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Toll Brothers, Inc. (TOL)

F2Q07 Earnings Call

May 24, 2007 12:00 pm ET

Executives

Robert I. Toll - Chairman of the Board, Chief Executive Officer

Joel H. Rassman - Chief Financial Officer, Executive Vice President, Treasurer, Director

Analysts

Dan Oppenheimer - Banc of America

Ivy Zelman - Credit Suisse

Stephen Kim - Citigroup

Nishu Sood - Deutsche Bank

Ken Zener - Merrill Lynch

Mike Rehaut - J.P. Morgan

Susan Berliner - Bear Stearns

Myron Kaplan

Timothy Jones - Wasserman & Associates.

Randy Raiseman - Durham Asset Management

Joel Locker - FBN Securities

Presentation

Operator

Good afternoon. My name is Regina and I will be your conference operator today. At this time, I would like to welcome everyone to the second quarter earnings conference call. (Operator Instructions) Mr. Toll, you may begin your conference.

Robert I. Toll

Thank you, Regina. Welcome and thank you for joining us. With me today are Joel Rassman, Chief Financial Officer; Fred Cooper, Senior Vice President of Finance and Investor Relations; Joe Sicree, Chief Accounting Officer; Kira McCarron, Chief Marketing Officer; and Greg [Zeigler], AVP of Finance.

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 based on assumptions about the economy, world events, housing and financial markets, weather and other factors beyond our control that could significantly affect future results.

Those listening on the web can e-mail questions to rtoll@tollbrothersinc -- that’s one word, tollbrothersinc -- .com. We will try to answer as many as possible.

Today we reported our results for net income, revenues, backlog and contracts for the second quarter and first six months ending April 30 ‘07. Fiscal year ’07 second quarter net income was $36.7 million, or $0.22 per share diluted, compared to fiscal year ’06 second quarter record of $174.9 million, or $1.06 per share diluted.

In fiscal year ’07, second quarter net income was reduced by after tax write-downs of $72.9 million, or $0.44 per share diluted. In fiscal year ’06, second quarter after tax write-downs totaled $7.3 million, or $0.04 per share fully diluted. Excluding write-downs fiscal year ‘07’s second quarter earnings were $0.66 per share diluted compared to $1.10 in fiscal year ’06’s second quarter.

Fiscal year ‘07’s six-month net income was $91 million, or $0.55 per share diluted, compared to fiscal year ‘06’s same period record results of $338.8 million, or $2.04 per share diluted.

Fiscal year ‘07’s six-month net income was reduced by after tax write-downs and a first quarter good will impairment, totaling $137.4 million, or $0.84 per share diluted. In fiscal year ’06, six months after tax write-downs totaled $8 million, or $0.05 per share diluted. Excluding write-downs and the impairment charge, fiscal year ‘07’s six months earnings per share were $1.39 per share diluted compared to $2.09 in fiscal year ‘06’s first six months.

Fiscal year ‘07’s second quarter total revenues were $1.17 billion compared to the second quarter record of $1.44 billion in revenues in fiscal year ’06. Fiscal year ’07’s second quarter end backlog was $4.15 billion compared to the second quarter record backlog of $6.07 billion in fiscal year ’06.

Fiscal year ‘07’s second quarter net signed contracts were $1.17 billion, a decline of 25% compared to fiscal year ’06’s second quarter total of $1.56 billion. We signed 2,031 contracts before cancellations in fiscal year ’07’s second quarter, a 14% decline from the 2,372 signed in fiscal year ’06’s second quarter. Net of cancellations, second quarter contracts totaled 1,647 units, down 24% from 2,167 units in the second quarter of fiscal year ’06.

Second quarter fiscal year ’07 cancellations totaled 384 units versus 436 units in first quarter fiscal year ’07 and 585 units in fourth quarter fiscal year ’06. Fiscal year ’07’s second quarter cancellation rate of 18.9% was lower than its first quarter cancellation rate of 29.8% and the 36.9% cancellation rate in its fourth quarter ’06. However, it was still well above our historical average of about 7%.

We continue to operate conservatively in the current difficult climate. We ended the quarter with over $550 million in cash compared to about $400 million one year ago, and more than $1.1 billion available under our bank credit facility. In the past year, we have trimmed our lot position by 28% from its high of 91,200 lots to its current 65,800 lots.

We have reduced our net debt to capital to slightly below 32%, which is as low as it’s been at the end of any second quarter since we’ve been public. We believe our prudent approach to managing our balance sheet should position us well in this down market and provide us sufficient capital to take advantage of opportunities that may arise in the future.

