Douglas C. Yearley, Jr. - Toll Brothers, Inc. Martin P. Connor - Toll Brothers, Inc. Robert I. Toll - Toll Brothers, Inc. Donald Salmon - TBI Mortgage Co..

Michael Jason Rehaut - JPMorgan Securities LLC Stephen East - Wells Fargo Securities LLC Nishu Sood - Deutsche Bank Securities, Inc. Alan Ratner - Zelman & Associates Stephen Kim - Evercore ISI Carl E. Reichardt - BTIG LLC Michael Dahl - Barclays Capital, Inc. Robert Wetenhall - RBC Capital Markets LLC Will Randow - Citigroup Global Markets, Inc.

Megan McGrath - MKM Partners LLC Jade Rahmani - Keefe, Bruyette & Woods, Inc. Jack Micenko - Susquehanna International Group LLC Alex Barrón - Housing Research Center LLC.

Good morning, and welcome to the Toll Brothers First Quarter 2017 Earnings Conference Call. All participants will be in 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, CEO. Please go ahead..

Thank you, Andrew. Welcome and thank you for joining us. I'm Doug Yearley, CEO.

With me today are Bob Toll, Executive Chairman; Rick Hartman, President, COO; Marty Connor, Chief Financial Officer; Fred Cooper, Senior VP of Finance and Investor Relations; Joe Sicree, Chief Accounting Officer; Mike Snyder, Chief Planning Officer; Don Salmon, President of TBI Mortgage Company; and Gregg Ziegler, Senior VP and Treasurer.

Before I begin, I asked you to read the statement on forward-looking information in today's release and on our website.

I caution you that many statements on this call are forward-looking statements 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 email questions to rtoll@tollbrothersinc.com.

We completed fiscal year 2017's first quarter on January 31. First quarter net income was $70.4 million or $0.42 per share diluted, compared to $73.2 million or $0.40 per share diluted in fiscal year 2016's first quarter. Fiscal year 2017's first quarter pre-tax income of $109.8 million compared to $116.8 million in fiscal year 2016's first quarter.

Revenues of $920.7 million and home building deliveries of 1,190 units were flat in dollars and up 12% in units, compared to fiscal year 2016's first quarter totals. The average price of homes delivered was $774,000 compared to $874,000 in 2016's first quarter.

Net signed contracts of $1.24 billion and 1,522 units rose 14% in dollars and 22% in units compared to fiscal year 2016's first quarter. The average price of net signed contracts was $817,000, compared to $870,000 in last year's first quarter. Fiscal year 2017 should be another year of substantial growth.

Fiscal year 2017's first quarter was our tenth consecutive quarter of year-over-year growth in total net contract units and dollars with double-digit increases in each of the last three quarters.

And for the first three weeks of fiscal year 2017's second quarter, non-binding reservation deposits were up 16% in units, compared to the same period in fiscal year 2016. Deliveries are projected to increase from 6,100 in fiscal year 2016 to between 6,700 and 7,500 in fiscal year 2017. We should also continue to post strong gross margins.

The other income and income from joint ventures, unconsolidated entities, is project to increase from $100 million in fiscal year 2016 to between $160 million and $200 million in fiscal year 2017. This should produce significantly higher earnings per share in fiscal year 2017 versus 2016, and improve our ROE to 12% of beginning equity.

As the only national home building company focused on the highly fragmented luxury market, we continue to enjoy strong demand and produce industry leading contract growth. Our strategic plan to diversify geographically, and by product type, enables us to appeal to a wide demographic interested in a luxury home. This is helping to drive our results.

We have a nationwide footprint of well-located and beautifully amenitized communities. Our homes offer great lifestyles, top school districts and easy access to employment and cultural centers, all for a great value.

Our affordable luxury product lines reach a large and growing base of affluent move-up, empty nester and millennial buyers, and our strong balance sheet gives us a financial edge over the small and mid-sized builders who are our primary competition in the luxury market. Our success is also driven by our tremendous brand.

Fortune magazine just named us Most Admired Home Building Company for the third consecutive year in its 2017 survey of the World's Most Admired Companies. Contracts in units were up this quarter in five of our six regions. California, the West, South, Mid-Atlantic and North.

And despite the interest rate rise at the end of 2016, our own results encouragingly showed an acceleration in contracts from November to December to January this quarter.

Contracts in our City Living division which operates primarily in the urban metro New York City market were down year-over-year this quarter, while our quarter-end backlog was up, our gross margins continue to far exceed company averages, and we continue to have confidence in the quality of our locations.

Last year included a grand opening of a building in Hoboken that resulted in 34 contracts in fiscal year 2016's first quarter, compared to a still solid 15 contracts in that same building this quarter.

In this quarter, we opened a Rem Koolhaas design building at 22nd Street between Lexington and Park Avenues, a block north of Gramercy Park and two blocks east of Madison Park, and we have sold 10 units in three months. California continues to be hot.

At Baker Ranch in Lake Forrest in the LA suburbs, we signed 66 agreements in the first quarter, double last year's first quarter total. And we have taken 30 additional deposits in the last three weeks, all at an average price of over $1.2 million.

In conjunction with our geographic and product diversification, we are also developing a significant portfolio of luxury rental properties, most of which will be built and owned in joint ventures. In total, our portfolio includes an excess of 10,000 units built, in construction or planned across the nation.

