KB Home (KBH) Q3 2018 Earnings Conference Call Transcript

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KB Home (NYSE: KBH) Q3 2018 Earnings Conference CallSep. 25, 2018 5:00 p.m. ET

Contents:

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  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon. My name is Devon, and I will be your conference operator for today. I would like to welcome everyone to the KB Home 2018 third-quarter earnings conference call. [Operator instructions] Today's conference call is being recorded and will be available for replay at the company's website, kbhome.com, for 30 days. Now I would like to turn the call over to Jill Peters, senior vice president, investor relations. Jill, you may begin.

Jill Peters -- Senior Vice President, Investor Relations

Thank you, Devon. Good afternoon, everyone, and thank you for joining us today to review our results for the third quarter of fiscal 2018. With me are Jeff Mezger, chairman, president, and chief executive officer; Jeff Kaminski, executive vice president and chief financial officer; Matt Mandino, executive vice president and chief operating Officer; Bill Hollinger, senior vice president and chief accounting officer; and Thad Johnson, senior vice president and treasurer. Before we begin, let me note that during this call items will be discussed that are considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

These statements are not guarantees of the future results, and the company does not take -- undertake any obligation to update them. Due to factors outside of the company's control, including those detailed in today's press release and in filings with the Securities and Exchange Commission, actual results could be materially different from those stated or implied in the forward-looking statements. In addition, a reconciliation of the non-GAAP measures referenced during today's discussion to their most directly comparable GAAP measures can be found in today's press release and/or on the Investor Relations page of our website at kbhome.com. And with that, I will turn the call over to Jeff Mezger.

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Jeff Mezger -- Chairman, President, and Chief Executive Officer

Thank you, Jill, and good afternoon. The third quarter marked another quarter of consistent execution on our returns-focused growth plan, driving considerable improvement in our key financial metrics. A principal component of this plan is growing both our scale and profitability, and our results for the quarter reflect our ongoing progress toward becoming a larger and increasingly profitable business. Looking at the specifics of the third quarter, we grew total revenues by 7% to $1.2 billion and increased earnings per share by more than 70% to $0.87.

We produced significant year-over-year gross profit margin improvement through a consistent focus on optimizing our assets, a continued rotation in the higher-margin communities, and an increasing benefit from lower interest amortization. Our gross margin this quarter was also helped by a geographic mix shift in deliveries toward higher-margin communities. In the third quarter, we expanded our gross margin by 180 basis points to 18.7%, excluding inventory-related charges. We also continued to effectively manage overhead costs while increasing scale, which resulted in a record-low third-quarter SG&A ratio.

Taken together, our operating income margin was up 190 basis points to 9.3%. Looking at our operating income on a per-unit basis, we generated approximately $38,000 per delivery in the third quarter of 2018, an improvement of more than 25% as compared to the prior-year quarter. Market conditions remain favorable as the key drivers that fuel housing demand are still in place. The economy is healthy and growing.

Consumer confidence is at an 18-year high. We are at or near full employment with wage growth now accelerating, and household formation is continuing at a steady pace. At the same time, the supply of both new and existing inventory remains insufficient to satisfy this demand, underscoring the opportunity for higher levels of new construction to bridge the gap. Taken together, these dynamics continue to support solid market conditions for the foreseeable future.

Homebuyers are demonstrating a preference for choice, fueling strong demand for our build-to-order product. Once again this quarter, we effectively balanced pace and price to capitalize on this demand, maintain among the highest absorption rates in the industry. Our net orders per community grew 11% in the third quarter to 4.1 per month with increases in each of our four regions. This marked the first time in many years where a third-quarter absorption pace was above four per month.

We accomplished improvement in pace while opportunistically capturing price, helping us to offset cost increases. We were able to raise prices in over 60% of our communities and still maintain accessible price points for first-time buyers. We are well-positioned from an ASP standpoint as our long-standing approach of offering our products and price in our homes to be attainable for the median household income of each submarket allows us to remain affordable and also competitive with resale, our biggest competitor. As we anticipated, our average community count declined by 7% during the quarter, yet we still produced a 3% increase in net orders.

Our $2 billion backlog provides visibility on deliveries for the remainder of this year, supporting our 2018 expectations, including housing revenues that are at the low end of our previous guidance range. Although we are pleased with our year-over-year absorption pace increase in the third quarter, we now recognize in retrospect that our full-year revenue guidance from last quarter was too aggressive based on the timing of getting our communities open and establishing our targeted pace to support projected fourth-quarter deliveries. In addition, with our backlog currently weighted outside of California, we're lowering our ASP expectations from our previous guidance, reflecting a third-quarter backlog ASP that is down 4% year over year, which will also impact our revenues. Managing the business for the balance of 2018, we made the decision to maintain our pace-price discipline and achieve a higher gross margin for this year as opposed to running our communities at a faster pace to preserve delivery volumes.

As a result, we're now expecting a gross margin of approximately 18% for this year, at the high-end of our previous guidance range. Our results this quarter clearly illustrate the strength of our returns-focused growth plan and our balanced approach to effectively deploying our substantial cash flow. During the quarter, we reinvested $600 million in land acquisition and development, driving our owned and controlled lot count to 53,400, a sequential increase of more than 3,800 lots, further supporting our future community count growth. We also repaid $300 million of debt at its maturity and still ended the quarter with a very healthy third-quarter cash balance of over $350 million in addition to our undrawn revolver.