We continue to seek a balance between our short-term goal of selling homes in a tough market and maximizing the value of our communities. Many of our communities are on sites in locations that are difficult to replace and in markets where approvals are increasingly difficult to achieve. We believe that many of these communities have substantial embedded value realizable in the future that should not be sacrificed in the current soft market.

In what generally remains a soft market, there are glimmers of strength in certain territories. Manhattan, Brooklyn and Queens in New York City, Jersey City and Hoboken in New Jersey are strong markets. Southern Connecticut and Dutchess County, New York are also good. Philadelphia suburbs and Delaware are solid. Raleigh, Austin, Dallas are holding up well, as are parts of northern California, primarily around Silicon Valley.

We saw another bright spot this past weekend in Chicago, which has been an otherwise weak market for us. We grand opened two communities in Glenview south of Chicago. In March ’06, through an auction process we had purchased from the town of Glenview the last residential parcels within a large master plan that was a converted naval base. This week we opened our sites and took 32 non-binding deposits, 23 back-ups to those on condos and cottages at the two communities.

We continue to believe that there is demand if you have the right product at the right price and the right location.

Now, for the numbers, Joel Rassman, CFO.

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Joel H. Rassman

Thank you, Bob. During the quarter, we delivered 1,686 homes at an average price of $666,000 for approximately $1.1 billion of revenues. Second quarter cost of sales before write-offs and interest was 73.1%, and after write-offs but before interest was 83.8%. Pretax write-offs were approximately $119.7 million, or 10.6% of revenues, within the remains of our revised guidance, compared to $12 million of write-offs in the second quarter of last year, which was 0.9% of revenues.

Approximately $116.1 million of the write-offs were related to active communities or owned land, while approximately $3.6 million was related to auctions for future communities. The main impairments were in the north at $49.5 million, principally in Illinois and Michigan; in the west, $53 million, principally in California and Arizona; and in the South at $16.4 million, principally in Florida.

We recognized $48.4 million of percentage of completion revenues with a 77% pre-interest cost of sales. We delivered 164 homes in these buildings. Construction during this quarter related to these buildings was somewhat slower than anticipated, as well as somewhat more costly.

Interest expense was approximately 2.3% of those revenues, a little higher than in previous quarters.

SG&A was 11.1% of total revenue. The selling expense portion was slightly lower in actual expenses but higher as a percentage of revenue than last year’s second quarter, and the G&A portion at $83 million was $12 million lower in actual expenses versus last year, and approximately the same percentage as a percentage of revenues.

Other income at $18 million benefited from $6.5 million of retaining deposits, $3 million from sales of parking spots in Hoboken as our indoor garage facilities were completed, and $4.5 million of interest income as we both had more cash to invest and higher average rate of interest.

In addition, joint venture income was approximately $4.7 million as deliveries were a little slower in our joint ventures than anticipated.

The tax rate at 38.3% was lower than expected. We expected it to be 39%, principally a result of tax-free income -- I mean, tax-free interest income.

For diluted EPS calculations, we had an average shares outstanding of 164.3 million.

The result of all of the above was after tax net earnings of $36.7 million, or $0.22 per share fully diluted.

In the current environment, giving any quarterly or annual guidance is difficult. It is especially challenging to estimate write-offs. However, we believe providing some educated guidance, even with its related uncertainties, is still better than no guidance at all. We have filed an 8-K and posted some guidance on our website. Please read all of our disclaimers about forward-looking information.

For traditional homes, based on our expected delivery mix, we believe closings for 2007 will be between 6,100 and 6,900 units with an average delivery price of between $670,000 and $680,000, and that deliveries for the third quarter will be between 1,400 and 1,800 with an average price per delivered home of between $665,000 and $675,000. Deliveries for the fourth quarter will be between 1,450 and 1,850 homes with an average delivered price of between $680,000 and $690,000.

We project the cost of sales as a percentage of revenues before write-offs for the third quarter will be between 75.9% and 76.5% as a percentage of sales, and for the fourth quarter between 76.5% and 77.3%.

Based upon market conditions, we do not believe we can estimate write-offs for either the third or fourth quarter and therefore will not provide any guidance on write-offs. We estimate that the percentage of completion revenues will be between $55 million and $60 million in the third quarter and $40 million and $45 million in the fourth quarter, with cost of sales of approximately 80%.

