioning period here that should improve as as time goes on.
Speaker 2
I I think we definitely look for improvement as time goes on. The expansion in the number of communities is around two thirds of the increase we look to see, year over year. Most of the rest is kinda normal compensation increases, and, the IT would probably be next. Additionally, we've added a few builders, including a builder down in, Atlanta and Nashville who expects to have deliveries, very late this year, but nothing in the interim because of the attached nature of their product.
Speaker 5
Okay. And then thinking through the ASP, and some of the mix shift, both product and geography wise, is the arrow flat up or down just big picture in 2021? Meaning, are we through a lot of the repositioning by the end of this year, or does that kinda continue into 2021?
Speaker 1
It will continue. As we said, we are committed to expand our price points, expand our buyer segments. As I mentioned, 46% of our contracts had a base price under 500,000. Now remember, our buyers generally have a lot premium they pay, and then they pick options and they go to the design center and they pick finishes. So so the delivered price of those houses, in some cases, in most cases, is probably over 500.
But, recently, I just got an update that 20% of the new land we bought is for homes that will be sold under $500,000. I don't think you'll see a dramatic shift in 2021, but it will be progressive. And we continue to see good deal flow at all price points. So it's just gonna be one more segment that we're going to focus on, but it will be gradual.
Speaker 2
And and I think, the diversity of our price points makes it, tough to say directionally where the average price is gonna come out because it's so dependent on which regions are doing better than others from a market perspective. We're selling homes from low 3 hundreds to $3,000,000. And, we've just seen the Pacific Region, is generally a higher price point, come back, a little bit delayed compared to many of the other regions. So if that continues, it could have a meaningful impact on the average price.
Speaker 5
Sure. And then presumably, you're gonna get some of that back on pace, I would imagine, as well as the product mix continues to shift.
Speaker 2
Yes.
Speaker 5
Thanks for taking my questions.
Speaker 2
Yep.
Speaker 0
The next question today comes from Truman Patterson of Wells Fargo. Please go ahead.
Speaker 6
Hi. Good morning, guys, and thanks for taking my I appreciate it. First, in the Northeast and Mid Atlantic, you know, orders declined a little bit. I'm just hoping you could discuss, a, demand in those regions and also your land positioning. You know, I know historically in the Mid Atlantic, you've had some battleship and larger master plan positions there.
And then on the demand side, could you just discuss a little bit if SALT is really hitting those areas, that geography?
Speaker 1
Sure, Truman. The flat orders in the Mid Atlantic and the North is just a result of not having community community growth. Our our community counts are flat. You know, as we've talked about, it it it's our home. We do very well here.
We have a dominant position. It is very difficult to find new land opportunities because the entitlements are so hard, and there's not a lot of growth. We've recognized the growth at south and west, and we've positioned ourselves accordingly without giving up on the Mid Atlantic and the North. You know, being flat with flat community count is, I think what we anticipated. And, you know, we're comfortable with where we're positioned there.
Virginia is a top five national market for us, performing very well. Philadelphia, Greater Philadelphia, has seen strength over the last year to year and a half. And so I think that's the story. It's just a lack of opportunities to grow community count and a lack of job growth and population growth.
Speaker 2
In terms of the larger kind of legacy communities that you asked about, Truman, I think, there's a active adult job in, Central Jersey that is, coming to the end, and then we have Loudoun Valley still chugging along in Virginia. Yep.
Speaker 6
Okay. Thank you for that. And then, you know, kind of the topic of the day is is coronavirus concerns in California. Clearly, California orders rebounded in the first quarter. But given the heavily Asian buyer in that market, some investors are fearful that both coastal and inland demand could at least be impacted near term.
I guess, what have you guys seen near term? And how do you guys think of this kind of playing out going forward?
Speaker 1
So we believe 11 closings in California have been pushed out. We think and we hope to the second quarter, due to the virus. That's the intelligence we're receiving from our sales teams out in California. We are much smaller in Orange County right now than we were three years ago, And Orange County has been where most of the Chinese buyers have, at least for Toll Brothers, have purchased. We don't see nearly as many.
