Based in Huntingdon Valley, Pa., Toll Brothers Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TOL)") else Response.Write("(NYSE: TOL)") end if %> is the largest builder of luxury homes in the U.S., constructing move-up, empty nest, and age-restricted residential communities in 18 states. In addition to building homes, the company also develops and improves its own land and offers services such as mortgage, title, and security to home owners. We talked with Toll Brothers Chairman and CEO Robert Toll about the current state of the luxury home building industry and the company's business outlook and growth strategies.

TMF: Why should long-term investors be interested in a company such as Toll Brothers?

Toll: One of the best aspects of Toll Brothers is that the past, while it's no promise of the future, is a pretty strong indication of where we'll be. It appears that during the '90s, we've had approximately 25% compounded growth in both revenues and earnings. On a nine-year basis, on a five-year basis, on a three-year basis, [or] any way you slice it, Toll Brothers is on a growth scale greater than General Electric for the same period of time. And yet, we have a multiple of under 7 [times earnings] now, and General Electric has a multiple of something like 40. Now I'm not suggesting that this company of ours is to be compared with General Electric. But in terms of growth, it certainly has proven itself as capable, even more so [than General Electric]. Our graph looks better than theirs.

"In down times, Toll Brothers has had tremendous good fortune to be able to expand because we are well capitalized and we can very favorably buy tracts of ground for future communities."

Now if you make part of this [General Electric] multiple, you will have tremendous appreciation in your investment. If you make none of the multiple expansion, you'll still have 25% appreciation if the past is any indication of the future. So, here's saying that you have a pretty good floor and pretty tremendous upside and reward for your long-term investment.

The strategy of the company is to continue to grow. We've expanded to about 34 markets. Nine years ago, I think we were at about six or seven markets. When we are through expanding just within the markets that we have entered, we will be three times the size we are today. [For example] in Northern Virginia, we have about 4% to 5% of the market. When we expand within our other markets that we've recently entered, such as Detroit, to the same extent that we've penetrated Philadelphia, we'll be three times the size of the company that we are today.

Another reason to invest long-term in Toll Brothers is that we have other businesses and business niches that make a substantial difference and appear to hold out a lot of high expectations for the future. Whereas five years ago we were only in the move-up market, where a typical buyer was a 42-year-old, today we are in the empty-nester business and we are in the age-restricted [business]. We have three businesses. For two of these, the empty-nester and the move-up, we have these being offered in the same large, country club communities. So, you have perhaps a doubling of the company, or a tripling of the company available from the additional penetration of our markets available to the investor, which means that there is again tremendous upside.

Finally, we've embarked on ancillary services, leveraging off our brand name. We've added a title company, an insurance company, a mortgage company, landscape and security [services]. None of these were offered up until two years ago. We're just now beginning to expand in those businesses, and they hold a strong future for us as well.

So for all of these reasons, I think that Toll Brothers is an excellent investment.

TMF: Should investors expect to see boom and bust cycles for your business as we've seen in the past, or is there a way that Toll Brothers can continue to build value even when the business is running against the economic winds?

Toll: I don't think economic cycles have been repealed, although it would certainly appear so currently. I think it was last week that I read with interest in Barron's that three more good years are being predicted for the automobile industry. As long as you have consumer confidence and you continue to run this cycle, our business should continue to boom because what we're selling is what most people desire first and foremost. With the exceptions of fire and food and water, [that] is a luxury home.

Even if you do get a down cycle sooner rather than later -- which by the way we'd welcome since we think it would help the investment climate for our company because it would clear out the worry [about] when the next downturn is coming -- I don't think that the downturn can impact the stock any more than it's already been discounted. It would appear to us that we are selling as though we are at doom's door. Therefore, I don't think that a down cycle would hurt.

We're working with tremendous demographics that may have in fact created a new paradigm -- sorry for the use of the word paradigm. The biggest years for births in the U.S., of course that's the Baby Boom, was not 1947 to 1957 but 1957 to 1964. So we're just now hitting the prime segment of the Baby Boom cycle for the move-up market. But on top of that, we're also reaping the benefits from the beginning of the Baby Boom. So you've got tremendous demographics. The same aspects of the demographics of age [apply to incomes]. Whereas 10 years ago 2% of the population in constant 1998 dollars were making $100,000 or more, today we have almost 10% of households making $100,000 or more. So you have a tremendous increase not only in the age when people would normally buy our luxury products, but they've got the money to buy the product.

In down times, Toll Brothers has had tremendous good fortune to be able to expand because we are well capitalized and we can very favorably buy tracts of ground for future communities. So a down cycle has actually helped us. We've gone through some pretty significant down cycles since we've been in business. We went public in 1986. 1988 through 1990 was a very poor period and we prospered. Here we are today enjoying what I think is the respective calm that the rest of our industry [is enjoying]. We're known as the nation's leading builder of luxury homes so the down cycles haven't hurt us. I don't think we have that much to fear.

TMF: Are demographics the main element that you look at when trying to determine return on investment prior to the start of a major development, or are there other considerations?

Toll: The most important point is to make sure that we have done our comparison analysis carefully and that we can sell homes for a price that would justify the cost of the ground, the improvements, and the amenities that we put into the site. We are known not just as builders, but as land developers. So we're not buying on a rolling option ground. We are taking the risk but also taking the reward of developing ground and putting in the amenities. Consequently, we make money from two different profit centers. We're not just merchant home builders; it would be unfair to call us that because our average home price is $440,000 in backlog, which puts us almost double what any other home builder does on average. We are [also] making money from development, from the approval process.

"The most important point is to make sure that we have done our comparison analysis carefully and that we can sell homes for a price that would justify the cost of the ground, the improvements, and the amenities that we put into the site."

This is why we have the highest margins in the industry. I read recently that within the Fortune 1000 there's a construction and engineering group. And within that group, which includes a lot more than home builders, we are number one for margins. That's because we do our own development work as well as the residential construction and marketing work.

TMF: Here in Northern Virginia, a big issue is suburban sprawl and there has been some backlash against rapid development in certain localities. How does the company approach these kinds of issues? Are you seeing more of them?

Toll: Yes, we are. Incidentally, Northern Virginia is very tame in its reaction to continuing development, when you compare it to Connecticut, New York, [or] New Jersey. I'd estimate that the average [development] approval time is probably four times in the New England and Northern Mid-Atlantic states to what it is in Northern Virginia. California is probably three times what it is [in Northern Virginia].

We're dealing with this issue everywhere. The good side of it is that it creates tremendous additional value for companies that do their own approval work and development work, such as Toll Brothers. We have 33,000 lots under control and these lots become more valuable the more that the "Not In My Backyard," or NIMBY, syndrome in markets influences public policy. It's an obvious reaction. We've got approximately three million people additionally a year in the U.S., and they've got to live somewhere. And if you're against urban sprawl, which translates really into against approving additional home sites that we build upon, all you've done is force up the price. And you've seen that the inflation in our business is fairly substantial compared to many other businesses.

We continually read that because of the Internet, pricing power [for businesses] is non-existent. There are very few sites that I'm aware of where you can dial-up [and buy] a house on the Internet, although we do have tremendous traffic from the Internet. I think we have about 1 million to 1.5 million visitors a year currently to our website. So, pricing power has been pretty strong for us because of this political movement against suburban sprawl.

TMF: I really appreciate you taking the time to talk with us today.

Toll: You're very welcome.

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