We estimate interest expense for the third and fourth quarters will be about 2.2% of revenues.

We believe that SG&A as a percentage of revenues will be between 11.6% and 12% in the third quarter, and between 11.1% and 11.5% in the fourth quarter.

We project other income and joint venture income combined to be approximately $12 million in each of the third and fourth quarters, and that our tax rate will be about 39% for the third and fourth quarters.

We are using 164.6 million shares outstanding for EPS purposes for each of the next two quarters.

Obviously, since we are not providing guidance for write-offs, we are not able to provide guidance for net income or earnings per share. However, you should note that for each $10 million of pretax write-offs, it would reduce earnings per share by approximately $0.037.

At this time, I will turn it back to Bob.

Robert I. Toll

Thanks, Joel. Regina.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Dan Oppenheimer with Banc of America.

Dan Oppenheimer - Banc of America

Thanks very much. I was wondering about your comments about the embedded value in many of the communities. I guess particularly it seems to indicate that you would be willing to let your sales per community continue to fall as you hold out on the pricing on the margin side. Is there a point at which you would decide to cut pricing more in order to increase the pace of absorption?

Robert I. Toll

There must be. That’s got to be rhetorical. I don’t know what that point is, however. I can’t give you a percentage basis or a pace volume basis. I think it depends upon the subjective relative value we place on the location in the ground compared to the pace and volume that the market is supplying us with at the time.

It would suggest, but this is very theoretical, that there are certain pieces that we would be willing to just close sales and sit on because we believe the locations are so good. I can’t give you anymore than that and we don’t see the sales dropping anymore than they currently have, but one never knows.

Dan Oppenheimer - Banc of America

Okay, and just as a follow-up, over the past couple of weeks since your preliminary call, are you getting more positive about the environment based on sales trends, the same, worse than several weeks ago?

Robert I. Toll

A little more confident, but I would emphasize little.

Dan Oppenheimer - Banc of America

Thanks very much.

Operator

Your next question comes from Ivy Zelman with Credit Suisse.

Ivy Zelman - Credit Suisse

Good morning. You know, with the expectations for the remaining months of the year, you seem as if the -- obviously you can’t factor in impairments and you can’t guide for us but pricing continues to come down, at least talking with other builders. I’m wondering what assumptions are you making on absorptions per project in order to get to your expectations for closings?

Robert I. Toll

I don’t know how to answer that. Go ahead, Joel.

Joel H. Rassman

We do a specific project-by-project identification of volumes per community. It is not done on an average basis. We vet it by looking through the reasonableness on the top side of both the individual estimates and the region estimates as to comparable periods and their historical ability to project, and that’s our best estimate. It is significantly lower on average than we had in the past but it is not done on a top side basis.

Robert I. Toll

I understand. We’re talking about the Monday G&A report. Every week, Ivey, we do a reevaluation of the projected pace for the next 12 months of sales in the community and that has not been going down in the last several weeks any longer.

With respect to price, I have not noticed any deterioration or any significant increase. We’ve been increasing some communities and decreasing some communities, but pretty much holding its own.

Ivy Zelman - Credit Suisse

And how is the existing market inventories continue to rise every week for the past 19 weeks -- obviously those are potential buyers that can’t sell their house right now; how is that impacting your sales in communities? Are you seeing the impact or has it been really not yet an issue?

Robert I. Toll

No, we see the impact of people that can’t off their homes and therefore can’t go to closing but I guess you see the relative metric when we took you through the cancellations in comparison, and they’ve been down the last three quarters. What did I say they are now, 18.9% or 18.8% compared to a couple of quarters ago when they were 36%? So obviously the cancellations are going down.

Ivy Zelman - Credit Suisse

With respect to your land buys and what you have currently in the portfolio, when you think about vintage, you said there’s a lot of embedded value. Would you like to share with us what year the vintages that you say has embedded value, or what percent of your land was purchased let’s say prior to 2003 or your --

Robert I. Toll

No, I don’t have that information. Do you, Joel?

Joel H. Rassman

It really isn’t -- it doesn’t matter when the land was purchased. It’s how well did you purchase it and how did you --

Robert I. Toll

Well, that’s true obviously, but do you have any --

Joel H. Rassman

No, I don’t.

Ivy Zelman - Credit Suisse

I think a lot of people would disagree with you, Joel, if they bought in 2005.