We have foreign buyers throughout California, but the Chinese buyers were really concentrated in Orange County. We see very few in Northern Cal or in LA County or Northern San Diego County where we also operate. With respect to the supply side, the only interruption that we're feeling right now is lighting, which is coming directly out of California, and some of the small appliances where either components or the or the full appliance are being manufactured in China. Longer term, there's some chatter about whether steel will become an issue, but we're not feeling that yet.
Speaker 2
The fourth quarter, our sales to foreign buyers was down to 7%, and it's approximately that percentage of our backlog right now.
Speaker 6
Okay. Just one follow-up on the lighting supply.
Speaker 2
Excuse me. In our first quarter, Truman, excuse me.
Speaker 6
Okay. Okay. Thank you. Just a follow-up on on the lighting supply being impacted by China and the coronavirus. Do you have an alternate supply chain outside of China that you can source that from?
It's my understanding that virtually all, you know, lighting in The US actually comes from China.
Speaker 1
Yes. We do. And, you know, if there's any one product that was to be hit, lighting would probably be the least impactful because worst case, you can always get a house lit up with, you know, temporary lights and, make it through a little while until the, you know, the chandelier and the and the sconce arrives.
Speaker 6
Okay. Thank you.
Speaker 2
Thank you.
Speaker 0
The next question today comes from Matthew Bouley of Barclays. Please go ahead.
Speaker 7
Hi. Thank you for taking my questions. So I wanted to ask around kind of that margin delta in 2020 that you mentioned, specifically the lower mix of Pacific and the lower margins within Pacific, so the second part of that, I guess. Do you expect that the Pacific margins, as we move past kind of the operational challenges, the weather challenges that you alluded to, is the underlying profitability there expected to actually turn higher sequentially in the second half? Or as you mentioned, those margins are above the fleet average.
Is there a risk that the Pacific margins kind of continue to move towards the rest of the business? Thank you.
Speaker 1
Sure. It's a good question. So the margin coming out of the Pacific is still higher than the company average. However, the California margin projected fiscal year 2020 versus actual and fiscal nineteen is 80 basis points lower. And in Seattle, twenty twenty to nineteen is 20 basis points lower.
Is it going to creep down to the company average? No.
Speaker 2
I think the other I'd agree with that. But I think the other couple points to make with respect to mix shift, in '19, the Pacific was around 34% of our total volume. We expect it to be down around 5% in 2020. And our single family business, which generally has higher margins, is also going to decline approximately 5% of total from 74% to 69%.
Speaker 7
Got it. Understood. Thank you for that color. And then I guess just a broader question about gross margins and visibility. Because obviously, you guys have the longer backlog and then there's always a kind of a strong level or generally has been a strong level of visibility as a result of that backlog margin.
So as we move past, again, these unforeseen kind of issues at Metro Crossing, do you suspect just as the business mix has changed, the product mix has changed, geographies, etcetera, is there any reason to suspect that kind of your level of margin visibility has also changed?
Speaker 2
No. I don't believe so, Matthew. I think we had some unique circumstances this quarter. Another matter that we didn't even mention is that our specs as a percentage of total sales for this quarter deliveries for this quarter was up to, four or 5% I'm sorry, 17%, which is up four or 5% compared to our normal of units delivered this quarter. And our specs generally have a little lower margin.
So a lot of moving pieces, but I don't think we're gonna see long term impact on our visibility as a result of this quarter.
Speaker 7
Okay. Thank you for the details. Appreciate it.
Speaker 1
You're welcome. Thank you.
Speaker 0
The next question today comes from Susan Maklari of Goldman Sachs. Please go ahead.
Speaker 8
Good morning.
Speaker 7
Morning.
Speaker 8
My first question is just around you know, you mentioned that you're not seeing any real change in in the labor, the availability of it. But as we look out and and think about yourselves having, you know, 31% order growth this quarter, a lot of your peers reporting similar kind of results probably, Are you anticipating that the labor will be more constrained looking further out? Could your delivery times be further extended? And what are you hearing from the trades and from your, you know, kinda on the ground?