Last night, we announced that we will begin paying a quarterly dividend equal to $0.08 per share or approximately 1% annualized of our current share price. That dividend is the next step in the maturation of our company, and along with stock repurchases, reflects our commitment to return cash to our shareholders and improve our return on equity.

This dividend should not in any way restrict our opportunities to invest in future growth either through land acquisitions, company acquisitions or other strategic initiatives. We also believe a dividend at this time and at this level will broaden our investor base. Now let me turn it over to Marty..

Thanks, Doug. Before I address the specifics, 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 today's press release. We are very pleased with our first quarter results.

We exceeded our earnings expectations as revenues surpassed the midpoint of our guidance and our adjusted gross margin and SG&A as a percentage of revenues also came in better than anticipated. As expected, our average delivered price and the average price point of new contracts declined due to a shift in mix.

The major components of this shift in mix were our acquisition of Coleman Homes in Boise, where prices average in the $300,000s as well as fewer City Living deliveries and contracts at our wholly-owned properties. In addition, we saw a sizable increase in townhome contracts in the North and Mid-Atlantic regions.

Our income from unconsolidated entities grew significantly over the prior year, driven largely by closings at our Pierhouse at Brooklyn Bridge Park and Sutton New York City joint ventures.

We also benefited from a $6.2 million gain associated with a partial sale and recapitalization of our Parc at Plymouth Meeting Apartment Living project in suburban Philadelphia.

This was the first project in which we round-tripped capital by selling a portion of our ownership position and replacing our construction loan with a non-recourse permanent loan.

We had invested $15.5 million in this project in September 2012 and have now received back $18.9 million on that investment and still have an unrealized gain of $7.5 million. This is the sort of result that has us encouraged regarding our apartment business.

Subject to our normal caveats regarding forward-looking statements, we offer the following guidance. We generally have not been impacted by significant delays due to the tight labor market, and thus, were able to exceed our delivery expectation this quarter.

This fact, along with our first quarter end backlog being up 19% in dollars and 21% in units, has led us to increase the midpoint of our guidance range by 100 units for full fiscal year 2017. We now project revenues and deliveries at a range of $5.2 billion to $6.2 billion and 6,700 to 7,500 units.

The remainder of our full fiscal year 2017 guidance remains unchanged from our December conference call. For fiscal year 2017's second quarter, we project deliveries of between 1,350 and 1,650 units at an average delivered sale price of between $810,000 and $835,000.

Adjusted gross margin is expected to be between 23.8% and 24.2% of revenues, while SG&A is projected to be about 11.4% of revenues in our second quarter. Other income and income from unconsolidated entities is projected to be between $40 million and $60 million.

Our Q2 tax rate should be around 37.5%, and our share count should average approximately 170.8 million shares in our second quarter. We remain focused on our return on equity and expect to exceed 12% ROE for the full 2017 year and make further strides in 2018 through various strategic initiatives as well as our core operations.

As an example of one such initiative, in December, we formed a joint venture at a large New York City project and essentially reduced Toll's equity commitment from about $350 million if we had built the project alone on our balance sheet to $30 million as a joint venture project with outside equity and construction financing.

Now, let me turn it over to Bob..

Thanks, Marty. The housing market continues its path of steady growth. Total housing starts rose in 2016 to approximately 1.2 million units, the highest level since 2007. However, despite this increase, nationwide housing starts remain well below historic norms of 1.6 million annually even if population has continued to grow over the past decade.

With home price appreciation strengthening personal balance sheets, the Dow Jones Industrial Average surpassing 20,000 for the first time, low unemployment, we believe the housing outlook for 2017 remains favorable.

The pent up demand of the past seven years may be starting to release, bringing more buyers into the market, especially in the move-up segment where rising home values are giving buyers more equity when they sell their homes in order to move up. The leading edge of the millennial generation has begun to form families, have children and buy homes.

The maturing baby boomers continue to demonstrate strong demand for our Active Adult homes. With supplies of new and existing homes still tight, we believe that a rise in demand could push home prices higher. More buyers will be motivated to get off the fence and into the market, which could raise prices higher and tighten supplies further.

This would especially benefit the luxury sector of the new home market where buyers have the incomes and balance sheets to pay for the homes of their dreams. This summer will mark the 50th anniversary of Toll Brothers' founding.

I can think of no greater honor to commemorate this milestone than to be named for the third consecutive year as World's Most Admired Home Builder by Fortune magazine.

We attribute this award to our tremendous associates and thank our entire team for their diligence and dedication to providing each and every one of our customers with the quality, value and service they expect from the Toll Brothers brand. Now, back to Doug..

Thank you, Bob. Thank you, Marty. Before I take questions, I think it's worth noting that very positive data concerning existing home sales was released by the National Association of Realtors this morning. In fact, it was the strongest data since February of 2007.

Obviously, this bodes very well for our business, as most of our buyers have a home to sell. Home buyers are beginning to realize gains on the sales of their homes, which gives them the confidence, flexibility and down payment money to trade up into one of our homes.

This increased home equity, gains in the stock market, the prospects of potentially lower tax rates and less sensitivity towards mortgage interest rates, due to generally larger down payments and stronger personal balance sheets, seems to be contributing to increased demand for our homes. So, Andrew, let's open it up for questions..

The first question comes from Michael Rehaut of JPMorgan. Please go ahead..