Robert I. Toll

No, you’re right and Joel’s right. Joel ducked the question, I think. You said the older stuff on average probably logically should have been bought for less than the new stuff. Joel said it depends on what you pay, which is also obviously right but your comment is more correct. But we don’t have the information for you as to how much was purchased in 2000, how much was purchased in ’98, how much --

Ivy Zelman - Credit Suisse

Okay, what about your interest and ongoing expectations for land buying right now? Are you underwriting new acquisition on option contracts and are you continuing to anticipate increasing the land portfolio?

Robert I. Toll

I would hope that we would increase the land portfolio somewhat from where we are now. We are actively looking and trying to buy. We have raised the thresholds because we can and because I think we should operate more prudently, more carefully than we did when the market was going up.

Ivy Zelman - Credit Suisse

You don’t feel that having almost a 10-year supply of land is enough?

Robert I. Toll

Well, we hope that it’s not 10 years, Ivey.

Ivy Zelman - Credit Suisse

Okay, Bob. Thanks.

Operator

Your next question comes from Stephen Kim with Citigroup.

Stephen Kim - Citigroup

This is Lenora for Stephen Kim. I was wondering if you could break out the spec inventory for us. If you could give us the total number and possibly break that out between work in process and completed.

Robert I. Toll

Okay. Joel.

Joel H. Rassman

We have very little completed spec inventory. We have 1,092 homes in our traditional product, 447 singles, 538 multis, which buildings have been started and we have not sold all the units in those buildings, and 107 age restricted, some of them rural, some multis, giving a total of 1,092. That’s 11% less than it was at the end of the first quarter.

Robert I. Toll

Understand please that the specs are automatic when you do the multi-family buildings. If you’ve got five attached and you sell three and you start the building, then you have -- you ended up with two specs. And if the buildings are 200-unit buildings and you begin the building with 130 contracts then you’ve got 70. We count specs from when the lumber is dropped and very little of the specs are completed but we certainly have more than we’ve had in the past.

Regina, I have a question from Mike Spillane: what is good will impairment? That’s a good question. The good will impairment is for our purchase of Silverman Homes in Michigan. We don’t ascribe -- in 1999 and we no longer ascribe any value to the purchase of the going concern of the name, and we had ascribed some value to that --

Joel H. Rassman

$9 million was left on the good will impairment.

Robert I. Toll

On the good will and we wrote that off.

Joel H. Rassman

We wrote that off in the first quarter, not this quarter.

Robert I. Toll

And how is a value assigned to that? I think Joel’s just explained it. Once upon a time we put a value on it and what was left and not written off, we have now written off and that was $9 million. Regina.

Operator

Your next question comes from Nishu Sood with Deutsche Bank.

Nishu Sood - Deutsche Bank

Thanks. First question for Joel on the impairments; of the impairments that you’ve taken to date, the vast majority have been of operating communities in owned land, much less than option lots. My question is how should we interpret that? For example, does that imply or speak to the length of your option contracts that you’ve entered in? Maybe you just haven’t gotten to the point where you are being forced to write off those option deposits?

Joel H. Rassman

No, that is not the reason but in previous quarters, I think it was more related to option land than in the most current quarters. We look at option land every quarter and make an evaluation -- two evaluations. The first evaluation is how, since most of our options are approval options, how likely is it that we will get our approvals and then, if we get our approvals, how likely based on current economic conditions is it that we will close that land? We don’t wait until the legal period of time elapses where we have to make the decision in order to write it off. If we think that it no longer has economic value today, even though we have three years left to go, we will write it off today.

Nishu Sood - Deutsche Bank

How many total option lots through the past four or five quarters have you written off?

Joel H. Rassman

Anybody have that number? I would think about 30,000 lots would be my estimate, but it’s a guess.

Robert I. Toll

Based on the 90 to 60, is that how you got that number?

Joel H. Rassman

Yes, it’s 91 to 60 but we added a little bit when --

Robert I. Toll

Pretty sophisticated, I think.

Joel H. Rassman

25, maybe.

Nishu Sood - Deutsche Bank

Okay, and a question for Bob; I was wondering if you could give us some more color on the Philadelphia market. Obviously an important market for you. What are some of the trends you are seeing there? For example, in some of the other larger metropolitan areas, you’ve seen greater strength closer in, greater weakness the further out you go. What kinds of trends are you seeing in the Philadelphia market, as it’s one of the areas you cite as an area with strength?