Speaker 1
Susan, it's a great question. As we, as an industry, continue to post these robust order numbers, the trades will be stretched. And we would expect that in certain markets, there will be pressure in in certain trades, and we need to manage that. Are we feeling it yet? No.
The field is not talking about it. Costs have are are going up less, than we have seen in some time. But if if this spring season continues with the velocity we've seen in the beginning of it, then, yes, I think there's going to be cost pressure, which also leads to construction cycle time pressure.
Speaker 8
Okay. Alright. Thank you for that. And then, you know, can you just talk a little bit about how the integration is going with some of these, more recent acquisitions that you've done? You know, anything there that, has kind of maybe surprised you or was unexpected and, you know, anything we should be aware of?
Speaker 1
It's all going well. They're all early, so we're dealing with, you know, purchase accounting rules that have compressed margins below what they will really be once we put purchase accounting behind us and and have normal operations. We one of the acquisitions was two weeks ago, So that that obviously is very, very early. But so far, so good with no surprises.
Speaker 8
Okay. Alright. Thank you.
Speaker 1
You're welcome. Thank you.
Speaker 0
The next question today comes from Mike Dahl of RBC Capital Markets. Please go ahead.
Speaker 9
Good morning. Thanks for taking my questions. First question, on gross margin, going back to a comment you made in response to Matt's question. I think some people might be a little surprised that the California margins are only projected down 80 bps and Seattle only down 20. So I just wanted to again, with respect to the first half versus second half dynamic, can you give us a little more color on what those margins are projected to be down in the first half of the year versus what's embedded in the second half?
And I guess as part of that, broaden out, talk a little bit more about your pricing power. Our own research suggests that you took pricing up in the vast majority of communities, including in California at the end of 1Q. Can you just give a sense of that and magnitude?
Speaker 1
Mike. It's Greg. I'll answer on the gross margin, and I'll let Doug answer on price increases. When we answered about gross margin for fiscal 'twenty, we're talking about as it relates to California and Seattle, we were talking about where we would see an overall decline in company average gross margin for fiscal twenty twenty versus fiscal twenty nineteen. And so California, with its decline in overall mix, has a negative 80 basis points impact on overall company gross margin.
Same story for Seattle, only at 20 basis points. Then on
Speaker 6
Got it.
Speaker 1
On price increases on price increases, I'll let Doug answer that. Yeah. You're right. We we had a we had a company wide price increase in mid January. There's another company wide price increase coming on Monday, allowing sales to sell through the weekend.
And in between those, many communities on their own because of good sales are are taking prices up. It it is a community by community decision except when we, go national, with what I just described as the January and, what is that, March 1, price increase. We have also increased the prices in our design studios. We have also increased the prices of our structural options that are being purchased from the at the community before you move into the design studio. We are also looking where possible to increase lot premiums.
So there's a lot of different way and by the way, we're also looking to decrease incentives. And so all of those tools are being used. And, right now, because of the strong demand, they have been effective, and I am hopeful that they will continue to be effective through the spring.
Speaker 9
That that's helpful, Doug. And just a quick follow-up on that one. Is it is it fair to say that some of these changes, you may get some benefits in the second half, but a lot of them will be kind of carryover into fiscal twenty one.
Speaker 1
Yeah. From here forward, most of what I'm talking about is, early twenty twenty one. There are still some communities that will deliver homes this fiscal year with sales into March or even April. And, of course, we have spec home inventory that can be sold in August and September. But for the most part, what I just described is a benefit to early twenty twenty one.
Speaker 9
Okay. Thanks. My my last question is really on the share count. So it's maybe a little confused by the share count guide given how much stock you purchased. And I think much of it was towards the end of the quarter, so it wouldn't necessarily have been reflected in the first quarter.
You you say the buybacks are going to remain a big part of capital deployment going forward, yet I'm trying to reconcile why the second quarter share count is only 132 and then, you know, why the full year share count then is is stepping up a little bit if you're gonna be progressively buying back more shares?
Speaker 2
It it Mike, it's really just a function of the weighted average share count math. In the first quarter, it's just the ninety days from, November 1 to, January 31 that the math implies. And then for the full year, it's the whole thing.