Thanks. Good morning, everyone, and nice quarter. Nice way to start off the year..

Thank you..

Thank you, Mike..

First question, I was hoping to get a little bit more sense of kind of a clarification, but maybe a little more in depth as well in terms of the trends throughout the quarter. You noted that contracts accelerated throughout the quarter. I was curious if that comment was referring to absolute numbers or year-over-year growth.

And you also mentioned geographically that California remained hot, I think were your words, and just curious if there are any other markets that are kind of standing out to you in one direction or the other..

Sure. With respect to the pattern over the quarter, my reference was to contracts. And it was year-over-year. And the exact numbers are November was 2.5%, up over the prior November, so November 2016 over November 2015. December was 13.4% up over December of 2015. And January of 2017 was 42.2% up over January of 2016.

With respect to California, yes, hot is the right word to describe it. Our numbers in Southern Cal doubled. Our sales doubled in the quarter. I referenced Baker Ranch, which is a flagship community of ours in Orange County. Northern Cal was only flat because of a lack of inventory.

We have a number of communities opening in the second half of 2017, but both Northern and Southern Coastal California, where we are located, are hot. Other markets that are doing well on the top of our list – well, I'll give you the top six. We've got – and this I'll give you in terms of sales per community for the quarter.

Believe it or not, Michigan is number one at a whopping 10 sales per community. Now part of that is because we have some townhome communities we've opened at a lower price point around Ann Arbor, within a mile or two of Ann Arbor that are doing extremely well. Virginia, Northern Cal, Southern Cal, New Jersey, Seattle would round out the top batch..

(20:27)?.

No, Vegas is very good but it just missed my cutoff but it would be right beyond that..

Great. No, that's great, Doug. Thank you so much for that. And then you also mentioned in your prepared remarks the rental business. And you said that 10,000 units built, in construction or planned, I was curious to get kind of the breakdown of that if possible, maybe on a rough basis.

And is this a business that you envision kind of holding and getting the rental income stream? Or would there be opportunistic sales of the units themselves when it's fully leased up?.

Sure, Mike. So the – we have about 3,000 of the 10,000 are leased up..

Stabilized..

Stabilized. We have another, call it, 2,000 that are either in relatively early stages of lease up or construction. And that would leave about 5,000 that are in development, which means we're getting in titles, we're beginning to put roads in, the lumber's beginning to hit the site. So that's the breakdown of the 10,000.

With respect to where see it going, we started this in the Washington, D.C. to Boston corridor. It made sense. It's our home area. We know it best. We have the – it just was a perfect fit for our core operations.

We have now expanded beyond that territory, which we love for apartments, into Atlanta, Dallas, Southern Cal, Northern Cal, looking in Denver, looking in Seattle. And you're going to see this as a national footprint pretty soon as we have management teams in most of those markets I mentioned.

You'll continue to see a blend of what Marty described as the round trip. We're at stabilization. We will either sell out our interest or sell down our interest. And then some other assets that we choose to hold longer-term.

That's dependent upon the location, the performance, and in many cases, the interest of our partner because, remember, we're generally a minority partner. So we have friends with us that certainly have a vote. But you will see that blend going forward where we will be reporting earnings to all of you and with some sales or sell-downs.

And at the same time, you'll see a portfolio being built up of stabilized assets for a future day..

Great. Thanks so much..

You're very welcome..

The next question comes from Stephen East of Wells Fargo. Please go ahead..

Thanks a lot. Congratulations..

Thank you..

Doug, there was a lot you gave us during the call or during the prepared remarks. If I could focus on the strong demand for a little bit. Sounds like you had some moving pieces here.

And I just want to understand how much do you think is specific to what you all are doing versus the luxury market being strong? And you had some shift down toward townhomes, you talked about Mid-Atlantic, you just mentioned Michigan. You've got your T | Select coming through the pipeline, et cetera.

Could you sort of blend all that together and talk a little bit about what you're seeing in the world and how you all are looking at the world from that perspective?.

That's a big question, Stephen. We – the answer is it's a mix. We're very proud of the brand. Fortune magazine three years in a row is something that is pretty special to us here. We work very hard at it. You've been out in the field. You spent time in our communities. You get it. We're different. We do it differently and the buyers recognize that.

We're very proud of our locations. We work hard on land acquisition. We buy at the corner of Main and Main, and that distinguishes us. However, we're also very comfortable with the general luxury market. Our buyers are well-positioned for all the reasons we gave in the prepared comments. 20% are all cash. Those that get a mortgage only lever up 70% LTV.

They put 30% down. The resale market is firming up. They have equity in their homes. The stock market is roaring. They have money in the markets. Tax rates may be coming down. And it's a very fragmented business that we tend to dominate, and the competition is small. It's local. It doesn't have our horsepower. It can't buy the land the way we do.

Doesn't have our balance sheet. It doesn't have our brand. It doesn't do it the way we do it. So, when you put that all together, I think that's why we're so successful and we're so excited about the future..

All right. That's perfect. That's what I was looking for. Switching gears, your capital allocation, you're paying the dividend now. You're repurchasing shares. You're talking about returns. You've participated in M&A over the past year.

So, as you sit and look forward into 2017 and 2018, can you help us shape how you view all the relative demands on your capital and where you rank order them, including you had mentioned the investment in apartments and then round-tripping also. So just sort of rank order how you look at the world and how that might be changing..