Robert I. Toll

Right. I don’t know that I would ascribe a trend to it. I would just say it’s holding its own and that we are selling not as well as we did in ’04, ’05 but we’re selling pretty well. We’ve got -- just eyeballing it, we’ve got about 20 communities in Philadelphia suburbs, which is what the Pennsylvania market is for us. That’s what we meant by it, anyway. We are holding our own pretty well. We are comfortable with the number of deposits and contracts that we are taking.

We also own lots in the Poconos, where we had done very well up through ’05 but the Poconos are not holding their own at all and that is a very soft market.

Nishu Sood - Deutsche Bank

Okay, thanks.

Operator

Your next question comes from Ken Zener with Merrill Lynch.

Ken Zener - Merrill Lynch

Good afternoon. I’m interested in your thoughts on why you impair the same level of equity and inventory as other builders, given obviously your likely lower cost of land and higher embedded value. Is there anything -- it would seem that higher embedded value, you would not have equal impairments but it’s not the case. Could you add some color around perhaps what I’m missing?

Robert I. Toll

Joel.

Joel H. Rassman

Impairment reviews are community by community. It is not -- you do not get to offset positive profits on future land deals or positive profits on owned land or value in owned land against some of the ones that are bad. It’s an individual community by community basis. I can’t evaluate how other people are taking their write-offs. I do know that when we look at our write-offs, we do it at each individual community and specifically look at the economic conditions of that community and that’s the number we get to.

You may find out that others are ahead of us or behind us in taking those reviews and we can’t evaluate that.

Ken Zener - Merrill Lynch

Right, just because it seems like when I think about it, if the value is greater in more of your communities, all else being equal it wouldn’t be the same. But I guess time will tell.

Bob, I wonder if you could give a little comment on given your focus where you are having success on the right product and the right price, I’m interested in your thoughts on the home sales data that we got today, which showed all the volume increase in the sub $200,000 category.

Robert I. Toll

I think what that indicates is that most new home builders that are large, the public home builders, their average product goes probably anywhere from about 250 up to us, which is about $700,000. So obviously the increase is taking place below our space, which means that we are not out of the woods yet.

I took with surprise yesterday and it’s now confirmed today by this analysis when the Secretary of the Treasury said that we’ve got the hard times pretty much behind us. I wondered how many communities he had and where he got that information but I now understand it. The information he got had not been peeled away, I guess, to show that it was $150,000 housing.

So I would say we have not got the bad times behind us yet, though it could be. You never know.

For instance, here’s an odd one; Chicago, which has been for us as I mentioned in the monologue, and we think for others as well but I don’t want to state specifically because I’ve only got my own info, has been a very tough market and yet we opened up last week the old Glenview naval air base, which is a master planned community now of many thousand homes. We bought the last parcel in there for two different kinds of products. We opened up offering to the public approximately 32 units and sold every one with back-ups. I think we had 23 back-ups to 32 sales and then we stopped taking back-ups and just said give us your name and we’ll call you. That’s significant. It shows that the market is really alive and well for the right product at the right price.

I think also what drove that is it’s a brand new offering, so there is a perceived investment opportunity. I’m not talking about speculators but owner occupiers who are not as afraid of catching a falling knife, as I’ve said in the past, but have some confidence with respect to this offering, which indicates to me that there’s probably significant pent-up demand that’s ready to go as soon as they can become convinced that they are not buying into a down-draft.

I think we are probably better off than the market seems to indicate right now but only The Shadow knows, as they used to say on the radio.

Ken Zener - Merrill Lynch

Thank you.

Robert I. Toll

You’re welcome. Regina, I’ve got a question from Robert Tracey, a question on impairment charge: could you please provide a breakout of the $72.9 million impairment charge between inventory, contracts receivable, and investments in unconsolidated entities, or was the entire impairment charge taken to inventory? Joel.

Joel H. Rassman

First of all, I think the $72.9 is an after-tax number, so let’s look at it on a gross basis. It was $116 million, a little bit more, on owned land and $3.6 million on optioned. We do not have any impairment charges with respect to contracts receivable and none of the impairment charges with respect to our partnerships or unconsolidated entities, so it was all either owned land, $116 million, or options, $3.6 million.

Robert I. Toll

Some of it’s -- it’s land we’re primarily operating on, or getting ready to operate on, or not. Regina.

Operator

Your next question comes from Mike Rehaut with J.P. Morgan.

Mike Rehaut - J.P. Morgan

Hi, guys, this is Ray on for Mike. A question on SG&A. It looks like you had a pretty good sequential decline. It looks like the guidance is guiding for $130 million on a dollar basis. Are you guys comfortable with that number? Do you guys see any chance of that improving or coming down over the back half of the year?

