Doug Yearley - CEO Bob Toll - Executive Chairman Rick Hartman - President & COO Marty Connor - CFO Gregg Ziegler - Senior VP & Treasurer.

John Lovallo - Bank of America Merrill Lynch Dan Oppenheim - UBS Dennis McGill - Zellman & Associates Stephen East - Wells Fargo Susan Maklari - Credit Suisse Michael Rehaut - JPMorgan Megan McGrath - MKM Partners Trey Morrish - Evercore ISI Jack Micenko - SIG Jay McCanless - Wedbush Securities Matthew Bouley - Barclays Ken Zener - KeyBanc Alex Barron - Housing Research Center.

Good morning and welcome to the Toll Brothers' Second Quarter 2018 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please also note this event is being recorded.

I'd like to turn the conference call over to Doug Yearley, CEO. Please go ahead, Sir..

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

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

Before I begin, I ask 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 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 rtoll@tollbrothers.com.

We completed fiscal year 2018's second quarter on April 30. Our double-digit dollar growth in revenues, contract and backlog reflects the health of the luxury new home market. We had another solid spring selling season. The value of second quarter signed contracts the highest quarter in our history, rose 18% in dollars on a 6% increase in units.

On a same store basis signed contracts of 9.04 per community, were up 16% from last year and the highest for a second quarter since 2005. This was our eighth consecutive quarter of year-over-year same-store contract growth.

Based on our second quarter results and feedback from our sales teams around the country, it does not appear that the rise in mortgage rates has had a negative impact on our business. The 30-year fixed rate mortgage is still only at 4.87%, which is up about 75 basis points in the past year. We have also not seen any impact from SALT.

The changes to the state and local tax deduction on our sales, California where SALT would be felt the most was particularly strong this quarter. For example, in Northern California, Metro Crossing and Fremont has sold 136 homes since opening three and one half months ago at an average price of $1.2 million.

In Southern California, Altair, located in Irvine has sold 78 homes since February at an average price of $2.5 million. I also want to highlight some other markets where we have seen strong sales. In Boise, a market that may be perceived as more interest rate sensitive, we continue to sell very well.

For the second quarter we took 14.5 contracts per community and ended the quarter with 354 homes in backlog. Our acquisition of Coleman Homes there continues to exceed our expectations. Active adult continues to sell well in both the Western markets such as Reno and Las Vegas and in the East.

For example, out West at Regency, at the Monte Ranch in Reno, we have sold 35 units in February. And in the East at Regency at Kimberton Glen located outside of Philadelphia, we have taken 36 agreements also since February. At Coastal Oaks which is a master plan community in Jacksonville, Florida, we have sold 42 homes since February.

I am proud of our performance this quarter considering our reduced community counts and the difficult comp the last spring. In 2017, our second quarter contracts were up 23% in dollars and 26% in units from the prior year and we had 12% more communities last year than this year.

Nonetheless, as I mentioned this quarter, we had the highest dollar value of contracts for any quarter in our company's history. We project third quarter end community count to be approximately 290 down from 312 at last year's third quarter end, but up from 283 at 2018 second quarter end.

With 75 planned new community opening in the back half of fiscal year 2018, we project to end fiscal '18 with approximately 315 communities compared to 305 at fiscal yearend 2017.

And without giving specific guidance on community count for fiscal year 2019, we already own or control enough communities we plan to open next fiscal year to project growth in community count and that is before potential new land acquisitions in the pipeline. Turning to revenues, we saw 17% rise this quarter with increases in every region.

California revenues rose 17% and was our largest region producing 27% of total revenues. The North was up 19%, the mid Atlantic was up 13%, the South was up 23%, so West was up 15% and City Living was up 17%.

California and the Western region combined produced nearly 50% of total revenues, reflecting the strategic diversification of the company's operations over the past decade. With our $6.36 billion backlog, we believe fiscal year 2018 will be a year of significant revenue growth.

Based on this backlog, a projected increase in community counts, the quality of our brand and land portfolio, the financial strength of the affluent home buyer, and the breadth of demographic segments we serve, we believe fiscal year 2019 will be another year of growth as well. Now, let me turn it over to Marty..

Thanks Doug. Before I address the specifics of this quarter, I do 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 release. We are pleased with our second quarter results.

We exceeded the midpoint of our guidance for revenues, units delivered, and average delivered price and we exceeded our specific guidance for SG&A, JV and other income and our tax rate. Adjusted gross margin came in a bit lower than the guidance for three main reasons.

First, we had some delayed high margin California closings, which we expect to shift into the third quarter. Second, we saw the impact of labor and material cost pressures, and the third reason was attributable to our strategy of reducing standing inventory in some of our finished condo projects in New York City.