Speaker 9
What what was your quarter end share count, Marty?
Speaker 2
Hold on a second. We're gonna find that. We'll get that to you in a minute, Mike.
Speaker 4
Okay. Thanks.
Speaker 1
Alyssa, while we look for that answer, let's move on to the next question.
Speaker 0
Certainly. The next question comes from Stephen Kim of Evercore ISI. Please go ahead.
Speaker 10
Thanks very much, guys. Appreciate a lot of the the the color. Just to touch, base one last time on this gross margin. You mentioned that the margin in the second half of, 2020 was gonna be up about 100 basis points versus I think the first half, Marty. I would just observe that you kind of did that in 2017 and 2018 as well.
This year seems to have more dramatic things to call out. I was curious as to why we aren't going to see maybe more of a striking difference between the back half versus the front half. I'm wondering, is that going to be because you still got this lingering effect of Metro Crossing deliveries that come in at a really low margin and you want to account for that? Or is it, you know, something else?
Speaker 2
I I really think it's the cadence of the order growth in the prior year. Right?
Speaker 1
Okay.
Speaker 2
Each quarter last year until our fourth quarter, we had a decline in orders. Generally, when you have a decline in orders, you get a little bit more aggressive in your discounting. We didn't have a positive in orders until the 2019. There's a tendency when you have a positive to take it rather than price into it. Yeah.
And so most of the increases are not happening until after we've first reported an increase in sales.
Speaker 10
Okay. Got it. So it's a little bit more of a lag effect. So, really, what we're talking about here is kind of like what you were addressing, I think, with Mike about 2021 is really where we start to see a margin that is more reflective of the housing environment that we've been, enjoying here It's really 2021 for you guys.
Speaker 2
Right. Great. Yes. That's correct. That's right.
Speaker 10
Okay. Then, with respect to your pivot, you're moving to somewhat lower priced homes. I was curious if you could talk about the likely impact of that on your backlog turnover ratios. I think that if we look at your closings guidance over the next several quarters or for the year, it doesn't seem to imply a significant improvement in backlog turnover ratios. I was wondering whether or not that was conservatism on your part or if there's an opportunity to see that actually pick up?
Because typically, I think smaller product, lower priced homes typically have a faster backlog turn.
Speaker 2
I think, I wouldn't consider it additional conservatism in, the numbers. I think in periods where we have, increasing orders, our backlog conversion tends to, slow down, and I think that's what you're seeing in the guidance we've given.
Speaker 10
Right. That's true. Okay. Okay. But, again, 2021 would probably be set up to, you know, enjoy somewhat higher turnover ratios, I would I would guess.
Speaker 2
That's that's that's the plan with respect to the entire shift to some of the lower, price points and quicker velocity homes.
Speaker 10
Sure. And then related to this pivot, or this transition, Bob, I'm gonna harken way back to 1995 when you bought Jeff Edmonds, and I think I remember you first talking about this dumb tax concept that you acknowledge that, hey. We're gonna absorb a bit of a dumb tax or pay a bit of a dumb tax as we move outside of the North East Corridor, which we know so well. I'm wondering whether or not that that kind of thinking should apply, as you move into somewhat lower price points, and if not, why not?
Speaker 11
I think it it's still appropriate to for the dumb tax in your underwriting. Otherwise, you're gonna be surprised, and you'll end up the dummy. So things are pretty much the same. We we we make these buys with significant underwriting that we don't have once you have the machine rolling for you.
Speaker 1
Great. Got it. Even I think I I I think when we enter a new market de novo, which is what I what I my I remember the conversation about dumb tax, which was if we can buy a builder to enter a new market that has an operation and a machine and a brand and architecture and contractors, you get a big head start over the organic, entry into the market where you go through three or four division presidents and you have the wrong architecture and you buy the wrong land and you have no contractors that wanna work for you. And there's a huge dumb tax associated with the start up. When it comes to a new product line that is pretty similar to what we're doing and it really kinda resembles, for example, active adult, which is at a lower price point, simpler houses, less upgrades and selections.