Robert I. Toll

That’s a good question. Joel.

Joel H. Rassman

I’m sorry, what was the 130?

Mike Rehaut - J.P. Morgan

The dollar amount.

Joel H. Rassman

Of SG&A? Okay, I think we’ve given you guidance as a percentage of revenue, given you guidance as revenues. The guidance we gave you is what we are comfortable with and I don’t know if it comes out to 130. I assume it does if you’ve done the mathematics. We’ve tried to control our expenditures and obviously as revenues go down, some of your overheads in the SG&A area are fixed and some are variable, and where we can, we’ve reduced them and where we can’t, we will see an increase in the percentage of those categories as it relates to revenues and that’s what we’ve tried to project down. So if you look at the mathematical numbers I’ve given you, that’s the range I’m comfortable with.

Mike Rehaut - J.P. Morgan

Okay. I wonder if you guys could update us on your high-rise pipeline, where you guys expect to open these and the timeline for when you guys expect to open those for sale?

Robert I. Toll

Everything that we’re building is open for sale. We’re sold out -- that was last week or the week before -- on Third Avenue in Manhattan, between 13th and 14th. Sales are going up pretty strong in Brooklyn on the first tower. The building is topped out. I think it is 31 floors, 32 floors. We have -- yes, the Northside Piers project. The stuff we are building in Queens, which is pretty much in line with Brooklyn. Long Island City with tremendous demand there. We are almost sold out on the other in-land Brooklyn stuff that we had. North Eight, we have only 11 units left there.

Hoboken is still pretty much going gangbusters. Jersey City, we are delivering units now. We have about 33 left to sell and we hope that when we’re ready to deliver, we will have all sold so that one worked out pretty sweetly.

We are going through the approval process on a couple of blocks worth of buildings in Brooklyn in Carol Gardens, and that pretty much deals with our pipeline. We’re looking for more deals. Our tower stuff on the beach in Florida we finished, we delivered and are done with our first tower. The second tower, we have about half left to sell, which represents about 20 units. It’s a small building. We will make delivery there I guess in about six months. Do you have a better estimate of delivery?

Joel H. Rassman

I thought it was a year from now.

Robert I. Toll

I’m not sure.

Mike Rehaut - J.P. Morgan

Okay, great. Thank you.

Operator

(Operator Instructions) Your next question comes from Susan Berliner with Bear Stearns.

Susan Berliner - Bear Stearns

Good afternoon. Joel, could you go over the free cash flow for the quarter, and also if you can articulate what you think it will be for the year?

Robert I. Toll

Joel.

Joel H. Rassman

It’s not a concept that we really focus in on because our definition is not the same as yours, so I would rather if you describe what you want to call free cash flow, I’ll be glad to try to respond to it, Susan. We reinvest most of our cash in our business and we’ve increased actual cash in hand over the last quarter and over the last year.

Susan Berliner - Bear Stearns

I guess if you could just say what your use of cash was this quarter versus in the prior year quarter?

Joel H. Rassman

I don’t think I have it. I will be glad to get you that data. It will come off the filings we are going to do next week and then talk to you.

Susan Berliner - Bear Stearns

Okay, great. Thank you.

Operator

Your next question comes from Myron Kaplan, a private investor.

Myron Kaplan

My question has been broached somewhat, but since it seems that the trend is for, even though the demand is all right in many markets, that the trend is for somewhat leveled, possibly even falling backlogs. What steps are you taking to cut your generalized overhead and cost structure?

Robert I. Toll

Taking the necessary steps. As a matter of fact, on Monday we had a meeting and decided upon a percentage of cut-back in the G&A. We will not be cutting the S side of SG&A. That’s the last thing we would do in a market where you need --

Myron Kaplan

Where you need to stimulate.

Robert I. Toll

-- good sales people and you need good contact methodology to get your prospects, clients into the offices. So instead of just newspaper advertising or depending upon the Internet, we do a lot of mailers, for instance, to prospective clients to interest them to come into the communities, so that will bump up your S side.

But on the G&A side, we are into our third cut, third generalized cut now in the past -- how long has it been, almost a year? No, I think we started after last summer. I think we were late and held off until about September or October, so from September or October to the present, we are into now our third level of G&A cuts.

Myron Kaplan

What size general reduction would you say that will accomplish compared to beginning of ’06?

Robert I. Toll

We haven’t given that information out and I’d rather stick with that position.