Related to that, we have made meaningful progress in our previously announced initiative to sell out the remaining inventory in some of our completed condo buildings in New York City. To date, we have sold approximately 48% of the units and 43% of the dollar value of the wholly owned inventory we began this fiscal year with.

This is a returns focused initiative that has some short term impact on margins, but will generate significant cash that we can reinvest in better opportunities. For the full year, we reaffirm our adjusted gross margin guidance at 23.75% to 24.25% of revenues, but acknowledge the challenges associated with labor and material cost inflation.

On the other hand, California, which is a higher margin business, is becoming a larger percentage of deliveries. In Q2, it was 27% of revenues. We expect that to grow steadily through the balance of the year to the mid to low 30% of revenue.

It's also important to note that all product types and all regions are projected to show margin improvement in Q3 and Q4. Consistent with our focus on return on equity and driving shareholder value over the last few years we have been reducing the number of years of land we own on balance sheet.

It is now below four years based on the midpoint of fiscal year 2018s projected deliveries. We will continue to focus on increasing the percentage of land we control through options in order to improve our return on equity.

Also related to return on equity to date, we have repurchased $291 million worth of our stock since the beginning of the fiscal year and reiterate our soft target of $400 million for the full year. Finally, in April we increased our quarterly dividend from $0.08 to $0.11 per share.

This returns the dividend yield to approximately 1% of our share price. Our apartment business continues to grow. We now control a pipeline of approximately 16,000 units in projects completed, in construction, under development or in approvals. We're expanding this operation beyond our Metro Boston to Washington D.C.

base, and now have teams in San Fran, Los Angeles, Atlanta, Dallas, and Phoenix, Earning the guidance for the third quarter and the balance of the fiscal year and subject to our normal forward looking statement caveats, we offer the following guidance.

We are increasing the midpoint of our full year delivery guidance by 50 units and $5,000 in average delivered price. That is approximately an $80 million increase to the midpoint of our revenue guidance for full fiscal year 2018. We now expect full year full year deliveries to be between 8085 units at an average price between $830,000 and $860,000.

For the third quarter, we expect deliveries between 2100 and 2200 units at an average price of between $830,000 and $850,000. We reaffirm our adjusted gross margin guidance for the full fiscal year of 23.75% to 24.25% of revenues with the third quarter estimated to be around 23.4%.

We reaffirm our fiscal year SG&A guidance of 10% of revenues with the rate of 9.6% expected in the third quarter. We revised the range for our fiscal year, JV and other income guidance down slightly to $130 million to $160 million and expect approximately $20 million of this to be in the third quarter.

Our effective tax rate guidance is reaffirmed at 23% to 25% for the year and our expectation for the third quarter is 27.5% of pretax income. As Doug noted, we project a slight increase in third quarter end community account compared to second quarter end. What our projected third quarter end community count is down about 7% from a year earlier.

We project a fiscal year end 2018 community account of approximately 315 compared to 305 a year earlier. Now let me turn it over to Bob..

Thanks Marty. Jobs are plentiful. Unemployment is low, wages are rising and existing home price appreciation is providing the equity for customers to buy new homes.

Home ownership in household formation rates are increasing while supply remains very constrained with a solidly and positions and the capital to expand through gaining market share and look forward to continue growth. Now over to Doug. .

Thank you Bob, thank you Marty Laura, we're ready for questions..

Thank you. We will now begin the question and answer session. [Operator Instructions] Our first question today will come from John Lovallo of Bank of America Merrill Lynch. .

Hey guys, thank you for taking my question. The first is the third quarter gross margin adjusted gross margin target of 23.4%. It would imply down about 160 basis points year over year despite some benefit from those delayed California closings that you mentioned.

What are the kind of the big drivers of that outside of maybe labor?.

I think the biggest driver is just a function of mix John. But as we've mentioned Q3 and Q4 of ‘18 are going to be improved over Q2 here. So things are going in the right direction..

Okay. And then maybe just on the labor comments that you guys made, it seems like you do utilize a slightly different labor base than most of the other public home builders. And your competition is more kind of the local guys.

I mean, what is driving in your view kind of the increases in labor, is it just a lack of availability of workers or you know, what's going on there?.

John, first, I don't think we use a different trade base than the other builders. With the exception of maybe some finished trades that are a little more custom and capable of finishing our homes to the higher standard that we demand and our client demands.

But we're all as an industry in this together and you know, as we've all talked about labor is tight. It's a combination of, I’d say, you know, probably 20% or 30% labor and the balance right now being materials, number one of which of course is the lumber is up significantly.