Sure, Stephen. One other you forgot to mention was paying off debt. And as we look at this particular year, we have $400 million of debt maturing in October at a 9% rate and we have converts that are callable in September and puttable in December for another close to $300 million.

So, as we look at that, call it, $700 million cash commitment, we have to balance what we want to do. We do not want to restrict our ability to do land acquisitions or company acquisitions.

So we looked at the dividend as an opportunity to demonstrate a commitment, a permanent commitment to shareholders, and a confidence in our business that meshed well with that sizable capital allocation at the end of the year associated with debt, whereas a repurchase of any stock here in the near-term, regardless of our perspective on the stock price, would have been a little less meaningful than the permanence of the dividend.

I hope that helps. We want to buy land first, companies first, and then we want to return capital to shareholders second..

Okay.

So that $700 million commitment, you don't see yourself refi-ing all that and rolling debt?.

We're going to remain open to that possibility. It will all depend on what the future looks like three to six months from now..

Okay. Thanks a lot..

You're welcome..

The next question comes from Nishu Sood of Deutsche Bank. Please go ahead..

Thank you. Also wanted to touch on the really strong demand trends through the quarter. Thinking about the reaction to the rates and the change in economic environment, was wondering if you could shed some light maybe on the improvement in demand.

Is it a greater conversion of traffic flow that's already been happening through your communities? Are you seeing a higher level of traffic flow driving it? And obviously, just trying to look for any potential clues on the consumer reaction to the macro environment..

Nishu, good question. Traffic is up a little bit. And the conversion is up a little bit which means the quality of the traffic has improved, and it's reflective of the better results. Nothing dramatic. Traffic numbers are still lower than they were a decade ago.

I'm convinced that's because of the Internet and the ability to do most of your buying or screening online before you spend the time to visit the model. But we're encouraged by traffic trends. We're encouraged by conversion ratios. Remember, rates went up a half a point back in November and then they stabilized in the beginning of this year.

And so we're very encouraged by the year-over-year acceleration that I just mention on the first question for Mike because January had the most acceleration of this quarter in orders. And that was after rates had pretty much flattened.

So that pull forward of demand because people fear a rate increase, you really would have thought would have occurred in November into December. But when you look at the trends we had throughout the course of the quarter, once the rates had settled in, very encouraging..

Got it. That's very helpful. And also wanted to ask about the dividend. Obviously, a big change in, obviously, the capital allocation policy. You guys I think celebrated the 30th anniversary of your IPO last year. You've been through a lot of cycles. Some people are going to view the dividend quite positively.

Some others may be concerned just about the implications on growth. You've been through many cycles in those 30 plus years. Why now? What's the broader thought process? I think you obviously laid out the allocations, the priority of allocation pretty well in some of your earlier Q&A.

But why now in the broader context, especially given the cycle and how many you've been through?.

I think, Nishu, it's a combination of factors. I think certainly you look at the size of the company and the liquidity and the capacity we have in our line, and a roughly $60 million annual commitment is something we can absorb. You look at the pace of this recovery, and you compare it to the land that's already on our balance sheet as owned.

And you say we can probably acquire land a little less aggressively or in different fashions, particularly as we're focused on return on equity. And I think lastly, you look back at the last cycle and the cash we generated was pretty dramatic as we went from $600 million of cash on our balance sheet at the end of 2006 to more than $2 billion in 2009.

So the cyclical nature of things combined with our sizable land holdings gave us confidence that we could do this, and we're interested in widening the potential investor base, and potentially lengthening the period of time people are in our stock. And we thought this was an appropriate tool do that..

Great. Thanks for your thoughts..

You're welcome..

The next question comes from Alan Ratner with Zelman & Associates. Please go ahead..

Hey, guys, good morning. Nice quarter and nice job with all the efforts on driving returns higher. And, Doug, it's good to hear that Jim Harbaugh is bringing a resurgence to the Michigan housing market as well. (33:25).

Whatever it is, we'll take it..

Exactly, exactly. I thought your comments on the townhome shift were pretty interesting.

I was curious, is that do you think more a function of where you had some community openings during the quarter? Or did you see a noticeable shift in demand towards some of your smaller more attached product throughout your North and Mid-Atlantic regions that you highlighted?.

Alan, it was simply a mix issue. We had a couple of openings of townhomes, one here in Philadelphia right at the King of Prussia Mall. That got off to a great start. And then as I mentioned – actually two locations in the Ann Arbor market of Michigan that just happened to open in the fall and have had terrific sales. So that's it.

There's no other mix except for the timing of some grand openings of some lower priced, well-located townhomes..

And as you look out into your community openings over the next few quarters, do you see any noticeable shift either in kind of average square footage of your product? Or was this purely just the timing of when these communities opened and going forward the product mix looks pretty similar to what we've seen in the past few years?.

It'll be very similar. Just to outline it for the group, in fiscal 2017, we expect to open 94 new communities. Of course, that's a gross number. We'll be selling out of many. And that will be led – Boise is included in that because we closed on Boise in Q1.

But beyond Boise, we will have we believe 14 grand openings in Southern Cal, 11 in Seattle, 10 in Philly, 7 in Dallas, 5 in Northern Cal. Those are the biggest numbers. And so what you see this year will be very similar to what you've seen in the past.