Growing our active inventory, while reducing our debt balance and interest incurred, is a powerful combination that is already generating gross margin improvement. With the progress that we've made in generating cash, we are well-positioned to strategically expand our business. In the third quarter, we acquired the assets of Landon Homes in Jacksonville, Florida, including approximately 2,100 lots that we now own or control across 17 communities, eight of which are open today, and nine communities, which will open over the next 18 to 21 months. We are currently the fourth largest builder in this market based on deliveries, and our position will be enhanced in 2019 and beyond with this acquisition.

Our local team is moving quickly, having completed the rebranding to KB Home and the introduction of our product in all but one active community that we acquired, which is a higher ASP move-up community. We also expanded into Seattle, a market that we have been evaluating for several years. Seattle has similar dynamics to the Bay Area and Denver, two markets that we know well, and we hired an experience division president, who's a Washington native with local market expertise and a strong network of relationships. This enabled us to move quickly on acquiring land, having already completed one acquisition with first deliveries planned for 2019 and a second scheduled to close in a couple of weeks.

Our market approach in Seattle is to offer affordable product in the high $300,000 to $400,000 price range, targeting first time and first move-up buyers in keeping with our core business strategy and our personalized approach to homebuilding. While it will take some time for us to reach meaningful scale in Seattle, we are excited about this opportunity to augment our West region. We remain on track with the community count trajectory that we shared with you last quarter. The third quarter marked a turning point, where our ending community count increased sequentially.

We estimate that we will be increasing our community openings this year between 15% and 20% year over year, and ending 2018 with a higher community count. As we look to 2019, we are again planning a significant year-over-year increase in openings and expect sequential growth in community count each quarter. We also expect that the makeup of our portfolio will reflect a greater percentage of core communities as we continue to rotate into higher margin, higher return communities. Moving on to the regional updates.

In the West Coast, demand remained healthy during the quarter, and we experienced a slight increase in our community absorption rate to 4.6 net orders per month, surpassing our companywide average. As we shared with you on our earnings call in June, the mix shift in net orders that we experienced in the second quarter of this year carried over into the third quarter as we continued to sell through many communities with ASPs in the range of $1.3 million to $1.8 million. This higher-price band represents about 7% of the region's net orders in the third quarter of 2017, as compared to 2% of our net orders this year, as we replaced these communities with other communities offering more affordable product. The combined effect of having fewer active communities given the regions' community count transition and selling out of many of our highest ASP communities negatively impacted our net order comparisons in the third quarter of 2018.

As a result, the West Coast experienced a 22% decline in net order value and a 15% decline in net orders. Our ending community count in the West Coast was up sequentially in the third quarter, and with a year-over-year increase in the number of planned openings in the fourth quarter, we continue to expect our 2018 ending community count in California to be up roughly 15% as we resume growth of this business. We like our submarket and product positioning across the region, and we are solidly positioned for quarterly sequential community count growth throughout 2019. Demand in our Southwest region also remained healthy with an absorption rate that was firmly above the companywide average.

The Las Vegas market in particular exhibited very strong demand and continued to lead the company in community absorption rate. Overall, the region's net order comparison was impacted by a declining community count year over year. With most of this year's third-quarter openings occurring near the end of the quarter, we have not yet captured their full benefit. As a result, the Southwest experienced a 1% decrease in net order value and an 8% decline in net orders.

In the Central region, our largest region in terms of units, net order value increased 9% on a 15% increase in net orders. While some of the favorable comparison to the prior-year quarter reflected the impact from Hurricane Harvey, which hit the Houston area at the end of the third quarter of last year, we also once again saw particular strength in our San Antonio division. Wrapping up the regional updates. Net order value increased 46% in the Southeast region on a 35% increase in net orders with every division producing a positive net order comparison.

We have seen a continuing trend of net order growth throughout the past year in the Southeast, and we are pleased with the momentum we are building. The region's results also this quarter included 78 net orders from the Landon Homes communities in Jacksonville. Before I wrap up, I would like to spend a few minutes on two announcements we made during the third quarter. First, our brand repositioning.

We launched a new logo and built our relationships tag line, which speaks to our connection with homebuyers and our build-to-order process and our commitment to customer satisfaction. This logo and tag line were developed based on extensive customer feedback as to what the KB Home brand represents to them. While the values underlying our brand remain the same, we have modernized its look and feel to further strengthen our engagement with customers in a way that emphasizes their choice and personalization in the homes they purchase. Our new branding is warmer and more contemporary, which can also be leveraged on social media.

The second announcement is our partnership with Google, the first for Google in homebuilding. Our new KB Home smart system utilizes Google Assistant to integrate compatible devices and features, enabling a higher degree of functionality and automation of smart home features and elevating the performance of homes in a personalized way. We were excited to launch the program two weeks ago at our Stapleton Starlight community in Denver, where it was well received by attendees who toured the home. The smart system will initially be offered at standard in select communities in Denver, Las Vegas, Jacksonville, and Orange County with additional components available as options in our studios.

Over time, we expect to roll this system out to all of our markets. We're excited about this partnership with Google and look forward to updating you on its progress over time, and our goal is to establish a leadership position in smart home technology just as we have in sustainability and healthier homes. In closing, we are pleased with our continuing trend of positive performance in the third quarter. With nearly 60% growth in our pre-tax income in the first nine months of 2018 and a solid outlook for the fourth quarter, we expect a meaningful improvement in our book value by the end of this year.

We are poised to finish 2018 with growth in revenues and a significantly higher year-over-year operating margin, fueled primarily by the expansion of our gross margin, a key goal for us. As we look ahead to 2019, the combination of community count growth beginning in the fourth quarter of this year, a substantial increase in communities slated to open in 2019 and maintaining our solid absorption pace gives us confidence in achieving our targets next year. With that, I'll now turn the call over to Jeff for the financial review. Jeff?