Absolutely, we're learning from it, and we can't buy trades yet at the pricing that some of the other low price builders can. I think we offset that through our brand and some of what we offer is a little bit better. And we have examples of that. So we're still learning, but I think we're further along in having our arms around that and understanding it, than, you know, what you kinda described as the old dumb tax definition when you enter the new market.
Speaker 10
Yeah. Great. That's actually very helpful. Thanks, for that, guys. Last question for me is a question about rentership.
You've been very, early and and, forward thinking in terms of the relationship you made with BB Living for the single family built to rent market. And I'm curious about the issue of whether rentership is losing its stigma. And given that you have such a strong presence at the, you know, the tonier price points of the market and, you're also seeing up close and personal the rentership side of the market and the receptivity in in markets when you're trying to get communities developed. Do you believe that the stigma from rentership is, declining? Can you give us a little bit of color if if you do believe that is so?
And what implications you think that has for the industry going forward?
Speaker 1
Yes. I think it's declining. And I think it's a function of the quality of many of the new multifamily apartment communities that we and others are building that feel and live like condo living with the lobby, the the the residence club, the gym, the golf simulation room, the pool the pool on the roof, the nine foot ceilings, the the finishing of the unit, the location, the ability to lock it and leave it and travel the world or head to Florida in the winter or whatever you may wanna do. So we when we look at the demographic and the wealth of our renters, we are amazed at how how they would typically have been buyers who are now deciding, not for financial reasons, but for lifestyle reasons, that they wanna rent. And so, yes, I think that stigma, while it is there a little bit, it is definitely declining.
And I think we are positioning ourselves to take advantage of that not only through b b living, but through the 20,000 plus units we are developing, through our apartment living group.
Speaker 2
And I think, study of the single family rental business implies that there are people in those products because they have to be from a financial perspective, but there are many that choose to be in those products because they want to, maybe from a frictional cost of ownership and disposition perspective and having seen some challenges in the past in terms of liquidating their real estate. So I would agree with Doug. And just to answer Mike Dahl's question from earlier, we have 129,800,000.0 shares outstanding as of the last day of the quarter.
Speaker 7
Thanks a lot guys.
Speaker 1
Thanks, David.
Speaker 0
The next question comes from Jade Rahmani of KBW. Please go ahead.
Speaker 12
Thank you very much. On the apartment rental business, I was wondering if you have an interest in creating permanent capital vehicle in which to hold those REIT assets. In my experience in the REIT sector, valuations typically are maximized based on recurring earnings rather than gain on sale type earnings, which are more volatile and unpredictable to the market. Do you have any thoughts on whether that makes any sense? And also, if there could be any combination potential with others in the homebuilding space like D.
R. Horton and Lennar that are pursuing similar strategies?
Speaker 2
Sure. So I think we continue to study a long term hold strategy for those assets, those multifamily assets that we may choose to hold, whether that's on balance sheet or in joint venture form or via a separate REIT like or REIT entity remains to be seen. But certainly, the multiples of cash flow from operations, funds from operations that the REITs get valued at is very appealing to us as we grow that portfolio. In terms of combinations with the other builders, we are not having any discussions along those lines at the moment.
Speaker 12
And can you just remind us the amount of, equity capital invested in each of the apartments, business, the rental business, as well as City Living?
Speaker 2
So the rental apartment business right now has an investment of $680,000,000 although we expect to reduce that by around $300,000,000 during the course of this year as we sell joint venture interests in future projects where we have already purchased the land, and city living is just under a half a billion dollars.
Speaker 12
Thank you.
Speaker 2
Thank you.
Speaker 0
The next question comes from Michael Rehaut of JPMorgan Securities. Please go ahead.
Speaker 13
Hi. This is Elad Helman on for Mike. Just first, given the delays on the 1Q closings, could you expand on what gives you confidence that they won't be delayed further and your level of confidence you'll be able to deliver most or all of these closings in two q at both Metro Crossing and some of the other locations you mentioned?