But it's really across the board with the labor force and then as I mentioned, a couple of different pretty significant materials, primarily lumber that go into the home. But we're all in this together. I really don't think there's a difference for Toll Brothers versus the other builders..

Okay. Thank you guys..

You’re welcome..

The next question will come from Dan Oppenheim of UBS..

Thanks very much. Just wanted to ask you about that, in terms of the California delays, you talked about the percentage of revenue getting into the 30s later in the year. And just it seems though that might mean that the delays persist a little bit longer.

I guess trying to just get a little bit more color on that in terms of how you're thinking about backlog conversion for the third quarter and so the overall mix there?.

Yeah. I don't think the delays we’re seeing are anything out of the ordinary. It's the typical, there've been some construction delays due to some labor issues. We have some buyers that requests the delay.

Our houses are big and very complicated and as you know in California, our price point is higher, which means the houses are bigger and have more options. It's something we're managing. It's something we're very focused on. And I'm confident that the situation will improve. But, it's nothing that causes me great alarm.

We've all been doing this a long time and we can bucket these delays into the normal categories, some of which I just mentioned. And we're going to do our best to manage it, but I would not be alarmed that this problem is going to increase or continue to the extent we just saw. .

We're talking 15 homes and they have that much of an impact on our margin because of the price point of those homes and the fact that their margin is 5% to 7% higher than our average. .

Right.

And I guess, but, so for backlog conversion for the second half of the year, should we expect that to be similar to what it was and then the second half of ‘17 or continue at a lower level relative to ‘17 as it was in the second quarter?.

I think in the guidance we've outlined, we've taken into consideration the volume of business in California and the situation we just encountered here in the second quarter. So I think you're looking at a backlog conversion of 30% for the next quarter. .

Okay. Thanks very much..

You're welcome. .

The next question comes from Dennis McGill of Zellman & Associates..

Hi, good morning guys.

First question on the gross margin comments Marty you had, can you maybe segment the three items you mentioned as far as order of magnitude which was more impactful? And then related to that with the discounting that you're doing in New York City to clear the inventory, the fact that you're holding guidance for the full year, does that mean you're making up for that somewhere else or that you're sliding just to the lower end of that versus what you might've thought before?.

I think, our success in California is offsetting our success in New York City with respect to that strategy. So, I think from that perspective you could say we're making up for it.

As it relates to the three components, they were second quarter issues and they were equally weighted around 10 to 15 points each, California delays, New York City success in inventory, clearance and cost creep from labor and materials. .

Okay, great.

And then second question, with the success that you're guiding to with respect to getting more communities open, and the strong absorptions you're seeing today, would you anticipate that there's any trade off between absorptions and community count as you go forward or either from mix or from how you're going to price the product?.

No. .

All right, appreciate it guys. Thanks..

Welcome. Thank you. .

Next we have a question from Paul Rubelzki [ph] of Wells Fargo..

Actually this is Steven. Hey guys. Quick question, the gross margin broke below 20% this quarter, I know that's temporary, but long term it's come down. So I guess a couple different things, one short term and one long term. Your guidance for 4Q implies you're going to be meaningfully up and up year over year.

Is that the inflection point when we're looking short term as far as year over year comparisons? And then Doug, as you look at longer term, it's down from where you all have historically been. You got a lot of product mix and geography mix that's changed. You're pushing your land to more options, etcetera.

But I guess if you could just help us out how you all think about the business today versus maybe you thought about it, 10, 15, 20 years ago from a gross margin perspective?.

Steven, I guess I'm a little confused by your reference to an inflection point in the fourth quarter. That will obviously be the high point of our margin for this quarter -- I'm sorry for this year, as it benefits from California becoming an increasingly large percentage of our total deliveries - margins for ‘19 yet. .

Yeah, I'm sorry. I was just talking about on a year over year basis, Marty, where the first three quarters are down and it looks like, you know, as you go through the numbers, potentially including capitalized interest that it looks like maybe fourth quarter will be up.

So just wondered if that was, if you anniversaried all of the decline in the gross margin?.

I think that's certainly the case for the fourth quarter and we'll give a 19 margin guidance at a later date..

Okay. Fair enough..

And, Steven, with respect to your broader question about whether we look at the business differently today with respect to gross margin and ROE and other metrics compared to 10 or 15 years ago. The answer is no. We are very proud of our margins. They are among the highest in the industry.

We have also, as you know, worked very hard in the last couple of years to improve ROE and I'm very proud of the results that are paying off on the ROE.

I think you'll continue to see that improve as we continue to do the things Marty mentioned, which is option more land, be more creative and land buying, move opportunities off balance sheet where appropriate, buyback stock issue dividends. And you know, we're, we're very focused on enhancing shareholder value through improving the ROE.