Jeff Kaminski -- Chief Financial Officer

Thank you, Jeff, and good afternoon, everyone. We are very pleased with our solid third-quarter results, which were primarily driven by our continued operational execution on our returns-focused growth plan and customer-centric business model. I will now highlight some of the significant improvements we produced in the third quarter, provide details on our outlook for the fourth quarter, and discuss our 2019 community count and housing revenue expectations. In the third quarter, housing revenues grew 7% from a year ago to over $1.2 billion, reflecting an 8% increase in the number of homes we delivered and a slight decline in our overall average selling price.

Three of our four homebuilding regions reported housing revenue increases, ranging from 12% in the Central region to 48% in the Southwest region, more than offsetting a 6% or $36 million decline in the West Coast region. The decrease in the West Coast revenues for the quarter was due to the impact of lower year-over-year community count during the first nine months of 2018, partially offset by year-over-year increases in absorption pace. We are expecting favorable community count trends in the future for our West Coast region as well as for the total company, and I will provide more detail relating to these expectations in a few minutes. We believe our current $2 billion backlog value supports projected fourth-quarter housing revenues of approximately $1.39 billion to $1.45 billion, and as Jeff mentioned earlier, we currently expect full-year housing revenues of approximately $4.6 billion, which is at the low end of our previous guidance range.

In the third quarter, all of our homebuilding regions posted increases in average selling price, ranging from 2% in the West Coast region to 7% in the Central region. Nonetheless, our overall average selling price of homes delivered decreased 1% year over year to approximately $408,000 due to a geographic mix shift of deliveries with a lower proportion of deliveries coming from our West Coast region, which reported an average selling price of $693,000 for the current quarter. For the 2018 fourth quarter, we are projecting an overall average selling price in the range of $400,000 to $405,000. Homebuilding operating income increased 38% from the year-earlier quarter to $105.6 million.

Our third-quarter homebuilding operating income margin increased 190 basis points on a year-over-year basis, mainly driven by continued measurable improvement in our housing gross profit margin. For the fourth quarter 2018, we expect our homebuilding and operating income margin, excluding the impact of any inventory-related charges, will be in the range of 9.3% to 9.7%. For the full year, we expect the same metric to be approximately 8.2%, which is at the high end of our previous guidance and within our 2019 target range of 8% to 9% under our returns-focused growth plan, a full year ahead of our original expectation. Our housing gross profit margin for the third quarter improved 180 basis points on a year-over-year basis to 18%.

Excluding inventory-related charges of $8.4 million in the current period and $8.1 million in the prior-year period, our gross profit margin for the quarter was 18.7%, also a year-over-year improvement of 180 basis points. Reductions in incurred interest from declining debt levels drove a decrease in the amortization of previously capitalized interest that accounted for 40 basis points of the gross profit margin improvement. Our adjusted housing gross profit margin, which excludes inventory-related charges and the amortization of previously capitalized interest, was 23.1% for the third quarter, up 140 basis points compared to the same period in 2017. The year-over-year increase primarily reflected a continuation of the favorable factors realized during the first half of this year.

These factors include margin improvement from community-specific action plans, including targeted home selling price increases calibrated with demand, and the opening of new higher margin communities, partly offset by increases in land, trade labor and material costs. Assuming no inventory-related charges, we expect our fourth-quarter housing gross profit margin will be in the range of 18.3% to 18.7%. Using the midpoint of the fourth-quarter range and excluding inventory-related charges, we expect the full-year 2018 gross profit margin at the high end of our prior guidance range of approximately 18%, which would represent a year-over-year improvement of 110 basis points and the achievement of our 2019 returns-focused growth plan goal for this metric a year ahead of schedule. Our selling, general and administrative expense ratio of 9.4% for the quarter reflects an improvement of 20 basis points from the same period in the prior year and a new third-quarter record low.

As we continue to focus on containing overhead costs, we are forecasting our fourth-quarter SG&A expense ratio to be in the range of 8.8% to 9.2%. Assuming the midpoint for the fourth quarter, our 2018 full-year SG&A expense ratio will be approximately 9.8%, which is within our prior guidance range. Our effective tax rate for the third quarter of 24% decreased from 37% in the prior-year period, primarily due to the favorable impact of the Tax Cuts and Jobs Act. We still expect our effective tax rate for the fourth quarter of 2018 to be approximately 27%.

Overall, we reported third-quarter net income of $87.5 million, or $0.87 per diluted share, up significantly from the $50.2 million, or $0.51 per diluted share, reported in the third quarter of 2017. Turning now to community count. Our third-quarter average of 217 was down 7% from 234 in the same quarter of 2017. We ended the quarter with 224 communities, representing a 3% decrease from the year-ago quarter.

On a sequential basis, our ending community count increased 7% and marked the beginning of a trend of sequential increases in community count that we expect to see for both the fourth quarter and throughout next year. On a year-over-year basis, we anticipate our fourth-quarter average community count will be about the same as the average of 228 communities in the fourth quarter of 2017. We now expect our community count at the end of 2018 to be up about 4% as compared to year-end 2017. In addition, while our third-quarter average community count for our West Coast region was down 16% from the prior-year period, we ended the quarter with 55 open selling communities, representing a sequential increase of 8%.

We expect another sequential increase in the fourth quarter and further growth throughout 2019, resulting in notable year-over-year increases in average community count for the region in each quarter of next year. We invested $601 million in land, land development, and fees during the third quarter with 58% of the total representing new land acquisitions. On a year-to-date land -- our year-to-date land-related investments of $1.4 billion increased 29% versus the prior-year period. We ended the quarter with over 53,000 lots owned or controlled, our highest quarter and lot count in four years.