Speaker 1
Yeah. We've built in conservatism in our numbers. We are already seeing a month into the second quarter, some of those delayed deliveries now delivering. We are far enough along at Metro Crossing with units now delivering every day, as opposed to, you know, two, three, four, six months ago when we were still waiting for inspections and certificates of occupancy to get started when things were more uncertain. So for for those those are the main reasons why we have we have more confidence that the the the missed closings will occur in q two.
We are very focused, I assure you, on getting Metro Crossing right and in those other markets I mentioned that have had misses fixing the problems we have. I am embarrassed by Metro Crossing. It is a huge lesson learned. It is one isolated, very large community in what otherwise has been a terrifically performing division. It should have been built more like a city living project while it's stick.
It is more similar to a high rise in that it is all condo. It is four or five stories on top of podium. It was incredibly complicated. We have learned lessons, and we are fixing it. But it has been painful.
Speaker 13
Okay. Thank you. And going back to margins and just looking a little bit longer term, what would the right way to think about the new normal for adjusted gross margins and kind of margins in fiscal year 'twenty one? Should we expect it to be back with maybe a 23%, 24% level or closer to 22% level or even lower than that given the changing regional mix you mentioned, some of the better pricing trends and also the mix to lower margin, but, you know, more affordable luxury.
Speaker 1
We're not gonna we're not gonna get that far out with the crystal ball. I think we'll leave it where we've our release was and what we said today, which is we're very encouraged by today's selling environment and the pricing power we are experiencing right now.
Speaker 13
Okay. Thank you.
Speaker 2
Thank you.
Speaker 0
The next question comes from Jay McCanless of Wedbush Securities. Please go ahead.
Speaker 14
Hey. Good morning. Thanks for taking my questions. The the first one I had, this environment right now feels very similar to to the beginnings of 2018 when builders were reflecting prices higher. And I was encouraged to hear you guys are raising prices, but were there any lessons learned from two years ago that you're implementing now so that you don't push afford push push the affordability or push the pricing lever too hard?
Speaker 1
Yeah. I think back then, we don't feel like we pushed pricing too hard. We got blindsided by a significant rise in interest rates in the 2018. It took the wind out of the sails of the industry. I don't think it was our pricing power or our price increases, excuse me, that caused sticker shock.
I think we were being fairly deliberate. I look back to that period of time and with the exception of a few places, particularly out west, you know, we didn't we did not hit price all that aggressively. Prices were going up, but it was measured. But I think what took it down then was was the rates. Yeah.
I I
Speaker 2
think we underappreciated the consumer psyche impact from the relative move in interest rates, the three and a half to four and a half percent. Might have changed their affordability that much, but it changed their mentality.
Speaker 1
And remember, not only three and a half to four and a half, but the Fed messaging that over the next year, we're going up to five and a half. And because you can't lock your mortgage in until sixty days before you're closing, when it takes nine to twelve months to build the house, you're thinking forward to when I can lock, and that could then be into the low 5. So it had a it had a bigger impact than just that one point move. It was the messaging around what more was coming.
Speaker 14
Got it. Thank thank you for that. The other question I had, could you could you just talk a little bit more about the demand issues that you're seeing in the Northwest? What's what's behind that? And then also, know, the closeouts that you all had this quarter, is is there the potential to maybe run the specs a little bit hotter and close out of some of this older land and and get the gross margins up a little bit faster than what y'all have anticipated?
Speaker 1
So for the the Northwest, I'll focus on Seattle because, Portland's a bit of a start up, and we're just very small there, just beginning to deliver. Seattle's up 265 in contracts in the first quarter. Seattle was our our highest margin, best market, what, Marty, five, six years ago? And then it was one of the first to slow down. Two years ago.
Two to three years ago, I believe. And it it baffled us. Right? Because the job growth was roaring. The economy was roaring.
And I just think there was such sticker shock from all the pricing that that we had and the increases we put in place that, there was a bit of a bubble effect. That has now worked itself out in what has continued to be a very strong economic market. There has been there's always limited supply in Seattle because entitlements are so difficult. And we are just now seeing tremendous new demand coming back that resembles, what we saw four or five years ago. And I just think it's it's it's the passage of time from when the market got some sticker shock, absorbed it, settled in, and now has come back.