But we're, most, we're most focused on driving earnings and we will continue to work hard to buy the best land we raised price when we can. California right now has significant pricing power, but we are also sensitive to making sure that we move through, the land that we have. And that of course is an ROE focused. So for us it's a balance.

It is no different from what we did in prior cycles. Obviously in prior recoveries there was more pricing power. So ROEs were naturally improving because those with land we're rewarded and this recovery has been a different, a bit different where there has not been as much pricing power.

And so, we have focused more and more on other levers that we must pull to improve the ROE. But you will continue to see us balance margin with ROE. .

Got you. And that's really helpful. Thanks Doug. And then on multifamily, you all have a really started to or you've been accelerating that business, if you will.

I guess, can you just give us a little more of view about what's happening? What's going on there? To me as we look at markets, we see, you know, a lot of inventory in the central business district with towers, etcetera. But we don't see much inventory at all as you start to move away from that and more, mid rise, low rise, that type of thing.

So just trying to understand how you all are looking at that business and what you expect going forward from it?.

Steven, we're very excited by our apartment business as we, as we stated today, we have over 16,000 units in various stages of entitlement development or lease up or stabilization. We have expanded the business beyond our core market of Washington DC to Boston. We now have teams in major cities around the country.

It is a blend of a suburban garden, apartment, infill midrise and city high rise, and that applies not just to the east, but in the newer markets that we've mentioned that we've entered. Our team is performing very well. We have a strategy of doing all of this off balance sheet.

It has a very high return on investment, return on equity, and we have a strategy generally for every three we build and stabilize. We will sell one and hold two, so we will return earnings to our shareholders regularly.

And as that business grows, obviously there's more threes, so there's more one that we sell a, but will we also be building a longer term portfolio. And we think that's a good balance and we're really excited about where the business is headed. And I think you're going to see a terrific growth and strong earnings coming out of it. .

Doug, can I ask you quickly on that, where you're at 16,000 now as you look out, you know, maybe over the three years or something like that, what would you all be comfortable taking this business?.

It’s in the early stages right now, it's only for us about four or five years old. So I would be very comfortable with this business doubling. I think there are plenty of opportunities in the markets. We're now in plus many more markets that we haven't even begun to enter or even begun to look at.

This year alone we have Gregg, how many, how many properties that will be under construction this year? Hold on? We have 2100 plus units that will be in construction this year. Average size is 300 to 350, so call that eight or nine new properties this year alone that are going up. .

And remember Steven, this business has a tendency to recycle capital so that you can build the next building with money from the last building through the refinancing or sell down process. So our capital investment in this is approximately a $0.25 billion right now, maybe $300 million.

And that's with the maybe a dozen projects we haven't found partners for yet. So that would go down when we get the partners money to buy 75%. So we're, we're really excited about the capital efficiency of this business. .

All right. That is hugely helpful. Thanks a lot..

And the next question comes from Susan Maklari of Credit Suisse..

Hi, this is actually Chris on for Susan. Thanks for taking our questions. It looks like you're expecting a pretty significant ramp up in community account in the back half of the year.

Is there any risk that some of those communities, pushed back in 2019 given the labor constraints we're seeing out there? And can you just give us a better sense of like the location and an overall profile of these communities?.

Sure. I'll answer the second part for the communities are really spread around the country. We've got a whole bunch, 16 of the 75 in Pennsylvania. But then we have an five in New Jersey. We have 10 in Nevada, a five in Southern California, 8 in Boise. But again, those numbers I gave you probably adds up to a third of the total.

So it's really widespread in, in most of our markets nationwide. With respect to labor and whether there's a risk of the community is getting pushed out, there's always the risk of some communities being pushed out. It's not because of labor.

We certainly have the land development crews to get, in most cases, get the roads in, get the community ready to be opened. If it's more about the permitting, the permitting process and almost all of our markets is complicated. It's tedious, it takes time. There can be 20, 30 permits associated with all a full land approval.

And that final permit you need from the county soil conservation district to give you the green light to go which our team may believe is coming in June and it comes in July or August can lead to a community being pushed out. But we're good at it.

We've hedged a bit in terms of the projections, we've given because we know historically that everyone we think may open will not. So I am comfortable with the guidance we've given and I think we're in good shape..

Got it. Thanks for that.

I think, could you just talk more on the regional differences you're seeing in California? Are there any specific areas that are driving the strength there and, how are you guys approaching, the pace of land acquisition in that state?.