Our lot count was up 8% sequentially from the second quarter, including the addition of approximately 2,100 lots that we own or control due to the asset purchase from Landon Homes in the third quarter. We are excited to put more capital to work in Jacksonville through this asset acquisition that complements our current footprint and customer focus, was free of goodwill and debt and will add incremental revenues and earnings to our results beginning in the fourth quarter of 2018. We remain focused on growing our community count and providing top-line revenue expansion as key components of our core business strategy and returns-focused growth plan. Consistent with our operating model, our investment strategy is focused on acquiring land for new communities that can offer product at price points attainable for the respective submarkets' median household income.

We expect our increasing level of land investment will drive additional such community openings resulting in 2019 year-over-year growth in average community count in the 10% to 15% range. Combined with our anticipated year-end backlog, we believe the number and mix of our open selling communities in 2019 will generate full-year housing revenues in the range of $5.0 million to $5.3 billion, up 12% over the prior year at the midpoint and achieving our original three-year target for this metric under our returns-focused growth plan. We ended the quarter with total liquidity of $817 million, including $354 million of cash and $463 million available under our unsecured revolving credit facility. During the quarter, we retired $300 million of our 7.25% senior notes at their maturity using internally generated cash.

In August, Fitch upgraded our credit rating to BB-, equal to the S&P rating, which was upgraded in January 2018, marking our fourth rating agency upgrade since April 2017. The implementation of our returns-focused growth plan, including the execution of our KB2020 business model, has generated substantial cash flow over the past seven quarters, enabling us to significantly reduce outstanding debt levels and fund measurable increases in land investments. These land acquisitions, in turn, drove a sequential increase in our third-quarter-ending community count and positioned us for continued future growth. In summary, we delivered strong results in the third quarter, with 7% growth in revenues, 190 basis points of improvement in our operating income margin and an increase of 45% in pre-tax income on a lower tax rate, all of which contributed to a 74% increase in our net income versus the prior-year quarter.

We also expect to generate further improvements in our financial performance in both the fourth quarter and 2019, as we continue executing on our returns-focused growth plan. Finally, we have announced a date for annual investor conference call scheduled for November 14 to provide an update on our progress toward achieving our three-year returns-focused growth plan objectives and furnish detailed guidance for the 2019 first quarter and full year. We will now take your questions. Devon, please open the lines.

Questions and Aswers:

Operator

At this time we will be conducting a question-and-answer session. [Operator instructions] Our first question comes from the line of Alan Ratner with Zelman & Associates. Please proceed with your question.

Alan Ratner -- Zelman & Associates -- Analyst

Hey, guys, good afternoon and a really nice quarter. So appreciate all the commentary and guidance. I think that clearly from your actions this quarter, you guys are still very optimistic about the cycle as evidenced by the acquisition in Jacksonville entering Seattle and just generally, the big ramp in your land activity. On the other hand, we're seeing in the stock market this -- a lot of trepidation over where we sit in the cycle today.

I think some other builders have highlighted more deceleration of late and probably at higher price points than you're operating at, but I'm wondering if maybe you could just talk a little bit about what you're seeing in the broader market maybe outside of your core price points and talk about the overall environment for incentives, discounting this time of year, inventories on the ground. You mentioned, Jeff, that it's obviously very tight, but we have seen those numbers creeping higher. So do you think this is a function of your outperformance based on the price point you're operating in, the location of your communities? Or do you think the stock market just has it wrong at this point and the market remains on much stronger footing than perhaps investors are given credit for?

Jeff Mezger -- Chairman, President, and Chief Executive Officer

Alan, you hit on two key points there in what you just rattled off. One, I do think with how we're positioned, where our prices are at and targeting the medians in the submarkets that we continue to enjoy very healthy demand. As I shared, our absorption rate per community is actually up, and we took the time to go into the detail on our community count and what's going on in each region to hopefully communicate that the markets are very healthy right now at the price points that we play at. Like you, I have seen all the coverage in the media and the investor world on where we're at in the cycle, and I keep getting back to the current inventory levels, which are low.

And while the national numbers are four months, many of the markets we're in today it's still two months, a month and a half, and then when you get into the price points we play at, it's even less. So there's not a lot of inventory out there at the affordable price bands, and much of the headlines, I think, are tied to higher price points that are seeing some slowdown. And we're trying to stay ahead of that at the price points that are slower, are well above us today and where we're operating. But if it comes down, we have to be prepared for that, and it's in part why we're rotating to lower-priced communities, positioning smaller models in higher-priced areas even to keep affordable and keep some insulation there.

But we think market conditions are very good and continue to see a growth opportunity as we head into '19.

Alan Ratner -- Zelman & Associates -- Analyst

Thanks for that. That's helpful. And then second, you gave the community count and revenue targets for next year. Just as you sit here today with the communities that are coming online and where you see your portfolio, any indication you could give us just directionally on margin at this point? I mean, it sounds like you're raising prices still in the majority of your communities.

Your sales pace is very strong, so I would think just based on that, that you have confidence and at least an ability to hold margin at the levels you're achieving today. But is there something else maybe kind of going on behind the scenes from a mix standpoint that we should be aware of?

Jeff Kaminski -- Chief Financial Officer

No, not really, Alan, just more continuation of the trends that we've been experiencing for the past couple of years. We'll still have a bit of a headwind from the reactivated communities. And we'll still be dealing with that next year, but I don't think they'll change significantly in one direction to the other. We are enjoying and we're starting to see come through the financials the results of the deleveraging and lower interest amortization, so that'll be a tailwind for the margins as we go into next year.