In terms of the margin, I'll give
Speaker 2
it to you, Marty. Sure. So the closeout issues that we referenced early with respect to margin aren't necessarily associated with selling the last three or four homes in a community. These are costs that happen two, three, four years after we've left the community, either because the municipality says they don't like the way we pave the road or the community association wants some better trees, whatever it may take, to to finally get ourselves off the bonds there. We estimate what those costs are gonna be as part of our gross margin as we deliver homes.
And in this particular quarter, we had a few costs that were higher than those estimates. So I don't think, Jay, Jay, to answer your question that, I'll say pushing through the last few homes in a community to burn through margin is gonna be something that we would look to do.
Speaker 14
K. Well, thank you for closing the loop on that. I didn't know if those two were related. So appreciate y'all taking my questions. Thanks.
Speaker 2
Thank you. Thank you.
Speaker 0
The next question today comes from Alex Barron of Housing Research Center. Please go ahead.
Speaker 15
Yeah. Hey, guys. Thanks. I wanted to understand the rationale for the switch in the regions. Was that reflecting some changes in the way you're operating the business, or what prompted that?
And then the second question was what motivated you to do the the most recent acquisitions? You know, what what is it that you liked about those particular builders or that region?
Speaker 1
So the region, the new definition of regions is driven under SEC rules by who in management has responsibility for certain territories. And we went through a bit of a reorganization here to better geographically align regions with our, five regional presidents. For example, Seth Ring, who resides in Southern California, was promoted to regional president and now has responsibility for California, Oregon, and Seattle. So the Pacific Region is tied to Seth, And that those same examples apply to all five regionals. And because of SEC rules, that is the reason why the the definitions changed.
With respect to the recent acquisitions, we are quite fond of the Southeast. We know there's terrific growth coming into the Southeast, and, our presence has been too small down there. We've been we had our eye in Atlanta. We found a great builder to acquire in Atlanta. We had our eye in on Charleston and Greensboro.
Sorry. Greensville. Greensboro was in North Carolina. Greenville. Sorry.
And we found a builder that built in Greenville, Charleston, and they threw in Myrtle Beach. We also had our eye on Nashville, and we found an infill builder that builds more mid rise townhome, higher density in both Atlanta and Nashville, and that's our recent Thrive acquisition of a few weeks ago. So they were all kind of strategic in terms of location and opportunistic in terms we we were able to put deals together that we think makes sense for us. So that was the rationale.
Speaker 15
Alright. Appreciate it. Thank you.
Speaker 2
Thanks, Alex.
Speaker 0
The next question comes from Carl Reichert of BTIG. Please go ahead.
Speaker 16
Thanks. Bye, guys. Thanks for squeezing me in. Marty, on the can rate, you mentioned it was higher than you thought, and I realized we're talking about relatively small number of units. But can you talk just a little bit about what was surprising in the can rate or the rationale for the cans that surprised you?
Speaker 2
Well, I don't think there was necessarily anything in the rationale. I think, many of those, elevated cans were concentrated in the Metro Crossing job where the consumers have been patient, but maybe their patience has has run out. Our can rate for years runs around 6%. It was elevated a little bit over the past few quarters. It remained elevated in this quarter despite a a better selling environment.
And I think that's what surprised us that when when the market's tough, you might expect cancellations to go up. But when the market's good, we generally don't see that happening.
Speaker 1
And, Carl, as we expand our as we expand our price points and even some of these builders we have acquired that build at lower price points, there are some markets where deposit requirements are lower. And it may be that in those markets, there could be a little bit higher cancellation rate because there's not as much pain when you do choose to cancel. On Metro Crossing, as Marty said, the cancellation rate has been elevated because we have been unable to deliver many of those units within the time frame that was required under the agreements with our buyers. So they had the right to get out, and some did. The only silver lining there is that most of those buyers who have canceled, have either transferred within Metro Crossing to another unit, or they bought so early in the process that we have had significant price increases, and the resale of those units has been higher than the underlying contract price.
Speaker 16
Okay. Thank you. I appreciate that. And then just a strategic question, just back on the the labor side. Did you know the narrative from a number of builders who have moved their mix to lower end and fast turn spec has been we our subs love to do this.