There's no fundamental move to townhomes or lower price point with the exception of the acquisition at Boise..

Got it. And second question if I could. You mentioned the City Living margins in your release still above company average. At the same time, that business is obviously shrinking as a percentage of the pie. Some may be due to timing. Some may be due to just where the demand is coming from.

Can you give us an update on the margin differential right now that you see on the traditional business versus City Living? I know it's probably tightened a little bit and just maybe talk a little bit about what the trends are in the traditional single-family business.

Are margins stable? Are they improving? Any additional color you can give there would be great. Thank you..

Sure. So I think in the first quarter of 2017, our City Living margins were a little higher than they were going to be for the rest of the year, but it's a very small sample size compared to the rest of the year. So we still see City Living margins in the 36%, 37% for the course of the year.

As you look around the country and by product type, there's pretty consistent margin performance this year compared to last year, and consistent with the guidance we've given for the full year throughout the course of the year..

So, just to clarify that then, the full year gross margin guidance, which I think is probably down maybe in the 50 plus basis point range, that's really driven by the combination of compression at City Living as well as any reduction in the share of deliveries from City Living?.

As well as the Boise acquisition. I think three months ago, we talked about a 50 to 60 point drop in those margins, which we're still holding to, and about half of it was associated with City Living and half of it was associated with Boise..

Perfect. All right. Well, appreciate the color as always, and good luck..

You're welcome..

The next question comes from Stephen Kim of Evercore ISI. Please go ahead..

Thanks very much. Sorry, lost you there for a second..

No, we're here, Stephen. Thanks..

Sorry about that. Yeah, so I wanted to ask about the success you're seeing in Southern California. I guess from what we've seen recently, it kind of seems you're gaining share at the high end from some of the large master planned communities.

And folks we talked to there kind of were complaining about a pullback in the Chinese buyers, but seem to suggest that you weren't really seeing that. And I assume much of that is due to superior land positions.

But I was wondering if maybe it was also attributable to maybe better control of the merchandising of your product versus what you can maybe do within those master plans. And just wondering if you could comment on your relative outperformance there versus the large master plans and if you think there's any important trends at work there..

Well, I don't think it has anything to do with restrictions or controls on I think you said merchandising in certain master plans that we're not in. I've never heard of that and I don't think that's occurring. I guess my quick answer is, jump on an airplane and go take a look at what we're doing because it is spectacular. It is just spectacular..

Yeah, we have..

And we have new communities opening and new models opening that are actually better than the ones that I was bragging about last year. So the locations are great. The product is great. The merchandising, the pools, everything is just spectacular, and the market is really strong. And we are not seeing less foreign buyers at all..

Yeah, right..

So I can't comment on the others. I can just continue to brag about us..

That's fine. That's good enough. So let me switch gears if I could to the T | Select. I mean, obviously, we're talking about an opportunity set that, actually somewhat similar to dividends, but I think even more pointedly so, was something that you really could have theoretically done at any point in your history.

And I was curious as to why this is the right time.

And maybe why you're better able to do it now than you were in the prior whatever 30 plus years? So was just basically the question of why now and why are you in a better position to do it now?.

The number one reason for now is millennials. This is a generation that is approaching the size of the boomers. And they will be buying their first home. Many of them a little bit later in life than the boomers did, so they will be wealthier, more established.

And we think there's a huge opportunity that their first home can be the 3 Series BMW, brought to you by Toll Brothers. And so that is what, in the last few years, drove the initial thought and the strategy. The secondary reason is that we're much bigger. We're much more geographically diverse.

And we're seasoned in so many more markets than we were a decade ago. We're opening T | Select in a couple of weeks in Houston. Bob wouldn't have brought T | Select into Houston 10 years ago because it was a new market to us. We didn't have the brand. We didn't have the seasoned management team, the land. We were still growing. We were still learning.

And now we've been at this for so long and we have such a great geographic footprint, that we have confidence. And we have the brand where we can slide in a little bit lower than where Toll Brothers has been, offer the same customer journey to our buyers, and we think hit a significant portion of primarily the millennial market.

T | Select may also apply to move-downs. We'll have to see. We're going to go very slowly. We're very sensitive to protecting the bigger brand. But I think the timing is those reasons. It's driven by the millennial generation, and it's driven by where Toll Brothers is today in so many markets..

Yeah, that's a great answer and I appreciate that. And I guess it ties into the question of land spend, which was only 23% of revs this quarter. And I was curious, if that's a sustainable figure, it's a pretty low figure. So I was wondering if that's sustainable at that level, particularly if you're going to be sort of rolling out T | Select.

And it sounds like you're going to be doing it gingerly. But nevertheless, if you could just sort of comment numerically how that kind of low 20% of revs land figure looks like to you as you look out over the next year or two.

Is that a level we should be expecting?.

As you know, we're very opportunistic on land spend, land buying, and I wouldn't read anything into this quarter. Remember that's closing dollars. And in our business, we may have tied a piece of ground up, one, two, three, four years ago, been processing entitlements and it just happened to close this past quarter.

So I wouldn't read anything at all into it. If I look at the land spend over the last three years, we've been in the $750 million to $1 billion range. And if the deals present themselves, we're very comfortable continuing in that range. We look at it market-by-market and deal-at-a-time, and we have an appetite.