So we are in what I'll call the best locations of, Southern Cal LA and the best locations of Northern Cal San Francisco, both markets and the sub markets around those two cities are performing very well. Down South.

I'd say Orange County is the best sub market and up North we have more activity in the East Bay, then the South Bay, but they are both very, very strong. With respect to land acquisition, we're active. We've seen some very interesting and exciting deals in the last quarter. It's very competitive. Land is obviously very expensive in California.

We put a lot of diligence and thought into everything we do out there, but based on the deal flow that I am seen, I think you'll continue to see strong results in good growth out west out in California..

Thanks. That's very helpful..

The next question comes from Michael Rehaut of JPMorgan..

Thanks. Good morning everyone. First question, just don't mean to beat a dead horse, but I think it's the big focus on, the results today. Understanding the gross margins a little bit, Marty, you highlighted labor and materials as being one of the drivers a little bit to the downside here.

I think most other builders have also cited labor materials is a continued source of inflation, but perhaps with an ability to at minimum offset those pressures, through price. Just one, it was curious given the solid pace that you've had and there's always a balance of pace versus price.

If you feel that at this point that you're able to fully offset it? Obviously you talked to most of your areas right now, continue to have very strong demand and you highlighted California not being impacted by rates or SALT.

So just thoughts around your ability to offset labor materials going forward?.

Well, Mike, I appreciate the focus of the question. And I think, we've said that, we expect margin improvement in every product line and in every region in the third and in the fourth quarter. The most impactful of those regions is California because of its already high gross margins and it becoming a larger percent of a total business.

So, every community stands on its own and we are able to achieve price increases in some that offset the cost increases. In others it's not able to be done. But overall, we're looking at improved margins for the third quarter and the fourth quarter..

The pricing of our units is not based on cost, neither should it be for any other builder. We try and get as much as we can and we try and get that not tied to course, but tied to the demand that we feel in the market.

So the offset feature of the increase in prices have really not there when you see these prices going up is because we have greater demand..

I understand. I appreciate that.

I mean, just kind of following on that in terms of pricing power, do you have a sense of the percent or raw rough percent of communities that you were able to raise prices this past quarter and , there's the rough amount and it made how that might compare to the prior quarter?.

I do not have that Mike..

Okay. Just one last one. Coming back to a question on apartment, the apartment business in the growth there. And Doug, you said that you could see that potentially doubling over the next few years. I was hoping to just get a kind of a brief recap of how you see that business from a returns standpoint relative to your core business.

I mean, we have another, one of your large competitors that's ventured into the apartment business as well? And, I think over time is looking to -- looking at options along with some of its other ancillary businesses to refocus on the core homebuilding operation.

It seems like you're looking to kind of build this - further build this out over time and, could we see it getting to a bigger percentage of pretax income over the next three to five years?.

Sure Mike. With respect to returns from this business, the projects themselves are underwritten to an upper teens, low 20s returns. And with our promote we add maybe five percentage points in our expectations to what we hope to achieve.

With respect to the size of the business and its contribution to income, last year had contributed around $25 million to our pretax bottom line. And this year we expect that to double. A lot of that is impacted by the pace and amount of gains on dispositions or sell downs of our interests.

And so, at this point we have not fully baked what we expect for 2019, but we are intending to grow this business such that the sales of buildings get a little bit more routine than they are right now..

And Mike I will add that the multifamily team runs independently. It has its own land teams, it has its own construction teams, it has its own management and leasing teams.

And I don't think at all are we distracted or not focused on the core business? We don't have land acquisition managers that are bouncing between multifamily opportunities and for sale. Occasionally they may overlap because there may be a property that could be suitable for either. And then we in here get to make that decision.

But, I'm very proud and happy with how the Apartment Living Group is running. And I'm very proud of how the homebuilding team is running. And I believe longer term we can continue to build both businesses efficiently and effectively..

Great. Thanks a lot..

And our next question comes from Megan McGrath of MKM Partners..

Thanks. Good morning, I wanted to circle back to order growth in the quarter.

Obviously some mixed results from net perspective, but can you talk us through where any region down here per year on an absorption paced growth perspective or was it all the declines due to community account declines?.

Megan, the only reason an area maybe down would be because its community count down. On a same store basis on the number of sales per community for the quarter, the divisions were up. .

Great. Thank you. And maybe a bit of a longer term follow up on California, given that it's contributing so much to your revenue and gross margin growth, if I think about, you talked about a little bit about the land, acquisition pipeline.

If you look at your land holdings there now and your community count plans, will it represent as much or more in your view in the next, let's say 12 to 18 months and it is now or are we seeing some kind of sort of short term peak in the California representation?.