We don't offer as much in the way of options upgrades, so it's simpler to build. And we expect to capture more labor, keep them busy. Your product, even with the transition over time, is still gonna be more complex, typically, offering more options and upgrades. So I'm I'm curious how in the markets where you don't have a lot of of share or scale, you you you feel that you can capture this this labor pool that's, you know, continues to be scarce. Is it different subs even in markets where you're in a master plan competing with other builders?
Or what can you do? Or is it pricing? What can you do to to retain those subs given the complexity of your your product relative to what some of the other guys are building on the low end?
Speaker 1
Before we will venture into affordable luxury at a lower price point, we will make sure that we have access to the subs. We will get plans in their hands early and make sure we, have our arms around the pricing. We have been successful in negotiating better prices because the houses are simpler. They will be built down the street. Every house will look more alike than a typical toll community where there's a lot more customization.
And so in some cases, it's the same trade base that we have in a market that is willing to work for less because of the efficiencies. And in some cases, we go to new trades. With the typical toll homes at the higher price, I think the front end trades are very similar to the other builders because the excavator and the concrete company and the the framer and the mechanical trades, can handle a toll house just like they can handle the others. But when you get into the finishes, the tile work, the trim work, which is much more complicated and we believe of a higher quality. We tend to have a different trade base that has been working with us for a long time, is loyal to us, and we're confident they'll be there.
And, so far, we haven't seen those labor problems. But that long answer is really that we will do our diligence on the opportunity to find trades at the right price before we will venture into, a different market segment or price point in a market.
Speaker 16
Great. I appreciate, especially that front end versus the finished trade is a is a good point. I appreciate that. Thanks a lot, folks.
Speaker 2
Thanks, Carl. Thanks.
Speaker 0
The last question today comes from Mark Weintraub of Seaport Global. Please go ahead.
Speaker 17
Thank you. You obviously stepped up the share repurchase quite a bit in the fourth quarter. I apologize if you you alluded to this, but what was the the rationale for for increasing it as much as you did? And were there any openings you had in January, and did you buy back any stock in in January yet?
Speaker 2
So I think you mean February.
Speaker 13
I'm sorry. February. Yep.
Speaker 2
We we are blacked out from mid January until Friday. As Doug mentioned, we are keen on Friday of this week. So we have not bought any stock since mid January. We do put a 10 b five one program in place during that period of time, but that's generally much lower prices than we might choose to do in the open market since it kinda runs on our on its own. Our rationale for allocating capital to buybacks is with a focus on return on equity.
It's as simple as that. Our stock, when we bought all those shares, was trading close to next year's beginning book value. We find ourselves in that same environment right now.
Speaker 17
Okay. And I I it's you were buying it at levels not dissimilar, even somewhat higher than the prior few quarters. So I'm just trying to understand, was this reflective of increased confidence in the outlook, or was there anything else at play
Speaker 10
beyond what
Speaker 2
I think in stages of 02/2019, when we didn't know where demand was gonna be, we were a little bit more conservative in holding on to our cash. Now, as we've seen demand turn in our favor, we're we've been a little bit more aggressive.
Speaker 17
Okay. Thank you.
Speaker 0
Concludes our question and answer session. I would like to turn the conference back over to Douglas Yearley for any closing remarks.
Speaker 1
Alyssa, thank you very much. Thanks, everybody, for, your questions today. I would like to conclude and wrap up by acknowledging all of our Toll Brothers colleagues who have worked tirelessly to build the great homes in the prestigious locations and provide what we think is exceptional customer service. I'm very grateful for all of their passion and all of their dedication. We like our strategy.
We like the market we're in right now. We like how we are diversifying. We understand we've taken our lumps right now with some guidance and some recent performance. Thankfully, it has been a bit isolated to the areas we have talked about. We are very focused on those, and we will learn and we will move forward, and we will continue to work hard to gain everybody's trust and support.
And I thank you.
Speaker 0
The conference has now concluded. Thank you for attending today's presentation.
Speaker 13
You
Speaker 0
may now disconnect.