But thankfully, we also have a great book of land and we can be, therefore, very selective..

And I think it's also fair to say that there is an initiative internally to defer some of our purchases until a more just-in-time situation for the use of land in an effort to improve our return on equity.

So some of the traditional land that we may have paid on day one for, we may pay a little bit more for on day last, so you may see some change not in the ultimate continuing of land spend, but when we choose to do it as we focus on our return on equity..

Yeah, no, that's a great point. Thank you very much for that. You may do dive deeper into that maybe at the conference or something. But thanks very much, guys. Great quarter..

Thank you. You're welcome..

The next question comes from Carl Reichardt of BTIG. Please go ahead..

Good morning, guys.

How are you?.

Good morning, Carl. Welcome back..

Thank you. I think this question got addressed the last call, but I'm still confused by it. So your lot option contracts are up I think 6,000 or something year-on-year, and your lots owned are down 2,000.

And I know part of that I think is Coleman, but can you just talk a little bit about why the difference, where it comes from, where you've been optioning more?.

Sure. I think when we – we look at owned and controlled, right. And some of those controlled are traditional land options. Others that are controlled are under contract but not yet closed on.

So, last quarter at the 10/31 period, the approximately 1,700 lots associated with Coleman were controlled even though we were going to buy them and did buy them a week after the quarter closed and moved them to owned. So that's not quite what I would consider an option contract.

And from time-to-time, you'll see a large deal skew those stats like Coleman did. I think over time....

Or Shapell..

Or Shapell. Over time, it's our intention to get more lots controlled through options or take-downs as a percentage of total compared to where we are right now because that's more capital efficient as it relates to our return on equity initiatives..

Yeah, that jibes with the comment you just made, Marty. Okay. Thank you. And then second question is just on M&A. Obviously, we've started to see some interesting sources. Mr. Buffett, some offshore buyers look at small builders and begin to get more active in the marketplace.

What are you guys seeing out there for small, mid-sized privates, and what's your interest level? And if there is one, is it to deepen your current share of markets, or to do something like Boise where you're looking outside your current market set?.

Yeah, as Bob just said, the answer is both. We have traditionally used M&A to enter a new market. That occurred in seven of the eight builder acquisitions. The only one that was not that case was Shapell which was effect – we were already in California. That was effectively a very large land deal.

There are several markets we are looking at that for – that would be new to Toll. And as part of that investigation, we not only look at land opportunities, we look at local builders. And that will continue. But there's also opportunity within existing markets to take advantage of a great deal. Remember that most value of a builder is its land.

So we always have to weigh, do we want to buy a builder that has some really good land, some above average land, and then maybe some average or below average land and blend that together in a market we're already in where we don't need the brand and the relationship with contractors and somebody to explain the architecture to us and how to buy land, et cetera? And we have to then weigh whether it's worth it to buy a portfolio that is a blend of different quality land with just chasing the best land deal in the market? So we're in action.

There are quite a few small and medium sized builders that are being marketed now. We have a team that focuses on M&A exclusively, but nothing to report. And I don't think it'll be any different from what you've seen out of us which is eight acquisitions over 21 years. We're very selective..

I appreciate that, Doug. Thanks a lot, guys..

You're welcome..

The next question comes from Mike Dahl of Barclays. Please go ahead..

Hi, thanks for taking my questions..

Good morning, Mike..

Sure. So Porter Ranch was part of the Shapell acquisition. It's a very – it's a town in LA County. It's 20,000 residents. It's been around for 30 years. We've mentioned before it's where ET was filmed when the kids were riding through the neighborhood. So that helps date it.

Very successful community and we were rolling until October of 2015 when the gas leak occurred several miles away. That gas leak took months to fix. The schools were closed. Of course, people had to move out. Right now, we're on pace of the recovery. We knew it would take some time.

We are selling at about two-thirds the pace that we were achieving before the leak. And that is up significantly since the month after the leak. The good news is there's been no change in pricing. We haven't had to come in with smaller products or at different prices or bigger incentives.

It's a great community with schools and office and retail and many happy residents and it's just taking some time to fully recover as we expected it would. So I'm happy with where it now stands but we fully recognize that we're not back all the way to where we know it will be..

Great. That's helpful. And then shifting gears to a question around guidance. Marty, you made the comment that one of the factors leading you raise your delivery guidance was not seeing the labor delays. And so I'd like to get a little more color on that.

Were these delays that you were expecting and just ultimately didn't happen? Is there something else you've found in terms of your construction process? And maybe some of the – some standardization or manufacturing of the components that's allowed you to do better than you originally anticipated?.

Well, I think we're doing, I'll say, as we anticipated. We are seeing an extended construction cycle but not any greater than what we had anticipated and not any I'll say worse than we had seen last year.

It may be taking us two to three weeks longer to build a house than in a normalized labor market but we've expected that and we've been able to hold to that. And so when we see sales pick up like they have and we don't see incremental delays beyond what we expected, it leads us to increase the delivery guidance..

Okay. Got it. Thank you..

The next question comes from Bob Wetenhall or RBC Capital Markets. Please go ahead..

Hi, good morning and congratulations on a very strong quarter and attractive guide. Hey....

Thanks, Bob..

Just wanted to understand a little bit more with – in terms of like the regions for the 90 odd communities you're opening, where is the bias in there in terms of – and what's the cadence for opening?.

So I think....