Hold on, let's get the numbers for you Gregg. Gregg is putting in front of me that the number is on community count throughout the year. We started fiscal ‘17 with 38 selling communities - in fiscal ‘18. I have yearend year end ‘17. Well one day, one day later.

So we ended fiscal ‘17 with 38 selling communities in California and we project the end of fiscal ‘18 with 39 plus one..

Okay.

And, and looking further out, I mean I guess my question really is dead kind of like how is this -- are you comfortable with this level of contribution from California? Would you like to get bigger? Is there a point at which you would be uncomfortable that it would be contributing so much to your revenue base?.

So what have you seen? We're not going to give specifics on community count or community location, except for my general comment.

When we started the call that right now we have owned and controlled land in place to grow community count in ‘19 and that, of course is before we continue to see deal flow and we have the deals in the pipeline that should add to that. .

We have five different markets in California, Northern Cal in San Francisco and Sacramento, Southern Cal, San Diego and Los Angeles, right. And a little bit in Palm Springs..

Yes on Palm Springs in Sacramento are very, very small. Our business is driven by San Francisco LA and the northern side of San Diego. I'm comfortable with our size right now in California and based on the deal flow that I see the land that we're working on, I'm hopeful that we can sustain it at this level..

Great. Thank you..

And the next question comes from Nishu Sood of Deutsche Bank. .

Q - Unidentified Analyst :.

Sure. A small part of it is sell out. We've had excellent sales and so a few more communities have sold out faster than we anticipated. So that is certainly part of it. And the 75 communities that will be opening in the second half, some of that is because we thought they may open in Q2 and now they're being pushed to Q3.

So it is a bit back end loaded not so much because we ran out and found new land, but because the timing of the entitlements, as I mentioned earlier, is not always perfectly predictable. And if we lose a month or two or three, we can have a community get pushed out. So that's really what, what is driving it. .

Appreciate the color there. So, I guess the second question then, if we're thinking about kind of the changes in the community counts trajectory and as well, it seems like there might've been some, a bit more intensity put on the close outs of the standing inventory and the condo projects in New York.

So if we're just thinking about kind of the operating cash flow expectations for the year, what kind of level are you guys anticipating? Obviously ‘17 was very impressive.

So just if you could help us, I guess understand that?.

Sure. So, and these are figures after land purchases and improvements and not reflecting any debt raises in excess of debt pay downs. So we think it's somewhere between a $250 million to $350 million. .

Great. Thank you for the questions..

Next, we have a question from Steven Kim of Evercore ISI..

Hey guys, it's actually a tray on for Steve.

The first question is, touching on the New York City apartments, how much generally did you cut your margin expectations for those units that you're trying to push through? And do you expect to be through those by the end of this year or do you think they could linger a bit into ‘19?.

So I think there is a potential for some of them to linger into next year because I'm the -- our appetite for margin reduction is not unlimited. So, we set expectations at the beginning of the year for margins in the mid to upper 20s. This quarter came in a bit below that, but we're still comfortable with that amount for the full year..

And, and I will mention that we have a number of buildings that are under construction and actively selling where we don't -- this is not the inventory issue, we've been talking about that are doing very well. At $2,000 a foot in New York City in the locations where we build the market is healthy. We're seeing very strong sales.

We're also seeing very strong sales in Jersey City. We talked about the building over a Provost Square now for the last year and that building will begin delivering in the fourth quarter.

So the focus that we talked about on this call has been with the lingering remaining units in buildings that are completed and occupied, some of those units are small and there's a few of those units that are large and very expensive.

And it's the larger, more expensive units that we have had to discount more because the, the upper end of the New York market is where there has been a more issues. And we, for example, we moved one very expensive unit out in the second quarter and that unit required discounting to be sold.

And thankfully we only have a couple of remaining large units in New York that we're hoping to work through over the next six months..

Okay, that's helpful. And then second, turning back a bit to labor, which you said it's an issue, but you guys also have total integrated systems to help kind of offset some of those labor challenges.

And I'm wondering if you could talk a bit about what you're doing at TIS to maximize the access labor that you do have?.

Yeah. So TIS our panel and trust, operation. We have four panel and trust plants that serve the Northeast, Mid Atlantic and Midwest.

And it solves a lot of labor because when wall panels and roof trust are built in our factories you have framers onsite for a week instead of two and a half weeks because the obviously panels and trusses arrive and they just get erected. And our labor force in those plants is solid and secure.

It's been with us for many years and that has certainly helped us in those markets I mentioned because we have the plants..

Our next question will come from Jack Micenko of SIG..