And we're still seeing really good experience with the new community openings. They continue to be, really, the main driver of the margin improvement in 2018 in the current year, and hopefully, that'll continue into next year. But no, there's nothing outside of that.

Operator

Our next question comes from the line of Stephen East with Wells Fargo. Please proceed with your question.

Stephen East -- Wells Fargo Securities -- Analyst

Thank you, and congratulations, guys, on a nice quarter here. Jeff, you talked about the demand that you've seen and we would agree based on what we're seeing out in the field. As you look at your entry-level trends across the markets, are you seeing any markets where you're starting to hit price constraints? Alan talked a lot about getting pretty worked up about it, and I think this -- the pricing and the affordability issue has really bubbled too at the top. Are you seeing any markets where, at the entry level, you're hitting that price constraint, and now you've got to do something different, i.e.

smaller product, etc.?

Jeff Mezger -- Chairman, President, and Chief Executive Officer

We haven't seen it yet, Stephen. We -- two things we track our LTVs, the qualifying ratio of our customers, the down payment, the FICO scores, that hasn't changed at all. Our average footage also hasn't changed at all, and for me, that's another proxy for what's going on with the consumer in that it's a consumer picking that size home, not us building the spec and then selling it. So footages are holding.

Our LTVs are holding. We've been moving to more affordable areas, so it's the same-sized home. Price may go down because we've moved 2 miles or 5 miles further from the employment centers, but we're not seeing any indication of our customer today that they're feeling a pinch. I've seen a lot in the media about interest rates going up, and I looked at the 30-year Fannie Mae numbers, and it's 4.6%.

It's the same thing it's been for four, five months. And I'm wondering if the media is banging that drum more because of what could happen in the future versus the reality of today. The rates really haven't moved that much this year.

Stephen East -- Wells Fargo Securities -- Analyst

OK, all right. And I'll follow on just quickly. How long does it take you to reposition your product? Is this like a six-month event? Or if you start to see constraints out there, how long does it take for you to reposition your product because of community constraints, etc.? And then you all built an off-site home in Vegas. Just interested to know how that's fitting into your future, how you all are thinking about off-site manufacturing.

Jeff Mezger -- Chairman, President, and Chief Executive Officer

You just exceeded your two question, but I'll honor it. And that's the third two, Steve. I'll go to that one first. We've done many concept homes over the years.

And the one that we're doing in Vegas in conjunction with a lot of our national suppliers and builder magazine, Hanley Wood. We always come up with new ideas out of these things. When you get everybody working together on how to create a more advanced home and technology or more advanced in energy efficiencies or healthier and in this case, it'll be all the above, great ideas bubble up. You find some that resonate.

You find a way to get that component to scale. Prices come down, and over time, it becomes a standard feature in the industry. So it's part of the evolution, and with that, comes the -- how do we manufacture our product for less cost. And that has been a challenge for decades.

And so far, we haven't been able to crack the code. So we're testing that one as well because you had a modular basis. What can we do? And how do we explore bringing our cost to build or our time to build down through things like that? As we keep trying these things, so far, we haven't been able to find one that -- where the costs are close enough, where it makes financial sense, but we're continuing to push the envelope there. Specific to retooling product, if it's a city like Phoenix or Texas or Florida, we have product series that range from 1,200 feet to 3,400 feet that are all the same width and all fit on the lots.

And as we bracket the incomes and the medians, we'll put houses out that are attainable in the model park that are attainable to that consumer profile. And if rates were to go up or affordability goes down or costs push price up, we can rotate into new models in a matter of a few months because they're all plan approved, and you just go get a permit and you build a new model park if you want to reposition the community. And we've done that pretty quickly over time. It's a little dicier when you get the California, where everything's pre-plotted and you'll have architectural reviews, and the cities and the planning departments get back involved if you want to change a product there.

But we've navigated that one as well. So we're very nimble in that regard, just plug and play for the most part.

Operator

Our next question comes from the line of Mike Dahl with RBC Capital Markets. Please proceed with your question.

Mike Dahl -- RBC Capital Markets -- Analyst

Hi. Thanks for taking my questions. Jeff, I wanted to ask a little about the revenue guide as it relates to next year, and I think the starting point really around the change to this year. I think you mentioned in your opening remarks, probably a little too aggressive on the opening schedule and establishing a target sales pace.

So could you just talk a little about, as you're establishing this 2019 guide, what you have layered in to the assumptions around those same issues to give yourself a bit of a buffer around that '19 guide so that you don't encounter -- or give us confidence that you're not going to encounter some of the similar headwinds?

Jeff Mezger -- Chairman, President, and Chief Executive Officer

Sure. Well, as we've been sharing for probably a year now, we've been playing catch up on community count, and there's a pretty quick turnover here, where we're opening a lot of communities and closing out of a lot of communities. And we're working hard to stay ahead, and we keep -- we ticked up our absorption rate this year with intent in that we knew our community count was going down and we had to build a bridge until the community count would come back. As we entered the year, we thought the community count would come back in the second quarter, then it was the third quarter, now it's settled into the fourth quarter, but it's now settled.

And I guess, I'd say that we've already taken that bullet in terms of fighting through the delays that we've experienced over the last year in getting communities open. So we go forward. We're going to be positioned at the end of the year with a community count and a backlog that sets us off on the trajectory that gets you to the range that Jeff shared. So as we sit here today, we don't see any storm clouds that would get in the way of the guidance we just put out there.