Hold on one second..

The concentration is as Doug outlined. Since we used that piece of paper, we can't find it now. It has significant openings planned for Northern and Southern California, Pennsylvania and certainly Boise from a year-over-year perspective but those have already happened.

What else you have, Doug?.

On the cadence, it is pretty consistent over the four quarters of the year. I've got – what I was just shown had 30 openings in Q1, 18 Q2, 16 Q3, and then 25 in Q4. So we roll them out when the roads go in and either the sales trail or the model opens. And the landscaping can hit and it's all ready to go.

And again, it's just the timing of when all of that can occur, when we get permits and when we can move forward. And I'm happy with this cadence..

Got it. And that's helpful. Thank you. And where is the bias towards the T | Select communities? I think you mentioned three to four openings of those T | Select communities? You're still on track it sounds like to achieve that.

Where are those going to be located?.

Texas, Pennsylvania, Florida are the first locations for T | Select..

And on track, it sounds like?.

Yes, on track..

Got it. And just one follow-up question then I'll pass it over. You had a large increase in option lots. And I think Carl touched on this. What's your ideal split between owned lots and option lots at this point in the cycle? And just based on the fact you sound really – you described California as being a hot market.

Are you biased to increase land spend opportunistically if you see some good assets coming to market?.

Absolutely. When Shapell arrived, probably the greatest deal this company's ever done. That was 5,000 lots that we had to buy. And that's the way the deal was. So we were – we will be opportunistic. We certainly want more option lots. We are very focused on ROE. We understand. Pre-downturn, we were 50/50 or better of option versus owned.

And as the market collapsed on the industry in 2006, 2007, it's pretty tough to shed owned lots. So you can shed option lots and that skewed our ratio the other way and we're moving them back. We're not going to get to 50/50. There aren't those opportunities out there unless we were to do very expensive land banking that we're not going to do.

So you'll see it move as our teams are more focused on optioning versus owning. We also have some opportunities to put larger assets into joint venture and keep them off our books.

We don't have a goal we're shooting to because we don't know the nature of the next opportunity and whether that seller will demand all cash or we can work out a terms deal. But it is something we're very sensitive to. And you will see us continue to work hard to improve ROE and option more land..

Got it. And one final question. You anticipate the cadence of the conversion rate in 2017 being similar to 2016. You've obviously done a very good job of navigating what some other competitors are talking about, labor shortages. You seem to move past that issue. Do you think the conversion rate holds up at a similar pace? Thanks, and good luck..

You're speak backlog conversion rate?.

Yes, sir..

And we don't see any reason why it wouldn't. And I think our increased delivery guidance is reflective of that..

Got it. Thanks very much..

You're welcome..

The next question comes from Will Randow of Citi. Please go ahead..

Hey, congrats on the progress on the dividend..

Thanks, Will..

Based on your commentary, it suggests pricing power and a good ability to offset cost inflation.

Given that, can you update us on your pricing inflation expectations for this year? Where are you seeing the most inflation? And are there any markets where you've seen a reversal or a swing in pricing power whether it'd be good or bad?.

I can't update you on what we think price increases will be during the course of the year because that is completely market driven. I can tell you today, we are experiencing pricing power primarily out West in the markets we've been talking about. Our incentives have remained flat companywide.

And our cost creep has been modestly below our price increases..

And then second, in terms of the softness in tri-state resale activity, including obviously price declines in Manhattan. Are they concerning? It seems like you're balancing that out with risk mitigation.

I guess how should we be thinking about Toll gearing up for potential market softness in the tri-state area? How has that shifted your earnings expectations for City Living? And is this recent softness temporary in your view?.

You talk about tri-state and then you talk about City Living. So I'll take them separately. Tri-state, Connecticut has been slow. We are small in Connecticut and we are being very cautious. Westchester County, New York has been strong. And New Jersey has been hot. A lot of that has to do with (59:19) and where our land is located.

So we are in no way giving up on the tri-state. If you have land in the right location, we think you can do very well, as we have. With New York, I highlighted a couple of buildings in my prepared remarks that are doing well. The Hoboken building continues to perform very well.

And we had a new opening, as I mentioned, on 22nd Street, where we're very happy to have 10 contracts in the first three months of opening. We have, in certain locations, as we've talked about, had increased incentives to sell. But even with those increases in incentives, our gross margins have far exceeded the company averages.

And we're very comfortable with the location of our properties in New York. We are being cautious. We haven't bought land in New York City in a couple of years now. We're looking. There are some deals that are coming back around at different pricing that may become interesting.

But I think we are well positioned to absorb what has been going on in New York City. As we've talked about, we've also moved some properties into joint venture. Marty gave the example of a $350 million equity requirement is now $30 million.

And so I think we're being cautious and smart but also ready opportunistically to jump on some opportunities that could come along..

Thanks again, guys, and congrats again..

Thanks, Will..

Thanks..

The next question comes from Megan McGrath of MKM Partners. Please go ahead..

Good afternoon. I don't have that many questions, but you mentioned your core customer being a bit more immune or less sensitive to higher rates.

Just curious if you've actually seen any changes in behavior from your customers, higher down payments, more cash sales, anything like that?.

Megan, we have not. We still have 20% all cash buyers. A lot of those come out of the Active Adult category. And those that get a mortgage are still on average putting 30% down and only mortgaging 70%. Rates today, the jumbo is about a quarter point below a conforming Fannie Freddie loan. It's about a 4.125% loan and a conforming is about 4.375%.