Myron Kaplan

Okay. Very good, well, thank you.

Operator

Your next question comes from Timothy Jones with Wasserman & Associates.

Timothy Jones - Wasserman & Associates

The first one is what have you done in these tough times -- you had talked about a couple of quarters ago cutting labor costs and material costs. Particularly you were talking then that I think your gypsum prices were down even though the posted prices were up, which doesn’t surprise me. Can you give me an update on how your cost reductions on labor and materials, especially gypsum and lumber are doing?

Robert I. Toll

I can’t give you the specifics on gypsum and lumber. Do you guys have that? Joel.

Joel H. Rassman

We have just some material costs. About $1,000 to $3,000 a house is where I would think we are this year to date.

Robert I. Toll

On the materials.

Timothy Jones - Wasserman & Associates

How’s the labor?

Robert I. Toll

On the labor, much more significant, I believe. I don’t know if you guys have the info but what we do typically is we will go to lowest priced in a region as opposed to a specific area. In other words, instead of just assuming that all homes in Dutchess County are going to cost $65 or $70 a foot, sticks and bricks to produce, we’ll go and look at what the older communities were costing us in north central Jersey, where we might have been building for $58 a foot. We take a look at those subs. They are now obviously willing to travel a lot longer and further for the work and we’ll go back up to our New York subs and say you are either going to meet the prices that we can get from the Jersey labor market or you are going to be replaced and guys are going to be riding a little longer in order to get the work. So we bring the prices down in that fashion, Tim.

Timothy Jones - Wasserman & Associates

The second question is you had gone a couple of years ago from about nine month backlog conversion up to about 12 months, having to do with mix and so forth. Now, with the backlogs down and maybe a change in what you are trying to sell, what would you guess, Joel, that your backlog conversion will be now? I understand the difference is the amount of specs you have, where the difference are, but just on a regular backlog conversion basis for the next year.

Robert I. Toll

It’s probably about 10-1/4 months.

Timothy Jones - Wasserman & Associates

So it’s come back down from the 12?

Robert I. Toll

Sure, as the backlog has come down.

Timothy Jones - Wasserman & Associates

Right, I understand.

Robert I. Toll

Thank you.

Operator

Your next question comes from Randy [Raiseman] with Durham Asset Management.

Randy Raiseman - Durham Asset Management

Just a few questions, and the first one I am just trying to tie what we saw in the new home sales number today to what we’ve been hearing from talking to the builders where we were told that April was a pretty tough month and then you see the big spike up in new home sales. Did you guys experience any big spike in cancellation rates at the same time in April? I don’t know if you can comment on that or not.

Robert I. Toll

I’m sorry, I stepped on your question. What I wanted to say was as you get further in to a down market in terms of length of time, the comparisons are going to get better, so that ultimately if we stay here for a long period of time, you will see that April sales equaled April sales last year. That’s not what we’re looking for, of course, so I think the statements are a little misleading. The comparisons are good but what you are comparing to stinks, so that’s why you are getting unhappiness expressed by the public home builders.

But sorry, I stepped on your question and didn’t hear --

Joel H. Rassman

He wanted to know about the April cancellation rates, which we really don’t have, was better than previous months, and the second part of his question I think had to do with the surprise of the strength of the numbers that were released. I think we addressed it a little bit this morning in a previous question, or rather this afternoon, where it seemed to be that the strength was coming from the $150,000 house, which is not what most of the public homebuilders sell. Someone indicated that it was primarily in the sub-prime buyer market where in March -- I’m speculating here -- given all the publicity it was probably much more difficult to get a mortgage if you were a buyer of a home relying on the sub-prime market than in April.

Randy Raiseman - Durham Asset Management

Okay, that makes sense and then just one other question, just following up. You guys made a comment that you are actively looking and trying to buy land. I just wanted to get a sense from you what your appetite is for M&A in that context.

Robert I. Toll

In the context of looking for land -- I don’t think we focus on M&A as a substitute for looking for land. I know that the comment was made three years ago when the market was hot. The best place to look for land was on Wall Street as opposed to on Main Street. I don’t think that’s the case anymore so if there’s any M&A activity out there, it’s probably not on an acquiring land basis, but what do I know.

Randy Raiseman - Durham Asset Management

Thank you.

Operator

Your final question is a follow-up from Stephen Kim with Citigroup.