It was more the frustration we've lived through over the past three or four months as communities missed a month or missed two months. When you think about it in our build-to-order remodel, it -- once you open a community, then you got to sell the home and then you got to build the home before you can close the home. Every month you miss in the opening, you're not building houses out there because you're waiting until you get your models done. And then you let the buyer pick their home and they build it.

So when we lose a month or two, it can push deliveries out a full quarter. And it's been painful, but we think we're over that bump now.

Mike Dahl -- RBC Capital Markets -- Analyst

OK. Thank you. And the second question -- and you provided a lot of helpful color and just breaking down some of the regional trends and some of the mix impacts going on. I'm curious to dig into California specifically just with some mix in product and potentially submarkets.

It sounds like that band of very high priced homes is now kind of at a potentially more normalized level. And so I'm wondering, if we look at the order average selling price of, call it, $580,000 and it goes $587,000 this quarter, so $580,000 to $590,000, is that now a band that we should be thinking about? Like you look at your community mix going forward into '19, and that's a reasonable price range. Or how should we think about kind of directionally where they at? [Inaudible]

Jeff Mezger -- Chairman, President, and Chief Executive Officer

Are you referring to -- are you referring, Mike, to California or the whole company?

Mike Dahl -- RBC Capital Markets -- Analyst

California, West Coast, specifically, just how to think about kind of where you're positioned for -- and also with respect to the 2019 expectations, how to think about that.

Jeff Mezger -- Chairman, President, and Chief Executive Officer

There's a few -- we hate to use this, but we'll do it. There's two different mix dynamics that are influencing our California ASP. One is in our coastal areas, strategically, we're moving to lower price points where we can. We've enjoyed great success, up at $1.5 million, $1.8 million, $2 million, and those communities have all sold through now.

We're reloading with more townhomes, duplexes, more density but not into the condos necessarily but more density and lower price points, so the coastal areas that may have been up in the low millions are probably in the sevens or eights. That's the way I would think of the coast. And then we also have a geographic mix shift in that the inland areas are now performing very well and a larger percentage of our business is coming from the inland areas as opposed to the coastal zone, which was predominant five years ago even, where a lot of our mix was just along the coast. So it wouldn't surprise me if between the two next year, our ASP in California is down versus this year.

But it'll be a better business. Our profitability will be better, and I think it's a better position if we were to get some kind of a slowdown. You're insulated a little better. So we like that move.

I think you'll see our ASP tick down some.

Operator

Our next...

Jeff Mezger -- Chairman, President, and Chief Executive Officer

And that would be included in the assumptions Jeff gave you on the guidance.

Operator

Our next question comes from the line of John Lovallo with Bank of America. Please proceed with your question.

John Lovallo -- Bank of America Merrill Lynch -- Analyst

Hey, guys. Thanks for taking my questions. First one is -- I'm just looking at the tape right here. The headlines are reading that KB Home sees housing slow down at higher price points.

I don't think that's what you said, but Jeff, that might -- can you maybe talk about if there is any moderation at higher price points, where you're seeing it? Maybe can you maybe help us what are the price points that that could be happening?

Jeff Mezger -- Chairman, President, and Chief Executive Officer

I'll give you an example. In many of the Texas cities, sales are a little slower when you get above $400,000, $400,000 to $500,000, and it's not a price point that we play at. I think, to get within those states or that state in this example, the sales are still OK. They're just not as strong as they were.

But that's not a price point we play in so...

John Lovallo -- Bank of America Merrill Lynch -- Analyst

Got you. So it was kind of more of a moderation, you would say?

Jeff Mezger -- Chairman, President, and Chief Executive Officer

Yes, that price point's well above the medians in the market.

John Lovallo -- Bank of America Merrill Lynch -- Analyst

Gotcha. And then one of the things that we've heard, and I just wanted to see if you guys would agree or not, but given some of the labor shortages in the markets, we've heard that some builders have been kind of toggling between starts and kind of completions. And that's why we've seen some variations in those numbers. I mean, is there any truth to that? Are you guys seeing that in the market?

Jeff Mezger -- Chairman, President, and Chief Executive Officer

That's the first I've heard of that. In our case, we pace our starts to our sales, and we work with our contractors to have adequate labor based on our sales rate in that community. And if we're selling five a month, we're starting five a month, then they manage to that. So I've not heard of people that are trying to meter deliveries tied to starts.

Operator

Our next question comes from the line of Jack Micenko from SIG. Please proceed with your question

Soham Bhonsle -- Susquehanna International Group -- Analyst

Hey, good afternoon, guys. This is actually Soham on for Jack this afternoon. Jeff, I guess, just want to start with you and get your thoughts on maybe reconciling the trends we're seeing in the existing market versus the new home market today because it really appears to be a tale of two worlds and a cause for confusion, I think, for investors. So what do you guys think is driving the differential, I guess, between your results, especially in California and what maybe we're seeing on the existing side with price cuts and higher inventory levels?

Jeff Mezger -- Chairman, President, and Chief Executive Officer

Again, I think, if you get into a specific city and look at where the price cuts are occurring, it's at the higher priced resales as well. The more affordable product, there isn't any inventory out there. So I don't think -- if you look in a city, however it's defined as affordable, I don't think you'll see a lot of inventory. A lot of the coverage on the resale side is supply constrained at the affordable levels, which is perfect for us.

Soham Bhonsle -- Susquehanna International Group -- Analyst

Right. OK. And then, I guess, second question was on the gross margins in the new communities. I think last quarter, you said these communities were coming on at roughly 18.5%.