And as you know, we have more jumbo buyers than the other builders. So the mortgage side of our business is good and the buyers are really doing nothing different than they had in the past.

Don Salmon's here running TBI Mortgage Company; Don, anything else to add?.

No. I think you hit it on the head. The spreads are good and the 7/1 ARM is 3.5% on a jumbo today. So I don't think it's an impediment to buying. There's lots of liquidity out there. We're seeing people, offerings every day almost with different stuff. So I don't think mortgages is an impediment right now. Thanks..

Great. Thanks. And then just a quick modeling follow-up question, I know you maintain your full year guidance for the margin. I think originally, last quarter, you had talked about margins ramping up pretty meaningfully in the back half of the year.

Just wanted an update on that if there have been any change in your view on what the mix would look like as we go throughout the year..

Well, We achieved some of that ramp up already in this quarter so we'll have less of it for the rest of the year. We've now delivered first quarter. We've given you guidance for second quarter and we've told you what the full year is going to be. We're going to leave it at that..

Okay. Thanks..

You're welcome..

The next question comes from Allyson Boyd of KBW. Please go ahead..

Actually, this is Jade Rahmani..

Hi, Jade..

Hi.

How are you? On the apartment side, can you comment on what you're seeing in terms of exit cap rates and institutional investment demand?.

Sure. So the transaction we just announced closed at a five cap rate which was consistent with where we had underwritten it. I think we continue to see investors have an appetite for the product, but their willingness to lever has been curtailed a bit.

Instead of seeing 70% leverage, we're seeing 55% to 60% leverage, be acceptable to the investors and, shockingly, the banks aren't upset about that either..

And in terms of your decision to retain an interest, what drove that?.

I think in this particular case, we really liked the asset. We liked the return on our residual basis in it. This is the Parc at Plymouth project. And we get fees as well as getting regular return on investment, and we have a $7.5 million gain to tap into at some point in the future if we want to..

Okay. Thanks very much for taking my questions..

You're welcome..

The next question comes from Jack Micenko of SIG. Please go ahead..

Hi, guys. You spoke bullishly about the apartment business in your prepared comments. There's a rhetoric obviously out there that says hey, look, the supply demand imbalance is going to shift heavier to the supply side this year and next.

So I guess my questions are do you share those concerns? Have you changed your underwriting and your processes around multi-family at all in light of that? I know you product's a lot different, it's more condo quality.

So it's probably a smaller renter segment, but just curious because you get these sort of push and pull debates out there around a lot of supply coming on and rents coming down, that sort of thing..

We haven't changed our underwriting, but we are being conservative. We always underwrite to today's market. So, as Marty mentioned, if we can't lever to 70% and we have to lever to 60%, we build that into the underwriting. If today's cap rate is five-and-a-quarter instead of five, we build that into the underwriting.

The one thing I'll comment on that you hit on a little bit, Jack, is location. The Main and Main strategy of Toll for sale applies to Toll rental. The quality, it's all condo quality. And that so far is paying huge dividends.

There is a dramatic difference between a 15-year-old apartment community in the Philadelphia suburbs and what we've been talking about that we just sold down our interest in, which is new and fresh and of condo quality, not just in terms of the units but in terms of the amenities, the residents' club, the dog spa, the pools, the gym.

And so we're going to continue with the Toll brand of luxury in the apartments. Be obsessed with location and the quality of what we build, but we're also going to be very aware of where the markets are moving and underwrite appropriately..

I think it's also helpful to note that our financial strength and our capital commitment to these projects is much greater than I'll say historical apartment developers who put 5% to 10% of the money in. They get a pension fund to join them and they bank to finance them. We're putting 25% in.

And as the banks and those pension funds get a little bit more selective on who they choose to partner up with, we look better and better..

Okay. Thank you..

The next question comes from Alex Barrón of Housing Research Center. Please go ahead..

Thanks. Very good job, guys..

Thanks, Alex..

See if you could comment on your outlook for the Active Adult market.

Kind of where you guys are at and where you think you'll be going in the next couple years on that?.

Sure. Active Adult is a growing part of our business. As we've talked about over the past year, we've now successfully moved it West of the Mississippi. And it is, today, about 14% of our revenue. Projected revenue for 2017 compared to about 11% in 2016. So you can see the growth there. And we're continuing to look for new opportunities.

And we've got Active Adult obviously all over the East and the Midwest. And now we have it in Denver. And we're looking at opportunities in Phoenix. We're looking at opportunities throughout the West Coast.

We're even looking in Texas, and with the boomers aging and hitting that move-down point of their life, we want to make sure we have plenty of Active Adult communities for them nationwide. So it will continue to grow over the coming years..

Okay. Great. And if I could ask something on your tax rates, so you gave us the second quarter.

Is that likely to remain similar for the remainder of the year, Marty?.

I think the tax rate we – guidance we gave for the full year is 36.2%, and we're sticking to that. So we're a little bit below that in the first quarter. We expect to be a little bit above that in the second quarter and average out at 36.2% or so for the year..

Okay. Best of luck, guys. Thanks..

Thank you..

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

Andrew, thanks very much. Thanks everyone for joining in today, and we'll see all of you soon. Take care..

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