Stephen Kim - Citigroup

My question related to inventory breakdown. I was wondering if you could provide a little bit more detail, as you kind of do in your Q or for the breakdown of let’s say inventory into construction in progress, land and land development, land option and fees?

Joel H. Rassman

We didn’t have it as of this morning because it requires us to do some reclassifications for three categories as we account for it, and it will be out next week.

Stephen Kim - Citigroup

All right, and then lastly if I could ask you a question about how the elevated level of cancellations has or maybe hasn’t affected your relationship with your buyers; I know historically you’ve had a cancellation rate of about 7%. I know it’s coming down but I also know that it’s been elevated.

Robert I. Toll

Yes, well, our recent quarter we said was 18.9% compared to 7%, so that’s very elevated.

Stephen Kim - Citigroup

Exactly, so I guess my question is number one, since I’m assuming that a large percentage of these cancellations relate to a person who is unable to sell his house and then ultimately they probably will, which would suggest that it is really more of a delay of a purchase than anything else. Are you doing what some of the other builders are doing, which is saying we’re going to keep your deposit but if you come back here in the next three months and buy another house from us, we’ll apply the deposit to that?

Robert I. Toll

Not too much. We do do that on the markets that are tougher but on the average bad market, we do not do it.

Stephen Kim - Citigroup

You lost me there. So if a market --

Robert I. Toll

What I was saying is yes, we offer those kinds of goodies, hope certificates, where the markets are really bad. But where the markets are just bad, we do not do it.

Stephen Kim - Citigroup

I see. And how long do those hope certificates typically last? A couple of months, or like a year?

Robert I. Toll

I would say just a couple of months.

Stephen Kim - Citigroup

Okay, so this is not going to be a significant issue that we need to be worrying about next year when hopefully --

Robert I. Toll

Not for us, anyway. Not at all.

Stephen Kim - Citigroup

Okay, I just wanted to make sure.

Robert I. Toll

It’s very, very small for us. We’re pretty serious about enforcing the contract rights. After all, they go one way. When they go the other way, we’re going to make sure that they stick.

Stephen Kim - Citigroup

Well, that’s right. You’ve made a big commitment on your end. All right. That’s what I needed. Thanks a lot.

Robert I. Toll

Thank you, Stephen. Regina.

Operator

Your final question comes from Joel Locker with FBN Securities.

Robert I. Toll

You keep saying final. Is it really the end, Regina?

Joel Locker - FBN Securities

Maybe it is.

Robert I. Toll

Maybe it is, maybe it isn’t. Go ahead.

Joel Locker - FBN Securities

Just on your operating margins, you are maintaining mid-teens, which is significantly better than most of the other builders whose impairments are down in the mid single digits, if not flat.

Robert I. Toll

Ah, you’ve noticed.

Joel Locker - FBN Securities

And you’ve always had a somewhat of a buffer over the other builders, but now at about 1,000 basis points, I just wanted to get your take on how you are maintaining that, even increasing it over the other builders.

Robert I. Toll

I don’t know about the other builders to the extent that I want to answer that by speaking on the comparison. I can answer it with respect to just speaking about ourselves. It goes back to the monologue where what we are doing is evaluating the embedded value that we think we’ve got in the community and saying that we are not going to drop our drawers in this community in order to maintain pace so that subcontractors and management have something to do. Rather, we will ask management to take a step back, operate on two communities instead of one, go from tie and jacket to boots in order to operate efficiently and we will operate with less volume and less pace but we are not going to cut margin because we think that when the market comes back, we’ll be happy that we saved the good ground. So it’s what we’ve already spoken about that probably maintains that margin.

Joel Locker - FBN Securities

So there is a little risk if the market does not come back for a few years that you might have to increase impairments just because of sitting on the land for longer than some of these other builders?

Robert I. Toll

That’s probably true.

Joel Locker - FBN Securities

And just on the $119.7 million, was that all recorded in the traditional home sale expenses or was a portion of that in the impairments or in percentage of completion?

Robert I. Toll

All traditional homes.

Joel Locker - FBN Securities

All traditional homes. All right, thanks a lot.

Robert I. Toll

You’re very welcome. Regina.

Operator

At this time, there are no further questions. Mr. Toll, are there any closing remarks?

Robert I. Toll

Thank you very much, Regina. Everybody have a great Memorial Day weekend. Thank you, Regina.

Operator

This concludes today’s conference call. Thank you for your participation. You may now disconnect. Bye-bye.

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Source: Toll Brothers F2Q07 (Qtr End 4/30/07) Earnings Call Transcript
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