So could you maybe give us an updated figure for this quarter and talk specifically to some of the operational things you're doing at these newer communities to drive the gross margin higher into next year?

Jeff Kaminski -- Chief Financial Officer

Right. I'm not sure we actually came out and said 18.5% last quarter for new communities. But certainly, it is lifting the margins, and we've seen that for the first three quarters of this year as the new communities coming on have provided a bit of the margin lift that we're seeing in our overall results. The -- what we're doing, I think, is we're basically just blocking and tackling.

I mean, we're -- the underwriting has been very good as we do land acquisitions. And as the communities are coming out in open, we're at or above underwriting guidelines, in many cases, in most cases, which is obviously adding incrementally to the business. I think we've tightened up on just basic things like what it costs to develop land and having a really good fix on our cost to build and pricing in the various submarkets where we're opening. The product positioning, I think, has been strong from the point of view of going after predominately first-time buyers, in some cases, first move-up buyers, but hitting those median income points in the market, in the various submarkets is helping a lot.

So just seeing a lot of success in what the -- how the divisions have been operating on new community openings. It gives us, really, a lot of confidence both in our future land investments -- or our land investments today for future community openings as well as into next year and our plan to continue improvements in the business.

Operator

Our next question comes from the line of Matt Bouley with Barclays. Please proceed with your question.

Marshall Mentz -- Barclays -- Analyst

Good afternoon. This is actually Marshall Mentz on for Matt. Thanks for taking the questions and congrats on the quarter. Just a follow-up on gross margin, just looking at where you've guided for the fourth quarter and recognizing you had a pretty strong result last year.

I think you're looking for something in the range of flat year-over-year as we move forward. What -- could you maybe speak to some of the moving pieces in there just given that some of the capitalized interest is rolling off and maybe would have expected that to be a little bit higher in expectation for the fourth quarter?

Jeff Kaminski -- Chief Financial Officer

Yes. I mean, the -- there's a lot of moving pieces as you mentioned. The mix of reactivated communities versus core communities as well on the actual communities that we're operating this year versus last year, we had a very strong, as you pointed out, fourth quarter, with quite a number of positive moves in the fourth quarter on the margin side and very few negative impacts that you normally see. So we think it's a good result.

We think the guidance for the fourth quarter would obviously provide us a very nice year-over-year impact. I think, in total, it's 110 basis points of improvement for the full year, which we're quite happy with. Outside of that, I mean, it's hard to get into any -- much more detail without really dissecting in the community level. But the community mix is significantly different.

It's probably 40% new communities that we'll be delivering out of versus last year, and that's what we're seeing based on today's backlog levels and some of the mix shift away from California. As we talked about a few times during the call, the community count in California came down this year. We're seeing a little bit lower mix out of the West Coast business. The best news coming out of that is that we hit the inflection point in the third quarter and expect to see that continue to build as we get into next year.

But it will take a while for those communities to come online and for the deliveries to come out of it. But that's probably the single largest difference between this year and last year. It's just the mix on the West Coast. But overall, I think a pretty solid result for the fourth quarter and enabled us to lift our guidance for the full year between the third-quarter performance and our fourth-quarter expectations.

Marshall Mentz -- Barclays -- Analyst

[Inaudible] Thanks for the clarity on that. And then maybe moving to next year and your guide for increasing community count 10%. Obviously, Jacksonville and Seattle are going to factor into that. But could you maybe touch on some other submarkets that we should expect additional communities where you're investing in, maybe just kind of spell out a little more about the pipeline for next year?

Jeff Kaminski -- Chief Financial Officer

Sure. Yes, we'll get into a little bit more detail. I mean, we have the call coming up in November, where we're giving a lot more detail and guidance both the first quarter as well as for the full year in 2019. And that's just more detail on the community count but kind of in response to the question from earlier as well on gross margin.

We'll get into some of that as well. So first of all, just to clarify the count for next year, we're expecting the average count to be up between 10% and 15%. So 10% is kind of the bottom end of the range. We thought pretty extensively about the California count being up similar -- in a similar fashion for next year and having quarter-over-quarter improvement.

We do see improvements throughout the business. Seattle will probably be, to be honest, a fairly small piece of it. I mean, it's a start-up operation, and we're building community count. We're building a team there.

We have a land pipeline going right now but we don't expect that to be significant on the company as a whole. But we are looking to push community count in all the regions across the business next year.

Operator

Our next question comes from the line of Nishu Sood with Deutsche Bank. Please proceed with your question.

Nishu Sood -- Deutsche Bank -- Analyst

OK. I may have missed it. But did you update the guidance for ROE? And also, any sense of the scope for improvement -- continued improvement in '19?

Jeff Kaminski -- Chief Financial Officer

Right. We didn't have it in the scripted remarks, but I can tell you, I think we said last quarter, 14%. We're probably in that same range, 14% to 15% for the full year, and that's obviously backing up all the first-quarter tax charge that we took due to the tax law change. So it still looks pretty strong, and it's still actually toward the top end of the range that we had set for ourselves for 2019.

And I think I'll save any other comments on '19 until the November call.

Nishu Sood -- Deutsche Bank -- Analyst

Got it, OK. And in the opening commentary, Jeff M., you mentioned a lot of mix issues. For gross margins, you specifically called out regional mix benefiting margins this quarter. Now I just wanted to clarify, were you trying to draw out a trend, which has been ongoing, and therefore, we should expect to continue? Or did you highlight that as something that was particular to this quarter that might reverse in the next quarter or two?