Good morning. Last couple of years it looks like SG&A is levered couple hundred basis points between the 2Q and 4Q and this year the guidance is a lot less obviously opening a lot of communities. Is that parked conservatism? Is it all the community openings? I'm just trying to understand that.

And then, the apartment personnel on team event, I believe that flows through JV.

That's not a driver of -- I'm just trying to figure out if, as a company are reaching terminal velocity on your G&A leverage or if there's, if there's more to go beyond the community openings in the back half?.

So on the G&A leverage I think, we reiterated our guidance that is a 50 basis point improvement from the year prior and we think there's room in the future as well. But we're not going to get into that at this point, Jack. .

Okay. And then Marty on the buyback, I guess she liked it at 45. You'll love it at 40.

How soft is that soft target of the $400 million and I guess at a higher level question, is growth or ROE the bigger focus?.

So it, it's tough to answer that equation without a focus on what's in the land pipeline, what's in the debt maturity pipeline, and what's in the M&A pipeline and what's in, all the opportunities pipeline.

So, I think, we gave you a soft target in our commentary and ironically the dollar price of the stock is not all that meaningful to the return on equity. If it helps the earnings per share a little bit. But $100 million out of equity is $100 million of equity, whether you divide it by $45 or $40. .

Okay, fair enough. Thank you..

And our next question comes from Jade Rahmani of KBW..

Good morning and that is actually Ryan Thomas on for Jade.

Just personally in terms of demand, are you seeing any noticeable impact and your buyer segments from either the rising rates are or declining affordability from the strong HP we've seen?.

Yeah. In my prepared remarks when we started, I talked about rates. We don't – they have not impacted our business. I look at the second quarter results, our sales teams around the country, have had nothing to say and have had no issues. So on the rate side, 4.87% rate, as I mentioned is still a low rate and is only 75 basis points up from a year ago.

So right now we're very comfortable with our business and no issues out there. A home price appreciation, it has also not been a factor except we sell move up homes generally, which means people looking to move up, have more value in their existing home, more equity and appear to be more interested to move up to our houses..

Okay, thanks for that color.

And then just in terms of the impairments in the quarter, can you give us some more detail on what drove that? And did any of the, any of that relate to the New York city condos you spoke about?.

It did not. Go ahead, Mike. .

There was one community in Connecticut in particular that drove the majority of that impairment is approximately $12 million. It was a bit of returns focused, the change in strategy.

We had slowly been working through this for a number of years, but now we acknowledged that the right course of action is to accelerate sales and recoup our investment as soon as possible. So the proceeds can go elsewhere. .

Great. Thanks. .

And next we have a question from Jay McCanless of Wedbush Securities..

Good morning. Thanks for taking my questions. The first question I had on the entitlement, I mean, is it sounds like that's your biggest headwind, when it comes to the reduction in the community growth guidance.

Do you foresee this getting better as we move through the rest of the year? Or is it still the municipalities just don't have enough people to get the permitting done timely?.

That hasn't changed much, so I don't think it's going to get worse. And I don't think it's going to necessarily get better. We build in a lot of tough places. The corner of main and main in the best towns and our markets are generally difficult places to build and there's a lot of permitting and we're good at it and we're in the middle of it.

It takes time. Most of the time we hit it right on, but occasionally we have a little bit of slippage. It's not about how busy municipality or county or a state is, it's just the complication of the permits. And so, we fight the fight every day.

As I said, we have hedged our number of it to you for this year because we have historic data and we know that every community that our teams tell us will open, will not, but most will. And going forward based on the deal flow, we have the land, we have secured, I'm very confident that we will continue to have community count grow. .

Thanks. And then the second question, looking at the slowdown in the West from almost 40% order growth in the first quarter to negative 6% this quarter. And then the continued soft results in the mid Atlantic and the north segments.

Was there any weather impact this quarter or was it all community driven?.

It was community count decline in the west. It was not weather related. .

In the north, in the Mid Atlantic, it's similar?.

That's correct..

Right. Thanks for taking my questions..

You're welcome. Thank you..

The next question will come from Matthew Bouley of Barclays..

Hi, thanks for taking my questions. I just wanted to follow up on the, on the California gross margins and kind of the longer term trajectory there. You're, you're calling for the sequential improvement this year. I think in the past you had called out an expectation for a year on year decline in California for the full year of 2018.

So the question is just kind of how are you thinking about the sustainability of those California gross margins, that that premium versus the rest of the business, beyond the next quarter or two? Thank you. .

So, margins in California prior to this year were benefited by a rapidly appreciating environment. And some land purchases at a very early time in the cycle. We are at the low point right now of our margin in California compared to Q3 and Q4.

And we've been encouraged by what we see out there as it relates to 2018 fiscal year end and the pricing power we have looking forward. .