Jeff Mezger -- Chairman, President, and Chief Executive Officer

Particular to this quarter, Nishu, we had the perfect storm where all the high-margin deliveries hit and some of the lesser margins didn't. But then they'll hit in the fourth quarter and could tweak us down to the couple of cents that Jeff guided.

Jeff Kaminski -- Chief Financial Officer

Right. Which is another factor in the question from earlier when we were talking about fourth quarter versus third quarter. That's part of it as well, the [Inaudible] shift a little bit.

Jeff Mezger -- Chairman, President, and Chief Executive Officer

For the year, it holds firm at the 18%.

Jeff Kaminski -- Chief Financial Officer

Actually, higher, at the high end of the range.

Operator

Our next question comes from the line of Stephen Kim with Evercore ISI. Please proceed with your question.

Trey Morrish -- Evercore ISI -- Analyst

Hey, guys. This is actually Trey on for Steve. I wanted to ask about the fourth-quarter SG&A guide. It's just that you'd be higher in terms of SG&A as a percentage of revenues relative to last year.

I'm wondering, why are you expecting it to be higher given that most of this year has trended down year over year?

Jeff Kaminski -- Chief Financial Officer

Well, I think, for the full year this year, we'll be actually fairly close to last year's full-year number. We are back in growth mode for the business, and we've seen declining community count now for actually a couple years. So we're very pleased with the reversal of that trend, and coming with that, we are adding in and have added in a bit of incremental expense to support the new openings and support a higher level of business as we move forward. So it's really as simple as that.

I mean, we had a blow away quarter in the fourth quarter last year. I think it was a company record fourth-quarter low for SG&A. While we like to set every quarter a company-low SG&A record, it's tough to guide to that and particularly, knowing what we have ahead of us and growth of the business. So it's really as simple as that.

I think the operating margin improvement speaks for itself, and that's what we'll continue to drive. And we'll try to get a piece of it out of both sides of that equation on the gross margin as well as the SG&A side. Well, we can get it, but in the fourth quarter, we're positioning for next year and for further growth as we get into 2019.

Trey Morrish -- Evercore ISI -- Analyst

Got it. Thanks for that. And then touching on your additional expansion in Jacksonville and your entrance into Seattle. Could you talk about what drove you to take such a notable incremental investment to increase your exposures to those areas?

Jeff Mezger -- Chairman, President, and Chief Executive Officer

The Seattle investment is minimal right now. We've closed on one parcel, and the Seattle's market pretty fragmented. You're not out there buying 200, 300 lots. They're smaller plays and you do a lot of them.

But the dollars involved aren't that great. If you look at Jacksonville, it's a great story in that. Their product was aligned with ours. We like our floor plans better, but the footages and the price points were similar and that the geographic complement of where they were open versus where we were open was also very good.

So we picked up a lot of communities that are a natural complement to us, and we move very quickly to plug and play in a business where it's our best operating team in Florida, very seasoned. And we have a great business in Jacks, so let's go build the scale. As I shared in the prepared remarks, right now we're fourth in Jacksonville. I don't want to be fourth.

We'd rather be first, second, third, and this will help us to get there. So it's really a pretty quick hit deal at a very reasonable price.

Operator

Our final question comes from the line of Jay McCanless with Wedbush. Please proceed with your question.

Jay McCanless -- Wedbush Securities -- Analyst

Hey, thanks for fitting me in. First question I have with the hurricanes back east. Does your guidance assume some impacts from Florence? And if not, what might we expect?

Jeff Mezger -- Chairman, President, and Chief Executive Officer

Jay, good question. And these natural catastrophes are always a bad thing. In our case, we're pretty fortunate in that it rained in Raleigh and closed our communities for a couple days, a little bit of flooding but really not bad all things considered. There's always an unknown when these things disrupt a region relative to building products, utility companies and whatnot, and we don't see a significant impact to the company in that our Raleigh business is quite small.

In terms of the Southeast, it's our smallest business. It may get disrupted a little bit but not enough to really move the needle on our guidance and where we think we're heading.

Jay McCanless -- Wedbush Securities -- Analyst

OK. That's good to hear. Thanks for the detail. Then just the other question I had in terms of -- could you maybe talk about with the California coastal markets where you're going down to the lower price points, is there any kind of maybe a price point where you need to get under with these changes to the sales tax deductions that seems to be more palatable to buyers? Is that kind of the strategy? Or are you just trying to find land that pencils -- that get your overall ASP down?

Jeff Mezger -- Chairman, President, and Chief Executive Officer

You just hit on what you last commented. At these price points, the lack of a write-off, a tax write-off on the real estate tax isn't a real driver. You have to get back up to higher price points for that to impact their taxes. This is all about getting product that's more affordable introduced into the market where the meat of the market is.

And we're not afraid to go in open communities at higher price points, but we think, today, it's a better play right now. And we're definitely going for higher density detached or townhomes or small condos, keep pricing them.

Operator

[Operator signoff]

Duration: 62 minutes

Call Participants:

Jill Peters -- Senior Vice President, Investor Relations

Jeff Mezger -- Chairman, President, and Chief Executive Officer

Jeff Kaminski -- Chief Financial Officer

Alan Ratner -- Zelman & Associates -- Analyst

Stephen East -- Wells Fargo Securities -- Analyst

Mike Dahl -- RBC Capital Markets -- Analyst

John Lovallo -- Bank of America Merrill Lynch -- Analyst

Soham Bhonsle -- Susquehanna International Group -- Analyst

Marshall Mentz -- Barclays -- Analyst

Nishu Sood -- Deutsche Bank -- Analyst

Trey Morrish -- Evercore ISI -- Analyst

Jay McCanless -- Wedbush Securities -- Analyst

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