Okay. Understood. Thank you for that. And then also following up on the city living gross margin side, kind of beyond the efforts you're making here on clearing inventory in New York, and also really thinking beyond the next two quarters.

So if you could kind of comment on where you think at this point, what a more normalized gross margin, what will look like in the City Living business? Thank you. .

We, we underwrite those buildings to a mid 30s gross margin, maybe a little higher over in Manhattan and a little lower on the Jersey side.

And we have a building delivering in the fourth quarter and through the first three quarters of ‘19 that, that is hitting those in the Jersey City side and that will be pretty much the dominant piece of a volume coming out in New York on balance sheet for a this year -- next year. .

Got it. Okay. Thank you very much..

The next question will come from Ken Zener of KeyBanc. .

Good morning all. Given where community counts are and obviously the back half ramp.

I'm wondering if you could talk to the impact on SG&A specifically of I guess a fixed component of that? How that might look? I'm obviously the higher closing that are fixed cost absorption, but could you kind of talked to you that cadence just a little bit? Thank you. .

Sure. So, the gross margin guidance for Q3 is better than Q2, despite an increase….

For SG&A specifically..

I'm sorry..

For SG&A….

Sorry, excuse me. For a SG&A again, we expect revenue volume to create efficiencies despite a little more a G&A associated with community account openings. So it should trend down in the third quarter and even more in the fourth quarter. We would continue to leverage G&A in future years below the 10% guidance that we set for this year. .

Okay, good. And then I hear, I'm not asking you about gross margin guidance. I think you've been a, you've explored that enough. I'm interested more just the kind of the process because you guys have larger, longer starter home, longer build time.

How might you be controlling those costs for lumber, for example? I know some builders reprice those builds with the trade and distributors every 30 days. Is there a way to kind of think about how you, with your longer build time, might address those front end costs changes differently than other builders? Thank you..

Traditionally with a bit of our volume going through from a lumber perspective in particular, the TIS plan, we've been able to buy in bulk and get some benefit from that and also by in advance. So there's some benefit. .

The Northeast, Mid Atlantic and Midwest that are benefited by the plants. All of our plants are on rail lines. We're able to bring in rail cars of lumber, so we can buy out maybe two, three, four months because we have a lumberyard warehousing operation where we're able to do that.

In the other markets, I think we have, even though our homes may take a little bit longer to build, most of the added length is on the finished side, which is beyond lumber hitting the home. And I don't think, I don't think we have a different situation than the other builders.

We do our best to manage the lumber buying by ourselves or by our framers to buy out in advance as much as we possibly can. And if we can get out a month or two that that would certainly be our goal. And that's what we strive for..

Thank you..

And our last question today will come from Alex Barron of Housing Research Center..

Yeah, thank you. Given the rising rate environment, whether you guys are thinking or actually shifting your price points or your size of homes or anything to make homes more affordable? That's my question number one.

And my other question is if you can give us an update on how Vegas is doing for you?.

Alex with respect to the mix, as we've talked about, have I think the greatest a variety and diversity of mix in the industry. So we're building the 2 million plus houses in places like California and the $300,000 homes in Boise and the $400,000 homes in Jacksonville, et cetera. So we have been shifting a bit to fill in the lower price point.

And that has been naturally happening over the last couple of years. That is not driven by mortgage rates. In fact, remember that our clients have much higher credit ratings. They put more money down and it's generally easier for them to get a mortgage because they're not tapped out when rates go up a little bit.

So the strategy for us to be more diversified is, I think just a smart strategy based upon the growth of this company, the geographic diversity of the company and the demographic trends have more millennials buying homes, but it's not being driven by the rate environment..

And we're seeing, 25% of our buyers this quarter pay all cash and that compares to a historical average of around 20%, which has trended up pretty steadily over the last three quarters. And we only see approximately 15% to 16% of our buyers take an adjustable rate mortgage.

If affordability was an issue that would go up instead of it having gone down around 5% in this most recent quarter..

And those that get a mortgage, the average LTV is 70%. So they're not maxing out their mortgage. .

It is a very large component of our business in active adult housing. One is, one is the average mortgage..

About half of those buyers pay cash and they are about 20% of our total. Second question concerned about how the Vegas market is doing the market feels pretty good. Our community has declined in the most recent quarter..

Yeah, we started the year with 11 communities in Las Vegas. Right now we're at nine and a year end. We project to be at 10, but in terms of same store business in Vegas is still very good. .

Okay, great. Thanks so much. .

You're welcome..

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

Thank you, Laura. Thanks everyone for listening in and have a wonderful memorial day, weekend and summer. Thank you. .

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